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Minutes of the Board Meeting on 29 November 2001

11.12.2001 10:05

The November situational report did not bring about any significant reassessment of the view on the Czech economy. However, it was expressed that risks had been increasing in one direction – i.e. towards a decline in inflation and in economic growth.

According to most indicators, inflation during October was more restrained than the CNB forecasts had predicted, and similar developments had been persisting now for a few months. The slowdown in inflation was caused by favourable oil prices, among other things. In this respect, it was stated that the assumption on oil prices of around USD 25/barrel – on which the previous inflation forecasts were based – now seemed to be unrealistically high. In comparison to the forecast from the October situational report, this would probably generate a decline in inflation within one to twelve months. Inflation would also be curbed by the strengthening of the Czech koruna vis-a-vis the euro, pulling import prices down and tightening monetary conditions in the economy. Agricultural producer prices developed in line with the assumptions and at this time would not present any substantial inflationary risk for food prices.

From the standpoint of the economic growth forecast, it was said that the actual indicators of development abroad increased the probability of arriving at the alternative, more pessimistic growth scenario presented in the October situational report. Czech economic growth could still be affected if foreign developments succeeded in undermining investor confidence and, in turn, halted the growth of gross fixed capital formation. In this particular case, Czech GDP growth in 2002 could fall well below the estimated level. The existing data, however, did not indicate that such a restraint in investment would actually occur. Growth in consumer demand also seemed to be robust. Overall, though, factors leading to a growth decline prevailed and had already shown up in the data on industrial production, real import and export and an interruption in the trend improvement seen on the labour market. Consequently, substantial demand pressures on inflation would not be expected in the upcoming period.

A slightly more favourable outlook for wage costs would also encourage a decline in inflation. This, among other things, was based on the revised version of the state budget proposal and on the actual demands of trade unions, which were slightly lower in comparison to previous assumptions. Nevertheless, these demands were still close to exceeding the sustainable level.

The Board followed up the presentation of the situational report with a discussion on the risks involved with the current forecasts. The discussion focused on the extent of the expected slowdown in economic growth. The actual data did not confirm a substantial weakening. Money supply growth continued to reach a figure of about 12% year-on-year. A continuation of fiscal expansion could be expected. Nominal and real wage growth was relatively high, supporting a stable rise in household consumption. Therefore, domestic demand continued to grow at a reasonable rate. However, one view expressed that the existing forecasts were too optimistic, possibly even for the alternative scenario of GDP development. The board members discussed the impact that a slowdown in growth could have on inflation developments.

A considerable amount of attention was paid to the exchange rate and the CNB’s intervention strategy. It was said that the present strengthening of the exchange rate had come at an inopportune time, because it combined with the effects of slowing external demand. With the participation of the Minister of Finance in the meeting, the Board presented the CNB’s intention to initiate negotiations with the Government and to collectively find ways of strengthening cooperation within the existing mechanisms for dealing with the effects of the privatisation incomes on the exchange rate. Consensus was reached on both sides that a more effective approach involving the Government and the central bank would be desirable.

One of the items on the agenda also addressed the issue of how to account in monetary policy for inflation’s weakening external cost factors, especially the decline in oil prices. On the one hand, it involved clearly exogenous factors. Accordingly, monetary policy should not strongly respond to the immediate effects associated with these factors, and escape clauses could be applied. However, positive cost shocks could also produce second-round effects, for example, in the form of the already observed decline in inflation expectations. In addition to favourable external cost factors, it was reasserted that there also existed some signals of weakening wage-cost risks for inflation. However, another view expressed that, in the context of a potential decline in inflation, expected nominal wage growth could be seen as unacceptably high in real terms.

During the discussion, the board members differed in the degree of importance they put on the specific factors (the exchange rate, economic growth outlook, and decline in the cost pressures of inflation). Nevertheless, it was agreed that all the arguments led in the same direction. Within the range of the most effective transmission, predicted inflation fluctuated inside the inflation target band, but the risks of inflation and growth significantly deviated in a downward direction. Therefore, it would not be inconsistent in an inflation-targeting regime to lower interest rates and to lessen any deviations of the economy from its balanced development. Lowering interest rates should also send signals for the exchange rate to weaken, even if the reason for its strengthening was not the interest rate differential, but privatisation incomes.

At the close of the meeting the Board decided unanimously – with all seven members present – to lower the CNB two-week repo rate by 0.50 percentage points to 4.75%, effective 30 November 2001. The discount and Lombard rates were lowered by the same amount to 3.75% and 5.75%, respectively.

Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Jan Frait (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek, (Chief Executive Director), Jiří Rusnok (Minister of Finance)

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