Minutes of the Board Meeting on 25 October 2001
The October situational report focused primarily on the new quarterly macroeconomic forecast, which was formulated on the basis of updated domestic and foreign data. In comparison with the previous assumptions of the July quarterly forecast, there was a reduction in expected growth for foreign demand and import prices. A substantial decline in CPI inflation in September supported the assumption of the largely short-term character of inflation growth in past months. Currently, import prices displayed anti-inflationary tendencies, and their neutral or even anti-inflationary effect could also be expected next year. Indicators of the demand-side of the economy, such as wage development and private consumption, continued to signal a gradual rise in demand-inflation pressures in comparison to the previous period. In contrast, the future development of demand inflation would be affected by strong uncertainties (downward in nature) relating especially to investment dynamics. After taking into account the original assumptions and all newly available information, the inflation forecast for this year and next year had been lowered. Based on this information, the inflation forecast remained inside the targeted band in the range of the most effective transmission.
If a more substantial slowdown in foreign demand occurred, followed by a decline in the domestic GDP growth rate, then there was a risk that labour-cost inertia in the short run could cause pro-inflationary pressures due to a rise in unit-labour costs associated with the pro-cyclical character of labour productivity. In the longer run, though, a reduction in demand pressures should have an anti-inflationary effect.
In the new quarterly forecast, the year-on-year GDP growth estimate was also lowered. Figures were at 3.6% for this year and 3.9% for 2002. The alternative estimate was based on the assumption of low foreign demand in contrast to the baseline scenario and strongly suggested that GDP growth in 2002 could be heading in a downward direction. The rapid appreciation of the koruna’s real effective exchange rate was indicated as another factor that could potentially affect the dynamics of economic growth as well as the current account deficit.
The Board followed the presentation of the October situational report with a discussion on the most important areas of the current macroeconomic framework. Members agreed that a wide range of demand and cost indicators suggested some relief from inflationary pressures. After the uneven developments in June and July, there was a sharp decline in CPI inflation and inflation expectations, as well as lower year-on-year growth for industrial and agricultural producer prices and a drop in the dynamics of the money supply. The nominal and real exchange rate of the koruna had begun to appreciate, and foreign inflation and external demand were declining.
A key part of the discussion focused on assessing the impact of the low dynamics of economic activity for the Czech Republic’s main business partners on domestic GDP growth at the end of this year and in the first quarter of next year. Several important transmission channels were identified. Through these channels, the decline in external economic activity could negatively affect the domestic economy. The most significant included the potential decline in net export, the volume of investment and consumer confidence. A substantial risk linked to the quantification of these factors led to a discussion on the robustness of the forecast for external demand and domestic economic growth for next year. Though well aware of the significant risks involved with both forecasts, most board members were in agreement with the Monetary Department’s forecast. This forecast, after lowering the predicted growth rate for 2002, still anticipated a slight increase in growth dynamics. One view as well suggested that there would be a higher likelihood of reaching the alternative forecast of lower GDP growth.
The Board discussed public finance performance from the standpoint of assessing short-term demand impulses and in view of long-term sustainable macroeconomic development. It was expressed that despite eased fiscal policy, which curbed the effects of a slowdown in foreign demand on the Czech economy, the medium-term trend of a rising deficit in public finance performance was disturbing mainly because of fiscal policy’s continued inability to function as an effective macroeconomic instrument. Because of the Czech Republic’s openness, lax fiscal policy in the long run presented a risk to the current account and the exchange rate of the koruna.
In view of the sudden and strong appreciation of the koruna’s real and effective exchange rate during past weeks, the Board discussed the CNB’s optimal reaction to this short-term development. Consensus among members once again confirmed that it was appropriate to use foreign exchange intervention for limiting short-term increases in the volatility of the exchange rate. In this respect, the possibilities of continuing to use the privatisation account were investigated. While assessing the current cooperation between the Government and the central bank in this area, it was stated that this instrument had been activated with the privatisation of Komercní banka. Thanks to this cooperation, only a small amount of foreign currency from this transaction was converted on the market. However, one board member expressed that the direct transfer of these privatisation proceeds to the CNB’s international reserves would have been more effective. It was indicated during the Board’s discussion with the Minister of Finance that demands for converting the remaining foreign currency from this transaction could be expected at the earliest in several months.
After assessing the October situational report, the Board decided, by a vote of six members to one, to leave the CNB two-week repo rate at its current level. Six board members voted in favour of leaving rates unchanged. One member voted for lowering interest rates by 25 basis points. The Board decided unanimously to intervene on the foreign exchange market with the goal of weakening the exchange rate of the koruna.
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)