Present at the meeting: 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)
During the presentation of the August situational report, it was stressed that the new information on the internal and external economic environment had in some respects sent contradictory signals. In July, there was another rise in CPI inflation, and the inflationary effect of public finance performance continued. Nevertheless, there were indications that declining demand abroad could have a dampening effect on domestic economic growth.
Money supply growth reflected the relatively lax monetary conditions. M2 had accelerated this year in comparison to last year. During recent months, the money supply had risen year-on-year by approximately 13%. In particular, corporate deposits experienced a considerable rise. Household deposits had so far shown relatively lower dynamics. Real interest rates on deposits were negative in comparison with current inflation and also in relation to expected inflation. State budget developments pointed to risks both on the income side and expense side. Though some seasonal improvements had been observed, the state budget registered the highest deficit of the past three years – despite substantially higher economic growth this year in relation to past years. Wages in the monitored organisations for 2001 Q2 corresponded to the forecast. Average nominal wage growth reached 9.3% year-on-year, 4.1% in real terms. The Czech koruna stopped strengthening in July vis-ŕ-vis the euro, and in August, the koruna weakened. The koruna strengthened against the USD. Selected macroeconomic indicators, including the recently published CSO confidence indicators, indicated that economic activity had slowed. Indicators dependent on the external environment, contrary to those linked to domestic demand, registered a certain slowdown in dynamics. One of the factors associated with the worsening trade balance in July was the economic growth slump in Germany. Seasonally adjusted data indicated that the dynamics of the unemployment rate decline had slowed. Year-on-year growth of unit-labour costs had picked up. The inflationary effects of wages would be eased by the anti-inflationary impact of slower import price growth. Import prices showed favourable developments owing to a faster decline in the prices of selected commodities on world markets and higher appreciation of the koruna vis-ŕ-vis the USD.
CPI inflation in July was higher than the CNB had expected. Although year-on-year inflation in the food industry corresponded to the forecast, there had been a visible deviation in adjusted inflation. Among others things, there was a steep rise in the prices of recreation. After assessing the newly available figures, there was a technical increase in the CPI inflation estimate for a horizon of approximately one year.
Following the presentation, the Board turned to an assessment of the situational report. During the first part of the meeting, the discussion focused on the nature of current inflation developments. Two main interpretations of higher consumer price growth were discussed.
According to the first interpretation, inflation developments in recent months could not be understood as short-term deviations alone. Inflation is a monetary phenomenon, and projection of inflationary pressures always depends on the demand situation and inflation expectations. The sharp price increase in the narrow segments of the consumer basket in recent months – not compensated by a decline in the prices of other items – was caused by overly relaxed monetary conditions.
Contrary to this view, the second interpretation placed more emphasis on the highly differentiated dynamics of prices in the consumer basket segments. The recent inflation episode was, therefore, the result of an excessive increase in food prices, which are volatile in general, and an exceptional rise in the prices of foreign travel. This was only a temporary, primarily cost-related shock that was starting to die out. In actual figures, demand-pull inflation could not be monitored too closely in the sense of overall accelerating price growth. This conclusion was supported by the prices of other items in the consumer basket (especially tradable commodities) which registered moderate dynamics consistent with the inflation target.
Next, the Board concentrated on assessing the risks of the existing macroeconomic and price outlook. In this respect, the board members also focused on information from the Minister of Finance about the expected developments of general government finances this year and the prospects for adopting a budget for next year. The Board stressed that an important indicator of future inflation development was wage-cost inflation. It was expressed that inflation expectations were increasing and that the overall macroeconomic environment would allow wage inflation demands to assert themselves more easily. The prediction of wage developments signalled a gradual rise in wage-cost inflation. Increased wage dynamics this year should lead to a significant increase in the growth of unit-labour costs. This would also mean a rise in disposable household income in comparison to last year, the impact of which would combine with the current decline in the savings level.
The sharp increase in the money supply was indicated as another inflationary risk. Despite the fact that higher money supply dynamics in July were partially affected by technical factors, the money supply for the past seven months had increased by CZK 120 billion compared with a CZK 25 billion increase in the same period last year.
Significant anti-inflationary factors were also identified. Fading cost shocks for the Czech Republic’s main trading partners or a reversal in food price growth could be expected. An important phenomenon was the strengthening pessimism concerning world economic growth, especially the German economy, which could have a negative impact on economic development in the Czech Republic.
Additional uncertainty in the inflation forecast was related to expected food price growth. The reversal in food price growth in the inflation forecast was based on the exceptionally fruitful harvest anticipated for certain agricultural commodities and the assumption of weakening export arbitration. It was expressed during the meeting that if the Government decided to subsidise the prices of agricultural products with intervention purchases, then there would be no reason at all for a decline in prices. In this respect, it was also noted that food price growth was, at least to some extent, a demand-related phenomenon, and a certain part of price fluctuations in the future could even be related to the convergence of domestic food prices with European price levels. However, one opposing view suggested that food prices were not yet significantly affected by convergence with European prices. This should occur to a greater extent when trade barriers were eliminated and when EU institutional regulations had been adopted.
Following the discussion of the August situational report, the Board decided to leave the CNB two-week repo rate at its current level. Three board members voted for keeping the rates at the same level, and three members voted in favour of increasing the interest rates by 0.25 percentage points. In the absence of the Governor, the presiding Vice-Governor casts the decisive vote for a tie-vote situation, in compliance with the Bank Board’s Rules of Procedure.