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Minutes of the Bank Board Meeting on 28 June 2001

12.7.2001 10:01

Present at the meeting: Zdeněk Tůma (Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Jan Frait (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

The meeting opened with a presentation of the June situational report on monetary and economic development. It was expressed that domestic economic activity had recently picked up momentum. A number of indicators from various economic sectors confirmed this development: a decline in unemployment, increased M2 growth, or a rise in the use of production capacity according to a survey of the industries. New GDP figures for 2001 Q1 showed that total demand had increased faster than was expected by the macroeconomic framework used for the quarterly inflation forecast in April 2001. In addition, import prices had slowed down domestic inflation to a lesser extent than the April forecast originally anticipated. Current price fluctuations were also affected by food prices. In general, food prices are very volatile, and their seasonality is difficult to predict. A change in the prices of natural gas was another factor affecting price movement. However, these effects should only be temporary in nature and would be reflected accordingly in the inflation forecast.

A number of factors could contribute to a slowdown in inflation. The anticipated growth decline in Europe would alleviate demand pressure on prices. Monetary conditions would tighten with the strengthening exchange rate and a shift in the longer end of the yield curve. It was mentioned during the presentation that revising GDP data would change the forecast base. However, owing to time considerations, this effect had not yet been fully assessed. The general conclusion suggested an increase in inflationary risks in comparison to May, while the present inflation forecast, prior to the July reassessment, was in line with the inflation target.

The Board followed the presentation on the situational report with a discussion of the new economic data. A considerable amount of newly available information confirmed that economic recovery had been faster than expected. Data concerning the labour market was mentioned several times. According to these figures, the economy could now move towards an environment of rising inflationary pressures. It was also expressed that current inflation factors were at this time more cost-related according to the figures. However, demand pressures could be underestimated due to difficulties interpreting information on consumption and income in the household sector.

Next, the Board turned to an assessment of the risks relating to the current economic outlook. The non-accelerating inflation growth that does not create other imbalances was discussed. It was said that the current non-accelerating inflation growth was higher than estimates from past years due to structural changes, but had probably not increased significantly. This suggested that the rate of economic growth might reach a level generating demand inflation. A theory presented during the meeting suggested that one possible inflationary risk concerned a rise in households’ propensity to consume. Such a development could be caused by an increase in consumer optimism supported by rising incomes. A view was put forth that the change in the level of inflation from 3%–4% to 5% could negatively affect the inflation expectations of economic agents. In this respect, it was also mentioned that current price developments were formed by temporary factors whose impact had been gradually dying out.

The Board now focused on a more general discussion of optimal interest rate settings. It was expressed that the phase of the economic cycle and fiscal policy settings should also be considered during decision-making on interest rates. If the economy experienced a recovery phase coupled with loosened fiscal policy, then a different level of rates would be required than, for example, during an economic decline or slow-growth phase. It was mentioned that temporary shocks during a recovery phase would be reflected more easily in inflation than during an economic decline and could, in this case, even be more permanent in character. The second general discussion concerned the nature and length of monetary transmission. In an open economy, the transmission of demand pressures could be very specific in character. The impact could initially carry over, for example, to the external deficit and then, in turn, affect price developments.

Board members also concentrated on factors that could lead to a slowdown in price growth. These factors included the expected economic growth decline in Europe, the strengthening effective exchange rate of the Czech koruna and a rise in the yield curve’s slope.

The Board acknowledged that, in comparison to the May discussion on risks, the nature of these risks could be more precisely described in June. One view was expressed that, in the light of the new information, the current forecast no longer needed to fully reflect economic developments. Board members agreed that the July economic forecast could imply a substantial reassessment of the economic outlook.

At the close of the meeting, the Board decided by a majority vote to leave the CNB two-week repo rate at its current level. Four board members voted for keeping the rates at the same level, and one member voted in favour of increasing the rates.

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