Statement of the Bank Board for the press conference following the monetary policy meeting
At its meeting today, the Bank Board of the Czech National Bank lowered the two-week repo rate by 75 basis points to 0.25%. At the same time, it lowered the Lombard rate to 1.00%. The discount rate remains unchanged at 0.05%. Five members voted in favour of this decision, and two members voted for lowering the repo rate by 50 basis points.
The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast. After the sharp fall in domestic market interest rates recorded in March, consistent with the forecast is a further decline in 2020 Q2. It must be stressed that the situation during the preparation of the forecast was exceptional owing to the ongoing coronavirus pandemic. The uncertainty regarding the external and domestic assumptions of the forecast and the way they are captured by the model system is thus extremely high.
The impacts of the coronavirus pandemic and the related measures will lead to a significant decline in global economic output this year. According to the forecast, euro area economic activity will drop markedly in the first half of this year. The situation will stabilise gradually in the second half of the year and the Czech Republic’s main trading partner countries will return to economic growth next year. Producer prices are expected to fall substantially this year, owing to the aforementioned drop in economic activity and the collapse of oil prices. Consumer price inflation in the euro area will slow considerably this year. The European Central Bank has launched massive securities purchases. The outlook for short-term euro area interest rates remains negative over the entire forecast horizon.
The price of oil dropped by almost two-thirds during the first quarter of this year. According to the forecast, it will stabilise close to USD 40 a barrel. The euro will appreciate slightly against the dollar.
The quarantine measures adopted by the government and firms caused the shutdown of a large part of the domestic economy in March. The restrictions are gradually being lifted and most sectors are gradually starting up again during Q2. However, the negative impacts of the subdued external demand and the very unfavourable perception of the economic situation among Czech households and firms will persist. GDP will therefore fall significantly this year and, despite a gradual return to growth, economic activity will not return to the pre-pandemic level before the end of next year. This will be due chiefly to fixed investment. Its return to growth will be dampened by the deep decline in external demand associated with the significant deterioration in global economic sentiment. Exports can also be expected to drop sharply. Following an initial decline, household consumption will fare somewhat better, supported by decreasing but still positive wage growth and massive stabilising fiscal policy measures. In addition to programmes to support the liquidity of households and firms hit by the pandemic, government expenditure will rise owing to a previously approved increase in pensions and non-market sector wages and continued investment activity in the public sector. The labour market will cool quickly in the first half of the year owing to the contraction of the economy and will continue to do so next year despite an economic recovery. Employment will decline appreciably until almost the end of next year. The unemployment rate will increase rapidly, peaking at the start of next year.
Inflation will rapidly return into the tolerance band around the target in the coming months, mainly due to the generally anti-inflationary impacts of the coronavirus crisis amid a deep decline of the domestic economy. Appreciably weaker domestic price pressures will outweigh the temporary inflationary effect of a weaker koruna. Inflation will therefore decline towards the 2% target at the end of this year. The decline in inflation will also be fostered by a drop in fuel prices stemming from the collapse of world oil prices and slower growth in administered prices. By contrast, food price inflation will remain high this year. The decline in inflation will also be slowed this year and the next by the price impacts of changes to indirect taxes. As a result, inflation will be close to the CNB’s 2% target next year.
Monetary policy-relevant inflation will be slightly lower than headline inflation, as the first-round effects of changes to indirect taxes will be slightly positive.
The koruna weakened sharply at the end of Q1 following the outbreak of the pandemic. The exchange rate will remain close to its current level over the entire forecast horizon due to the worse foreign and domestic economic outlook and narrower interest rate differential.
After the sharp fall in domestic market interest rates recorded in March, consistent with the forecast is a further decline in 2020 Q2 followed by broad stability. This decline in rates reflects the effects of government quarantine measures on the domestic economy as well as the significantly worse external outlook. As already stated, these facts will have significant anti-inflationary consequences. By contrast, the decline in rates will be slowed by the recent sharp weakening of the koruna, which is contributing to an easing of the overall monetary conditions.
The outlook for domestic economic activity this year has deteriorated substantially by comparison with the previous forecast. The inflation forecast at the monetary policy horizon is unchanged. The new forecast implies significantly lower interest rates this year and the next and a weaker koruna-euro exchange rate than the previous outlook.
The Bank Board assessed the risks to the forecast in the current extraordinary situation as being unprecedentedly high and requiring an even greater easing of the monetary conditions compared with the baseline scenario of the forecast. In the current situation, the risks are naturally connected with the course of the pandemic and especially with the duration and size of the impacts of the quarantine measures on the global and Czech economy.
At the moment, the CNB does not see a need to intervene immediately in financial markets by providing liquidity to financial institutions. Nonetheless, following an amendment of the Act on the CNB, it is for preventive reasons preparing a liquidity-providing instrument for some non-bank entities licensed by the CNB. These institutions will newly be able to obtain liquid funds in the form of short-term loans from the CNB. Such loans will be secured on the part of these financial institutions by the same securities that are used as standard collateral by credit institutions in liquidity-providing CNB repo operations, i.e. above all Czech government bonds.
In addition, for credit institutions (banks, foreign bank branches and credit unions), the CNB is working on broadening the range of eligible collateral used in existing liquidity-providing operations to include mortgage bonds. Liquidity-providing operations with three-month maturity will also be introduced for credit institutions.
The specific parameters of these operations will be published on the CNB website in the coming days. The Bank Board expects these operations to be announced regularly from 18 May 2020. At the same time, the Bank Board expects the relevant institutions to conclude the necessary contractual documents with the CNB or adjust their balance sheets so they are able to fully cover their liquidity needs themselves.
The CNB views these new instruments as additions to the range of monetary policy and macroprudential measures contributing to an environment on the Czech financial market that will enable Czech financial institutions and, in turn, the entire Czech economy to better deal with the current economic situation.
In its conduct of supervision, the CNB is continuing to take a flexible approach to how the individual supervised entities are to comply with certain regulatory duties. This is in line with the approach of the European supervisory authorities. The aim is to reduce the regulatory burden and thus create room for the individual supervised entities to react more flexibly to changes in the overall economic situation.
These steps enable, in particular, credit institutions to use their good capital position to support and finance the real economy while maintaining a prudent approach to risk management. This balanced approach of credit institutions to funding their clients may help reduce the contraction of the real economy and, as a result, lower the credit losses credit institutions may face in this crisis.