Minutes of the Bank Board meeting on 3 August 2023

Present at the meeting: Aleš Michl, Jan Frait, Eva Zamrazilová, Tomáš Holub, Karina Kubelková, Jan Kubíček, Jan Procházka.

The meeting opened with a presentation of the fifth situation report and the new macroeconomic forecast. According to this forecast, inflation would fall further in 2023 Q3 and return close to the 2% target at the start of 2024, where it would stay over the monetary policy horizon. Consistent with the baseline scenario of the forecast was a decline in market interest rates over the entire outlook.

The Bank Board assessed the risks of the forecast and the uncertainties of the outlook as being significant and tilted to the upside. The threat of inflation expectations becoming unanchored and the related risk of a wage-price spiral, which would lead to renewed demand-pull pressures and persistent inflation, were the main upside risks to inflation. A longer effect of expansionary fiscal policy was also an inflationary risk. The general uncertainties of the outlook included the future course of the war in Ukraine, the availability and prices of energy, and the future monetary policy stance abroad.

At the start of the meeting, Aleš Michl recalled the situation in July 2022, when the new CNB Board had taken over responsibility for the monetary policy and financial stability of the Czech Republic with inflation at its highest level in history, except for the period of transformation of the Czech economy in the early 1990s. The Board’s chosen strategy in the form of holding interest rates at 7% combined with a strong koruna exchange rate policy, i.e. the creation of the tightest monetary conditions in 25 years, was succeeding in reducing inflation. As well as headline inflation, he mentioned core HICP inflation, which in the Czech Republic was falling at the fastest rate in the EU. On the other hand, according to Aleš Michl, the current inflation level and its outlook still did not allow interest rates to be cut, as it was necessary to ensure that inflation did not remain persistent and continued to fall. He also noted that in October, moreover, annual inflation would probably increase temporarily due to last year’s low comparison base arising from the fall in electricity prices induced by the introduction of the government energy-savings tariff.

According to Eva Zamrazilová, the key thing was whether the observed decline in inflation was being caused mostly by fading external cost pressures or by cooling domestic demand. If the disinflation had been caused more by the fade-out of negative supply-side effects – as suggested by falling indicators of stress in value chains – than by a cooling of the domestic economy, it would represent a problem for the long-term return to the inflation target. Tomáš Holub identified the inflation stemming from high profit margins as an important price factor. The growing anecdotal evidence of high growth in profits in large corporations, i.e. especially in oligopolistic structures, might indicate a slower decline in margins in the future. Karina Kubelková added that the peak in corporate profitability might still lie ahead and the highly positive gap in mark-ups might take several years to close. She also mentioned the risk of firms translating higher wage growth into higher prices rather than covering the higher costs from their high margins. The Board also identified the outlook for the annual core inflation rate, which, according to the forecast, would fluctuate around 3.5% next year, as one of the main arguments for keeping monetary policy tight for longer. In this connection, Tomáš Holub and Jan Kubíček said that although the CNB’s target was the headline inflation index, it was imprudent to rely on volatile items such as food and energy prices to push headline inflation down towards the target next year. Jan Procházka noted that the inflation load in the economy was still large. Besides the persistent inflationary pressures observed in services prices, the board members also repeatedly noted the risk of greater-than-expected repricing in January. The impacts of tax changes, which, in aggregate, were likely to be tilted to the upside, were also uncertain. Tomáš Holub, Karina Kubelková and Jan Procházka mentioned the exchange rate of the koruna – which had recently reacted very sensitively to just a hint of a future interest rate cut by weakening – as a minor upside risk to inflation.

The Board devoted a large part of its discussion to wage growth and the labour market, which it repeatedly referred to as still very overheated and generating a whole range of upside risks to inflation. Jan Kubíček noted the still rising employment, with the labour market absorbing new additional workers even though real economic activity was falling. This was leading to a decline in national economic productivity, which, together with rising wages, implied growth in unit labour costs and hence inflationary pressures. Tomáš Holub said that the re-emerging tightness in the labour market would contribute to the inertia of the brisk wage growth and therefore also to the persistence of core inflation. Jan Procházka noted that the imbalances observed on the domestic labour market, in a situation of a negative output gap, were showing structural rather than cyclical signs and would therefore keep the labour market tight for longer. He also said that real wages were falling more than in previous inflation episodes, creating conditions for more intensive catch-up in the coming years and additional inflationary pressures. According to Jan Frait, the overheated labour market had been contributing to the overshooting of the inflation target for years and would remain the primary source of inflationary potential unless there was a significant impulse leading to a change in this situation. Aleš Michl and Karina Kubelková also noted that there was also still a possibility of faster-than-forecasted wage growth, because wage bargaining and the signing of new collective agreements did not usually take place until the autumn.

A majority of the board members agreed that fiscal policy remained quite a substantial upside risk to inflation. Eva Zamrazilová noted the still very high public finance deficit. The government had resolved to consolidate, but even so, structural state budget deficits would persist in future years, implying a further inflow of new money into the economy and hence representing an upside inflationary factor. Karina Kubelková pointed out that there was still a danger that the Constitutional Court would abolish the reduction of the extraordinary increase in pensions in June. The extent of the impacts of the compensation paid as a result of the caps on energy prices was another unknown. She and Jan Kubíček felt there was a risk of more expansionary fiscal policy associated with the upcoming parliamentary elections.

In the Board’s discussion of the current and future monetary policy stance, there was a consensus that keeping interest rates at the current level for longer was the only way of delivering continued disinflation and a sustainable return of inflation to the 2% target. Given the inflationary overall balance of risks, the Board therefore unanimously disagreed with the baseline scenario of the forecast, which assumed that interest rates would start to come down in the third quarter of this year. The board members agreed that the risk of excessively tight monetary policy was clearly lower than the risk of insufficiently tight monetary policy in the sense of easing prematurely. Aleš Michl and Jan Frait pointed out that longer rates had corrected downwards and that some easing had thus already occurred from this perspective. On the other hand, according to Tomáš Holub and Jan Procházka, the real interest rate conditions were autonomously tightening very quickly as inflation expectations decreased. Aleš Michl and Jan Procházka warned against a potential wave of optimism leading to an excessive easing of the monetary conditions, which the first interest rate cut might trigger. The next part of the debate was also devoted to two alternative scenarios quantifying two inflationary risks: a scenario of a slower decline in inflation expectations in the domestic economy and a scenario of a more vigorous recovery in consumer demand stemming from a rapid decline in the saving rate from its current high level. Both scenarios assume that interest rates are kept close to the current 7% level until the end of this year. In this regard, Eva Zamrazilová agreed with the alternative scenario, which implied that keeping interest rates restrictive for longer will ensure that inflation falls to the 2% target even in the event of elevated inflation expectations. The other board members agreed with this. Against this, the Board considered the scenario of a faster recovery in demand as less likely now, as high-income households were maintaining the highest – and a relatively stable – saving rate and there was no reason for this pattern of behaviour to change quickly in an environment of still high interest rates.

Part of the Board’s debate was focused on financial stability. The board members repeatedly mentioned that, given the nature and level of the debt in the Czech economy, the current level of interest rates –  and leaving them at this level for longer –  did not pose a risk to financial stability. Jan Procházka agreed that nothing dramatic was currently going on in the economy and said that although fewer new firms had been established in the first half of this year than last year, the number of bankruptcies had fallen year on year in all categories monitored. Tomáš Holub added that even a temporary undershooting of the inflation target, if driven by a decline in energy and food prices, would be favourable from the perspective of the budgets of households and firms. Eva Zamrazilová pointed to the need to keep monetary policy restrictive for longer in relation to the property market as well, as the amount of loans granted was starting to pick up slowly and the risk of a sharp recovery of the mortgage market and related growth in property prices thus persisted. Jan Frait also drew attention to this risk, especially if mortgage interest rates were to reach a relatively low level in a situation of brisk wage inflation or expectations of growth in disposable income. He also said that without tighter monetary conditions it was practically impossible to rectify the wrong expectations of private agents associated with the period of very low interest rates.

In a discussion of the risks stemming from the rest of the world, the Board agreed that the external environment was anti-inflationary overall. Karina Kubelková pointed to the continued worsening of the economic situation in Europe. In this regard, Jan Procházka said that the primary risk was a sustained downturn in the German economy, where problems of a structural, and not only cyclical, character were starting to emerge in the form of a re-orientation from industry towards a higher share of services. Jan Frait identified synchronised monetary policy tightening around the world as another potential source of anti-inflationary pressure. This could manifest itself in economies with a considerable delay and trigger a global shock under certain conditions. In his opinion, the weakening of economic activity in Europe could to some extent be structural in nature, but he regarded this more as a downside risk to inflation. 

The Board decided to leave interest rates unchanged. The two-week repo rate remains at 7%, the discount rate at 6% and the Lombard rate at 8%. All seven members voted in favour of this decision.

Since October 2022, the CNB has not intervened on the foreign exchange market to counter depreciation of the koruna. The Bank Board at this meeting formally ended the intervention regime announced in May 2022 and at the same time resumed the programme of sales of part of the income on international reserves. As part of the managed float regime, the CNB will always as a matter of principle prevent excessive fluctuations of the koruna exchange rate that would jeopardise price stability or financial stability, at any time the Bank Board deems it necessary.

Author of the minutes: Martin Motl, Monetary Department