Minutes of the Bank Board meeting on 27 September 2023

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

The meeting opened with a presentation of the sixth situation report based on an assessment of the information obtained since the summer forecast was drawn up. Consistent with the forecast was a gradual decline in interest rates from the third quarter of this year onwards.

In light of the new information, the Board said that the summer forecast was materialising comparatively well. Nonetheless, it assessed the uncertainties and risks of the forecast as being significant and going in both directions. Aleš Michl emphasised that unanchored inflation expectations continued to pose a risk to wage growth and inflation going forward. Expectations were meanwhile proving to be adaptive and were responding to the latest inflation readings. Annual inflation was highly likely to go up again appreciably in October for technical reasons. Karina Kubelková said the decline of inflation to the CNB’s target could be slowed if inflation expectations were not anchored at 2%. According to Jan Procházka and Tomáš Holub, insufficiently anchored inflation expectations could materialise in repricing in January.

Expansionary fiscal policy was identified as an upside risk to inflation. According to Aleš Michl, alongside tight monetary policy, a substantial reduction in government borrowing was necessary to bring down inflation. With the exception of loans to central government (which were up by 18.7% year on year in July 2023), growth in the quantity of money in the economy had slowed sharply over the past 12 months. The inflationary fiscal policy was also highlighted by other board members (Jan Kubíček, Karina Kubelková and Eva Zamrazilová). According to Jan Kubíček, it was partly for this reason that monetary aggregates in the Czech Republic were currently growing at the fastest rate in Europe. Eva Zamrazilová added that although the M3-to-GDP ratio was currently below its long-run trend, the latter had been affected by the extraordinary period of the Covid pandemic, so the evolution of money called for caution.

A large part of the debate was devoted to the labour market. The wage growth observed in the second quarter had been almost one percentage point lower than in the summer forecast, yet the labour market remained tight and unemployment low. According to Jan Kubíček and Karina Kubelková, the increase in wages – as indicated by the available analyses – was far more broad-based and robust (given firms’ current profitability) than in the past. This would contribute to keeping core inflation elevated. The situation was also showing signs of persistence. It would therefore be desirable for the forthcoming wage bargaining process to result in moderate wage growth. In addition, Jan Kubíček assessed the labour market situation more as a general uncertainty.

The Board also discussed some other risks. Elevated prices of crude oil and fuels were an upside risk to inflation, with potential second-round impacts on transport prices, among other things. Another upside risk was the weaker-than-expected exchange rate of the koruna, which was due mainly to the response to the unexpectedly sharp interest rate cut in Poland. Regarding this, Tomáš Holub said that the financial market could react quite strongly to the start of the monetary policy easing phase in the Czech Republic, especially if its timing and extent were not communicated well in advance. The risk of lower economic growth in Germany and generally subdued external demand had increased. Jan Procházka identified this as the sole anti-inflationary factor. Jan Frait also mentioned the effect of weaker external demand associated with tighter monetary policies. Eva Zamrazilová referred to monetary policy as being far less effective than would be desirable in this inflation episode. This ensued from a comparison of domestic inflation with Slovakia, where inflation had been following a very similar path as in the Czech Republic but at totally different interest rate levels. In a discussion of the risks to the forecast of domestic inflation pressures, Jan Frait said it seemed unlikely in the present situation that households would suddenly reduce their saving rate sharply and start to spend substantially more without renewed optimistic expectations.

A large part of the debate was devoted to the start of the process of lowering monetary policy rates and the pace of return towards their neutral level. It was said repeatedly that the robustness of the disinflationary trend would be critical for monetary policy setting. The board members therefore expected the interest rate path to be generally higher in the coming quarters than in the baseline scenario of the current forecast. According to Aleš Michl, monetary policy had to be kept tight for longer given the outlook for core inflation, which would be above the target for all of next year. Jan Procházka would not be troubled by a brief undershooting of the 2% target, because the decline in inflation would be due mainly to energy prices. Karina Kubelková would consider it very premature to lower rates at the September meeting, not least because she herself viewed the balance of risks to the current forecast as inflationary. Jan Procházka again noted that inflation would go up temporarily in the final three months of this year (albeit due to a technical factor linked to the energy savings tariff in late 2022). The need not to disrupt the downward trend in inflation expectations (which are highly adaptive) might thus imply that the first cautious rate cut could be made at the end of this year. Jan Kubíček also felt that the reduction should not be very forceful to begin with. Jan Frait did not rule out a fundamental discussion about the first rate cut already at the November meeting. However, he also emphasised the need to proceed cautiously in easing monetary policy, especially with regard to the supply side of the economy, which could be hit by a set of shocks that would temporarily increase inflation and foster growth in inflation expectations. In the view of Tomáš Holub, too, it made sense to head towards lower interest rates over the rest of this year, not least because waiting until the February meeting would, under the baseline scenario of the current forecast, subsequently require more forceful downward steps in rates, which in turn could cause the exchange rate to react unfavourably. As regards considerations of lowering interest rates, Eva Zamrazilová remarked that the weakening of the exchange rate over the past month had delivered a monetary policy easing of roughly 25 to 50 basis points. The exchange rate represented a large uncertainty going forward as well, so in her view it was delaying the decision to reduce interest rates.

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: Aleš Michl, Eva Zamrazilová, Jan Frait, Tomáš Holub, Karina Kubelková, Jan Kubíček and Jan Procházka.

Author of the minutes: Jan Syrovátka, Monetary Department