Minutes of the Bank Board meeting on 8 February 2024
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 first situation report and the new macroeconomic forecast. According to this forecast, inflation would decline sharply at the start of this year and be close to the 2% target over the monetary policy horizon. Consistent with the baseline scenario of the forecast was a rapid decline in market interest rates in the course of this year.
The Bank Board assessed the risks of the forecast and the uncertainties of the outlook as being broadly inflationary. A slower decline in the elevated inflation expectations was a risk in this direction. Given the tight labour market, this could be reflected in higher wage demands. Higher-than-expected inertia in services prices and a halt in tradables disinflation, which had so far been due mainly to fading supply-side problems, were additional upside risks. An inflationary risk in the longer term was an acceleration of money creation in the economy stemming from excessive lending activity in the property market. The latter could lead to renewed highly positive contributions of imputed rent to core inflation. By contrast, a stronger-than-expected downturn in global economic activity and in German economic output was a downside risk to inflation. The future monetary policy stance abroad remained an uncertainty of the outlook.
At the start of the meeting, Aleš Michl said monetary policy had significantly reined in the growth in the quantity of money in the economy in recent quarters by reducing growth in lending to the private sector. The change in monetary policy strategy since July 2022 had therefore contributed significantly to reducing inflation. It was now necessary to persist with tight monetary policy to ensure that inflation reached the long-term target of 2% in all its components, especially its core component, as volatile items such as food and energy prices could not be relied on in the disinflation process. It was also necessary to make sure that growth in the quantity of money in circulation did not increase. Aleš Michl proposed an interest rate cut of 50 basis points to demonstrate that the Board is forward-looking and believes that inflation will fall considerably this year compared to last year. However, he added that it was vital to exercise constant caution and remain hawkish.
A large part of the Board’s debate concerned the monetary policy stance and the interest rate reduction strategy. Aleš Michl pointed out that the neutral rate could be higher than before the pandemic, due in part to the general government deficits. Partly because of this uncertainty, he favoured easing monetary policy slowly and steadily. This would make it possible to assess the impacts of the previous rate cut and, if need be, to halt the easing process at a higher level than assumed in the forecast. Jan Frait, Eva Zamrazilová and Jan Procházka agreed, with Jan Frait noting that the long-term equilibrium interest rate could also be higher because of growth in the risk premium due to foreign investors having a less positive perception of the Czech economy. According to Aleš Michl, the speed of any further reduction in rates would also depend on an assessment of the movement of the koruna exchange rate. On this subject, Jan Kubíček and Jan Procházka noted that if the koruna were to weaken more significantly than in the forecast, it would be an argument for slowing or even halting the interest rate reduction process. As regards the optimal monetary policy response, a majority of the members favoured the scenario of a more even reduction in interest rates than in the baseline scenario of the forecast, which would deliver greater restriction. It was meanwhile said repeatedly that in view of the degree of uncertainty, the potential monetary policy error in the form of a greater undershooting of the inflation target was relatively small and would have minimal impacts on the real economy (Jan Kubíček and Jan Procházka). According to Jan Frait, it was not desirable to keep the yield curve steeply inverted, as this was making the cost of operating financing excessively high for firms focused solely on the domestic economy. Tomáš Holub noted that it was necessary to continue the process of lowering nominal interest rates so that real interest rates did not autonomously become increasingly tight as inflation fell. This would not be justified given the subdued growth in GDP and household consumption and restrictive fiscal policy this year. On this point, Jan Frait, Eva Zamrazilová and Jan Kubíček said that monetary conditions were already easing via a decline in market interest rates with longer maturities and via depreciation of the koruna. According to Tomáš Holub, Karina Kubelková and Jan Kubíček, a 50 bp rate cut was still quite a lot more cautious a step than the rate reduction consistent with the baseline scenario of the forecast, so it could be viewed as a cautious decision reflecting the said modest upside risks to inflation.
The Board discussed a potential slower decline in core inflation as an important upside risk to inflation. Concerns about inertia of inflationary pressures in prices of services were also repeatedly mentioned in this context. According to Tomáš Holub, some of the factors that had been aiding the disinflation process up to now might start to turn around. As examples he gave renewed growth in imputed rent and also tradables prices, which might recover on the back of a weakening koruna coupled with rising maritime transport prices and temporary shortages of components in some sectors. Karina Kubelková and Jan Procházka also drew attention to the risk of renewed supply chain disruptions, which could cause a halt and turnaround in the global disinflation trends that had recently been driving down foreign and domestic inflation. Jan Frait mentioned weak productivity growth as another inflationary supply factor.
The Board went on to discuss the risk of elevated inflation expectations. There was a consensus that this risk had diminished but had yet to disappear completely. The scenario of elevated inflation expectations was also discussed in this context. Eva Zamrazilová pointed out that inflation expectations had been following observed inflation in recent years and were therefore backward-looking. This was confirmed by the current inflation expectations of businesses, which she regarded as overestimated, as they were still at around 5%, while most outlooks were indicating that the high inflation had been defeated. Moreover, they contradicted the CZSO’s business survey, according to which firms were in most cases expecting selling prices to be stable over the coming months. According to Eva Zamrazilová, firms’ elevated inflation expectations thus suggested possible efforts to price in higher inflation due to a potential increase in profit margins. On this point, Jan Procházka noted that earnings in some sectors of the economy were below the pre-pandemic level according to the available data. This was also limiting the Czech economy’s ability to increase wages, among other things. Tomáš Holub also described wage growth as surprisingly subdued over the last six months. In his view, there was an evident preference on the labour market for staying in employment even at the cost of accepting a sizeable fall in real income. According to Jan Frait, the observed relatively low wage growth was no great surprise, as companies had hit certain barriers that prevented them from raising their selling prices any further, and they would ultimately have to start cutting growth in costs and increasing wages more slowly. According to Jan Kubíček and Jan Procházka, the risk of a wage-price spiral had not materialised.
The board members also discussed the uncertainty surrounding the amount of repricing in January. The January inflation figure was to be published in a week’s time. Eva Zamrazilová and Karina Kubelková said that the January repricing risk persisted, but the recent trend was in line with the forecast. Jan Procházka mentioned the risk of the repricing being postponed from January to subsequent months, where it would be less visible. On the other hand, Jan Frait said that even though there was considerable uncertainty about how high consumer price inflation had been in January, it was fairly certain that the domestic and foreign environments were non-inflationary. In this connection, repeated mentioned was made of the sizeable revision of the outlook for domestic real economic activity, while Jan Frait and Karina Kubelková also mentioned the persisting risk of weaker demand from the Czech Republic’s main trading partner countries, especially Germany. Worse sentiment impacting on the corporate sector could manifest itself negatively in a slower recovery in household consumption via lower wage pressures. They also stressed that the ECB and other central banks could keep monetary conditions too tight too long.
At its meeting, the Bank Board lowered the two-week repo rate by 0.50 percentage point to 6.25%. At the same time, it lowered the discount rate by the same amount to 5.25% and the Lombard rate to 7.25%. Six members voted in favour of this decision: Aleš Michl, Eva Zamrazilová, Tomáš Holub, Karina Kubelková, Jan Kubíček and Jan Procházka. One member, Jan Frait, voted for reducing rates by 0.75 percentage point.
Author of the minutes: Martin Motl, Monetary Department