Minutes of the Bank Board meeting on 1 August 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 fifth situation report and the new macroeconomic forecast. According to this forecast, inflation would be close to the 2% target for the rest of this year and would stay near it over the monetary policy horizon. Consistent with the baseline scenario of the forecast was a modest decline in market interest rates.

The Board assessed the risks and uncertainties of the forecast as broadly balanced overall. Increased wage demands in the private and public sector were an inflationary risk. Potential excessive growth in total public sector spending would also lead to a risk of the state budget having an inflationary effect. Higher-than-expected inertia in services inflation 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 a potential acceleration of money creation in the economy stemming from a significant recovery in lending activity, especially on the property market. By contrast, a downturn in global economic activity and weaker German – and hence Czech – economic output were a significant downside risk to inflation. The future monetary policy stance abroad remained an uncertainty of the outlook.

Aleš Michl began by saying that price stability had been restored in the Czech Republic. Developments to date and the inflation outlook allowed the CNB to continue lowering interest rates cautiously. To maintain inflation at the target level in the long term, Aleš Michl meanwhile considered it necessary to persist with tight monetary policy until the core component of inflation was fully under control. The strategy of lowering rates cautiously would allow the CNB to interrupt or halt the decline in rates at still restrictive levels if the need arose. In addition, Jan Frait, Eva Zamrazilová and Jan Kubíček pointed out that there had recently been some autonomous easing of the monetary conditions – both through the exchange rate and, in particular, via a decline in longer interest rates. According to Jan Frait, it could also be concluded from this that the markets were not fully convinced that central banks would succeed in keeping monetary policy tighter than in the previous decade, and the CNB should not confirm them in that. On this, Aleš Michl said that the average base rate in the Czech Republic over the ten years to 2022 had been 1%, i.e. too low. In his opinion, this now seemed like a monetary policy mistake. Rates could therefore be expected to be higher than they had tended to be in the past. He and Jan Procházka noted that a higher interest rate level would prevent excessive creation of new money and motivate economic agents to save and invest rather than borrow.

The assessment of the monetary conditions also involved an in-depth discussion of the exchange rate of the koruna, which had weakened noticeably since the previous monetary meeting. Partly because of relatively good foreign trade results, Jan Kubíček regarded the current weak level of the koruna exchange rate as undervalued. For this reason, he felt greater caution should be exercised in lowering interest rates, not least also because the koruna was apparently becoming an instrument of speculation in relation to other currencies and so might not reflect the fundamentals of the Czech economy. On this, Eva Zamrazilová and Karina Kubelková said that the evolution of the koruna exchange rate tended to favour a cautious attitude to rate cuts. In this regard, Tomáš Holub and Karina Kubelková drew attention to the US and euro area central banks’ cautious approach to lowering rates, which was passing through to the koruna exchange rate via the interest rate differential. According to Eva Zamrazilová and Tomáš Holub, a large rate cut could – in the context of the CNB’s previous communications – further weaken the koruna and generate new inflationary pressures, which was not desirable.

The board members repeatedly mentioned services prices as one of the main upside risks to inflation. Eva Zamrazilová pointed out that if annual services price inflation within core inflation were adjusted for imputed rent and package holiday prices, it would exceed 6%. In this regard, Jan Procházka noted that wages were a fundamental cost item in services, so their expected growth to make up for the loss of real purchasing power in recent years was associated with a risk of further transmission of rising wage costs to end prices. However, he and Tomáš Holub said that firms were so far absorbing the fairly brisk growth in wages into their still elevated – though falling – profit margins. According to Aleš Michl, it was therefore an objective of monetary policy in this phase to maintain an environment of subdued demand pressures. He and Jan Procházka said that restrictive monetary policy would contribute to firms having to cover wage growth from their margins and not incorporating them into their end prices. This was supported by Jan Frait, who, in a situation of a tight labour market, elevated wage growth and relatively strong wage demands, regarded it as desirable to have monetary policy relatively tight for preventive reasons. Eva Zamrazilová identified potential higher-than-expected growth in property prices as another possible upside risk to inflation, adding that it was therefore not appropriate to excessively support the current property market recovery by easing monetary policy too quickly. On this, Tomáš Holub noted that even the still positive real interest rates would not necessarily hold back growth in property prices sufficiently if expectations of buoyant property price growth began to prevail in the market. According to Eva Zamrazilová and Karina Kubelková, food and fuel prices – traditionally volatile items that could move surprisingly in the opposite direction at any time in spite of market expectations – were additionally helping to keep inflation low. Karina Kubelková also said that a modest undershooting of the inflation target could meanwhile happen in some months. Rather than a threat to achieving the inflation target, she saw this as scope for the potential materialisation of modest upside risks to inflation. Eva Zamrazilová did not consider an undershooting of the inflation target for a time to be a problem either, pointing out that the price level in the Czech Republic was 30% higher than three years ago.

The board members agreed that the anti-inflationary risk in the shape of a greater slowdown in domestic economic activity, which was experiencing only a very weak recovery, one that was below average even by European standards, had increased substantially. According to the Board, this partly also reflected developments abroad, in particular worse new data from the German economy. As for domestic factors, Tomáš Holub and Jan Kubíček mentioned the restrictive effect of fiscal policy this year, which was dampening the pace of recovery of the economy and especially of household consumption. Jan Frait also identified household consumption as a downside risk of the forecast, because of the weak outlook for growth in disposable income. On the other hand, Eva Zamrazilová and Karina Kubelková said that fiscal policy could have an upward effect on inflation next year, owing to expected growth in general government expenditure. Eva Zamrazilová also noted that tight monetary policy does not have major impacts on exporters, as they finance themselves through other channels. Moreover, the weaker exchange rate at present was also relatively advantageous to this group.

At its meeting, the Bank Board lowered the two-week repo rate by 0.25 percentage point to 4.50%. At the same time, it lowered the discount rate by the same amount to 3.50% and the Lombard rate to 5.50%. All seven members voted in favour of this decision.

Author of the minutes: Martin Motl, Monetary Department