TEXT-Minutes from Czech c.bank May 31 board meeting

...meeting, released on Friday.

Present at the meeting: Zdenek Tuma (Governor), Ludek Niedermayer (Vice-Governor), Miroslav Singer (Vice-Governor), Mojmir Hampl (Chief Executive Director), Robert Holman (Chief Executive Director), Pavel Rezabek (Chief Executive Director).

The Board discussed the May situation report assessing the new data on the economy and the risks associated with the fulfilment of the April macroeconomic forecast. These risks were assessed in the situation report as being on the upside overall. Annual consumer price inflation had risen to 2.5 percent in April and was thus 0.4 percentage points higher than forecasted. This deviation was due to higher-than-forecasted growth in food prices, greater-than-forecasted impacts of changes to indirect taxes, faster-than-forecasted growth in regulated prices and higher-than-forecasted adjusted inflation excluding fuels. Figures from the real economy suggested a risk of higher-than-expected GDP growth in the first quarter of 2007. This was confirmed by developments in the labour market, where employment growth had accelerated and the unemployment rate had fallen.

After the presentation of the situation report, the Board discussed the risks associated with the April forecast, consistent with which is a gradual rise in interest rates. The majority of the board members agreed that the past downside risks to inflation were abating. In this context, it was argued that these downside risks had allowed interest rates to be kept below their equilibrium level and that their abatement meant convergence of current interest rates to these monetary policy neutral rates.

There was a discussion about whether the upside risks of the forecast associated with the evolution of the domestic economy were already starting to materialise. Some of the board members felt that the expected higher GDP growth coupled with pressures from the labour market would lead to mounting inflation pressures, which had already partially manifested themselves in the higher inflation in April. Against this, the opinion was expressed that the high growth in construction and industry might have been due to the unusually good weather in the first quarter, which would not necessarily recur. The higher-than-forecasted rise in the consumer price index might thus have been due to a combination of several factors that were not linked with monetary policy, such as shifts in the seasonality of food prices, shifts in the timing of the impacts of the increase in indirect taxes and the of the rise in regulated prices, etc.

The Board also discussed the labour market figures. The relatively sharp fall in the general unemployment rate compared to the forecast was identified as an upside factor, as it might lead to higher wage growth. On the other hand, however, mention was made of the persisting downside effect of the still falling nominal unit wage costs in industry and construction due primarily to rapid labour productivity growth. In this context, however, the opinion was also expressed that some of the structural changes in the labour market, for example the greater involvement of employment agencies, might have led to this factor being overestimated.

In the light of the effects on economic growth and inflation in the Czech Republic, the Board also discussed the pick-up in economic growth in the euro area and the related revision of the external growth prospects. The distribution of this additional growth impulse between potential output growth and cyclical growth was discussed. In this context, it was said that no upside effects of the higher euro area GDP growth on other economic indicators in this region (core inflation, wages, household incomes) were apparent so far. Against this, it was argued that the higher GDP growth abroad would lead to an increase in foreign interest rates and hence to an increase in the interest rate differential, which might then affect capital flows and cause the koruna exchange rate to depreciate or remain weaker than forecasted. At the same time, however, concerns were expressed that an interest rate increase by the CNB might restart the Czech koruna's appreciation trend. The board members nonetheless agreed that the shift in the risks of the forecast was linked more with domestic economic factors than with external ones.

The Board also discussed the uncertainties associated with the fiscal policy settings. It was said that, aside from the impacts of the indirect tax increases, the planned reform of public finances would also probably generate a slowdown in demand-pull inflation impulses. The discussion also covered the cost factors of inflation linked with the increased outlook for oil prices and the higher-than-expected industrial producer price index. According to some of the board members, the current oil price trend is due to one-off factors that should not be overvalued. On the other hand, though, cost pressures were now emerging among other cost prices in the producer price index as well.

At the close of the meeting the Board decided to increase the CNB two-week repo rate by 0.25 percentage points to 2.75 percent, effective 1 June 2007. At the same time it decided to increase the discount rate and Lombard rate by the same amount, to 1.75 percent and 3.75 percent respectively. Three members voted in favour of this decision, and three members voted for leaving rates unchanged. In compliance with the Bank Board's Rules of Procedure the chairman casts the decisive vote for a tie-vote situation.

(Reporting by Mirka Krufova in Prague)

Keywords: CZECH ECONOMY/CENTRALBANK