TEXT-Minutes from Czech c.bank June 28 board meeting

...meeting, released on Tuesday.

Present at the meeting: Zdenek Tuma (Governor), Ludek Niedermayer (Vice-Governor), Mojmir Hampl (Chief Executive Director), Pavel Rezabek (Chief Executive Director), Vladimir Tomsik (Chief Executive Director).

The meeting opened with a presentation of the June situation report analysing the new statistical data and assessing the risks to the fulfilment of the current macroeconomic forecast. According to the situation report, the risks to inflation were now on the upside. The underlying domestic factors included new information from the labour market, including faster wage growth, along with an upswing in economic growth and higher-than-forecasted inflation. Expected external economic growth had picked up pace and expected interest rates in the euro area had risen. Another moderate upside risk to inflation was the exchange rate of the koruna, which was weaker than assumed in the current macroeconomic forecast. The situation report did not identify any major downside risks to inflation.

After the presentation, the Board discussed the situation report. The majority of the members agreed that the balance of risks was tilted towards the upside. The Board focused in detail on the current labour market situation and its relationship to the current phase of the business cycle. Wage growth, which in many cases will probably be faster this year than indicated by information from collective bargaining, was discussed. In this context, it was said that there were signs of tension in the labour market, as in some branches of industry and construction it was proving difficult to saturate the high demand for workers. The prevailing view in the discussion was that the newly observed growth in nominal unit wage costs in industry was indicating wage-cost pressures. It was also said, however, that temporarily increased nominal unit wage costs can also be a sign that businesses are gearing up for a further strengthening of demand, and the opinion was expressed that faster-growing wages can be natural for a converging economy.

In a debate on the newly published GDP figures it was said that the rapid economic growth was continuing, and the view was presented that a further increase in domestic demand growth could be expected. The opinion was expressed that rapid economic growth should not be a reason for tightening monetary policy. Against this, however, it was said that this had not been the case in the past either, when increases in output growth had been largely explained by revisions to the estimate of the potential, non-accelerating inflation level of output. It was also pointed out that the economic growth figures for previous years had been revised upwards. The opinion was expressed that potential output growth would therefore be raised in the new forecast and that this could also entail a re-assessment of inflation pressures.

The Board moved on to discuss the inflation risks stemming from the exchange rate, which was weaker than forecasted, and the link between the exchange rate and the size of the interest rate differential. It was said that previously the exchange rate had helped to depress inflation, whereas now its growing deviation from the forecast was an additional inflationary factor. It was also said that the koruna had some time ago split off from the other regional currencies and started to weaken gradually amid low volatility. The opinion was expressed that unless the interest rate differential narrowed this trend would probably continue. Against this, however, it was said that in response to new data, and probably also thanks to past CNB communications, the slope of the koruna yield curve had increased and the interest rate differential had narrowed somewhat as a result. It was also said in the debate that the effect of the interest rate differential should not be overestimated and that in the past it had not been a deciding factor as regards monetary policy.

Another of the upside factors debated was the observed higher agricultural producer price inflation. In this context, however, it was said that the ensuing risk was reduced by the high volatility of this indicator as compared to the volatility of food price inflation, and also by the fact that agricultural producer prices affect food prices to only a minor extent. The impacts of a further potential rise in energy prices was also discussed. This rise might be significantly faster than previously assumed. It was also said that in addition to the direct inflationary effect, rising energy prices could have a negative impact on economic growth, thereby depressing this direct effect.

Given the upside balance of risks to inflation, the Board discussed the possibility of raising interest rates. The opinion was expressed that overall the upside risks of the current forecast were sufficiently conclusive and quantitatively significant and that the July forecast would in all probability lead to a recommendation of a faster rise in rates than the April forecast. The appropriate response should therefore be to raise rates already at the present meeting. Against this, the opinion was expressed that the new forecast might provide a new view of the future, that apart from the movement of the exchange rate to weaker values the situation in the economy had not changed qualitatively since last month, and that monetary policy should not react hastily to short-term exchange rate fluctuations. It was also said in the debate that the new data could also be interpreted as meaning less intense inflation pressure and that the situation thus did not necessitate an immediate interest rate increase. It was also said that the risk of error arising from not raising rates was not particularly significant.

After discussing the situation report, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 2.75 percent. Four members voted in favour of this decision, and one member voted for increasing rates by 0.25 percentage point.

(Reporting by Mirka Krufova in Prague)

Keywords: CZECH CENTRALBANK/