TEXT-Minutes from Czech c.bank September 27 board meeting

...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), Vladimir Tomsik (Chief Executive Director).

The meeting opened with a presentation of the September situation report analysing the new statistical data and assessing the risks of the July macroeconomic forecast. According to the situation report, the changes to VAT, the rise in excise duties and the changes to regulated prices would all be more inflationary than forecast. Another upside risk to inflation was faster-than-expected growth in food prices. A downside risk, by contrast, was August inflation, which at 2.4 percent in annual terms had come in 0.2 percentage point lower than forecast, mainly due to adjusted inflation excluding fuels. Other downside risks included the stronger exchange rate and the interest rate developments abroad. According to the situation report, the overall balance of risks to headline inflation was on the upside, although the risks to monetary-policy relevant inflation were conversely assessed as being on the downside.

After the presentation of the situation report, the Board discussed the newly available information and the balance of risks of the current forecast. The Board agreed that the balance of risks to monetary-policy relevant inflation was tilted towards the downside. The prevailing view, however, was that information going beyond the assumptions of the July forecast had also emerged since the forecast was created. The turmoil on global financial markets and the approval of the fiscal reform were identified as events raising the uncertainty of the decision-making process above its usual level. Nonetheless, the majority view among those present was that the outlook for the economy expressed in the forecast remained valid.

In a discussion about the fiscal policy changes, the opinion was expressed that the implementation of the tax reform might further spur corporate and private investment. This should lead to an increase in the rate of gross fixed capital formation above the level assumed by the current forecast. Against this, it was said that the reduction in the budget deficit would probably mean a fall in expenditure and hence a decrease in government consumption.

In the context of the turmoil on the financial markets, the Board agreed that lower growth abroad and, as a result, weaker external demand could be expected by comparison with the forecast assumptions. The opinion was expressed that the change in the shape of the yield curve might also reflect a revision of the economic growth outlook. Against this, however, the view was expressed that on this occasion the fall in yields might not necessarily signal a significant cooling, since the yield curves were being affected by short-term factors. Besides, the fall in yields was also a result of central banks' efforts to avert an economic slowdown. Regarding the influence of the potential slowdown abroad on the Czech economy, it was emphasised that unlike in the past the domestic growth was based to a large extent on domestic demand, so any negative external shock could be comfortably accommodated.

The Board discussed the current evolution of the exchange rate and agreed that its present level was strongly anti-inflationary compared to the forecast. The Board also examined the factors possibly underlying the fairly fast appreciation of the koruna. There was broad agreement that one factor was rapid closure of positions using the Czech koruna as the financing currency. It was also said that in the context of an appreciating koruna the fall in short-term interest rates in the EMU should not be overestimated, as a negative interest rate differential could be expected in the short run, and that clearly would not stimulate capital inflows. Against this, the opinion was expressed that in particular the most recent increase in domestic interest rates might have encouraged the appreciation of the exchange rate, and also that the outlook for a possible rate cut by the ECB was important in this context.

A key item of the discussion was the labour market. The view was repeatedly expressed that there were bottlenecks in this market and that the situation there was generally strained. The labour market was regarded as one of the major sources of inflation pressures. Nonetheless, the view was also presented that the reform measures tightening the conditions for providing unemployment benefit as well as the opening up of the market to foreign workers would increase the supply of labour and counter demands for excessive pay rises. As regards nominal unit wage costs, the opinion was expressed that their 2.8 percent growth was consistent with the inflation target, hence wage costs were not necessarily a direct upside factor for inflation at present. Against this, however, it was said that the current neutral effect of unit wage costs was different from the past situation, when wage costs had been strongly anti-inflationary.

The Board focused in detail on the current inflation situation. It discussed adjusted inflation excluding fuels, which was still fairly low; the forecast, however, expected rising inflation pressures from the real economy. The slowdown in producer price inflation was noted; in the discussion it was said that this may be due to competition and adequate technology, allowing firms to absorb cost pressures. However, it was also pointed out that agricultural producer prices were conversely rising surprisingly fast.

The interpretation of the difference between predicted and actual adjusted inflation excluding fuels in July and August was discussed. A possible technical reason for this difference was a change in seasonality due to the newly defined consumer basket, specifically the changes in representatives and the method used to monitor prices of foreign package holidays. Nonetheless, it was said repeatedly in the discussion that there might also be economic reasons for the lower inflation, in particular greater competition from foreign travel agencies.

At the close of the meeting, the Board decided unanimously to leave the two-week repo rate unchanged at 3.25 percent.

(Reporting by Mirka Krufova in Prague)

Keywords: CZECH CENTRALBANK/

[Reuters/Finance.cz]