TEXT-Minutes from Czech c.bank November 29 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), Pavel Rezabek (Chief Executive Director), Vladimir Tomsik (Chief Executive Director).

The meeting opened with a presentation of the November situation report, which focused on assessing the newly available information and on its implications for the risks associated with the fulfilment of the October macroeconomic forecast. At 4 percent in October, annual consumer price inflation had been 0.2 percentage points higher than predicted by the October forecast. This deviation had been due to higher-than-expected growth in food prices. Accelerating food prices were the main upside risk to inflation now and for the months immediately ahead. However, the upside risks also included a higher outlook for regulated price inflation due to the planned healthcare reforms, a higher outlook for energy prices, and the magnitude of the second-round effects of the cost shocks linked with the rises in indirect taxes and regulated prices starting in January 2008. By contrast, the downside factors included a substantially stronger exchange rate, a slightly lower expected level of economic activity in the third quarter and an outlook of somewhat slower economic growth abroad. The overall risks of the forecast were assessed as being slightly on the downside, with the principal upside and downside risks diverging to either side rather significantly.

After the presentation of the situation report, the Board began its discussion. The board members agreed that both the upside and downside risks to inflation were quite significant, and a majority of the members felt that those risks had increased further since the previous situation report. The most extensively discussed upside factors were the accelerating food price inflation and the combination of energy price inflation, regulated price inflation and rising indirect taxes. The Board debated whether the observed growth in food prices was a short-term shock that would abate in the foreseeable future, or a long-term trend that might persist beyond the monetary policy horizon. Some of the board members expressed the view that food price forecasting is generally subject to extraordinary risk and questioned how far this factor should be taken into consideration in the decision-making. Other members, however, argued that the observed evolution of food prices should not be ignored, especially if it was going to foster a potential rise in inflation expectations.

In the context of the other upside risks to inflation, the Board discussed the extent to which the newly identified inflation pressures might materialise in the remaining months of 2007, i.e. before inflation starts to be sharply affected by the expected changes to regulated prices and indirect taxes resulting from the public finance reform. Many of the board members conceded the possibility that annual inflation would be higher in November and December than predicted by the October forecast, and drew attention to the risk of potential rapid adverse impacts on inflation expectations, even though those expectations seem quite well anchored in the long term.

The exchange rate featured prominently in the discussion of the downside risks to inflation. Some of the board members emphasised the fact that the rapid appreciation of the koruna in July had returned with renewed vigour in November. The discussion of the other downside risks focused on developments at home and abroad. Some of the board members expressed concerns about potential persistence of the adverse consequences of the mortgage crisis for the financial sector and about a possible future slowdown in euro area growth. A moderate risk of higher inflation abroad was also mentioned. Attention was given to signals of a possible modest downturn in domestic economic activity in the third quarter of 2007.

Another major topic discussed by the Board was the way in which economic agents are likely to form their inflation expectations in the period ahead. Some of the board members expressed concerns that the persisting tightness in the labour market may feed through to wage bargaining, which, in turn, might stimulate secondary inflation pressures and foster a slower fall in inflation in 2008. Some of the board members inferred from this that it was necessary to respond pre-emptively to the risk of rising inflation expectations. Although they conceded that the inflation pressures might ease in 2008, they regarded a pre-emptive response as necessary.

There were differences in opinion between the board members regarding the overall perception of the distribution of the individual upside and downside risks to inflation. However, all the board members agreed that the rise in prices in 2008 would be a one-off affair and that after it ended inflation would begin to head back towards the CNB's inflation target.

At the close of the meeting the Board decided by a majority vote to increase the CNB two-week repo rate by 0.25 percentage point to 3.50 percent, effective 30 November 2007. At the same time it decided to increase the discount rate and Lombard rate by the same amount, to 2.50 percent and 4.50 percent respectively. Five members voted in favour of this decision, and two members voted for leaving rates unchanged.

(Reporting by Mirka Krufova in Prague)

Keywords: CZECH ECONOMY/CBANK

[Reuters/Finance.cz]