TEXT-Minutes from Czech c.bank December 19 board meeting

...on Wednesday.

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 Board was presented with the December situation report, which analysed the new information and subsequently assessed the economic risks relating to the October forecast. According to the new situation report, the risks of the October forecast were balanced and their contrary effects were exceptionally strong.

At 5.0 percent in November, inflation had been 1.1 percentage points higher than predicted by the October forecast, mainly as a result of stronger-than-expected growth in the prices of food and fuels. In addition to accelerating prices of food and fuels, the outlook for regulated prices could be regarded as an upside risk to the October inflation forecast, owing chiefly to stronger growth in energy prices. Continuing appreciation of the koruna was an important downside risk of the forecast, exerting downward pressure on import prices and leading to tighter monetary conditions. The lower outlook for euro area economic growth and euro interest rates over the medium to long term acted in the same direction. GDP growth figures for the third quarter of 2007 had been significant new information. Economic growth of 6.0 percent had been only 0.1 percentage point lower than assumed in the October forecast. At the same time, GDP growth figures for the second quarter had been revised upwards. Data on GDP growth thus confirmed the assumption that the economy was expanding rapidly, albeit at a gradually decreasing pace.

After the presentation of the situation report, the Board discussed the new distribution of the risks relating to the October forecast and its implications for monetary policy. The Board agreed that the risks of the forecast were significant in both directions but roughly balanced overall. The discussion focused on the risks connected with the higher-than-forecasted inflation in November. There was consensus that inflation developments at the monetary policy horizon, which were surrounded by a higher degree of uncertainty than usual, were of key significance to considerations of monetary policy interest rate settings. Board members agreed that the current high level of inflation and the expected rise in inflation at the beginning of 2008 reflected mainly the build-up of one-off factors. The effects of these factors would start to unwind in 2008 and inflation would then return rapidly to lower levels. Further dampening of inflationary pressures would be aided by a slowdown in economic growth. Higher inflation caused by food and energy prices would result in slower growth in real disposable income which, in turn, would lead to a decline in the rate of increase of household consumer demand. The tightening of the exchange rate conditions would probably have a negative impact on the expansion of net exports.

The appreciation of the koruna, which was already acting towards a more pronounced decrease in import prices excluding food and fuels and whose effect might intensify in 2008, was identified as a significant downside risk to inflation. This risk could increase over time if the exchange rate remained strong. It was repeatedly emphasised that the evolution of the exchange rate during the preparation of the February forecast would be a very important indicator. The downside risks were also intensified by a less favourable economic outlook for the euro area and the United States. At the same time, the risks to this outlook were still skewed to the downside in connection with the large degree of uncertainty surrounding the impact of financial instability associated with the US mortgage market crisis.

It was discussed whether higher short-term market interest rates relative to the monetary policy rate reflected incorporation of expected monetary policy interest rate growth by market participants or the existence of liquidity and risk premia as currently observed on money markets abroad. In this context, an opinion was expressed that if higher market interest rates were connected with the aforementioned premia, further increases in the monetary policy rate might push money market rates to higher - and possibly inadequate - levels.

Given their substantial share in the current rise in inflation, food prices were an important subject of debate. Opinions were expressed that the current growth in world prices of food would come to a halt in 2008. This should be fostered mainly by the supply response to the increase in demand for agricultural products. It could also be assumed that the below-average harvest of 2007 would not repeat itself regularly in the years ahead. The Board agreed that the extent of the upside risk stemming from food prices could be lower than suggested by the November inflation figures. A hypothesis was discussed that the data on food prices in November had already partly reflected the increase in the VAT rate effective from January 2008. This was supported by the fact that food price inflation in November was higher than in the neighbouring countries. Weekly survey data for the last two weeks indicated a halt in food price inflation in November. Therefore, it could be assumed that food prices would be flat or grow only moderately in the coming months. It was said that the recent increase in fuel prices had also been probably temporary, as it had been affected to a large extent by production capacity shortfalls and alternative imports. Growth in the prices of food and fuels would therefore be of a temporary nature overall and unwind at the monetary policy horizon. Adjusted inflation excluding fuels was also mentioned as a factor dampening the inflationary risks. Its current level was in line with the forecast, but if the prices of restaurant services related to food price inflation had been excluded, adjusted inflation excluding fuels would have been below the forecast in November.

Some of the board members stressed the upside risks to inflation, pointing out that a further pick-up in inflation owing to the increases in VAT and regulated prices might affect hitherto well-anchored inflation expectations, which would result in stronger second-round impacts on inflation. The build-up of price shocks, administrative measures and tax changes affecting items of everyday consumption at a single moment was identified as the source of these risks. Attention was also drawn to the strong industrial producer price inflation in October, the highest since April 2005. Against this, a counter-argument was expressed that a wage-price spiral stemming from rising inflation expectations could only materialise if high inflation prevailed for a longer period of time. Given the one-off nature of the current inflationary pressures, such a situation was unlikely to occur.

After discussing the situation report, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 3.50 percent. Five members voted in favour of this decision, and two members voted for increasing rates by 0.25 percentage point.

(Reporting by Mirka Krufova in Prague; Editing by Ruth Pitchford)

Keywords: CZECH ECONOMY/CBANK

[Reuters/Finance.cz]