TEXT-Minutes from Czech c.bank Oct 26 board meeting

Nov 3 (Reuters) - Following is the full text of the minutes from the Czech central bank (CNB) governing board's October 26 monetary policy meeting, released on Friday.

Present at the meeting: Zdenek Tuma (Governor), Ludek Niedermayer (Vice-Governor), Miroslav Singer (Vice-Governor), Michaela Erbenova (Chief Executive Director), Jan Frait (Chief Executive Director), Robert Holman (Chief Executive Director).

The Board discussed the October situation report containing the new macroeconomic forecast. As in the July forecast, the economy was above the non-accelerating inflation level of output. The current output gap had been revised downwards slightly, owing to the rather lower-than-forecasted second-quarter growth. During 2007, conversely, the output gap was slightly above the July forecast. In 2008, the output gap would gradually close. The forecast predicted a gradual slackening of economic growth from more than 6 percent in 2006 towards 5 percent in 2008. Underlying this, the structure of economic growth would change, with the contribution of net exports gradually being replaced by accelerating household consumption. However, gross fixed capital formation would remain a major growth factor.

The October forecast contained some changes relative to the July forecast, especially with regard to the coming four quarters. In the short term, the inflation forecast had been scaled back as a result of lower expected growth in food prices, fuel prices and adjusted inflation excluding fuels. Compared to the July forecast, the estimated impact on inflation of the increase in excise duties on cigarettes had also been reduced and the timing of this effect had been put back slightly. By contrast, the prediction for regulated prices had been revised upwards slightly for 2007. In the course of 2007, according to the forecast, consumer price inflation would thus edge up from lower initial values. As in the July forecast, it would reach the upper boundary of the tolerance band of the inflation target at the end of 2007. In the following two years inflation would thus generally be characterised by a large contribution of administrative effects. Monetary-relevant inflation (adjusted for the first-round effects of changes to indirect taxes) would also pick up pace over the course of the forecast and just exceed the point inflation target at the end of the monetary policy horizon.

Consistent with the new macroeconomic forecast and its assumptions was a gradual rise in interest rates.

After the presentation of the situation report, the Board discussed the uncertainties and risks associated with the forecast. There was a consensus that the new forecast would not lead to any change in the current view of the domestic economy. Over the forecast horizon, the economy would be characterised by quite high growth and rising inflation. The Board also stated that inflation would be affected in the coming quarters by a high weight of administrative effects and would therefore show greater volatility. This volatility would be evident as early as October and November this year, when inflation was expected to dip temporarily below 2 percent as a result of a reduction in gas prices. The administrative measures were associated with uncertainty in terms of both the timing of their effects on inflation and the degree of pass-through to inflation expectations.

The Board's discussion covered both the upside and downside risks to inflation. On the upside, attention was drawn to the possibility of faster-than-forecasted economic growth in the Czech Republic. In particular, consumer demand might accelerate as a result of positive developments on the labour market, consumer optimism and continuing growth in lending. It was also said that this changed structure of economic growth could have a more inflationary effect, even if the overall rate of growth were to fall.

Better economic growth abroad, especially in the euro area, might also lead to higher inflation. The uncertainty consisted in whether any change in economic growth in the euro area would be cyclical in nature or a reflection of improved structural trends. In the event of higher-than-expected potential growth of the euro area, the need for the ECB to raise interest rates would lessen, which would, in turn, have an anti-inflationary effect in the Czech Republic.

The Board also discussed the labour market situation. It seemed from the available indicators that the turnover of the registered unemployed was rising. It was said that the effect of penalty exclusions from the labour office register might be lower in reality than indicated by the statistics, because in a favourable phase of the economic cycle a proportion of the unemployed would be able to find work themselves without the assistance of labour offices. It was also said that some regions and some sectors might experience workforce shortages, especially in high-demand professions. And that would have an effect on wage growth going forward.

Turning to the downside factors, the Board focused its attention on the future pick-up in adjusted inflation during 2007, which was linked to some extent with the assumption of rising inflation expectations. The majority of the board members agreed that the extent of the pass-through of administrative effects to inflation expectations, and the rise in inflation caused by it, constituted a major uncertainty for the forecast.

The Board's discussion also touched on the fiscal situation. There was uncertainty regarding the economic interpretation of the initial base relating to the revision of the 2005 fiscal deficit, and also regarding fiscal policy in the medium term. The fiscal policy outlook beyond 2007 was currently very blurred owing to political uncertainty.

At the close of the meeting, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 2.5 percent. Five 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) ((prague.newsroom@reuters.com; Reuters Messaging: mirka.krufova.reuters.com@reuters.net; +420 224 190 477))

Keywords: ECONOMY CZECH CBANK TEXT