Czech Economic Outlook and Prospects for the Exchange Rate Floor

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1 Czech Economic Outlook and Prospects for the Exchange Rate Floor Vladimir Tomsik Vice-Governor Czech National Bank Small Talks Symposium 9 October 2015 Investor Seminar 10 October 2015 IMF/WB Annual Meeting in Lima 1

2 Outline Exchange rate as a further MP instrument Current economic development CNB s forecast Prospect for exit of the exchange rate floor Summary and conclusions 2

3 Background of November 2013 decision In , the Czech economy was going through the longest recession in its history (impact of the weakening foreign demand and proceeding domestic fiscal consolidation): decline of GDP (mainly due to falling consumption and investment) increasing unemployment rate decreasing real wages weak consumer and business confidence Inflation decreased to the lower boundary of the tolerance band around the CNB s 2% target and it was expected to fall to (or even below) zero. Standard monetary policy tools reached their limits: interest rates at technical zero forward guidance verbal FX interventions 3

4 November 2013 decision To avoid deflation or long-term undershooting of the inflation target the Bank Board decided to start using the exchange rate as an additional instrument for easing the monetary conditions: The CNB will intervene on the FX market to weaken the koruna so that the exchange rate is close to CZK 27/EUR. The exchange rate commitment is one-sided: CNB will prevent excessive appreciation of the koruna exchange rate below CZK 27/EUR. On the weaker side of the CZK 27/EUR level, the CNB is allowing the exchange rate to move according to supply and demand on the FX market. The CNB stands ready to intervene automatically, i.e. without the need for an additional decision of the Bank Board, and without any time or volume limits. CNB is a forward-looking Inflation Targeter 4

5 The exchange rate after the decision CZK/EUR rate, CNB commitment and FX interventions /13 4/13 7/13 10/13 1/14 4/14 7/14 10/14 1/15 4/15 7/15 10/15 FX interventions (rhs, EUR bil.) CZK/EUR (lhs) Exchange rate commitment (lhs) After the CNB s policy announcement, koruna reached 27 CZK/EUR quickly, and has been moving at somewhat weaker levels since then. Actual interventions only within few days after the policy decision of the CNB. Further interventions needed in late summer 2015 (data so far published for July and August, in line with our regular release calendar). 5 1

6 Outline Exchange rate as a further MP instrument Current economic development CNB s forecast Prospect for exit of the exchange rate floor Summary and conclusions 6

7 GDP growth Structure of annual GDP growth (contributions in p. p. to annual p. change; s. a.) I/11 I/12 I/13 I/14 I/15 Government consumption Change in inventories Household consumption Net exports Gross fixed capital formation Contributions of branches to GVA growth (contributions in p. p. to annual p. change; s. a.) I/11 I/12 I/13 I/14 I/15 Manufacturing Agriculture Financial services Other industry Construction Trade and other services Demand side: The GDP is growing mainly thanks to the domestic demand. The corporations and the households have stopped postponing their expenditure. Positive fiscal impulse. Supply side: Industry and services have been contributing mostly to GVA growth since The recovery was driven by exportoriented manufacturing sector initially, but has now become broad-based. 7

8 Labour market 9 Unemployment indicators (percentages; s.a.) 4 Average nominal wage (annual percentage changes) LFSS = Labour Force Sample Survey I/11 I/12 I/13 I/14 I/15 General unemployment rate (LFSS) Share of unemployed persons I/11 I/12 I/13 I/14 I/15 Average wage in the Czech Republic The economic recovery is having a visible positive impact on the labour market. Unemployment has been decreasing noticeably. Nominal average wage has been rising in both business and non-business sector. 8

9 Inflation 1,5 Structure of inflation (annual percentage changes; contributions in p. p.) 1,0 0,5 0,0-0,5-1,0 1/ / Adjusted inflation excluding fuels and food Administered prices Indirect taxes in non-administered prices Food prices (including alcoholic beverages and tobacco) Fuel prices Annual consumer price inflation (in per cent) The headline inflation is still well below the CNB s 2% target (0.3% in August) Adjusted inflation excluding fuels (core inflation) remains stable, just above 1%. Food prices have returned to a modest year-on-year decline. The fuel prices decline is caused by the global drop in oil prices. 9

10 Outline Exchange rate as a further MP instrument Current economic development CNB s forecast Prospect for exit of the exchange rate floor Summary and conclusions 10

11 GDP forecast Current CNB s forecast and outcome in 2015 Q2 GDP growth structure ((annual percentage changes; s.a.) I/11 I/12 I/13 I/14 I/15 I/16 I/17-4 III/13 IV I/14 II III IV I/15 II III IV I/16 II III IV I/17 Change in inventories Gross fixed capital formation Household consumption Government consumption Net exports GDP growth 90% 70% 50% 30% confidence interval The GDP growth accelerated to 4.6% in 2015 Q2 (there are one-off factors in 2015). The forecast expects that the GDP growth will continue thanks to expanding domestic and external demand. However, in it will slowdown to slightly less than 3%, implying no tendency for an overheating. 11

12 Inflation forecast 6 5 Current CNB s forecast and expected outcome in 2015 Q3 Monetary policy horizon 3 Core inflation (annual percentage changes) Inflation target I/11 I/12 I/13 I/14 I/15 I/16 I/17-1 III/13 IV I/14 II III IV I/15 II III IV I/16 II III IV I/17 90% 70% 50% 30% confidence interval Net inflation Adjusted inflation excluding fuels The headline inflation has been slowing in 2015 Q3 (more than the July forecast expected) and is still well below the CNB s target. The downward surprise is mainly caused by food prices. Fuel prices have also fallen more than forecasted (due to low oil prices). Adjusted inflation excluding fuels (i.e. core inflation) has developed as expected. Despite an expected increase, inflation will remain below the target for most of next year. 12

13 Interest rates forecast 3 Current CNB s forecast of 3M PRIBOR III/13 IV I/14 II III IV I/15 II III IV I/16 II III IV I/17 90% 70% 50% 30% confidence interval The forecast assumes that market interest rates will be flat at their current very low level and the koruna exchange rate will be used as a monetary policy instrument until the end of Consistent with the forecast is an increase in rates in

14 Risks to the forecast The risks to the current forecast over the next few quarters are anti-inflationary. On the downside: food and fuel prices and administered energy prices (due to the decline in world commodity prices) expectations of more subdued inflation in the global economy On the upside: faster GDP growth stronger wage dynamics Sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will not occur until early

15 Outline Exchange rate as a further MP instrument Current economic development CNB s forecast Prospect for exit of the exchange rate floor Summary and conclusions 15

16 Prospect for exit of the exchange rate floor In case of growing anti-inflationary risks the exit can be announced even later than in 2016 H2. The primary objective of monetary policy, i.e. to maintain price stability, has a strict priority over the impacts of the CNB's measures on its financial results. Losses on the CNB s balance sheet were frequent in the past and there is neither political pressure nor economic necessity to generate profits. The negative interest rates are not a preferred tool of CNB s monetary policy; however, CNB has not excluded their potential use if needed. 16

17 The exchange rate after the exit The subsequent return to conventional monetary policy will not imply appreciation of the exchange rate at the forecast horizon to the slightly overvalued level recorded before the CNB started intervening: The exchange rate was slightly overvalued before the CNB intervention. The weaker exchange rate of the koruna is in the meantime passing through to domestic prices and other nominal variables. The absence of counterparty (real-money clients will be hedged by previous transactions and there will be no counterparty to close the long koruna positions). Slower speed of the real equilibrium appreciation in subsequent years compared to pre-crisis figures. CNB will be prepared to intervene in case of excessive appreciation (standard managed float regime) 17

18 Outline Exchange rate as a further MP instrument Current economic development CNB s forecast Exit of the exchange rate floor Summary and conclusions 18

19 Summary and conclusions CNB is using the exchange rate as a further monetary policy instrument at the ZLB within its IT regime. The weaker exchange rate has averted the risk of deflation driven by insufficient demand, and has speeded up the economic recovery. CNB will not discontinue the use of the exchange rate as a monetary policy instrument before the second half of The subsequent return to conventional monetary policy will not imply appreciation of the exchange rate at the forecast horizon to the slightly overvalued level recorded before the CNB started intervening The Czech exit will not be the Swiss exit 19

20 Thank you for your attention Vladimir Tomsik 20

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