Czech Economy and CNB s Exchange Rate Commitment: Waiting for Godots Tomáš Holub (Executive Director, Monetary Department) 24 November 2015, London Citibank Investor Seminar
Motto ESTRAGON: Charming spot. Inspiring prospects. Let's go. VLADIMIR: We can't. ESTRAGON: Why not? VLADIMIR: We're waiting for Godot. (Samuel Beckett, 1953) 2
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 3
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 4
GDP growth Structure of annual GDP growth (contributions in p. p. to y/y change; s.a.) Contributions of branches to GVA growth (contributions in p. p. to y/y change; s.a.) 5 4 3 2 1 0-1 -2-3 I/11 I/12 I/13 I/14 I/15 Government consumption Change in inventories Household consumption Net exports Gross fixed capital formation 5 4 3 2 1 0-1 -2-3 I/11 I/12 I/13 I/14 I/15 Manufacturing Agriculture Financial services Other industry Construction Trade and other services The GDP growth was actually never a Godot. The growth in 2014 was broadly in line with CNB s expectations (despite weaker EA growth). In 2015, it has been well above expectations (although the flash estimate for 2015 Q3 at 4.3% is below the current forecast in y/y terms, suggesting some downward data revisions for 2015 H1). The growth has been quite broad-based. 5
Credit growth 15 10 5 0 Loans to non-financial corporations (y/y in %) -5 1/11 1/12 1/13 1/14 1/15 Loans to non-financial corporations, total Medium- and long-term loans to non-financial corporations Short-term loans to non-financial corporations 16 14 12 10 8 6 4 2 0-2 -4 Investment loans to non-financial corporations (y/y in %, contributions in p.p.) 1/14 3 5 7 9 11 1/15 3 5 7 Manufacturing Real estate activities Energy Wholesale Construction Agriculture Other Investment loans to NFCs, total (annual percentage changes) Loans to NFCs, total (annual percentage rates of growth) For quite some time, the recovery seemed to be creditless, but this Godot has finally arrived, driven mainly by investment loans. From the MP point of view, this shows that the transmission has worked. FS view of the Board: It was said that the surge in corporate loans was occurring after quite a long period of decline/stagnation and hence was not dangerous for now. It was also said that it was more appropriate to react to excessive credit growth with macroprudential policy tools. 6
Labour market Unemployment indicators (in %; s.a.) Average nominal wage (y/y in %) 8 4 3 7 2 1 6 0 5-1 -2 4 I/11 I/12 I/13 I/14 I/15-3 I/11 I/12 I/13 I/14 I/15 General unemployment rate Share of unemployed persons Average wage in the Czech Republic The real side of the labour market (employment growth, unemployment rate) has followed the turnaround in the economy as expected. On the other hand, nominal wage growth in the business sector remained quite sluggish until recently (wageless recovery). The 2015 Q3 data suggest this Godot may be about to arrive (but any strong conclusion might be pre-mature on this). 7
Inflation 2 Structure of inflation (y/y in %; contributions in p. p.) 1 0-1 1/14 4 7 10 1/15 4 7 10 Adjusted inflation excluding fuels and food ("core") Administered prices Indirect taxes in non-administered prices Food prices (including alcoholic beverages and tobacco) Fuel prices Annual consumer price inflation (in per cent) Headline inflation remains well below the 2% target (0.2% in October) Adjusted inflation excluding fuels (core inflation) is mildly increasing (1.3%). Food prices have been growing only very slowly so far. The fall in fuel prices is caused by the global drop in oil prices. 8
Inflation forecasts over time Inflation forecasts since November 2013 compared to the reality (y/y in %) Inflation definitely looks like a Godot the prospect of a return to the 2% inflation target has shifted in time. All forecasts prepared in 2015 placed the achievement of the target around the turn of 2017. Sustainable achievement of the target is key for future exit (see below). 9
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 10
GDP forecast GDP growth (y/y in %) GDP growth structure (y/y, contributions in p.p.; s.a.) 10 8 8 6 6 4 4 2 2 0 0-2 -2-4 I/11 I/12 I/13 I/14 I/15 I/16 I/17-4 IV/13 I/14 II III IV I/15 II III IV I/16 II III IV I/17 II 90% 70% 50% 30% confidence interval Household consumption Gross fixed capital formation Change in inventories Net exports Government consumption GDP growth GDP growth forecast: 4.7% in 2015; 2.8% in 2016, 2.9% in 2017. The economy has been boosted this year by a pickup in external demand, easy monetary conditions, low oil prices and EU funds. The slowdown in 2016 will reflect a fall in government investment due to the EU funds cycle, unwinding of the effect of an increase in inventories at the start of this year and of the fall in oil prices. 11
Labour market forecast 2 Employment, unemployment (y/y in %; percentages; s.a.) 8 6 Average nominal wage (y/y in %) 1 7 4 2 0 6 0-1 5-2 -2 I/11 I/12 I/13 I/14 I/15 I/16 I/17 4-4 I/11 I/12 I/13 I/14 I/15 I/16 I/17 Employment Nominal wages in the business sector General unemployment rate (right-hand scale) Nominal wages in the non-business sector The rising economic activity will manifest itself in a further improvement in the labour market situation. The employment will continue to rise and unemployment will decrease further. Wage growth in the business sector will increase noticeably, which is one of the crucial preconditions for meeting our 2% inflation target in a sustainable manner. 12
Inflation forecast Headline inflation (y/y in %) Core inflation (y/y in %) 6 5 4 Monetary policy horizon 3 2 3 2 Inflation target 1 1 0 0-1 IV/13 I/14 II III IV I/15 II III IV I/16 II III IV I/17 II 50% 30% confidence interval 50ka 70ka -1 I/11 I/12 I/13 I/14 I/15 I/16 I/17 Net inflation Adjusted inflation excluding fuels Both headline and monetary policy-relevant inflation will increase and hit the 2% target at the monetary policy horizon. In 2017, they will be slightly above the target. Core inflation will stay close to its current level for the rest of this year and rise next year (growing economy and wages, dissipating fall in import prices). In 2017, it will remain above 2%. 13
Interest rate path 3 3M PRIBOR (in %) 2 1 0 IV/13 I/14 II III IV I/15 II III IV I/16 II III IV I/17 II 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 2016 (like all previous forecasts in 2015). CNB Board, November minutes: ˮThe likelihood that it would be necessary to discontinue the exchange rate commitment earlier than assumed in the forecast was decreasing over time. ˮGiven the very low outlook for interest rates abroad, some of the board members expressed doubts about the postexit rate of growth of domestic interest rates assumed in the forecast. 14
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 15
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 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. 16
The exchange rate and FX operations CZK/EUR rate, CNB commitment and FX operations After the CNB s policy announcement, koruna reached 27 CZK/EUR quickly, and has been moving at somewhat weaker levels since then. Actual interventions took place only within few days after the policy decision of the CNB. Further interventions needed in late summer 2015. FX interventions comparable in magnitude to purchases from clients. 17
Overall monetary conditions 0,3 0,2 0,1 0,0-0,1-0,2-0,3 Real monetary conditions index -0,4 I/04 I/05 I/06 I/07 I/08 I/09 I/10 I/11 I/12 I/13 I/14 I/15 Exchange rate component Interest rate component Basic RMCI Exchange rate commitment and low interest rates have led to significant relaxation of both components of monetary conditions. Monetary policy thus supports growth in domestic demand, which has contributed significantly to overcoming the recession and avoiding an even deeper undershooting of the inflation target. 18
Czech economy in figures: 2015 vs. 2013 Available on 7th November 2013 y-o-y changes in % Available on 19th November 2015 Gross domestic product (s.a.) Q2/13-1,3 Q2/15 4,6 Household consumption (s.a.) Q2/13 0,0 Q2/15 3,1 Gross capital formation (s.a.) Q2/13-14,0 Q2/15 9,4 Industrial production (s.a.) 9/13 1,8 9/15 3,1 Construction output (s.a.) 9/13-12,7 9/15 3,0 Retail sales incl. the automotive segment (s.a.) 9/13 0,3 9/15 8,6 Consumer price index 9/13 1,0 10/15 0,2 Industrial producer prices 9/13 0,6 10/15-3,9 ILO general unemployment rate, age 15 64 (s.a., in %) Q3/13 7,1 Q3/15 5,0 Employment Q3/13 0,7 Q3/15 1,3 Number of vacancies 9/13 39 thous. 9/15 109 thous. Average monthly nominal wage Q2/13 1,2 Q2/15 3,4 Gross operating surplus of non-financial corporations Q2/13 1,3 Q2/15 9,2 Composite confidence indicator (index) 10/13 88,9 10/15 95,1 Key indicators have been developing much better than before Nov 2013. Growth in consumer and producer prices remains low due to the drop in global prices of energy and agricultural commodities. 19
A counterfactual analysis CPI Inflation (%, yoy) Real GDP Growth (%, yoy) 4 Counterfactual simulation 8 3 6 3 Actual data 6 2 4 2 4 1 2 1 2 0 0 0 0-1 -2-1 -2-2 I/12 I/13 I/14 I/15-4 -2 I/12 I/13 I/14 I/15-4 Without the CNB s policy action, we would have been in a relatively deep deflation, and the recovery would have been much slower. 20
Output gap estimates Output gap (in % of potential output) The economy has approached from below its potential. If we were a GDP targeter, we could perhaps say: Charming spot. Inspiring prospects. Let's go. (even that is actually not correct, as the forecast assumes the floor being maintained till the end of 2016). But looking at our mandate, we have achieved the secondary objective, not the primary one (price stability defined by the 2% target). 21
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 22
Timing of the exit The CNB s Board has repeatedly confirmed that it will not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016. All these statements remain valid. The exit will take place only once there are conditions for a sustainable achievement of the 2% inflation target even after the exit, i.e. without a need to go back to unconventional measures. A need to maintain significantly expansionary monetary conditions persists. The likelihood that it will be necessary to discontinue the exchange rate commitment earlier than assumed in the forecast is decreasing over time. In this situation, the Bank Board discussed extending the duration of the exchange rate commitment. It agreed that its discontinuation would probably shift to around the end of 2016. 23
Czech vs. Swiss approach and exit Swiss Czech MP regime officially not IT inflation targeting Reason for entry export competitiveness deflation risk, undershooting of inflation target Balance sheet constraints quite important none Safe heaven yes, on global scale no (or regional only) Communication of exit none from the very beginning Foreign trade structure luxury goods; diversified between EUR and USD price-sensitive goods; strong EUR concentration Characteristics of the exit discretionary explicitly linked to sustainable achievement of the inflation target Regime after exit officially free float managed float Even though the two floors are seemingly quite similar, one can find sharp differences almost in all key aspects of the policy. The CNB s approach to the exit will thus be much different from the Swiss case (and so most probably will be market positioning before the exit). 24
Design of the exit The exact form of the exit will depend on the actual circumstances, but there is preference for a clean, one-off exit. The exit will be transparent. The exit will mean going back to the managed float regime, in which the central bank stands ready to smooth out excessive exchange rate volatility. 25
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 s intervention. The weaker exchange rate of the koruna is in the meantime passing through to domestic prices and other nominal variables (even though at an overall low level of inflation). 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 the pre-crisis figures CNB will be prepared to intervene in case of excessive appreciation (standard managed float regime) 26
Estimated equilibrium exchange rate 105 100 95 90 85 80 75 70 65 60 I/00 I/01 I/02 I/03 I/04 I/05 I/06 I/07 I/08 I/09 I/10 I/11 I/12 I/13 I/14 I/15 Equilibrium band CZK/EUR There seems to be a widely held believe that the CZK s exchange rate before the CNB s policy action was the right one. But our analyses show it was slightly overvalued (in line with the IMF s estimates). The BEER method suggests that the 27 CZK/EUR level was broadly in line with the long-term fundamentals (productivity differentials, FDI, etc.). 27
Equilibrium trends in CNB s forecasts in % Before crisis Post-crisis Czech GDP growth 4.0 3.0 Effective EA GDP growth 2.1 1.8 Real exchange rate appreciation 2.4 1.5 The GDP growth differential is likely to be smaller post-crisis than before the crisis (1.2 p.p. now vs. 1.9 p.p. before) due to: more mature stage of the GDP catch-up (in PPP, Czech GDP is currently close to 80% of the euro area average) legacy effects of the crisis As a result, the real exchange rate appreciation trend will also be slower (CNB forecasts assume 1.5% a year). A part of this may go via an inflation differential, if EA inflation stays below 2%. The exact numbers are subject to uncertainty, but qualitatively the argument is clear-cut. 28
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 29
PPI outlook in the effective euro area Forecast assumptions about PPI in effective EA since November 2013 vs. the reality (y/y in %.) The persistent deflation in euro area producer prices is contributing significantly to the low inflation in the Czech Republic. Their return to positive growth rates has been a key Godot we are waiting for. The ECB s policy actions are thus positive also for the CNB. 30
Exchange rate spillovers In normal circumstances, ECB s easing would create appreciation pressures on the CZK, which would be moderated by CNB s rate cuts. At the ZLB and without exchange rate commitment, the appreciation might be significant, thus offsetting most of the positive spillovers. The exchange rate commitment, however, insulates the economy from these adverse financial spillovers. They may only lead to increases in the CNB s FX reserves, but given that the CNB faces no balancesheet constraints, this is not an issue. November Board minutes: any exit from the CNB s exchange rate commitment before the ECB s quantitative easing was discontinued could be very complicated. 31
Negative interest rates FX interventions have been pushing some market interest rates into the negative range. This has been endogenously delivering further easing of monetary conditions. Negative policy interest rates are not a preferred tool; however, the CNB has not ruled out their potential use if needed (and has done some logistical preparations this year to make them feasible). Negative rates might be used as a complement to the exchange rate commitment, not as its substitute. 32
Outline Current situation of the Czech economy which Godots have already arrived, and which have not (yet?) CNB s new macroeconomic forecast CNB s exchange rate commitment experience so far Prospects for exit from the exchange rate commitment Spillovers of the ECB s policy Summary and conclusions 33
Summary and conclusions The Czech economy is growing strongly this year, but easy monetary conditions are still needed and an exit would be clearly premature. The Godots that are yet to arrive: a speed-up in domestic nominal wage growth (may be coming soon); return of euro area PPI to positive growth rates (assumed in 2016 H2); and most importantly achievement of the CNB s 2% target (expected at the turn of 2017). The CNB s Board has repeatedly confirmed that it will not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016. All these statements remain valid. At its last policy meeting, the CNB s Board agreed that the exit would probably shift to around the end of 2016 (i.e. in line with the forecast). The Czech exit will not be the Swiss exit. ECB s further policy actions would have mostly positive spillovers in the context of the CNB s exchange rate commitment (but may delay the exit). 34
Thank you for your attention www.cnb.cz Tomáš Holub tomas.holub@cnb.cz 35