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Czech Economy, CNB‘s Exchange Rate Commitment and Future Exit
Vojtěch Benda
(Board Member)
Tomáš Holub (Executive Director, Monetary Department)
7 September 2016, London
CNB / Morgan Stanley Investor Seminar
Outline
• Exchange rate commitment and its performance so far
• Current economic developments and the latest CNB’s forecast
• MP considerations and prospect for exit from the exchange rate floor
• Summary and conclusions
2
The exchange rate commitment
• The CNB‘s one-sided exchange rate commitment at 27 CZK/EUR was introduced in November 2013 to avoid deflation or long-term undershooting of the inflation target.
• It has been repeatedly prolonged as a result of (mainly foreign) anti-inflationary cost-push shocks and low inflation environment, but deflationary risks from the domestic economy have been averted.
• The FX interventions to support the commitment are automatic, i.e. without the need for an additional decision of the Bank Board, and without any time or volume limits.
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Exchange rate and FX interventions
• Since July 2015, the exchange rate has stabilised close to the ”floor“.
• The volume of CNB‘s interventions varies over time, but overall has not been extremely large (there is no upper limit anyway).
− The sum of FX interventions has reached EUR 20.6 bil. until mid-2016 (the sum of client operations – mainly inflow of EU funds – has reached EUR 10.5 bil. since Nov 2013).
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1/13 4 7 10 1/14 4 7 10 1/15 4 7 10 1/16 4-1
0
1
2
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4
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6
7
8
24,5
25,0
25,5
26,0
26,5
27,0
27,5
28,0
28,5
29,0
Foreign exchange interventions (right axis, EUR bil.)
Client operations (right axis, EUR bil.)
Exchange rate commitment (left axis)
CZK/EUR (left axis)
CZK/EUR exchange rate, CNB‘s commitment and FX interventions
GDP impact – rule of thumb evaluation
2013 2014 2015
GDP -0.5% 2.7% 4.6%
Gross value added -0.5% 3.4% 3.9%
Contribution of individual factors to the GDP dynamics
fiscal impulse -1.0 p.p. 0.3 p.p. 0.8 p.p.
growth in effective EA 0.6 p.p. 1.1 p.p. 1.9 p.p.
oil price 0.0 p.p. 0.1 p.p. 0.7 p.p.
tobacco excise duties 0.0 p.p. -0.7 p.p. 0.7 p.p.
monetary pol. + sentiment -0.1 p.p. 1.9 p.p. 0.5 p.p.
Source: CZSO, CNB‘s calculations
5
• According to CNB‘s rule-of-thumb calculations, the exchange rate commitment has significantly contributed to the economic recovery.
• This conclusion is confirmed also by more sophisticated methods (even though the exact quantifications differ).
Output gap
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• Thanks to the swift economic recovery, the Czech economy has approached its potential output level (and is expected to stay close to it throughout the forecast period).
-6
-4
-2
0
2
4
6
8
I/08 I/09 I/10 I/11 I/12 I/13 I/14 I/15 I/16 I/17 I/18
Production function Kalman filter HP filter
Output gap estimates (in % of potential output)
Labour market situation
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• The labour market slack has been eliminated, too. The number of registered unemployed persons has declined significantly and the number of vacancies has simultaneously increased.
• This has supported stabilisation of core inflation close to 1%.
Beveridge curve (s.a. numbers in thousands; heat: annual adjusted inflation ex. fuels in %)
-1
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16
headline inflation
net inflation
start of targetband 3 - 5 %
target band 2002-2005( announced 4/2001)
end of target band 2 - 4 %
target 1998 6% +/- 0,5p.p.
target1999
target 2000
target 2001 3% +/- 1p.p.
point target 3%(announced 3/2004)
target 2005 2%+/- 1 p.p.announced 4/1999)
point target 2%(announced 3/2007)
Inflation vs. targets
8
• In spite of the positive real economic developments, the Czech Republic has been going through the longest period of below-target inflation.
(y/y in %)
-3
-2
-1
0
1
2
3
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Import prices Export-specific technology Intermediate goods prices Total
Fundamental factors of inflation
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• The model-based decomposition confirms that the anti-inflationary pressures are imported from abroad (red bars), while the domestic economy (yellow bars) has had an upward impact on prices.
Costs in the consumer sector(quarterly percentage changes; contributions in percentage points; annualised)
Outline
• Exchange rate commitment and its performance so far
• Current economic developments and the latest CNB’s forecast
• MP considerations and prospect for exit from the exchange rate floor
• Summary and conclusions
10
GDP growth
Demand side:
• The GDP is growing thanks to consumption and net exports.
− Temporary decline in gross capital formation in 2016 (drop in government investment financed from EU funds).
Supply side:
• Manufacturing and services have been contributing the most to the GVA growth since 2014.
− The recovery was driven by export-oriented manufacturing sector initially, but has now become broad-based. 11
Structure of GDP growth(contributions in p.p. to annual change in %; s. a.)
Contributions of branches to GVA growth (contributions in p.p. to annual change in %; s. a.)
-2
-1
0
1
2
3
4
5
6
I/12 I/13 I/14 I/15 I/16
Manufacturing Agriculture
Construction Financial services
Trade and other service Other industry
-4
-2
0
2
4
6
I/12 I/13 I/14 I/15 I/16Change in inventories Government consumptionGross fixed capital formation Net exportsHousehold consumption GDP growth
Leading indicators
• Industrial production growth has slowed down.
• Construction production growth has turned negative again due to a drop in public investment financed from EU funds.
• Retail sales growth remains high, but sales in services declined recently.
• Both business and consumer confidence indicators remain at much higher level than in 2013.
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Business leading indicators(annual percentage changes, average of 2005 = 100)
Leading indicators of household consumption(annual percentage changes, average of 2005 = 100)
70
80
90
100
-15
-10
-5
0
5
10
15
12/I III 13/I III 14/I III 15/I III 16/I
Industrial production
Construction production
Business confidence indicator (right)
60
75
90
105
120
-2
0
2
4
6
8
12/I III 13/I III 14/I III 15/I III 16/I
Retail trade except automotive segment
Sales in services
Consumer confidence indicator (right)
-4
-2
0
2
4
6
I/12 I/13 I/14 I/15 I/16
Average nominal wage in the Czech Republic
Labour market
• The economic recovery is having a visible impact on the labour market.− Unemployment has decreased noticeably (even though the pace of this decline has
been slowing recently).
− Nominal average wage has been rising in both business and non-business sector.
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Average nominal wage(annual changes in %)
Unemployment indicators(in %; s.a.)
3
4
5
6
7
8
9
I/12 I/13 I/14 I/15 I/16
General unemployment rate (LFS)
Share of unemployed persons
Inflation
• The headline inflation (0.5% in July 2016) is still well below the CNB’s 2% target due to cost-push shocks.
− The sharp annual decline in fuel prices still continues.
− Administered and food prices either decline or grow only very slowly.
− Adjusted inflation excluding fuels (core inflation) increased slightly (to 1.1% in July), owing to an acceleration in both tradable and non-tradable prices.
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-1
0
1
2
1/15 4 7 10 1/16 4 7
Indirect taxes in non-administered prices Fuel prices
Food prices Administered prices
Adjusted inflation excluding fuels and food Annual consumer price inflation
Structure of inflation(y/y in %; contributions in p. p.)
• Growth in external economic activity will slow in 2017 and then speed upslightly again. The outlook reflects the (first) impact of Brexit vote on Consensus Forecasts.
• The decline in industrial producer prices will fade out in early 2017.
External environment outlook
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-1
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3
-1
0
1
2
3
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Differences Previous forecast New forecast
Effective PPI in the euro area(y/y in %; differences in p.p. – rhs)
Effective GDP in the euro area(annual changes in %; differences in p.p. – rhs)
-4
-2
0
2
4
-4
-2
0
2
4
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Differences Previous forecast New forecast
Forecast: monetary policy assumptions
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• The forecast assumes market interest rates to be flat at their current very low level and the exchange rate to be used as a monetary policy instrument until mid-2017.
• Consistent with the forecast is an increase in interest rates in the second half of 2017.
• Note that the forecast does not incorporate any ”tactical“ considerations associated with the exit (e.g. that rate hikes will probably start increasing only once the situation stabilizes in the FX market).
GDP forecast
• GDP will slow down this year (2.4%) due to a temporary decline in gross capital formation (government investment financed from EU funds). In 2017-2018, growth will speed up to 3%.
• Economy will still be supported by easy monetary conditions, low oil prices and ongoing growth of external demand.
• Household consumption will grow in line with increasing real income.17
CNB’s GDP forecast (annual changes in %; s.a.) GDP growth structure (contributions in p.p.)
-2
0
2
4
6
8
10
III/14IV I/15 II III IV I/16 II III IV I/17 II III IV I/18
90% 70% 50% 30% confidence interval
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-2
0
2
4
6
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Change in inventories Government consumptionGross fixed capital formation Net exportsHousehold consumption GDP growth
Labour market forecast
• The rising economic activity will manifest itself in the labour market situation, but the already low unemployment rate will be a constraint.
− Total employment will continue to rise, but at a falling pace, while the decline in unemployment rate will slow.
− The return of inflation to the target, a renewed pick-up in economic activity and an increasing shortage of available labour will result in a wage growth close to 5% 2017 and 2018.
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Employment, unemployment(annual changes in %; rhs in %, s.a.)
Average nominal wage(annual changes in %)
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-2
0
2
4
6
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Nominal wages in the business sector
Nominal wages in the non-business sector
3
4
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6
7
8
-2
-1
0
1
2
3
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Employment General unemployment rate (right)
Inflation forecast
• Headline inflation will start to rise in the period ahead despite a continued moderate decrease in administered prices and subdued food price growth.
• At the MP horizon headline inflation will slightly exceed the 2% inflation target, in 2018 inflation will return to the target from above.
• Core inflation pick-up will be due to rapid wage growth and to a renewed increase in PPI in the euro area.
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CNB’s headline inflation forecast (annual change in %) Core inflation (annual change in %)
-1
0
1
2
3
I/12 I/13 I/14 I/15 I/16 I/17 I/18
Net inflation Adjusted inflation excluding fuels
-1
0
1
2
3
4
5
6
III/14IV I/15 II III IV I/16 II III IV I/17 II III IV I/18
90% 70% 50% 30% confidence interval
Inflation target
Monetary policy
horizon
-0,5
0,0
0,5
1,0
1,5
2,0
2,5
3,0
I/01 I/03 I/05 I/07 I/09 I/11 I/13 I/15
Consumer prices in non-tradables sector
Nominal unit labour costs
Balassa-Samuelson effect
• The B-S effect was weakened in recent years due to very muted wage dynamics in the non-tradables sector. But the gap between wage levels in the tradables and non-tradables sectors has started to widen again.
• Rising unit labour costs at the start of 2016 in the non-tradables sector can be expected to contribute to consumer inflation breaking away from levels slightly above zero over the next a few quarters.
• This will aid fulfilment of the inflation target.
Average wage (CZK) Consumer prices and wage costs in the non-tradables sector
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0
500
1000
1500
2000
2500
3000
0
5000
10000
15000
20000
25000
30000
I/00 I/02 I/04 I/06 I/08 I/10 I/12 I/14 I/16
Differences (right-hand scale)Wages in tradables sectorWages in non-tradables sector
Risks to the forecast
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• The risks to the forecast over the next a few quarters were assessed as balanced by the CNB‘s Board at its August meeting.
Uncertainties include: − impacts of the referendum in the United Kingdom on the external demand
− the effect of the domestic election cycle on an increase in public expenditures
− the depth of a fall in government investment this year
− the impact of a long-lasting low inflation on anchoring of inflation expectations
-1
0
1
2
1/14 4 7 10 1/15 4 7
Adjusted inflation excluding fuels and foodAdministered pricesIndirect taxes in non-administered pricesFood prices (including alcoholic beverages and tobacco)
0
20
40
60
80
100
120
140
160
180
2008 2009 2010 2011 2012 2013 2014 2015
Exports Imports Balance
Brexit: limited impact on Czech economy
• The impacts of Brexit in the short- and medium term will materialize via increased economic uncertainty and slowdown of the UK economy.
− Direct impact: a 1.5 p.p. slowdown in UK demand is estimated to reduce growth in Czech exports to the UK by about 5 p.p. in 2017.
− Indirect impact: increased uncertainty in Europe; the CNB forecast includes outlooks for the Czech Republic’s external demand and other foreign variables, which already incorporate the expected impacts of Brexit (impact via economic sentiment).
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Czech trade in goods with the UK(CZK billion; balance of payments methodology)
Exports to the UK (2015):• 5.1% of total Czech goods exports• 5.9% of total Czech service exports
Outline
• Exchange rate commitment and its performance so far
• Current economic developments and the latest CNB’s forecast
• MP considerations and prospect for exit from the exchange rate floor
• Summary and conclusions
23
Monetary policy considerations
• A need to maintain expansionary monetary conditions at least to the current extent persists.
• Domestic inflation is still being affected by anti-inflationary cost-push effects from abroad. Monetary policy focuses on their potential adverse second-round effects.
• In this context, the CNB still stands ready to shift the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations (which would affect nominal variables, especially wages).
• The possibility to introduce negative interest rates have been discussed repeatedly during 2016, but not at the last meetings.
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• Negative interest rates are not an appropriate tool for additional easing of monetary conditions.
− There is ultimately an effective lower bound (ELB).
− We do not know, where the ELB is; but it is likely to be less negative in the relatively cash-rich Czech economy than in some other countries.
− Negative nominal rates could pose challenges to financial stability, which might outweigh any potential monetary policy benefits (even though they would not represent a major problem for the stability of Czech banks).
2%4%
8%
10% 11% 11%
21%
Sweden Denmark United States Switzerland Euro area CZ Japan
Negative interest rates – what for? (i)
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Currency in circulation (in % of GDP; source: IMF, SNB)
Negative interest rates – what for? (ii)
• Negative rates could serve effectively as a tool for defending / supporting the exchange rate commitment.
− They could be a useful tool if there were expectations or materialization of appreciation pressures on the koruna (due to the existing interest rate differential between the Czech Republic and the euro area).
− Such pressures had not been observed so far, and – even if they were to materialise –negative rates would not be applied automatically (as the CNB is not limited in the amount of foreign exchange reserves it can buy and hold).
• Overall, negative interest rates are not a preferred tool for the CNB; however, CNB has not excluded their potential use if needed.
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Prospect for exit from the exchange rate floor
• The CNB‘s Board has repeatedly confirmed that it will not discontinue the use of the exchange rate as a monetary policy instrument before 2017.
• The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.
• 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.
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Time axis
Design of the exit
• 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.
• 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.
• Board‘s decisions on interest rates hikes after the exit will probably not strictly adhere to the forecasted path.
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The exchange rate after the exit
• The subsequent return to conventional monetary policy will not result in the exchange rate appreciating sharply to the slightly overvalued level recorded before the CNB started intervening:
− The exchange rate was slightly overvalued before the CNB intervention (and it has appreciated in nominal effective terms since early-2015).
− The weaker exchange rate of the koruna is in the meantime passing through to domestic prices and other nominal variables.
− The absence of counterparty (exporters will be hedged 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)
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90
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94
96
98
100
102
1/12 1/13 1/14 1/15 1/16
koruna appreciation
Nominal effective koruna exchange rate(2010 = 100)
Outline
• Exchange rate commitment and its performance so far
• Current economic developments and the latest CNB’s forecast
• MP considerations and prospect for exit from the exchange rate floor
• Summary and conclusions
30
Summary and conclusions
• CNB is using the exchange rate as a further monetary policy instrument at the ZLB successfully within its inflation targeting regime.
• The weaker exchange rate has averted the risk of deflation driven by insufficient demand, and has speeded up the economic recovery.
• Headline inflation will start to rise in the near future and slightly exceed the 2% target at the monetary policy horizon, i.e. 12-18 months ahead.
• CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.
• The subsequent return to conventional monetary policy will not result in the exchange rate appreciating sharply to the slightly overvalued level recorded before the CNB started intervening.
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Thank you for your attention
www.cnb.cz
Vojtěch Benda
Tomáš Holub
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