use of the exchange rate as a monetary policy instrument ......sep 26, 2014 · • in november...

Use of the Exchange Rate as a Monetary Policy Instrument:

CNB Experience

Annual Lecture, Joint Vienna Institute 26 September 2014

Miroslav Singer Governor, Czech National Bank

Overview

• CNB monetary policy and Czech economy before November 2013 and reasons for weakening koruna

• November 2013 FX interventions • What has happened in Czech economy since weakening

of koruna • CNB forecast (August 2014) and monetary policy

decision of 31 July 2014

M. Singer – Exchange Rate as Monetary Policy Instrument: CNB Experience 2

Source: CNB

Key CNB rates (in %)

The CNB lowered its key interest rates to “technical zero” in November 2012; no further easing of the monetary conditions was possible via interest rates


Monetary policy since autumn 2012 • In autumn 2012 CNB announced that if it became necessary to

ease monetary conditions further, it would do so by weakening exchange rate of koruna

• In November 2012 CNB halted sale of yields on its forex reserves

• During 2013 CNB made verbal interventions aimed at weakening koruna verbal interventions had some effect (tenths of koruna) for roughly one year they delivered unusually stable exchange rate

in historical terms but effectiveness of interventions gradually faded

The CNB completely exhausted its main monetary policy instrument, i.e. interest rates


Prices in main sectors (y-o-y changes in %)

During 2013 disinflationary and deflationary tendencies strengthened across the entire economy

Source: CZSO

Producer prices in manufacturing

Construction prices

Prices of market services Agricultural producer prices


Output gap (in % of potential output)

Estimates of the output gap (a signal of unused production capacity) in mid-2013 were strongly negative (May 2014 CNB forecast)

Source: CNB


Household deposits (CZK thous. per capita)

Household deposits per capita rose from CZK 138,000 in 2008 Q1 to CZK 183,000 in 2013 Q3, i.e. by 33%; this growth reduced demand by about 2.5% of GDP a year

Source: CNB

Note: Household deposits = Transferable deposits + other deposits


Other disinflationary and deflationary factors

• Falling growth of monetary aggregates and velocity of money • Inflation expectations had fallen to historical lows • Czech economy was more subdued than any of its neighbours • Falling inflation in euro area further ECB interest rate cuts • Lowest-ever wage growth in private firms • Decline in fixed investment lasting more than two years and

related fall in share of Czech exports on European markets • Several-year-long fall in property prices (except in Prague) • Even excluding expected decline in energy prices, price index

would not have been positive without CNB intervention The constantly rising disinflation risks as reflected in the CNB’s forecasts were indicating an ever-increasing decline in inflation well below the inflation target


The November 2013 FX interventions


The Bank Board’s decision of 7 November 2013

• CNB weakened koruna to around CZK 27/euro (roughly equivalent to cutting rates by 1 percentage point)

• Expressed (one-sided) exchange rate commitment: to prevent excessive appreciation of koruna below CZK 27/euro on weaker side of CZK 27 level to allow exchange rate to float

according to supply and demand on foreign exchange market • Weakening of koruna was aimed at:

averting real threat of deflation attaining inflation target earlier helping economy to recover faster exiting zero interest rate level earlier (and returning to use of main

monetary policy instrument sooner) The exchange rate became a new tool in the IT regime


FX interventions (1997–2003)

In 1997–2003 foreign exchange interventions had been used to suppress volatility of the koruna…


FX interventions (1997–2014)

…whereas in November 2013 they became an instrument for weakening the koruna; the interventions in November 2013 were far larger than those in 1997–2003


The koruna on 7 November 2013

We had expected that the exchange rate would jump to the target level straight after that level was announced and that we would then defend the target level through trading; this did not happen; we had to force the rate to the target level through active trading; this took around four hours

Source: Bloomberg


Market situation during the interventions

• By coincidence, ECB surprisingly cut rates on 7 November 2013 huge increase in interbank FX market trading

• Along with our interventions, settlement limits between some banks were reached transmission of our intervention activity to market prices was suppressed for short while

• Problem solved by expanding set of intervention partners • CNB interventions lasted only a few days • Scale of interventions: EUR 7.5 bn

The exchange rate of the koruna has been determined in the market for ten months now without CNB interventions


FX reserves (EUR millions)

The CNB’s FX reserves increased as a result of the November 2013 interventions


Interventions and the quantity of money in the economy

The koruna deposits arising after the interventions were placed with the CNB via repo transactions and deposit facilities

Note: In the Czech financial system the central bank withdraws rather than supplies liquidity; there is a long-term liquidity surplus in the system


Koruna-euro exchange rate (3 Jan 2000–23 Sep 2014)

Source: Eurostat The November weakening of the koruna was not at all unusual by historical standards


What has happened in the Czech economy since the weakening of

the koruna


After four quarters of growth, the economy stagnated in quarter-on-quarter terms in 2014 Q2; in year-on-year terms it grew by 2.7%

Source: CZSO


Industrial production contracted by 3.2% y-o-y in 2013 H1 but rose by 6.2% y-o-y in 2014 H1

Industrial production (y-o-y changes in %)

Source: CZSO


The importance of insufficient demand as a barrier to growth in industry shrank from 60.3% in 7/2013 to 43.9% in 7/2014

Barriers to growth in industry (in %)

Source: CZSO


Gross operating surplus (cur. prices) fell by 4.8% y-o-y in 2013 H1 but rose by 17.1% y-o-y in 2014 H1 (and in euro terms by 10% y-o-y in 2014 H1)

Key financial indicators (annual percentage changes)

Source: CZSO


Retail sales fell by 0.3% y-o-y (seasonally adjusted) in 2013 H1 but rose by 5.6% y-o-y (s.a.) in 2014 H1

Retail sales (y-o-y changes in %; constant prices)


Source: CZSO

Spending on deferred consumption items such as cars is rising the fastest

Retail sales: four categories (y-o-y changes in %; constant prices)


Source: CZSO, own computations

* Easter holidays in 2013: March; in 2014: April

Exports, imports and capital formation

Source: CZSO

The broadly flat next exports in 2014 H1 reflect a recovery in consumption- and investment-related imports


Labour market

• Proportion of part-time work is falling • Number of employed (Labour Force Survey; s.a.) rose from

4,856,900 in 7/2013 to 4,872,000 in 7/2014, i.e. by more than 15,000

• Number of unemployed (LFS; s.a.) fell from 364,800 in 7/2013 to 313,500 in 7/2014, i.e. by more than 51,000

• Number of vacancies (Ministry of Labour and Social Affairs) rose from 40,200 in 7/2013 to 51,100 in 7/2014, i.e. by 10,900 (and from 40,600 in 8/2013 to 54,700 in 8/2014, i.e. by 14,100)

More than 25,000 jobs were created in the economy between July 2013 and July 2014


State budget performance (CZK bn – GFS 1986 methodology)

Source: Ministry of Finance

The deficit for 1–8/2014 was down CZK 21.4 billion y-o-y; total budget revenues were up 5.8% in the same period


Annual inflation was at very low levels in 2014 Q2; in July it rose to 0.5% and in August to 0.6%

Inflation (y-o-y in %)

Source: CZSO


The long-running y-o-y decline in the “tradables – other” category switched to y-o-y growth in 7/2014

Inflation – main categories (y-o-y in %)

Source: CZSO, CNB


Industrial producer prices (annual percentage changes; contributions in

percentage points)

The y-o-y decline in industrial producer prices has been slowing since March; in July it stood at -0.1% and in August at 0%

Source: CZSO


CNB forecast (August 2014)


GDP will grow on the back of accelerating growth in external demand, easy monetary conditions and higher government investment

Source: CNB

GDP growth forecast (annual percentage changes; seasonally adjusted)


Headline inflation will start rising in 2014 Q3 and will be close to the target at the monetary policy horizon

Headline inflation forecast (y-o-y in %)

Source: CNB


Monetary-policy relevant inflation will be just below the target at the monetary policy horizon

Monetary-policy relevant inflation forecast (y-o-y in %)

Source: CNB


The forecast expects market interest rates to be flat at their current very low level until 2015 Q3

Interest rate forecast (3M PRIBOR in %)

Source: CNB


GDP growth will fluctuate around 3% over the next few years; the growth will be macroeconomically balanced

CNB forecast in figures

• GDP: 2.9% in 2014; 3.0% in 2015; 2.8% in 2016 • CPI: 0.4% in 2014; 1.8% in 2015; 2.1% in 2016 • 3M PRIBOR: 0.4% in 2014; 0.5% in 2015; 1.6% in 2016 • Real wages: 2.3% in 2014; 2.7% in 2015; 2.5% in 2016 • Unemployment (ILO): 6.4% in 2014; 6.3% in 2015 • Gov. deficit as % of GDP: -1.2% in 2014; -1.5% in 2015 • Gov. debt as % of GDP: 45.4% in 2014; 44.9% in 2015 • Current account as % of GDP: -0.4% in 2014; 0.2% in 2015


Monetary policy decision of 31/7 • Board decided to continue using exchange rate as additional instrument

for easing monetary conditions and confirmed commitment to intervene in market if needed to weaken exchange rate so as to keep it close to CZK 27/euro

• Asymmetric nature of exchange rate commitment, i.e. willingness only to intervene against appreciation below announced level, is unchanged

• Return to conventional monetary policy will not imply appreciation to level recorded before CNB started intervening, as weaker exchange rate of koruna is in meantime passing through to prices and other nominal variables

• Risks of forecast were assessed as slightly anti-inflationary; main risk is longer-lasting very subdued inflation in euro area

• Board would have to find further noticeable increase in anti-inflationary factors before moving exchange rate commitment to weaker level

The CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2016 M. Singer – Exchange Rate as Monetary Policy Instrument: CNB Experience 37

A recession in the euro area would be a greater risk than the impacts of the Ukraine–Russia conflict (unless its extreme scenarios materialise)

Risks going forward • Euro area:

Slowing growth and possible return of recession Risk of deflation High debt burden (need for deleveraging)

• Ukraine and Russia: Further escalation of conflict and deeper economic decline Russian retaliatory measures (further restrictions on imports in EU)

• Czech trade with Ukraine and Russia: Goods turnover in 2013: Ukraine 0.9%; Russia 4.5% Main exports to Russia: machinery, cars; main imports: oil, gas Oil imports to CZ are not dependent on pipelines via UKR and RUS

• Banks in CZ have large credit exposures to UKR and RUS potential negative impacts on their operations in CZ


The Czech economy is on a path towards equilibrium and faster growth; external factors could slow the growth

Summary • Czech economy has avoided deflation and emerged from recession • Recovery is on increasingly firm foundations (rising domestic demand);

growth aided by government policies and Nov weakening of koruna • Czech economy growing much faster than most advanced EU countries • Inflation low but non-negative; low inflation due to subdued inflation in

euro area, falling administered prices and slowing food inflation • Inflation will gradually rise, returning to 2% target in 2015 H2 • Job creation will increase in 2015 • CNB will not discontinue use of exchange rate as monetary policy

instrument before 2016 • External risks rising due to developments in euro area and Ukraine–

Russia conflict • Impacts of conflict on domestic growth will depend on further

developments (current estimates are in tenths of pp)


Thank you for your attention

Miroslav Singer Czech National bank

Na Příkopě 28 115 03 Praha 1

[email protected] Tel: +420 224 412 000


use of the exchange rate as a monetary policy instrument ......sep 26, 2014 · • in november...

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