CNB’s Exchange Rate Commitment:
Past, Present and Future
Vladimír Tomšík (Vice-Governor)
Tomáš Holub
(Executive Director, Monetary Department)
28 October 2015, London
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
Background of November 2013 decision
• In 2012–2013, the Czech economy was going through the longest recession in its history (impact of weakening foreign demand and domestic fiscal consolidation under way):
− decline in 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
4
Alternative regime choices
• Inflation targeting had served the Czech Republic well, and its logic clearly required a further easing of the monetary conditions.
• Alternative policy regimes were viewed as clearly inferior:
− Exchange rate peg: would eliminate the role of the exchange rate as a shock
absorber; negative own experience from the 1990s
− Price level targeting: an option unexplored in practice; may require deflationary
policy if the price level overshoots the target; would require an even more
aggressive easing in the November 2013 situation, thus not solving the problem of having to find a further MP instrument at the ZLB
− Nominal GDP targeting: similar issues to price level targeting, plus the problem
of significant national account revisions
• Within the inflation targeting framework, the exchange rate was assessed as by far the most efficient ZLB instrument in the Czech context.
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:
• The 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.
The CNB is a forward-looking inflation targeter.
Exchange rate since the decision
• After the CNB’s policy announcement, the koruna reached 27 CZK/EUR quickly, and has been moving at somewhat weaker levels since then.
• Actual interventions only within a few days after the CNB’s policy
decision. Further interventions needed in late summer 2015 (data so far
published for July and August, in line with our regular release calendar). 6
CZK/EUR rate, CNB commitment and FX interventions
0 1 2 3 4 5 6 7 8 25 26 27 28 29 1/13 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)
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
-3 -2 -1 0 1 2 3 4 5
I/11 I/12 I/13 I/14 I/15
Manufacturing Other industry
Agriculture Construction
Financial services Trade and other services
-3 -2 -1 0 1 2 3 4 5
I/11 I/12 I/13 I/14 I/15
Government consumption Net exports
Change in inventories Gross fixed capital formation
Household consumption
GDP growth
Demand side:
• GDP is growing mainly thanks to domestic demand.
− Corporations and households have stopped postponing their expenditure. − A positive fiscal impulse.
Supply side:
• Industry and services have been the biggest contributors to GVA growth since 2014.
− The recovery was initially driven by the export-oriented manufacturing sector,
but has now become broad-based. 8
Structure of annual GDP growth
70 75 80 85 90 95 100 105 110 1/11 7 1/12 7 1/13 7 1/14 7 1/15 7 Business indicator Consumer indicator
Composite confidence indicator -15 -10 -5 0 5 10 15 20 1/11 7 1/12 7 1/13 7 1/14 7 1/15 7 Industrial production Seasonally adjusted data HP trend
Industrial production and confidence
• Industrial production growth
continued in 2015 Q3.
• Data on construction output and
retail sales also show ongoing high growth.
• Business and consumer confidence has increased noticeably since 2013.
9
Industrial production index
Labour market
• The economic recovery is having a visible positive impact on the labour market.
− Unemployment has been decreasing noticeably.
− The average nominal wage has been rising in both the business and non-business sectors.
10
Average nominal wage (annual percentage changes) Unemployment indicators
(percentages; s.a.)
LFSS = Labour Force Sample Survey
4 5 6 7 8 9
I/11 I/12 I/13 I/14 I/15
General unemployment rate (LFSS) Share of unemployed persons
-3 -2 -1 0 1 2 3 4
I/11 I/12 I/13 I/14 I/15
Average wage in the Czech Republic
-1 0 1 2
1/14 4 7 10 1/15 4 7
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)
Inflation
• 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 price decline is caused by the global drop in oil prices.
11
Structure of inflation
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
GDP forecast
• GDP growth accelerated to 4.6% in 2015 Q2 (there are one-off factors in 2015).
• The forecast expects GDP growth to continue thanks to expanding domestic and external demand.
• However, in 2016–2017 it will slow to slightly less than 3%, implying no tendency to overheat.
13
Current CNB forecast and outcome in 2015 Q2
-4 -2 0 2 4 6
I/11 I/12 I/13 I/14 I/15 I/16 I/17 Change in inventories Government consumption Gross fixed capital formation Net exports
Household consumption GDP growth
GDP growth structure (annual percentage changes; s.a.)
-4 -2 0 2 4 6 8 10
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
Labour market forecast
• The rising economic activity will manifest itself in a further improvement in the labour market situation.
− 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.
− In 2015 Q2 wage growth picked up pace more strongly than expected by the CNB forecast, but nominal unit labour costs actually decreased in year-on-year terms.
14 4 5 6 7 8 -2 -1 0 1 2
I/11 I/12 I/13 I/14 I/15 I/16 I/17 Employment
General unemployment rate (right-hand scale)
Employment, unemployment
(annual percentage changes; percentages; s.a.)
-4 -2 0 2 4 6
I/11 I/12 I/13 I/14 I/15 I/16 I/17 Nominal wages in the business sector
Nominal wages in the non-business sector
Average nominal wage (annual percentage changes)
Inflation forecast
• Headline inflation slowed in 2015 Q3 (more than the July forecast had expected) and is still well below the CNB’s target.
− The downward surprise is mainly caused by food prices.
− Fuel prices also fell more than forecasted (due to low oil prices).
− Adjusted inflation excluding fuels (i.e. core inflation) developed as expected.
• Despite an expected increase, inflation will remain below the target for
most of next year. 15
Current CNB forecast and expected outcome in 2015 Q3
-1 0 1 2 3 4 5 6
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 Inflation target Monetary policy horizon -1 0 1 2 3
I/11 I/12 I/13 I/14 I/15 I/16 I/17
Net inflation Adjusted inflation excluding fuels
0 1 2 3
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
Interest rate forecast
• 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.
− Consistent with the forecast is an increase in rates in 2017.
According to the forecast, sustainable fulfilment of the target, which is a condition for a return to conventional MP, will not occur until early 2017.
16
Risks to the forecast
17
• The risks to the forecast over the next few quarters were assessed as being anti-inflationary by the CNB Bank Board at its September MP meeting.
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
The staff have just finalized a new forecast incorporating these risks, which will be discussed by the Board
VW scandal
as a risk to the forecast?
• The automotive sector is very important in the Czech economy, but it has by far not been the only driver of Czech growth.
• Besides the negative profitability and reputational effects, there are also some potentially positive ones:
− Škoda is not present in the US market, where the legal consequences may be severe.
− Škoda is not producing diesel engines, and may benefit from a shift to petrol engines.
− Škoda is a close – and cheaper – substitute to VW, less reliant on the brand premium.
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
Prospect of exit from the exchange rate floor
• The CNB Bank 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.
• In case of growing anti-inflationary risks, the exit may 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 (see the next part of our presentation).
• Negative interest rates are not a preferred tool of the CNB’s monetary policy; however, the CNB has not ruled out their potential use if needed.
To sum up, there are no factors that could lead to an exit before the second half of 2016.
Czech vs. Swiss approach and exit
21
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 haven yes, on global scale no (or regional only) Communication of exit none from very beginning Characteristics of exit discretionary explicitly linked to
sustainable achievement of inflation target Regime after exit officially free float managed float • Even though the two floors are seemingly quite similar, one can find
marked 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 will be market positioning before the exit.
Design of 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.
Exchange rate after 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 a counterparty (real-money clients will be hedged by previous transactions and there will be no counterparty to close long koruna positions). − Slower real equilibrium appreciation in subsequent years compared to pre-crisis
figures (see the next slide).
The CNB will be prepared to intervene in case of excessive appreciation (standard managed float regime).
24
Equilibrium trends in CNB forecasts
• The GDP growth differential is likely to be smaller after the crisis than before the crisis (1.2 p.p. now vs 1.9 p.p. before) due to:
− a more mature stage of the GDP catching-up process (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 the inflation differential if EA inflation stays below 2%.
The exact numbers are subject to uncertainty, but qualitatively the argument is clear-cut.
in % Before crisis Post-crisis
Czech GDP growth 4.0 3.0
Effective EA GDP growth 2.1 1.8
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
26
• Monetary policy objective set forth
− in the Constitution of the Czech Republic
− in the Act on the Czech National Bank.
• The CNB’s primary objective is to maintain price stability.
• The CNB shall support the general economic policies of the Government leading to sustainable economic growth
− without prejudice to its primary objective
− with full independence of the CNB in its conduct of monetary policy.
• In line with its primary objective, the CNB manages international reserves with professional care (i.e. it optimizes the risk-return trade-off, taking their size as given, determined by the monetary policy objectives).
Monetary policy has clear priority over any financial considerations.
CNB’s past experience with negative equity
• The CNB had negative equity for 16 years without experiencing any problems for its monetary policy or its other legal responsibilities.
• The Czech government has not been used to profit distributions from
the CNB (unlike in the Swiss case). 27
-100% -75% -50% -25% 0% 25% -200 -150 -100 -50 0 50 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 C Z K bn.
CNB’s past P&Ls and their sources
• In 2001–2007, FX revaluation losses due to an appreciating nominal exchange rate were the main source of the CNB’s total losses (while the other components of the P&L were clearly positive on balance).
• This source of losses has always been viewed as legitimate, and not
undermining sound monetary policy. 28
-80 -60 -40 -20 0 20 40 60 80 100 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0 2 01 1 2 01 2 2 01 3 2 01 4 CZK b n .
FX revaluation MP and FX reserves yields
Bank restructuring etc. Other (operational costs etc.)
CNB’s balance sheet structure
• The FX revaluation losses were linked to the fact that the CNB’s assets are dominated by foreign assets, which are not matched by foreign
liabilities.
• But this does not mean that the FX reserves are excessive (see the next
CNB’s FX reserves vs other IT countries
30
Total Reserves as % of GDP (in 2014) Total Reserves in Months of Imports (in 2014) Total Reserves as % of M2 (in 2014)
0% 10% 20% 30% 40% 50% UK Australia Canada Dominican Rep. New Zealand Sweden Uganda Guatemala Indonesia Colombia South Africa Norway Turkey Ghana Armenia Mexico Brazil Chile Georgia Poland Albania Romania Paraguay Iceland South Korea Philippines Serbia Czech Republic Japan Moldova Israel Peru Hungary Thailand 0 5 10 15 20 UK Canada Australia Dominican Rep. Georgia Armenia Ghana Czech Republic Sweden New Zealand Guatemala Hungary Moldova Poland Turkey South Africa Mexico Romania Serbia Uganda Paraguay Chile Albania Indonesia Thailand South Korea Colombia Norway Iceland Philippines Israel Peru Japan Brazil 0% 20% 40% 60% 80% 100% UK Australia Canada New Zealand Sweden South Korea South Africa Turkey Norway Mexico Chile Georgia Thailand Poland Indonesia Colombia Guatemala Czech Republic Albania Philippines Brazil Serbia Paraguay Iceland Israel Romania Ghana Dominican Rep. Hungary Uganda Peru Japan Moldova Armenia
Yields on CNB’s FX reserves
• The yield in foreign currency has consistently exceeded the CNB’s sterilisation costs over the last decade, on average by 1.9 p.p. a year.
• It is far from obvious that the koruna’s future nominal appreciation trend will be higher than that (we assume 1.5% a year in real terms in our
macro forecasts for the post-crisis period).
31 -10% -5% 0% 5% 10% 15% 20%
Outline
• Exchange rate as a further instrument in the inflation targeting regime
• Current economic developments
• CNB forecast
• Prospect of exit from the exchange rate floor
• Balance sheet consequences – an analysis of the irrelevant
• Summary and conclusions
Summary and conclusions
• The CNB is using the exchange rate as a further monetary policy instrument at the ZLB successfully 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.
• The CNB will not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016.
• Balance sheet consequences are strictly secondary to the price stability objective (and may be more benign than most people seem to believe).
• 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
