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Press release on the Monetary Council’s meeting of 26 May 2008

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26 May 2008

1     At its meeting on 26 May 2008, the Monetary Council reviewed the latest economic and financial developments and voted to raise the central bank base rate by 25 basis points, from 8.25% to 8.50%, with effect from 27 May 2008.

2     The Council discussed the May 2008 issue of the Bank’s Quarterly Report on Inflation. In the Council’s view, consistent with the projection presented in the Report, Hungarian economic growth continues to be subdued and the fall in inflation has been less rapid than expected. The Council decided to raise official interest rates at its meetings in March and April in response to the deterioration in the outlook for inflation.

Inflation has been falling less fast than expected, due to cost shocks of domestic and international origin: inflation may be significantly above target in 2009 assuming unchanged monetary conditions; however, it may reach the target in 2010, if the significant upside risks do not materialise. The output gap is likely to remain negative over the entire forecast period, due in part to the dampening effects on demand of fiscal policy, which will help to reduce inflation through its disciplinary effect on domestic firms’ price and wage setting decisions. Improvements in external and domestic balance is expected to reduce the vulnerability of the economy.

However, there are significant upside risks on the horizon relevant for monetary policy. Despite the pressing need to adjust, the reduction in the rate of wage growth may be slower than expected as a consequence of the recent cost shocks. If economic agents pass more of the cost increases through to higher prices, or if they rely more heavily on past inflation in their price and wage-setting decisions than assumed in the central projection, it will add to inflation pressures. And if the recent deterioration in the global inflation environment continued, it would also increase the risk of higher domestic inflation.

In the Council’s judgement, the policy tightening that has taken place so far will contribute to the further reduction in inflation, despite the strong cost shocks affecting the economy. The Council remains committed to achieving the 3 per cent target, while striving to prevent second-round effects. It has taken its decision to raise the base rate in view of the significant risk that the inflation target would not be met on the horizon relevant for policy. The Monetary Council believes that maintaining tight monetary policy is necessary and it will stand ready to take actions, if there is a threat to the inflation target.

3       The abridged minutes of today’s Council meeting will be published at 2 p.m. on 13 June 2008.

MAGYAR NEMZETI BANK

MONETARY COUNCIL