THE MONETARY COUNCIL’S STATEMENT IN THE JUNE 2013 ISSUE OF THE QUARTERLY REPORT ON INFLATIONPrint
At its meeting on 25 June 2013, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 25 basis points from 4.50% to 4.25%, with effect from 26 June 2013.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 10 July 2013.
The Monetary Council has reduced the level of the central bank base rate in a series of small steps, but significantly overall, since August 2012.
The condition of the real economy, and particularly weak domestic demand, warranted a significant reduction in the base rate over the entire period, while the outlook for inflation shifted in the same direction and changes in perceptions of the risks associated with the economy were supportive. Consequently, incoming data and information have confirmed that the Monetary Council had appropriate room to continue the current monetary policy easing cycle. The recent policy actions have been consistent with the medium-term achievement of the inflation target.
The Council will maintain a consistent and conservative approach to monetary policy. In addition to the priority of meeting the inflation target in the medium term, the Council will also take into account the condition of the real economy and financial stability considerations. Marked and lasting shifts in perceptions of the risks associated with the country’s economy may influence the room for manoeuvre in monetary policy.
In the Council’s judgement, the medium-term outlook for inflation remains consistent with the medium-term achievement of the inflation target.
In the short term, inflation is likely to ease further, mainly driven by falls in administered prices and commodity prices, while developments in underlying inflation will continue to reflect the disinflationary impact of weak domestic demand. The inflation rate adjusted for the direct price level increasing effects of indirect taxes is expected remain below 3 per cent over the medium term. In the longer term, the effects of government measures increasing production costs in some sectors are likely to feed through to the corporate sector. With capacity utilisation remaining low, however, the pass-through to consumer prices is likely to be gradual and partial. Looking forward, companies’ efforts to rebuild profitability, loose labour market conditions and the adjustment of inflation expectations are likely to lead to historically low earnings growth, which, in turn, may contribute to the maintenance of the low inflation environment. Overall, inflationary pressures are likely to remain moderate over the medium term.
Global economic activity picked up in the first quarter of 2013. But the risk of a multispeed growth environment amidst the global recovery increased.
Following the improvement in the previous period, sentiment in international financial markets weakened, while indicators of real economic activity remained subdued. The major central banks maintained or eased further monetary conditions in the past quarter, in line with the fragile economic situation and the low inflation environment. In terms of perceptions of the risks associated with the Hungarian economy, sentiment in global financial markets was supportive over the past quarter, but investor uncertainty has increased recently.
Hungarian economic growth resumed in the first quarter of 2013.
The rate of domestic growth, which was favourable in an international comparison, was also supported by the adjustment affecting output in some sectors of the economy at the beginning of the year. However, the slow improvement in underlying growth suggests that the expansion of domestic GDP may continue in the next quarters. Growth is likely to be driven by exports, and new capacity created in the automobile industry may contribute to an increase in Hungary’s export market share even as external demand remains subdued. Domestic demand is expected to stabilise this year following the decline in previous years. Household real income is expected to grow markedly this year, but the reduction in debts accumulated in previous years, tight lending conditions and precautionary motives may impede a faster recovery in consumption. The Council expects corporate investment to fall this year as the investment projects in the automobile industry are completed. With the outlook for demand improving, a tangible improvement in investment is likely to occur, which may be supported by favourable lending conditions for small and medium-sized enterprises resulting from the Funding for Growth Scheme. A material recovery in domestic demand is expected 2014.
Hungary’s current account adjustment has been one of the most significant across European Union countries since the onset of the crisis.
The external surplus of the Hungarian economy is expected to increase further in 2013, before stabilising at a high level in 2014, reflecting the further gradual rise in net exports and the increased use of EU transfers. The country’s external liabilities and debt are likely to continue to fall as the external balance improves further, which may contribute to a reduction in Hungary’s external vulnerability.
The government deficit on an accrual basis is expected to remain below 3 per cent of GDP both in 2013 and 2014. Gross government deficit is likely to remain on a downward path over the forecast period and fall below 78 per cent by 2014.
In the Council’s judgement, the achievement of the medium-term inflation target and the condition of the real economy allow further cautious monetary policy easing.
In the Council’s view, the economic data becoming available in the first half of the year suggest that weak domestic demand and slack in the labour market have a strong disciplinary effect on economic agents’ price and wage-setting decisions, while temporary effects have also contributed to a reduction in inflation this year. The tax-adjusted inflation rate is expected to remain below 3 per cent over the medium term — the direct upward effect on prices of the Government’s tax measures is outside the influence of monetary policy. The low inflation environment may help to better anchor the nominal path of the real economy to the Bank’s inflation target. Looking ahead, the output of the Hungarian economy is likely to return to its potential level only gradually, which suggests that inflationary pressures will remain moderate as the temporary effects dissipate. The latter will also be supported by developments in underlying inflation and the subdued rate of earnings growth. The Council judges that the medium-term achievement of the inflation target and the position of the real economy warrant further monetary policy easing. However, changes in risk perceptions represent a risk in terms of the room for manoeuvre in monetary policy.
There is significant uncertainty surrounding future developments in the macroeconomy and financial markets.
In the Council’s judgement, the degree of spare capacity in the economy and the global financial market environment are the two most important sources of uncertainty for monetary policy.
The potential output of the Hungarian economy has been growing at a slow rate since the onset of the crisis, reflecting the decline in investment and the existing financing constraints; however, there continues to be a considerable degree of uncertainty surrounding the size of available capacity that could be brought into production. If productive capacity has been damaged to a smaller extent, then the path of potential output may be higher and the cyclical position of the economy may be wider. With a wider cyclical position, the ability of companies to pass on cost shocks into prices is more limited and the inflationary impact of cost shocks to companies is smaller, which, in turn, may warrant a further substantial easing of policy.
In the Council’s view, global financial markets have become more fragile recently. Developments related to the quantitative easing programmes implemented by leading central banks will be key in sustaining the supportive financial market environment. A further uncertainty arises from the possibility that the euro-area recession will be more prolonged despite the significant efforts by European institutions. A marked deterioration in the financial environment may limit the room in which monetary policy can manoeuvre.
Based on the above considerations, the Monetary Council has decided to reduce the base rate by 25 basis points. In the Council’s judgement, there remains a significant degree of spare capacity in the economy, inflationary pressures are likely to remain moderate in the medium term, and therefore the 3 per cent target can be met with looser monetary conditions. However, the global financial market environment has been volatile recently. A sustained and marked shift in perceptions of the risks associated with the economy may influence the room for manoeuvre in monetary policy. The Council judges that as long as the outlook for inflation and the real economy justifies it, interest rates can be reduced further; however, increased caution is warranted in the volatile and rapidly changing global environment.
MAGYAR NEMZETI BANK