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THE MONETARY COUNCIL’S STATEMENT IN THE SEPTEMBER 2013 ISSUE OF THE QUARTERLY REPORT ON INFLATION

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24 September 2013

At its meeting on 24 September 2013, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 20 basis points from 3.80% to 3.60%, with effect from 25 September 2013.

Since August 2012, the Monetary Council has reduced the level of the central bank base rate in a series of cautious steps, but to a substantial extent overall.

Over the period, the condition of the real economy, and particularly weak domestic demand, warranted a significant reduction in the base rate, while the outlook for inflation remained consistent with the achievement of the 3 per cent target over the medium term. Changes in perceptions of the risks associated with the economy were supportive throughout the period. The substantial easing in monetary policy so far and higher volatility in sentiment in global financial markets in the past month have called for increased caution.
The Council is seeking to maintain a balanced and conservative approach to monetary policy. In addition to the priority of meeting the inflation target, the Council will also take into account the condition of the real economy and pay particular regard to financial stability considerations. Marked and lasting shifts in perceptions of the risks associated with the economy may influence the room for manoeuvre in monetary policy.

In the Council’s judgement, currently there is no material inflationary pressure in the economy.

In recent months, the Bank’s measures of underlying inflation have fallen to historically low levels. Favourable developments in underlying inflation reflect the combined effect of subdued domestic demand, declining inflationary pressures in external markets and the gradual adjustment of inflation expectations. The reductions in regulated prices, implemented in a series of steps this year, have also contributed to the development of a low inflation environment.
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 domestic demand remaining subdued, 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 moderate earnings growth, which in turn may contribute to the maintenance of the low inflation environment. Overall, inflationary pressures are likely to remain muted over the medium term.

The global environment points to the maintenance of persistently accommodative monetary conditions.

Global activity was driven by developed economies in the second half of the year. By contrast, economic activity in developing countries, whose share of Hungarian exports has been increasing, was weaker than expected. Looking ahead, the significant differences in growth rates across the most important economic regions are likely to narrow, with the slow expansion in external demand in the second half expected to continue next year.

Demand-side inflationary pressures remain weak as economic growth continues at a moderate pace. In response, developed country central banks have maintained loose monetary conditions. In terms of perceptions of the risks associated with the Hungarian economy, sentiment in global financial markets have been broadly supportive; however, sentiment deteriorated and risk aversion increased in markets in the past quarter. In addition to developments in the euro-area debt crisis, expectations related to the liquidity measures by major central banks and risks facing large emerging economies were the main factors influencing investor decisions.

Looking ahead, the Monetary Council expects the pattern of growth to be more balanced.

Economic growth is likely to pick up gradually in the coming quarters. Both exports and domestic demand are expected to contribute to the slow improvement in underlying growth. Exports are likely to remain the main driving force behind growth: in addition to the recovery in external demand, the increase in the market share of Hungarian exports is expected to contribute to export growth, due to the instalment of new capacity in the automobile industry. Low inflation and wage increases for certain employee groups in the public sector are expected to boost the purchasing power of households’ disposable income. However, household caution is only likely to diminish as debts accumulated in the past are reduced. In addition to the investment projects implemented by the Government from EU funds, private sector investment demand is likely to remain moderate, reflecting unused capacity, the uncertain outlook for growth and tight credit conditions. However, the Bank’s Funding for Growth Scheme is expected to contribute to an easing in financing constraints for small and medium-sized enterprises, thereby supporting the recovery in private investment.
Overall, demand is likely to remain below the productive capacity of the economy, and therefore the real economic environment is expected to remain disinflationary looking ahead. The negative output gap may close at the end of the forecast horizon.

External debt is likely to fall further.

The external surplus of the Hungarian economy is likely to rise further this year, reflecting a rising surplus on goods and services partly due to the improvement in the terms of trade, the expected decline in the income deficit and the increasing use of EU transfers. In 2014, however, the surplus on goods and services is unlikely to rise further, partly reflecting higher investment and imports as a result of the Funding for Growth Scheme, while the amount of EU transfers is likely to fall, due to the new budget cycle. But with the external financing capacity remaining high, the external debt ratio is likely to fall further, which in turn will reduce the country’s vulnerability.

In the Council’s judgement, the medium-term achievement of the inflation target and the condition of the real economy continue warrant further cautious easing of policy.

In the Council’s view, the economic data becoming available in the course of the year indicate that weak domestic demand and loose labour market conditions have a strong disciplinary effect on economic agents’ price and wage-setting decisions. Although temporary effects have also contributed to the reduction in inflation, underlying developments point to continued moderate inflationary pressure even in the medium term. There continues to be significant spare capacity in the economy and output is likely to return to its potential level only gradually. As a result of these factors, inflation is likely to remain persistently below the 3 per cent target, before returning to it at the monetary policy horizon. The low inflation environment may help the Bank’s inflation target to better anchor the nominal path of the economy. Taking into account developments in perceptions of the risks associated with the economy, the medium-term achievement of the inflation target can be ensured with policy easing which is more cautious than usual.

The macroeconomic outlook is surrounded by a range of uncertainties.

In the Council’s judgement, the degree and disinflationary impact of spare capacity in the economy as well as uncertainty around the global financial market environment are the two most important sources of risk to monetary policy. There are both upside and downside risks to developments in investment, and consequently to the future path of the economy’s potential output.

In the Council’s view, the potential output of the Hungarian economy has been growing at a slow rate since the outset of the crisis, reflecting weak investment and the existing financing constraints; however, the size of available capacity that could be brought into production is surrounded by a considerable degree of uncertainty. A wider cyclical position and lower inflation expectations may lead to stronger disinflation through price and wage-setting decisions, which in turn may warrant a further substantial easing of policy. In the Council’s judgement, possible developments in the external environment, both in terms of the real economy and financial markets, may adversely affect perceptions of the risks associated with the Hungarian economy and limit the room for manoeuvre in monetary policy.

Looking ahead, the recovery in investment may be faster if companies spend a greater portion of loans received under the Funding for Growth Scheme to finance additional and sustainable investment. If the decline in investment experienced during the crisis proves longer than expected, it may result in a less favourable path.

Based on the above considerations, the Monetary Council has decided to reduce the base rate by 20 basis points.

In the Council’s judgement, there remains a significant degree of spare capacity in the economy and inflationary pressures are likely to remain moderate. Achieving the 3 per cent inflation target over the medium term provides scope for further monetary policy easing. Global financial markets are showing signs of stabilisation following a period of increased volatility. A sustained and marked shift in perceptions of the risks associated with the Hungarian economy may influence the room for manoeuvre in monetary policy. In the Council’s view, considering the outlook for inflation and the real economy and taking into account perceptions of the risks associated with the economy, further cautious easing of monetary conditions may follow.


The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 October 2013.

Magyar Nemzeti Bank

Monetary Council