THE MONETARY COUNCIL’S STATEMENT IN THE June 2014 ISSUE OF THE inflation REPORTPrint
24 June 2014
At its meeting on 24 June 2014, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 10 basis points from 2.40% to 2.30%, with effect from 25 June 2014.
The monetary council’s statement on macroeconomic developments and its monetary policy assessment
Since August 2012, the Monetary Council has reduced the central bank base rate significantly.
The reductions in the base rate during the period were justified by the low inflation environment, subdued medium-term inflationary pressures and a degree of spare capacity in the economy. Risk perceptions associated with the economy were also generally supportive. In the Council’s judgement, the significant easing of monetary policy implemented so far has helped the Bank achieve the inflation target in the medium term and has contributed to the strengthening of domestic economic growth. The Council’s aim is still to maintain a balanced and conservative approach to policy. In addition to the primary goal of meeting the inflation target, the Council also takes into account the condition of the real economy and incorporates financial stability considerations into its decisions.
Inflation is likely to remain low for an extended period and to reach levels around 3 per cent consistent with price stability only at the forecast horizon.
In the Council’s judgement, inflation is likely to remain well below the 3 per cent target in 2014, before moving into line with the medium-term inflation target from the second half of 2015. The dynamics of consumer price inflation have been historically low in recent months. Subdued inflation in external markets, the degree of unused capacity in the economy, moderate wage growth, the fall in inflation expectations and the reductions in regulated prices, implemented in a series of steps, have all contributed to the development of a low inflation environment. At the forecast horizon, the domestic real economic environment is expected to continue to have a disinflationary impact, although to a declining extent. Persistently low inflation alongside rising domestic demand reflects mainly the positive impact of moderate wage growth due to continued slack in the labour market and other supply-side cost shocks. The persistently low inflation environment is expected to help anchor inflation expectations playing a key role in determining the nominal path of the economy more firmly around the Bank’s inflation target.
In the Council’s judgement, the Hungarian economy returned to a growth path in 2013. Looking ahead, economic growth is likely to continue.
Economic activity has picked up gradually in the past quarters, with output rising across a wide range of sectors. Looking ahead, Hungarian economic growth may continue in a more balanced pattern than previously. Rising exports are likely to play an important role as a source of growth in the coming years as well. In addition, domestic demand is also expected to strengthen further. Investment is likely to continue accelerating, reflecting the improvement in the outlook for activity, the easing in credit constraints also due to the Bank’s Funding for Growth Scheme and the increasing use of EU funding. Household consumption is also likely to grow gradually, resulting from the expected increase in the real value of disposable income and the reduced need for deleveraging. Meanwhile, the behaviour of a large number of households continues to be influenced by the ongoing reduction in debts accumulated in the years prior to the crisis and the gradual easing in credit conditions. As a result, propensity to save is likely to remain persistently above levels seen in the period prior to the crisis. Despite the pick-up in domestic demand, capacity utilisation is expected to improve only gradually due to the protracted recovery in Hungary’s export markets.
Financing capacity stabilising at high levels; falling external debt.
The external position of the economy continued to improve towards the end of 2013, as reflected in the significant decline in external debt ratios. The trade surplus, while remaining substantial in the coming years even as import picks up due to increasing consumption and investment, is likely to keep the current account surplus high over the entire forecast period. The slight decline in the income balance deficit is expected to contribute to Hungary’s external position remaining strong. On balance, the external financing capacity of the economy is likely to remain high despite the slight fall in EU transfers due the new budget cycle. In line with this, the country’s debt ratios, key indicators in terms of the country’s vulnerability, are likely to continue to improve. At the same time, the Bank’s self-financing programme is expected to help reduce the country’s gross external debt.
The Hungarian risk premium has declined significantly in the past quarter. Volatility fell in financial markets.
International investor sentiment was volatile in the past quarter, mainly reflecting the reduction in the pace of the Fed’s asset purchases, the ECB’s interest rate cut and announced new package of policy measures and the continuation of the conflict between Ukraine and Russia. Domestic risk premia have fallen significantly since publication of the March Report. The CDS spread, foreign currency bond spreads and long-term yields declined. The exchange rate appreciated. The volatility of the major risk indicators fell relative to the previous quarter. The announcement of the Bank’s self-financing concept also contributed to the improvement in risk perceptions associated with the economy. Compared with other emerging market economies, Hungary’s persistently high external financing capacity and the resulting decline in external debt have contributed significantly to the reduction in its vulnerability. The Monetary Council will continue to closely monitor developments in the global financial environment.
The macroeconomic outlook is surrounded by both upside and downside risks.
In connection with the baseline projection in the June Report, the Monetary Council identified three alternative scenarios which might significantly influence the future conduct of monetary policy. In the alternative scenario assuming a persistently low external inflation environment and a slower-than-expected recovery in external demand, the inflation target may be achieved with looser monetary conditions than assumed in the baseline scenario. In the risk scenario assuming an unfavourable external environment and higher investor risk aversion, inflation moves in line with price stability in the medium term under considerably tighter monetary conditions than implied by the baseline projection. A third scenario, assuming a pick-up in domestic employment and consumption, resulting in stronger growth in domestic economic activity, also implies a tighter monetary policy stance.
After reviewing the projection in the June Report, the Council judges that there remains a degree of unused capacity in the economy and inflationary pressures in the economy are likely to remain moderate for an extended period. The negative output gap is expected to close gradually at the monetary policy horizon; however, achieving price stability in the medium term points in the direction of monetary easing and the macroeconomic outlook points in the direction of persistently loose monetary conditions. Considering the outlook for inflation and taking into account perceptions of the risks associated with the economy and the pick-up in economic growth, further cautious easing of monetary policy may follow; however, based on available information the central bank base rate has significantly approached a level which ensures the medium-term achievement of price stability and a corresponding degree of support for the economy. Over the coming period, changes in the domestic and international environment might influence this picture.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 July 2014.
MAGYAR NEMZETI BANK