THE MONETARY COUNCIL’S STATEMENT IN THE SEPTEMBER 2014 ISSUE OF THE INFLATION REPORTPrint
23 September 2014
At its meeting on 23 September 2014, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 2.10%.
the monetary council’s statement on macroeconomic developments and its monetary policy assessment
The Monetary Council finished the two-year easing cycle in July 2014.
With a cumulative 490 basis point reduction, the central bank policy rate fell to 2.1 per cent as a result of a two-year easing cycle. In the Council’s judgement, with the easing cycle finished, maintaining the current low level interest rates for an extended period ensures the achievement of the Bank’s medium-term inflation target and a corresponding degree of support to the real economy. 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 close to zero per cent this year, before rising to levels around 3 per cent consistent with price stability in the second half of the forecast period.
The Council expects the inflation rate, on average, to remain around zero per cent, before rising gradually to levels around the medium-term target in the course of next year. The dynamics of consumer price inflation have continued to be historically low in recent months. Low inflation in external markets, favourable developments in commodity prices and imported inflation, subdued domestic demand, the fall in inflation expectations and the reductions in administered energy prices have all contributed to the low inflation environment. At the forecast horizon, the domestic real economy is expected to continue to have a disinflationary impact, albeit to a declining extent, as domestic demand recovers gradually. As a result of improvements in productivity and moderate wage growth alongside economic growth, low inflation is likely to persist for a sustained period, despite the pick-up in domestic demand. Low inflation environment for a prolonged period is likely to lead to a persistent reduction in expectations, which is expected to help anchor inflation expectations playing a key role in determining the nominal path of the economy around the Bank’s medium-term inflation target.
In the Council’s judgement, economic growth is likely to continue, despite slightly weaker external demand.
The recovery in the real economy has continued over the past quarter, with output rising across a wide range of sectors as employment continued to grow. The protracted recovery in Hungary’s external markets and the economic sanctions imposed due to the conflict between Ukraine and Russia have resulted in a slightly weaker external demand environment; however, economic growth is expected to continue, reflecting the pick-up in domestic demand. The improvement in the outlook for activity, the effect of the Funding for Growth Scheme, the easing in credit constraints and the increasing use of EU funding are expected to support investment growth. As seen in previous quarters, the gradual improvement in employment and rising household real income due to low inflation are playing a key role in the recovery in household consumption. As a result of the legislative process affecting household loans, household net financial wealth is expected to increase, accelerating the deleveraging process. However, the recovery in consumption is likely to remain moderate, due the slow fall in precautionary motives following the crisis. The decision is expected to contribute to an increase in household income, but the saving rate is likely to remain above pre-crisis levels, due to the slow fall in precautionary motives. Looking ahead, Hungarian economic growth may continue in a more balanced pattern than previously.
Hungary’s financing capacity remains high and external debt is falling.
The external position of the economy continued to improve in the first half of 2014, as reflected in the decline in external debt ratios. The trade surplus, while remaining substantial in the coming years even as imports continue to rise due to increasing consumption and investment, is likely to keep the current account surplus high over the coming years. The slight decline in the income balance deficit is expected to contribute to Hungary’s external position remaining strong. The external financing capacity of the economy is likely to remain substantial as the use of EU transfers remains high despite the new budget cycle. Consistent with this, the debt ratios, key in terms of the country’s vulnerability, are likely to continue to decline.
The Hungarian risk premium has remained broadly unchanged in the past quarter and sentiment has been volatile in global financial markets.
International investor sentiment has been volatile in the past quarter, mainly reflecting the escalation of geopolitical conflicts, uncertainty surrounding an interest rate increase by the US Federal Reserve, the interest rate reduction by the European Central Bank and its additional monetary policy measures. Of the domestic risk indicators, the CDS spread and foreign currency bond spreads have not changed significantly since publication of the June Inflation Report. Long-term yields also remained around levels seen at the beginning of the quarter, following a sharp rise due to temporary factors. The forint exchange rate has depreciated in the past quarter, due in part to country-specific reasons, but mainly as a result of the changes in international investor sentiment. Hungary’s persistently high external financing capacity and the resulting decline in external debt have contributed to the reduction in its vulnerability. In the Council’s judgement, a cautious approach to monetary policy is still warranted due to uncertainty about future developments in the global financial environment.
The macroeconomic outlook is surrounded by both upside and downside risks.
The Monetary Council considered three scenarios around the baseline projection in the September Report, which, if materialise, might influence the future stance of monetary policy. In the alternative scenario assuming a weaker-than-expected recovery in Hungary’s trading partner countries and, consequently, lower inflation, the inflation target can be achieved with looser monetary conditions than assumed in the baseline scenario. In the risk scenario assuming an earlier-than-expected monetary policy tightening by globally influential central banks, tighter domestic monetary conditions than suggested in the baseline projection can ensure that inflation moves in line with price stability in the medium term. A third scenario, which assumes more robust growth in domestic employment and consumption, and, consequently, stronger domestic activity growth and a faster increase in inflation relative to the baseline projection, also implies a tighter monetary policy stance.
In the Council’s judgement, there remains a degree of unused capacity in the economy and inflationary pressures are likely to remain moderate in the medium term. The negative output gap is expected to close gradually at the monetary policy horizon. Looking ahead, therefore, the disinflationary impact of the real economy is likely to diminish and, with current monetary conditions maintained, inflation is likely to move into line with the target over the medium term. The Council judges that, based on available information, the current level of the central bank base rate is consistent with the medium-term achievement of price stability and a corresponding degree of support to the economy. If the assumptions underlying the Bank’s projection hold, achieving the medium-term inflation target points in the direction of maintaining current loose monetary conditions for an extended period.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 October 2014.
MAGYAR NEMZETI BANK