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The Monetary Council’s statement in the March 2015 issue of the inflation report

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24 March 2015


At its meeting on 24 March 2015, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 15 basis points from 2.10% to 1.95%, with effect from 25 March 2015.


THE MONETARY COUNCIL’S STATEMENT ON MACROECONOMIC DEVELOPMENTS AND ITS MONETARY POLICY ASSESSMENT


In the Monetary Council’s judgement, persistently loose monetary conditions are consistent with the achievement of price stability.


In the Council’s judgement, maintaining loose monetary conditions for an extended period is warranted by the medium-term achievement of the Bank’s 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.


Growth prospects of the global economy have improved in recent months. The low inflation environment is likely to persist for a sustained period.


Differences remain across the individual regions in terms of economic growth. Of the world’s developed regions, the recovery in the euro-area economy has been stronger than expected but modest, while growth in the US has been robust. Growth has been stable or slowing in most of the major emerging market economies. Global inflation remains moderate, in line with the decline in commodity prices, particularly persistently low crude oil prices and subdued demand, and inflationary pressure in the global economy is likely to remain moderate for a sustained period looking ahead. There have been differences in the monetary policy stance of globally influential central banks in recent months: the ECB has extended its quantitative easing programme while the Fed has maintained its monetary policy instruments. Monetary conditions remain loose overall and, consequently, global interest rate and liquidity conditions continue to be supportive.


In the Council’s judgement, inflation is likely to be significantly below the inflation target this year, and is expected to rise to levels around 3 per cent only towards the end of the forecast period.


The Council expects inflation to be significantly below the inflation target over the short term. At the beginning of the year, inflation turned out to be below the projection in the December 2014 issue of the Inflation Report, mainly reflecting the decline in commodity prices. Domestic inflation is likely to be substantially below the target in the first half of the forecast period, mainly reflecting strong cost shocks. With the pick-up in domestic demand and reflecting the increase in wages, core inflation is likely to rise gradually; however, this process may slow due to the second-round effects of declining commodity prices. Overall, more moderate underlying inflation developments point in the direction of a low inflation environment, and therefore inflation is expected to approach levels around 3 per cent towards the end of the forecast period. The stabilisation of expectations over the recent period is likely to ensure that price and wage-setting will be consistent with the inflation target over the medium term as domestic demand recovers.


Domestic economic growth may continue to be robust, with domestic demand remaining the main engine.


Growth in the domestic economy has continued over the past quarter. In the coming quarters, domestic demand is still likely to be the main engine behind growth. Rising household real income as a result of low inflation and increasing employment are expected to contribute to the increase in household consumption. The measures taken in the wake of the uniformity decision by the Supreme Court are likely to contribute significantly to an improvement in the wealth and income position of households, thereby supporting the deleveraging process. In addition, the conversion of foreign currency loans into forints reduces households’ exchange rate exposure, which in turn may lead to a gradual reduction in precautionary savings. Investment is likely to grow gradually due to the pick-up in activity and the extension of the Funding for Growth Scheme. In line with the improvement in income positions, household investment activity is expected to rise steadily over the forecast period. In addition, the rate of export growth is likely to remain robust, reflecting higher growth in Hungary’s export markets. The negative output gap is expected to close at the end of the forecast period, and therefore the real economic environment is likely to continue to have a disinflationary impact in the coming quarters. Disinflationary effects from the global economy remain strong, while the price depressing effect of domestic demand is likely to diminish gradually.


Hungary’s financing capacity remains high and external debt is decreasing.


As seen in previous periods, the four-quarter value of the economy’s external position continued to be high in the third quarter of 2014. Over the coming quarters, the current account surplus and the external financing capacity of the economy are expected to stabilise at a high level, reflecting two opposing effects. The trade surplus is likely to grow in the coming quarters despite rising consumption and a modest pick-up in investment, mainly reflecting the improvements in the terms of trade and rising external demand. This effect is likely to be reduced by the end of the budget period of European Union funding, which may lead to a significant reduction in the transfer account balance in 2016. The country’s external debt ratios, key in terms of the country’s vulnerability, are likely to continue to decline, reflecting its high external financing capacity. The Bank’s self-financing programme and the expected fall in banks’ external debt due to the conversion of foreign currency loans into forint will contribute to the reduction in gross debt.


The Hungarian risk premium has fallen in the past quarter and sentiment has been generally favourable in financial markets.


International investor sentiment has been generally favourable in the past quarter. Global risk appetite was volatile at the beginning of the year, before improving from the end of January. The deterioration in sentiment due to the political events in Greece, the abandonment of the exchange rate cap by the Swiss National Bank and the escalation of the conflict between Ukraine and Russia were offset by announcements related to the ECB’s asset purchase programme and favourable economic news from the US. Of the domestic risk indicators, the CDS spread has fallen sharply over the past quarter. Long-term yields on forint-denominated bonds have remained broadly unchanged since publication of the December Inflation Report. The forint has appreciated against the euro in the past quarter, due mainly to international factors. Hungary’s persistently high external financing capacity and the resulting decline in external debt have contributed to the reduction in its vulnerability. The upgrade by Standard & Poor’s in March also reflects the improvement in perceptions of the risks associated with the Hungarian economy. In the Council’s judgement, however, a cautious approach to monetary policy is still warranted due to uncertainty in the global financial environment.


The macroeconomic outlook is surrounded by both upside and downside risks. Downside risks to inflation increased.


Overall, downside risks to inflation increased relative to the December Report assessment. The Monetary Council considered three alternative scenarios around the baseline projection in the March Report, which might influence significantly the future conduct of monetary policy. The alternative scenario assuming persistent deflation in the euro area poses downside risks to inflation and growth, and therefore looser monetary conditions than assumed in the baseline projection ensure the achievement of the inflation target. Lasting geopolitical tensions could lead to a decline in external demand associated with a rise in the risk premium. The resulting exchange rate depreciation might raise inflationary pressures, and therefore a tighter monetary policy stance ensures that the inflation target is met at the forecast horizon. In case the alternative scenario assuming more considerable second-round effects of the cost shocks, inflation expectations might move away from the target, resulting in a significantly lower path for nominal wage growth. All this could lead to lower inflationary pressure in the medium term, which calls for looser monetary conditions than assumed in the baseline projection during the period.


In the Council’s judgement, there is a degree of unused capacity in the economy and inflationary pressures are likely to remain moderate for a sustained period. The real economy is likely to have a disinflationary impact at the policy horizon and the negative output gap is expected to close only gradually. Based on data becoming available previously, the probability of second-round effects taking hold in the wake of the change in inflation expectations has increased. The Council judges that, after reviewing the March Inflation Report, the outlook for inflation and the cyclical position of the real economy point in the direction of a reduction in the policy rate and loose monetary conditions for an extended period. Cautious easing of monetary conditions may continue as long as it supports the achievement of the medium-term inflation target.


The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 April 2015.

MAGYAR NEMZETI BANK
Monetary Council