24 January 2005

1.      At its meeting on 24 January 2005, the Monetary Council considered the latest economic and financial developments and decided to reduce the central bank base rate by 50 basis points, from 9.50% to 9.00%, with effect from 25 January 2005.

After reviewing macroeconomic data released in recent months, the Monetary Council judged that the favourable inflation trend which emerged towards the end of last year, outperforming even earlier expectations, would be likely to continue over the period ahead. The decline in inflation and nominal wages in 2004 H1 suggests that the risk of inflation expectations remaining persistent at a high level has diminished. Improvement in the outlook for inflation has made a case for a reduction in the Bank’s key policy rate. However, Hungary’s equilibrium position and the market’s attitude to it require maintaining a cautious approach to interest rate policy. Although the investment climate worldwide continues to be favourable, domestic financial markets have recently showed signs of uncertainty, to which the Monetary Council will continue to pay close attention in taking its decisions.

The decline in the rate of consumer price inflation continued in December. That also affected core inflation, being crucial in the assessment of longer-term trends. A number of factors which monetary policy controls have contributed to the latest interest rate reduction. This is evidence that last year’s predictable interest rate policy and the stable exchange rate have proved successful in reining in price rises caused by the increases in indirect taxes. In the Monetary Council’s view, there is a possibility that inflation will return to its level in the period before the tax hikes and, therefore, the Council does not perceive any considerable risk of inflation rising above the 4% and 3.5% inflation targets set for end-2005 ands end-2006 respectively.

Last year, the primary focus of the Bank’s interest rate policy was to prevent the indirect increases in taxes from causing a lasting rise in inflation. Wage growth in 2004 H1 was slowing steadily. But November’s data on private sector wage growth warrants caution. The recent modest increase in wages suggests that the rise in inflation expectations has not been sustained. Consequently, disinflation is expected to continue this year.

According to the latest data, the economic upturn has continued. In particular, export and output figures have reinforced the view that corporate business activity picked up towards end-2004. Although household demand rose more slowly in 2004 than in previous years, its growth rate exceeded earlier expectations.

The favourable foreign trade data have slightly reduced the risks to external equilibrium; however, the current account deficit is estimated to have amounted to nearly 9 per cent as a proportion of GDP.

Reducing Hungary’s external imbalance requires lowering the general government deficit substantially. Transitory measures played a major part in the 2004 deficit outcome. At this juncture, therefore, there are few signs of a fiscal consolidation programme which would be consistent with the convergence programme and would satisfy financial markets, rating agencies and Hungary’s European partners.

The global investment climate continues to be favourable, although it also carries significant risks. However, due to the domestic equilibrium problems, foreign demand for forint-denominated investments has recently been modest, despite international investors’ continued robust willingness to take risks. Taking into account the above factors, with the current 50 basis point reduction in the base rate the interest rate spread has come near to a level which will require the Council to take a cautious policy approach in the future, given the risks outlined above.

2.      The Minutes of the Council’s meeting will be published on 11 February 2005.

3.      Inflation in December 2004, at 5.5%, was higher than the MNB’s inflation target, which it had set at 3.5±1% in October 2002, consistent with the Government’s Medium-Term Economic Policy Programme. This difference was due mainly to the increase in indirect taxes, announced by the Government in mid-2003 and implemented in early 2004. Excluding the effect of indirect tax hikes, inflation would have remained in the target range. Following the announcement of tax increases, the Monetary Council reassessed the inflation target and decided not to counterbalance the direct inflationary impact of the tax measures. The Council’s objective with the decision was to prevent higher inflation from feeding through to inflation expectations and to ensure that the increase in prices remain temporary, which it stressed regularly in its communications. Although greater certainty will be provided on the issue in the course of the year, inflation and wage developments as well as surveys of inflation expectations suggest that last year’s excess inflation has not led to persistently high inflation expectations.

4.      At its meeting, the Council also discussed the conceptual framework for the Quarterly Report on Inflation, to be issued on 21 February.


Monetary Council