23 January 2006

1. At its meeting on 23 January 2006, the Monetary Council considered the latest economic and monetary developments and left the central bank base rate unchanged at 6.00%.

Macroeconomic data released since its previous interest rate-setting meeting have not changed the Council’s overall assessment of domestic economic performance. Consumer price inflation in December was broadly in line with expectations. In the medium term, the Council expects domestic economic growth to be balanced and inflation to be consistent with the 3% medium-term target. 

The year-on-year rate of inflation, at 3.3% in December, was below the 4% target, remaining within the ±1 tolerance band; and core inflation fell to 1.3%, a historical low. The Council’s expectation is that core inflation will rise to levels around 3% in the medium term. The reduction in VAT rates in January has made it more difficult to evaluate inflation developments, and is also likely to introduce a degree of uncertainty to distinguishing between persistent and temporary effects in the months ahead.

Short and long-term yields both fell in the early weeks of 2006, simultaneously with the increase in investors’ risk appetite around the world. However, significant risks continue to surround Hungary’s economic balance and convergence process. In the Monetary Council’s view, official interest rates are currently at adequate levels to meet the medium-term inflation objective.

The Council continues to stress the importance of reducing the general government borrowing requirement, in order to achieve sustainable economic growth and keep inflation on track around the target. Delays in fiscal consolidation will increase the vulnerability of the Hungarian economy and reduce the room for monetary policy manoeuvre.

The minutes of today’s meeting will be published at 2 pm on 10 February 2006.

2. The Council’s evaluation of meeting the 2005 inflation target

The year-on-year rate of inflation, at 3.3% in December, was below the 4% target and remained within the ±1 tolerance band. This meant that the Bank’s inflation target for 2005 was met, despite the rise in energy prices.

In 2005, annual average consumer price inflation was 3.6% and annual average core inflation was 2.1%.

Disinflation affected a wide range of products. Annual average core inflation, the best gauge of long-term inflation developments, fell to 1.3% towards end-2005. Rapid disinflation of prices showing fairly stable movements is a sign of price stability becoming broad based.

The fall in inflation was particularly marked in the case of goods competing with imports, which may have been explained by a combination of global, regional as well as domestic developments. Tradables prices also fell to historical lows in developed countries, implying that imported inflation remained slow. Disinflation of tradables prices was also explained by changed trade patterns in the aftermath of Hungary’s EU accession and by the resulting increase in competition in the domestic market. Finally, following the financial market turbulence, characterising the second half of 2003, the exchange rate appreciated and then stabilised, which also supported the disinflation process.

In early 2005, inflation developments showed clear signs of returning to a more stable path; and the one-off price increasing effect of the 2004 tax measures did not build in expectations. Domestic demand did not trigger significant inflationary pressure. Household consumption growth was moderate throughout the whole year, remaining significantly below the rates of earlier years, and contributed to the pattern of economic growth becoming more favourable.

Simultaneously with improvements in the investment climate and the outlook for inflation, the Council continued the series of small interest rate reductions – begun in spring 2004 – with further pronounced cuts. As a result of the Council’s interest rate policy, the base rate fell to 6.00% by year-end, while the forint exchange rate remained in a territory which contributed to inflation returning to levels consistent with price stability. Despite the significant fall in short-term yields, however, the continued high level of long-term yields continues to reflect the risks to the long-term economic path.

Labour market developments also supported the fall in inflation. The pick-up in business activity was fuelled by higher corporate productivity and, consequently, it did not increase the demand for labour. Rising labour supply also reduced wage inflation pressure. Private sector wage inflation was downwards from 2004 H2, and the rise in corporate sector ULC slowed to levels consistent with price stability.


Monetary Council