28 August 2006

1.    At its meeting on 28 August 2006, the Monetary Council considered the latest economic and financial developments and voted to increase the central bank base rate by 50 basis points, from 6.75% to 7.25%, with effect from 29 August 2006.

Economic data which have become available over the past few weeks, and the Government’s stabilisation measures, announced recently, have led the Monetary Council to revise materially its view of macroeconomic conditions. The planned measures are expected to contribute significantly to a substantial reduction in the general government deficit and Hungary’s external financing requirement, which, in turn, may improve the country’s risk assessment. However, meeting the medium-term price stability objective requires further monetary tightening, due to the increased upward risks to inflation.

The direct effects of the budgetary measures, and increases in indirect taxes and administered prices are expected the have the strongest upward effect on consumer prices over the short term. Measures causing increased costs of production, which may force the corporate sector to raise prices at some point in the future, contribute to this. However, the Government’s actions affecting incomes are expected to act as a drag on domestic demand growth, which may partly offset direct inflationary consequences.

The latest consumer price data, particularly those for processed foods and market services, point to higher inflation over the period ahead. In addition to the expected effects of the planned fiscal measures, imported inflation, and particularly rises in the world market price of oil, poses an upward risk to CPI inflation.

All of these influences are expected to lead to a temporary pick-up in inflation, then inflation may fall gradually towards the end of 2008 after reaching a peak in the first half of 2007. But even after the expected immediate effects of the fiscal measures unwind, inflation is likely to be above the target, if the current monetary conditions are to remain unchanged over the entire forecast period. In particular, during the period most relevant for monetary policy, i.e. 6–8 quarters from now, headline and core consumer price inflation both would be significantly higher than the Bank’s 3% medium-term target.

Inflation expectations and future labour market conditions may play a key role in the medium-term effects and potential spillover of the one-off price increases expected to occur in the near future. Dwindling demand and rises in the costs of labour may depress firms’ demand for labour, which, coupled with lay-offs in the public sector, may result in higher labour supply. Nevertheless, private sector nominal wages may only continue rising, if market participants do not factor the expected one-off price increases into their expectations. For this reason, it is a key task for the Monetary Council to coordinate inflation expectations and to mitigate the second-round effects of the planned fiscal measures by pursuing predictable monetary policy.

2.    The minutes of this Council meeting will be published at 2 p.m. on 8 September 2006.


Monetary Council