21 May 2007

1    At its meeting on 21 May 2007, the Monetary Council considered the latest economic and financial developments and voted to leave the central bank base rate unchanged at 8.00%.

2    Also at its meeting, the Council discussed the May 2007 issue of the MNB’s Quarterly Report on Inflation. In the Council’s judgement, from its current high level inflation is likely to return to close to the medium-term target on the horizon relevant for monetary policy, although this process may be slightly slower than projected in the previous Report. However, this path – seen as the most likely outcome – continues to be surrounded by risks in both directions.

In the current high inflation environment, expectations remaining stuck at a level incompatible with price stability continues to represent the most important upside risk to inflation. In this regard it is good news that recent developments in consumer prices have been consistent with the fall in inflation expected by the Council. However, the rapid rise in wage growth is still a cause for concern, despite the reduced scope of the informal sector. Nevertheless, falling demand in response to the fiscal austerity measures may result in a greater-than-expected disinflationary impact.

Business conditions continue to be shaped by the benign external environment and weak domestic demand. In 2007, the pace of Hungarian economic growth is likely to slow, due mainly to fiscal consolidation and the decline in household consumption. But growth may recover over the next few years, as the effects of fiscal restriction unwind gradually; and domestic demand may contribute significantly to growth.

The government deficit may remain below the target this year and next, explained mainly by the stronger-than-expected increase in revenue. However, this favourable picture becomes rather mixed as the expected decline in revenue as a percentage of GDP over the longer term poses risks to meeting the deficit targets for subsequent years. Consequently, meeting the expenditure targets for 2009 may require additional government measures which could provide a solid foundation for the objectives set out in the Convergence Programme.

Risks to the Hungarian economy have diminished significantly recently. Fiscal adjustment has made a material contribution to the reduction in the country’s external financing requirement this year. And the international investment climate has been broadly supportive in recent months.

The Monetary council decided to leave the policy rate on hold taking into view the high degree of uncertainty around the future outlook for inflation. Even if investors’ positive sentiment about forint-denominated investments remains, a necessary condition for reducing the policy rate further is a greater degree of certainty with which upside risks to inflation are eliminated.

3    The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 June 2007.