26 November 2007

At its meeting on 26 November 2007, the Monetary Council reviewed the latest economic and financial developments and voted to maintain the central bank base rate at 7.50%.

The Council also discussed the November 2007 issue of the MNB’s Quarterly Report on Inflation.

The Monetary Council’s view is that inflation will decline gradually and economic growth rise slowly over the next two years, consistent with the projection presented in the Report. The recent rise in food prices has put stronger-than-expected upward pressure on overall inflation, and therefore, annual average inflation in 2008 is likely to be around 5%, despite the contractionary effect on domestic demand of the Government’s fiscal adjustment measures. For the Council the most likely scenario continues to be a decline in inflation to 3% in 2009, as an effect of subdued domestic demand growth. However, this requires that the fast increase in prices over the past few years in response to a series of external shocks should not lead to expectations becoming stuck at high levels.

There has been more evidence since the August projection that food price inflation, triggered in part by external causes, may persist for a while. The latter, combined with the sharp rises in energy prices and other adverse shocks over the recent past, creates an environment for monetary policy in which the emphasis is placed on counteracting second-round inflationary pressure and bringing down inflation expectations. The slowdown in domestic demand may help to rein in second-round inflationary pressure, because firms will face increased difficulty in offsetting the earlier downward squeeze on profit margins by raising prices. As a consequence, the disciplinary strength of lacklustre demand may contribute to disinflation through restraining pay growth or, as a less benign outcome, through a fall in employment. Nevertheless, the Monetary Council continues to closely monitor price and wage setting trends in the private sector. It is of key importance for the Bank’s objective of delivering price stability that next year’s wage increases should be consistent with both productivity growth and the prospective fall in inflation.

There continues to be considerable uncertainty in international financial markets caused by the problems in the US mortgage market. Investors’ risk appetite has fallen again recently, which, in turn, has had a negative effect on required risk premia on forint-denominated assets. The Council’s decision to leave the key policy rate unchanged also reflects its judgement about the uncertainty surrounding the international environment and domestic inflation developments. There will be a case for a further reduction in interest rates if domestic economic conditions suggest that the risk of higher inflation transmitted through expectations has diminished and international financial market sentiment has improved further.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 7 December 2007.