25 February 2008

1    At its meeting on 25 February 2008, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 7.50%.

2    The abridged minutes of today’s Council meeting will be published at 2 p.m. on 21 March 2008.

3    At its meeting, the Monetary Council also discussed the February 2008 issue of the Quarterly Report on Inflation.

In the Council’s view, while Hungarian economic growth continues to be weak, the fall in inflation may be slower than previously expected, consistent with the projection presented in the Report.

Although the inflationary effects of the fiscal adjustment measures implemented since 2006 have been wearing off, the disinflation process has more recently been held back by cost shocks of both international and domestic origins. The sharp rises in food and energy prices, as well as the increases in domestic producers’ energy prices and administered prices at rates above inflation have been particularly relevant in this respect. The Council has on several occasions expressed that it does not intend to offset the direct effects of cost shocks, due to their temporary nature. However, were potential second-round effects to arise which could lead to a sustained rise in inflation expectations, monetary policy tightening could not be avoided.

The recent rise in producer prices has forced domestic firms to make marked adjustments in order to ensure that operations remain profitable. That in turn is acting as a brake on economic growth over the short term. For the time being, only a smaller part of the adjustment has occurred through prices; and the Council expects it to be fully implemented basically through restraining labour costs and improving productivity. This view is reinforced by the subdued rise in wage costs in the final quarter of 2007.

However, the prospects for economic activity have deteriorated in recent months. The contribution of net exports to economic growth is expected to be lower in 2009, due to the slowdown in the global economy. Moderate real wage growth and the fall in employment are likely to hold back household consumption growth. Deteriorating external domestic economic activity, as well as rises in credit spreads are expected to be constraining investment. Evidence from business and household surveys, suggesting that economic agents expect the economic recovery to be increasingly sluggish over the period ahead, is consistent with this view. These factors may contribute to a fall in inflation from the demand side.

The deterioration in the international investment climate has had an adverse impact on the premium required on forint-denominated assets. If the recent rise in exchange rate risk perceived by investors persists, it may put additional upward pressure on inflation.

In the Council’s judgement, the adjustment which has been underway in the private sector is a positive development; however, the new cost shocks are putting its sustainability at risk. A prolonged period of disinflation carries the risk that expectations may become stuck at a relatively high level.  If the emergence of second-round inflationary effects cannot be ruled out with certainty in the near term, then monetary policy may have to be tightened.