25 May 2009

At its meeting on 25 May 2009, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 9.5%.

The Council discussed the May 2009 issue of the Bank’s Quarterly Report on Inflation.

The outlook for the world economy have continued to weaken in recent months. The economic downturn in Hungary is likely to be deeper than the European average, as the slowdown in activity abroad, the tightening of credit supply and the Government’s fiscal measures are acting as a drag on growth simultaneously. Domestic inflation may drop below the Bank’s medium-term target as a result of the sharp downturn in activity, after allowing for the temporary effects of tax changes.

Data released over the past quarter indicated a further deterioration in the outlook for the domestic economy. World trade fell by nearly one-fifth in the first few months of 2009. Based on the latest data, however, the slow recovery in business expectations and de-stocking may suggest that business conditions have been stabilising. The slowdown in Europe has had unusually adverse effects on the external trade sector, due to the composition of Hungarian exports. The Government’s actions to improve competitiveness, coupled with the real depreciation of the forint over the recent period, have been only partly successful in offsetting the decline in external demand. The Hungarian economy is only expected to recover in 2011, in line with the outlook for growth in Europe.

Domestic firms have frozen wages, sharply reduced employment and postponed investment decisions in response to their worsening sales prospects. But despite these efforts, corporate profitability has deteriorated considerably, with the adjustment process likely to continue in the period ahead. Greater income uncertainty caused by falling employment and the contraction of credit supply are prompting households to scale back consumption and investment spending. As a result, propensity to save may increase further, with a pick-up in domestic demand not expected before 2011.

The introduction of new policy instruments by the MNB and direct lending by the Government are helping the banking sector cope with reduced access to funding in the market. However, lending activity is expected to remain subdued, due to uncertainty about the prospects for growth, and banks are likely to seek to reduce risks associated with their loan portfolios.

Procyclical fiscal policy has also contributed to the decline in domestic demand. Constraints on deficit financing do not permit the operation of automatic fiscal stabilisers in full. Over the longer term, the actions taken by the Government to maintain fiscal sustainability are expected to contribute to an increase in the economy’s potential growth rate and to putting the government’s indebtedness on a sustainable path. All these factors may help restore market confidence and reduce the costs of financing for the economy; however, they may deepen the recession over the short term.

There has been a considerable improvement recently in sentiment towards Central and Eastern Europe, and the domestic financial markets have shown signs of consolidation; however, global appetite for risk has remained volatile. Although the package of fiscal measures announced by the Government may lead to a further improvement in sentiment towards Hungarian assets over the longer term, this has not yet been reflected in higher demand for domestic financial assets.

The Monetary Council took its decision to maintain interest rates after considering the outlook for the real economy and inflation as well as the latest financial market developments. The base rate may be reduced further in the coming months, if the recent improvement in sentiment continues, and if policy easing does not jeopardise the stability of the financial intermediary system and does not threaten to disrupt capital flows.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 June 2009.


Monetary Council