27 July 2009

At its meeting on 27 July 2009, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 100 basis points from 9.50% to 8.50%, with effect from 28 July 2009.

Consistent with the assessment of previous months, the Monetary Council continues to judge that the Hungarian economy is undergoing a severe downturn this year and that a rapid recovery in growth is unlikely over the period ahead. Inflation rose in 2009 Q2, reflecting the combined effect of several factors. First, the weaker exchange rate relative to the average of previous years has been feeding through gradually into domestic prices. Second, shocks related to certain volatile components of the CPI also drove up overall inflation. By contrast, a more prolonged period of subdued demand limits the scope for price increases, as evidenced by lower services price inflation compared with the average of previous years.

Looking ahead, the Monetary Council expects inflation to be below the medium-term target on the horizon relevant for monetary policy; however, inflation is likely to be high over the next twelve months as a result of the indirect tax changes, which, in turn, adds to upside risks to inflation through expectations.

Real economic adjustment has also been reflected in the substantial improvement in external balance. Current account data for 2009 Q1 showed that the adverse economic environment, the deterioration in the outlook for growth and earlier constraints on access to credit put pressure on economic agents to cut back their expenditure sharply. Although this is clearly positive from the perspective of rebalancing the economy, it also raises the possibility that domestic demand may be weakening faster than projected, and, consequently, output could decline more sharply than previously expected. Net exports may be stronger than forecast, due to a sharper-than-expected decline in imports.

Global risk appetite and sentiment towards Central and Eastern Europe have stabilised in recent months, after improving in the spring. In line with this, perceptions of risk associated with the Hungarian economy also improved. As a result, favourable trends also emerged in the money and capital markets relevant for Hungary. The first foreign currency sovereign bond issue since the onset of the financial crisis was a success; and non-resident investors purchased large amounts of forint-denominated government bonds in the secondary market after a long pause. The exchange rate settled at higher levels than previously, accompanied by reduced volatility.

In the Council’s judgement, the recent improvements in perceptions of risk and external balance have allowed, and the developments in the real economy and inflation justified, a reduction in the central bank base rate. Interest rates may be reduced further, consistent with the inflation targeting framework, if trend inflation developments do not jeopardise price stability and if perceptions of risk allow it.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 12 August 2009.


Monetary Council