At its meeting on 31 May 2010, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 5.25%.
The Monetary Council also discussed the Bank’s June 2010 Quarterly Report on Inflation.
Latest data suggest that the Hungarian economy has begun to recover more strongly than expected, and the country is also likely to have emerged from recession in early 2010. Nevertheless, there remains a considerable degree of slack in the economy, constraining companies’ ability to raise prices. Due to the downward effect on prices of weak domestic demand, core inflation may remain well below the target. However, as a result of global energy price inflation, the consumer price index may settle around the Bank’s 3% target on the horizon relevant for monetary policy, higher than previously forecast. Hungary’s risk assessment deteriorated in the past month, due to global developments, and the future outlook is surrounded by significant uncertainty.
Last year’s structural divergences within the economy may remain: domestic demand growth is likely to lag behind the pick-up in exports and is only expected to make a material contribution to overall economic growth from 2011. In terms of the longer-term outlook, uncertainty about growth prospects in Hungary’s major trading partner economies implies a downside risk to domestic growth. Concerns over the sustainability of public sector debts in several EU countries require substantial fiscal adjustment by governments, which, in turn, may slow growth in Hungary’s external demand.
The outlook for inflation is also shaped by rising economic activity abroad and an accompanying increase in energy prices, as well as by the slow recovery of domestic demand. Weak domestic demand will continue to put significant downward pressure on prices over the next 18 months. Core inflation is therefore expected to remain well below the target. This effect, however, may be partly offset by rises in energy prices due to the strengthening of global activity, the depreciation of the euro and increases in administered prices. In 2012, the recovery of domestic demand may lead to an increase in core inflation.
As a result of all these factors, inflation may remain around 4% in the second half of this year, after the effects of the VAT increase drop out of the index, and may only edge back to around the target in 2011.
Perceptions of the risks associated with the Hungarian economy have increased markedly in the wake of global developments. Sovereign debt problems in a number of euro area Member States and the associated concerns over the prospects of the euro area have resulted in a reduction in risk appetite among investors worldwide. That, in turn, has had an adverse impact on perceptions of the risks associated with the countries of Central and Eastern Europe, including Hungary. Considering that fiscal sustainability has become the focus of international investors’ attention, it is particularly important to maintain disciplined, long-term sustainable fiscal policies. This is especially relevant for countries with high debt levels, such as Hungary.
In light of increased perceptions of risk associated with Hungarian financial assets and inflation risks, the Monetary Council has decided to leave interest unchanged. Interest rates may only be reduced further if the outlook for inflation as well as perceptionsofrisk allow.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 June 2010.
MAGYAR NEMZETI BANK