20 December 2010

1) At its meeting on 20 December 2010, the Monetary Council reviewed the latest economic and financial developments and voted to raise the central bank base rate by 25 basis points from 5.50% to 5.75%, with effect from 21 December 2010.

In the Council’s judgement, the Hungarian economy is likely to continue to recover from recession over the next two years; however, output will remain below potential throughout the period. Inflation is expected to considerably exceed the Bank’s 3% target in the coming quarters, due to significant cost-push shocks hitting the economy. The Council judges that there is a risk that, in the absence of monetary policy tightening, inflation expectations will rise due to persistently above-target inflation and the cost-push shocks will have second-round inflationary effects.

Strong external demand is expected to remain the main driver of Hungarian economic growth; however, recent evidence suggests that a recovery in consumption was under way in Q3. Household consumption is likely to pick up further, due to the easing of tax burdens on personal incomes and improvements in employment. In the Council’s view, investment is only likely to materially contribute to growth from next year. Investment by companies will rise on the back of FDI flows into manufacturing, which, however, will be partly offset by heightened uncertainty about the business environment.

Movements in the prices of industrial goods and services reinforce the view that weak domestic demand and high unemployment continue to exert discipline on price and wage setters. However, the economy has been hit by adverse cost-push shocks. The broadly based increase in unprocessed food prices has been feeding through into processed food prices. The passing of some of the sector-specific taxes on to customers and rises in fuel prices may generate additional inflationary pressure. As a result of these factors, inflation in 2011 may be significantly above the 3% target, and it is doubtful whether the target will be met in 2012 in the absence of monetary policy tightening.

The Council notes that it is important that the price and wage-setting decisions are consistent with significant spare capacity remaining in the economy and loose labour market conditions, despite the temporary upward effects on inflation.

Perceptions of the risks associated with Hungarian financial assets have not fallen, despite the improvement in investor sentiment towards emerging markets. The latest downgrading of Hungary’s sovereign debt and the protracted rise in the country’s risk premium relative to other CEE countries reflect concerns over fiscal sustainability and the predictability of the economic environment.

The Monetary Council has decided to raise the base rate in light of inflation remaining persistently above the 3% target as well as the upside risks to inflation. In the coming months, the Council will decide whether to raise interest rates after weighing up the balance of inflation risks.

2) The abridged minutes of today’s Council meeting will be published at 2 p.m. on 12 January 2011.

Monetary Council