25 October 2010

At its meeting on 25 October 2010, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 5.25%.

In the Council’s judgement, the Hungarian economy has begun to emerge from recession in the course of 2010; however, output is likely to return to its potential level only slowly. Weak domestic demand continues to exert a dampening influence on inflation. The proposed government measures may result in a marked change in the outlook for the economy, adding to the upside risks to inflation and increasing uncertainty in the investment environment. The Monetary Council will assess the likely quantitative impact of these measures in light of the November Quarterly Report on Inflation.

In the short term, buoyant external demand may continue to be the engine of growth for the Hungarian economy. Growth in employment and the proposed cut in personal income tax rates may help to strengthen consumption demand next year. The introduction of windfall taxes may reduce the predictability of the taxation system, which, in turn, may weigh on firms’ investment intentions.

Recent inflation data suggest that the pass-through of the weaker exchange rate into consumer prices may be slower than expected, which, however, may be offset in the short term by an increase in food prices. In the medium term, accumulated cost pressures at companies exercising restraint in their pricing policies may have an upward effect on inflation as demand gradually recovers, which may also be reflected in core inflation developments. The possibility that some industries will pass the cost of the windfall tax on to consumers may also put upward pressure on inflation. This effect may be mitigated if private sector firms take account of the Government’s personal income tax measures in setting next year’s wages, which could lead to a fall in their wage bill. With respect to meeting the inflation target, there continues to be an upside risk to the extent that economic agents’ inflation expectations are not firmly anchored due to persistently above-target inflation.

Perceptions of the risks associated with the Hungarian economy have improved slightly over the past month, due partly to the increase in global risk appetite and partly to the Government’s continued commitment to meeting the 2011 deficit target of 3%. In the Council’s view, while the proposed government measures are expected to have an overall positive influence on labour supply, they will reduce the predictability of the economic environment, and therefore their impact on longer-term growth is uncertain. While the government deficit on an ESA95 basis will fall, the structural position, which is a key factor in terms of longer-term developments, will deteriorate significantly, because the effects of the tax changes resulting in persistent revenue shortfalls will be offset by temporary measures proposed to improve the fiscal balance. Consequently, achieving a long-term sustainable path for the fiscal budget will require additional structural measures on the expenditure side.

The Monetary Council has decided to leave interest rates unchanged in light of the uncertainty about the inflation outlook and a prolonged period of output below potential. If upside risks to inflation materialise or there is a sustained increase in perceptions of the risks associated with the economy, an increase in the central bank base rate may be necessary.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 17 November 2010.


Monetary Council