29 November 2010

At its meeting on 29 November 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 5.25% to 5.50%, with effect from 30 November 2010.

The Monetary Council discussed the MNB’s November Quarterly Report on Inflation.

In the Council’s judgement, the Hungarian economy is likely to continue to recover from recession over the forecast period; however, output will remain below its potential level.

Inflation is expected to rise in the short term, due to significant cost-push shocks hitting the economy. Under unchanged monetary conditions, inflation may remain above the 3% target for a sustained period. In the Council’s view, there are risks that inflation expectations will rise due to persistently above-target inflation and that the cost-push shocks will have second-round inflationary effects.

Hungarian economic growth continues to be driven by industrial sales on the back of strong external demand. Labour demand in the exporting sectors has increased, which has led to a rise in employment. Domestic demand may also begin to pick up in the course of 2011. Household consumption is expected to increase, due to the reduction in the personal income tax burden and improvements in employment. Investment is expected to increase as a result of a couple of projects undertaken in the manufacturing sector. However, investment activity may be restrained by heightened uncertainty surrounding the current business environment due to the imposition of sector-specific windfall taxes.

Incoming data are consistent with the view that weak domestic demand and high unemployment continue to have a disciplinary effect on firms’ price and wage-setting decisions. The pass-through of the depreciation of the exchange rate during the summer has turned out to be smaller than previously expected. Loose labour market conditions allow firms to restore their profitability by offering moderate wage increases rather than by raising prices. However, the economy has been hit by adverse cost-push shocks. There has been a broadly based increase in unprocessed food prices, which is likely to feed through into processed food prices. The passing on of some of the windfall tax imposed on certain sectors to customers may generate additional inflationary pressure. As a result of these factors, and assuming unchanged monetary conditions, inflation in 2011 may significantly exceed the 3% target and may remain above it in 2012.

The Council notes that it is important that 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 the Hungarian economy have increased recently, due partly to the fall in global risk appetite and partly to country-specific factors, and particularly to a decline in the predictability of the economic environment. The latter is also reflected by the fact that since the middle of October Hungary’s risk premium has risen by more than in other countries with similar risk profiles.

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. It may be necessary to increase the base rate further in the coming months in order to meet the inflation target.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 December 2010.

Monetary Council