16 May 2011
At its meeting on 16 May 2011, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 6.00%.
In the Council’s judgement, Hungarian economic growth is likely to pick up gradually over the next 6 quarters; however, the level of output will remain below potential throughout the period. Inflation is expected to be significantly above the target in the short term, due to the cost-push shocks hitting the economy, but may fall back close to 3% by the end of next year even without further policy tightening.
Inflation is likely to continue to be dominated by the balance between two opposing forces. On the one hand, commodity prices, particularly oil and agricultural prices, continued to rise, the upward effect of which was reflected in higher consumer prices. In addition, core inflation picked up more sharply than the Council anticipated, reflecting a stronger-than-expected pass-through of the marked rise in agricultural prices to food prices. On the other hand, developments in services and traded goods prices suggest that weak domestic demand and high unemployment continue to exert discipline on price and wage-setting behaviour. Loose labour market conditions are allowing firms to restore their profitability by moderating earnings growth, rather than by raising prices. The Council’s past interest rate increases may reduce possible second-round effects of the cost shocks. As a result of these factors, inflation is likely to be significantly above 3% this year and then to fall back to settle around the target towards the end of next year as the first-round effects wear off.
External demand is expected to remain the main driver of Hungarian economic growth in the coming quarters. There is no sign yet of a pick-up in domestic demand. Looking ahead, the rate of household consumption growth is expected to continue to be fundamentally determined by the slow recovery in employment and subdued earnings growth. Disbursements to members of real returns on their private pension fund contributions are likely to provide a temporary boost to household consumption, with the reduction in the tax burden on personal incomes expected to provide a sustained stimulus. However, the Government’s planned fiscal adjustment measures may lead to a sharp fall in household disposable income in 2012. If maintained over a sustained period, current tight credit conditions in the household market may hold back the recovery in consumption demand and reinforce the disinflationary effects from the real economy.
The significant amount of spare capacity in the economy, and uncertainty around the external economic environment and the recovery in consumption are impeding the recovery in corporate investment. In addition, tight lending conditions and increased business uncertainty continue to act as a drag on investment activity. The Monetary Council judges that there is a significant risk that the productive capacity of the economy will expand more slowly over a prolonged period in response to weaker private sector investment activity, which in turn may dampen the disinflationary effects of weak domestic demand.
There has been a reduction recently in perceptions of the risks associated with the Hungarian economy, as reflected in a fall in risk premia and increased demand for forint-denominated assets. This may partly be explained by increased global investor demand for financial assets of emerging market economies.
The Monetary Council has decided to leave interest rates unchanged in light of the above considerations. There remain both upside and downside risks to inflation.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 June 2011.
MAGYAR NEMZETI BANK