18 April 2011

At its meeting on 18 April 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 16 months; however, the level of output will remain below potential throughout the period. Inflation is expected to be considerably 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 monetary tightening.

Looking ahead, inflation is likely to continue to be dominated by the balance between two opposing forces. On the one hand, the economy has been hit by adverse cost-push shocks, which are expected to feed through to core inflation in the short term. On the other hand, 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 also reduce possible second-round effects of the cost shocks. On balance, therefore, inflation is likely to remain significantly above 3% in 2011, before falling back to around the target towards the end of next year as the first-round effects wear off. The Council judges that it may be necessary to maintain interest rates at their current level over a sustained period in order to meet the target for CPI inflation in 2012.

Strong external demand is expected to remain the main driver of Hungarian economic growth, with domestic demand likely to recover only gradually. The rate of household consumption growth is expected to continue to be determined by the slow recovery in employment and subdued real earnings growth. Disbursements to members of real returns on their private pension fund contributions are likely to provide a temporary boost to 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 disposable income in 2012. If maintained over a sustained period, current tight credit conditions in the household market may continue to 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 outlook for growth are impeding the recovery in corporate investment. Increased business uncertainty due to tight credit conditions and the effects of windfall taxes also acts 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.

Perceptions of the risks associated with the Hungarian economy have fallen recently, as reflected in a decline in risk premia and an increase in demand for forint–denominated assets. In large part, this is likely to have been driven by higher global investor demand for financial assets of countries of the CEE region. However, it is difficult to judge how long this improvement will continue.

The Monetary Council has decided to leave interest rates unchanged in light of the above considerations. It is justified to maintain interest rates at their current level, as long as economic developments are consistent with the projection in the Bank’s March Quarterly Report on Inflation. If incoming data suggest a greater pass-through from the cost shocks, it may be necessary to tighten current monetary conditions in response to upside risks to inflation. However, a slower-than-expected recovery in lending to households and weaker-than-expected domestic demand may warrant a reduction in interest rates in the medium term.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 4 May 2011.

Monetary Council