20 December 2011

At its meeting on 20 December, the Monetary Council reviewed the latest economic and financial developments and voted to raise the central bank base rate by 50 basis points from 6.50% to 7.00%, with effect from 21 December 2011.

The Monetary Council also reviewed the December issue of the MNB’s Quarterly Report on Inflation prepared by Bank staff.

In the Council’s judgement, the Hungarian economy is likely to be stagnant next year, with growth expected to resume in 2013. The level of output will remain below its potential over the entire forecast period. The consumer price index may increasingly reflect the disinflationary impact of weak domestic demand as the effects of the indirect tax increases and the exchange rate depreciation wane.

The outlook for inflation and growth and the recent increase in perceptions of the risks associated with the economy made it necessary to raise interest rates. Inflation can be brought back to 3% by early 2013 by maintaining a tight monetary policy.

The increases in VAT and excise duties are likely to raise the consumer price index significantly in 2012. Fiscal compensation will cushion the effect of the minimum wage increase on companies’ labour costs and therefore it is unlikely to cause considerable inflationary pressure. However, the depreciation of the forint in recent months, reflecting the increase in perceptions of the risks associated with the economy, has led to a deterioration in the inflation outlook. The Monetary Council is closely monitoring developments in tax-adjusted core inflation, in addition to movements in the consumer price index. In the Council’s judgement, the outlook for Hungarian economic growth is unfavourable. The slowdown in global growth, contractionary fiscal policies aimed at preserving the sustainability of public debts in Europe and the vulnerability of the financial system point to a weak outlook for activity in Hungary’s export markets, which in turn may dampen export growth.

The euro-area debt crisis has made it more expensive for Hungarian banks to roll over their external funding. In the current uncertain economic environment, the weaker outlook for growth and tighter credit conditions are acting as a drag on investment activity. As a result, corporate investment may fall in 2012, which will be only partly offset by a couple of large individual investment projects in manufacturing. The Monetary Council welcomes the agreement between the Government and the Banking Association, which is likely to reduce the burden on foreign currency debtors and thereby strengthen bank lending activity.

The process of balance sheet adjustment by households is likely to be protracted, reflecting the effects of the weak exchange rate. Given the uncertain prospects for income growth and the indirect tax increases, consumption is likely to remain persistently low. The Government’s measures to ensure that the target for next year’s budget deficit is met are also likely to act as a significant brake on domestic demand growth, but may help reduce perceptions of the risks associated with Hungary.

Perceptions of the risks associated with the Hungarian economy have increased recently, due to the escalating euro-area sovereign debt crisis, the increasing risks faced by the European banking sector, the deteriorating outlook for global growth and domestic factors. Higher risk premia and increased financing risks are limiting the potential growth of the economy. In view of the significant uncertainty surrounding the outlook for global and domestic growth and financial markets, the Monetary Council considers it important that an agreement between the Government, the European Union and the International Monetary Fund is reached as soon as possible, in order to reduce financing risks.

Monetary policy can best support the recovery by ensuring a predictable economic environment, maintaining price stability and preserving the stability of the financial system. The recent depreciation of the forint has led to a deterioration in the inflation outlook and increased the vulnerability of the domestic financial system.

The Monetary Council decided to raise the base rate by 50 basis points in view of increased perceptions of the risks associated with the economy and upside risks to inflation. If risk perceptions and the outlook for inflation deteriorate significantly further, it may prove necessary to raise interest rates again.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 11 January 2012.

Monetary Council