20 June 2011
At its meeting on 20 June 2011, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 6.00%.
The Monetary Council discussed and commented on the June 2011 issue of the MNB’s Quarterly Report on Inflation prepared by Bank staff.
In the Council’s judgement, the recovery of the Hungarian economy is likely to continue over the next two years; however, the level of output will remain below its potential throughout the period. Domestic demand is expected to recover only slowly and gradually. Consequently, inflation may fall back to 3% by the end of 2012 even without policy tightening, despite the cost shocks hitting the economy.
Inflation has increasingly been dominated by the balance between two opposing forces. On the one hand, continued rises in commodity prices are feeding through into core inflation in the short term. On the other hand, the disciplining effect on price and wage-setting of the persistent weakness in domestic demand and high unemployment is likely to become the dominant influence as the effects of the cost shocks wear off. Loose labour market conditions are allowing firms to restore their profitability by moderating wage growth. As a result, inflation is likely to be materially above 3% this year and then to fall back to the target towards the end of next year even without policy tightening. 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 by the end of 2012.
In the Council’s judgement, domestic demand growth is expected to recover only slowly. The latest data show little sign yet of a pick-up in household consumption. Indebted households may continue to adjust their balance sheets and maintain their high propensity to save for longer than previously expected. Disbursements to members of real returns on their private pension funds contributions are likely to provide a temporary boost to household consumption. By contrast, the slow recovery in employment and the reduction in government expenditure required to stabilise fiscal balance are likely to lead to a fall in household disposable income in the short term, and are only expected to result in higher income growth over the longer term through a sustained rise in employment.
The factors influencing the recovery in private sector investment are weak domestic demand, tight credit conditions and the effect of windfall taxes. Although a couple of large individual investment projects in manufacturing are likely to help bring about a recovery, private sector investment is only expected to increase materially from mid-2012. In the Council’s judgement, the decline in private sector investment in the past few years points to a persistently lower output path than previously expected.
External demand is expected to remain the main driver of Hungarian economic growth in the short term, due to the slower-than-expected recovery of domestic demand. Global economic activity is expected to slow slightly, but its effect on Hungarian exports may be offset by the implementation of large-scale investment projects, mainly in the car industry. The trade surplus, reflecting strong export growth and weak imports due to subdued domestic demand, is likely to make a significant contribution to economic growth over the next two years.
Perceptions of the risks associated with the Hungarian economy have recently been shaped by the improvement in sentiment towards emerging market economies. Concerns over the sustainability of public debt in some euro-area periphery countries intensified; however, this had only limited impact on risk premia in countries of Central and Eastern Europe, which was viewed as a positive development. Positive market reactions to the latest update of the Government’s Convergence Programme and the interest rate premium on the forint may also have contributed to relative stability.
The Monetary Council has decided to leave interest rates unchanged in light of the above considerations. Inflation is likely to be above target in the short term, due to cost-push pressures stemming from the rise in commodity prices. However, owing to the disciplining effect on price and wage-setting of the persistent weakness in domestic demand and high unemployment, the 3% inflation target can be achieved at the end of 2012 by maintaining interest rates at their current level over a sustained period.
There are both upside and downside risks to the baseline projection for inflation, with the Council assigning different weights to them. Developments in commodity prices are a main source of uncertainty for the future course of interest rate policy. Further sustained increases in the prices of oil and agricultural products may make it necessary to increase interest rates in order to reduce inflationary pressures. A potential further decline in the risk premium on the forint in response to the fiscal adjustment may ease inflationary pressures through an appreciation of the forint exchange rate, which in turn may provide scope for an easing of monetary conditions in the medium term. However, the protracted debt crisis in the euro-area periphery may have adverse effects on perceptions about the risks associated with forint assets, which in turn may warrant an increase in interest rates.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 6 July 2011.
MAGYAR NEMZETI BANK