21 February 2011
At its meeting on 21 February 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 Monetary Council’s judgement, the pick-up in economic activity is likely to continue over the next two years; however, the level of output will remain below potential throughout the period. Inflation is expected to be considerably above the Bank’s 3% target in the coming quarters, due to the significant cost-push shocks hitting the economy. In terms of the medium-term outlook for inflation, the main risk is that expectations are unanchored due to a prolonged period of above-target inflation, and therefore the adverse cost shocks may have second-round inflationary effects.
Strong external demand is expected to remain the main driver of Hungarian economic growth this year, with domestic demand likely to recover only gradually. The easing of tax burdens on personal incomes and the expected slow improvement in employment may stimulate household consumption; however, tight credit conditions and the sustained rise in commodity prices may act to restrain consumption. Large individual investment projects currently underway point to a pick-up in whole-economy fixed investment, but heightened uncertainty about the business environment and weak lending activity may press down on investment growth.
The low level of core inflation and moderate earnings growth in the private sector are consistent with the view that weak domestic demand and high unemployment continue to exert discipline on price and wage-setting behaviour. However, the economy has been hit by adverse cost-push shocks. Rises in unprocessed food and fuel prices have led to the build-up of inflationary pressure in the economy. As a result, inflation may remain significantly above the 3% target this year. The extent to which the cost shocks feed through to consumer prices will be an important factor influencing movements in inflation over the medium term.
The Council notes that it is important that the 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 prices. Potential increases in wages, inconsistent with corporate performance, may pose a threat to meeting the inflation target as well as to job security.
Although risk premia on Hungarian financial assets have fallen markedly in the past month, which may reflect lower perceptions of risks associated with some high-debt countries of the euro area and the slight recovery in confidence in domestic economic policy, they continue to be high compared with those in other countries of Central and Eastern Europe. In the coming months, the nature of the long-term structural budget measures to be announced by the Government may be a key factor shaping perceptions of the risks associated with the economy, in addition to global factors.
In the Monetary Council’s judgement, the policy tightening implemented in the past three months is likely to help bring inflation back close to the target after the first-round effects of the cost shocks wear off. The Council has therefore decided to leave interest rates unchanged. In the coming months, the Council will decide whether to raise interest rates again after considering upside risks to inflation.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 18 March 2011.
MAGYAR NEMZETI BANK