At its meeting on 25 October 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, economic growth is likely to remain subdued over the next two years, with the level of output remaining below its potential throughout the period. In the short run, inflation is likely to pick up as a result of certain Government measures and a depreciating exchange rate. It is then expected to moderate in the weak demand environment as the effects of the cost shocks and indirect tax increases wear off. However, there is considerable uncertainty around the degree and time path of disinflation, as developments in inflation have been affected by several shocks in the short term.
In the Council’s judgement, the outlook for growth has worsened significantly recently. Consumption demand is likely to be persistently low, reflecting the protracted process of balance sheet adjustment by households, uncertain income prospects and the further tightening in credit conditions. Significant fiscal adjustment next year is also likely to act as a brake on domestic demand growth.
In the uncertain economic environment, the tightening in credit conditions and the weaker outlook for growth are likely to be a drag on investment activity. Corporate profitability is expected to fall, reflecting rising labour costs due to the increase in the minimum wage and the tightening in the rules on write-offs of losses incurred in previous years. As a result, corporate investment activity may fall in 2012, which will be only partly offset by a couple of large individual investment projects implemented in manufacturing and the use of EU development funds. Service sector investment is unlikely to pick up, due to the significant margin of spare capacity. Household investment may reach its trough at the end of this year, but is expected to remain flat thereafter.
Domestic lending continues to make little contribution to economic growth. Rolling over short-term external funding has become more expensive and difficult for banks, due to the sovereign debt problems in the euro-area periphery. In addition, banks’ capital position has been deteriorating due to early repayments by households of their foreign currency-denominated mortgages. These factors may lead to a further tightening of credit supply constraints.
The slowdown in global activity, concerns about debt sustainability in some euro-area periphery countries and the vulnerability of the financial system point to a weaker outlook for activity in Hungary’s export markets, which in turn is likely to dampen export growth. Despite the slowdown in external demand, exports are likely to remain the main driver of subdued domestic growth over the next two years.
Over the past month, Hungarian risk premia have remained elevated, due mainly to the deteriorating outlook for global growth and the protracted debt crisis of the euro area. The decline in domestic banks’ capital buffers due to the option for households to repay their foreign currency debt at below-market rates represents a significant source of uncertainty in terms of Hungary’s risk perceptions. The Monetary Council welcomes the Government’s commitment to next year’s 2.5% deficit target, which, if met, may contribute to reduced perceptions of the risks associated with the economy.
The deteriorating outlook for activity points to disinflationary pressure from the demand side. The increases in VAT and excise duties are likely to boost the consumer price index temporarily. Although the weaker exchange rate and the planned increase in the minimum wage may generate short-term inflationary pressures, subdued inflationary pressures due to weak demand are likely to dominate developments in annual CPI inflation as the impact of cost shocks and the indirect tax increase gradually fades. However, there is considerable uncertainty around the degree and time path of disinflation, as developments in inflation have been affected by several shocks in the short term. The Monetary Council will therefore monitor particularly carefully the potential spillover impact of these shocks and developments in tax-adjusted inflation, in addition to the consumer price index.
Monetary policy can best support the recovery and contribute to an environment conducive to investment and job creation by maintaining predictability and preserving the stability of prices and the financial system. The risks to the outlook for inflation and financial market developments warrant a wait-and-see policy stance. The Monetary Council has therefore decided to leave interest rates unchanged.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 16 November 2011.
MAGYAR NEMZETI BANK