28 March 2011

At its meeting on 28 March 2011, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 6.00%.

Members discussed the March issue of the MNB’s Quarterly Report on Inflation.

In the Council’s judgement, Hungarian economic growth is likely to pick up gradually over the forecast horizon; 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 short term, due to the cost-push shocks hitting the economy, but may fall back close to the target 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, weak domestic demand and high unemployment continue to exert discipline on price and wage-setting behaviour. On the other hand, the economy has been hit by adverse cost-push shocks, the effects of which are expected to feed through to core inflation in the short term. According to the latest available data, however, the extent of this pass-through has been smaller than previously. Loose labour market conditions are allowing firms to restore their profitability by moderating earnings growth, rather than by raising prices. The recent interest rate increases have been successful in reducing possible second-round effects of the cost shocks. On balance, therefore, inflation in 2011 is likely to remain significantly above the Bank’s 3% target and then fall back to settle around it towards the end of next year. 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. The Council’s collective view that it is important that administered prices only change to the extent justified by cost increases and welcomes the Government’s commitment in this area.

Strong external demand is expected to remain the main driver of Hungarian economic growth this year, with domestic demand likely to recover only gradually. Disbursements to members of real returns on their private pension fund contributions are likely to provide a temporary boost to household 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 household disposable income in 2012. If maintained over a sustained period, current tight credit conditions in the household market may weigh down on consumption demand growth and reinforce the disinflationary effects from the real economy.

Increased business uncertainty due to tight lending conditions, the effects of windfall taxes and changes to corporate income tax regulations has been a drag on corporate investment activity recently. 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.

Perceptions of the risks associated with the Hungarian economy changed little in March following the improvement in previous months. The announcement of the Government’s fiscal adjustment measures left risk premia broadly unaffected, as it had already been priced in by the market.

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 path outlined in the Report. 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 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 6 April 2011.


Monetary Council