At its meeting on 29 November, the Monetary Council reviewed the latest economic and financial developments and voted to raise the central bank base rate by 50 basis points from 6.00% to 6.50%, with effect from 30 November 2011.
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. The consumer price index will increasingly reflect the disinflationary impact of weak domestic demand after the effects of the indirect tax increases have worn off; however, the depreciation of the forint in recent months is a threat to meeting the 3 per cent inflation target. Exchange rate depreciation is also increasing the vulnerability of the domestic financial system.
The increases in VAT and excise duties are likely to raise the consumer price index significantly in 2012. Fiscal compensation to companies will partly offset the effects of the minimum wage increase. The depreciation of the forint in recent months may lead to a build-up of inflationary pressure even in the medium term. The extent to which companies will be able to pass cost increases on to prices is a source of uncertainty in terms of the future outlook for inflation. 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 activity, concerns about debt sustainability in some euro-area periphery countries and the vulnerability of the financial system point to a weak outlook in Hungary’s export markets, which in turn may dampen export growth.
Consumption demand is likely to remain persistently low, reflecting the protracted balance sheet adjustment by households, uncertain income prospects, the inflationary impact of indirect tax increases and the weaker exchange rate. Significant fiscal adjustment next year is also likely to act as a brake on domestic demand growth.
Domestic lending continues to make little contribution to economic growth. Rolling over short-term external funding has become more expensive and difficult for Hungarian banks, due to the sovereign debt problems in the euro-area periphery. Furthermore, the banking sector’s capital position has been deteriorating due to losses arising from early repayments by households of foreign currency-denominated mortgages, which in turn weakens banks’ lending capacity. Also, the banking sector’s willingness to lend is low. These factors may lead to a further tightening in credit supply, as confirmed by the Bank’s latest lending survey.
In the current uncertain economic environment, the weaker outlook for growth and the tightening in credit conditions are acting as a drag on investment activity. Corporate profitability is expected to deteriorate. As a result, corporate investment may fall significantly in 2012, which will be only partly offset by a couple of large individual investment projects in manufacturing.
The depreciation of the forint and the increase in risk premia have continued over the past month. The deteriorating outlook for global growth, the escalating euro-area sovereign debt crisis and growing tensions in the banking sector have been the main factors contributing to these unfavourable developments. All this leads to a deterioration in the outlook for growth in Hungary, while creating more unfavourable financing conditions for the country. The adverse impact of the early repayment option for foreign currency borrowers on domestic banks’ capital position and increasing fiscal sustainability concerns also contributed to the increase in risk premia. The decision by the Government that it would conduct talks with the International Monetary Fund led to only temporary improvement in market sentiment, which deteriorated again following the move by Moody’s to downgrade Hungary’s sovereign debt rating. In this situation, the Monetary Council considers it important that an agreement between the Government and the international organisations as well as between the Government and the Banking Association is reached as soon as possible.
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 depreciation of the forint in recent months has caused a deterioration in the inflation outlook and increased the need for balance sheet adjustment in the economy. The Monetary Council decided to raise the base rate by 50 basis points in view of the upside risks to inflation and increased perceptions of the risks associated with the economy. If the outlook for inflation and risk perceptions remain persistently unfavourable, it may prove necessary to raise interest rates further in the coming months.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 7 December 2011.
MAGYAR NEMZETI BANK