24 January 2011
1) At its meeting on 24 January 2011, the Monetary Council reviewed the latest economic and financial developments and voted to raise the central bank base rate by 25 basis points from 5.75% to 6.00%, with effect from 25 January 2011.
In the Monetary Council’s judgement, the Hungarian economy is likely to continue to recover from recession over the next two years; however, 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 significant cost-push shocks hitting the economy. In terms of the medium-term outlook for inflation, the main risk is that inflation 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 improvements in employment may stimulate household consumption. Large individual investment projects currently underway presage a pick-up in corporate investment; however, heightened uncertainty about the business environment may be a factor pressing 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 oil prices have led to inflationary pressure in the economy. This may be aggravated by the partial passing on to customers of the cost of sectoral levies. As a result of these factors, inflation may be significantly above the 3% target this year, and it is doubtful whether the target would be met in 2012 in the absence of further policy tightening.
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.
The continued high level of the risk premium on Hungarian financial assets reflects market concerns about the sustainability of the fiscal position and the predictability of the economic environment.
The Council has decided to raise the base rate in view of the upside risks to inflation. In the coming months, the Council will decide whether to raise interest rates again after considering upside risks to inflation.
2) The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 February 2011.
The Council’s assessment of performance in meeting the inflation target in 2010
The Bank’s 3% inflation target was not met in 2010. CPI inflation remained significantly above 3% over the year as a whole. The low level of core inflation, at below 2% from the second half of the year, reflects the effects of weak domestic demand. Increases in indirect taxes, announced in the previous year, continued to have an upward impact on prices in 2010 H1; however, even after most of those effects wore off, inflation has not fallen back close to the 3% target, due mainly to rises in food and other commodity prices. Consequently, the rate of consumer price inflation exceeded considerably the MNB’s continuous target for the fourth consecutive year.
Since the introduction of the 3% continuous target on 1 January 2007, the Hungarian economy has been hit by a number of shocks which have raised the consumer price level at the same time as reducing whole-economy output. In view of the real economic costs of monetary tightening and the output gap assumed to be negative at the time the shocks hit, the Bank decided not to offset the direct upward effect on prices of those shocks. The repeated cost shocks prevented inflation expectations from stabilising at around the 3% target in the absence of robust monetary policy response. The elevated level of inflation expectations, in addition to the cost shocks, may be another factor explaining why price stability could not be achieved in Hungary, despite the historically low level of capacity utilisation.
Past international experience suggests that small, open economies – both advanced and emerging ones – have succeeded in bringing down inflation expectations and stabilising them at a low level by using an inflation targeting regime. In order for the inflation targeting regime to be successful in Hungary, monetary policy should focus on anchoring inflation expectations and making appropriate, well-timed responses to future inflation shocks as its main priorities.
MAGYAR NEMZETI BANK