27 November 2012

At its meeting on 27 November 2012, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 25 basis points from 6.25% to 6.00%, with effect from 28 November 2012.

In the Monetary Council’s judgement, economic output is likely to fall this year, with growth only expected to resume in 2013. The level of output will be below its potential and unemployment will remain above its long-term level determined by structural factors. Weak demand conditions are expected to persist and the inflation target can be met in 2014 as the temporary inflationary impact of shocks to inflation wanes.

The slowdown in CPI inflation in October mainly reflected the fall in fuel prices and the moderation in administered price inflation. The short-term outlook for inflation improved, mostly as a result of favourable developments in non-core inflation items. A sustained reduction in risk premia may lead to an improvement in the medium-term outlook for inflation as well, while the Government’s cost-raising measures may point in the opposite direction. The consumer price index remains high, due primarily to rises in food prices as well as the effects of tax increases and other administrative measures. Inflation is likely to remain well above the target this year and next; however, the disinflationary impact of weak domestic demand is expected to increasingly dominate inflation developments as the upward pressure from one-off price level shocks subsides. The Council expects the 3 per cent inflation target to be met in 2014. In order to reduce cost pressures on companies and reach a higher level of employment, it is crucial that increases in wages next year, particularly in the minimum wage, are consistent with changes in whole-economy productivity.

The Hungarian economy remains in recession and growth is likely to resume next year as the country’s export markets recover. Both external and domestic factors point to weak growth over the period ahead. In the Council’s judgement, output will remain persistently below its potential level and the labour market will remain loose. The weakness of corporate investment and persistently high unemployment suggest that the economy’s potential growth rate is significantly below its pre-crisis level.

The measures announced by the Government confirmed its commitment to maintain a low fiscal deficit path. There is considerable uncertainty about the macroeconomic effects of the adjustment measures: the short-term outlook for growth and inflation is likely to be broadly unaffected, but cost pressures may arise in the medium term and the potential growth rate of the economy may fall, reflecting the reduced ability of the banking system to attract capital and restrained lending activity.

Higher risks around the agreement with the multinational organisations and the downgrade of Hungary’s sovereign debt by S&P may lead to an increase in perceptions of the risks associated with the economy. The Council continues to consider it crucial that an agreement between the Government and the European Union and International Monetary Fund is reached, as this would contribute to a sustained improvement in risk perceptions and a decline in yields as well as to the sustainability of government debt and would help support lending activity and improve the investment climate.

The Council judges that there remains a substantial margin of spare capacity in the economy. Therefore, the cost shocks hitting the economy have no adverse effect on the medium-term outlook for inflation, and the disinflationary impact of weak domestic demand will dominate as the impact of cost shocks wanes. The favourable global financial market environment, coupled with the Government’s strong commitment to maintain a low fiscal deficit, may contribute to a sustained decline in risk premia on domestic financial assets. Expected developments in inflation and financial markets as well as persistently weak demand warrant a lower interest rate level. The Council will consider a further reduction in interest rates if the improvement in financial market sentiment continues and the medium-term outlook for inflation is consistent with the 3 per cent target.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 5 December 2012.

Monetary Council