30 October 2012

At its meeting on 30 October 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 6.50% to 6.25%, with effect from 31 October 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 in the period ahead. Weak demand conditions are expected to persist and the inflation target can be met in 2014 after the temporary inflationary impact of shocks to inflation wanes.

Inflation picked up in September, mainly reflecting rises in food and fuel prices. The consumer price index remains high due mainly to increases in raw material prices as well as the effects of tax changes and administrative measures. Inflation is likely to stay significantly above the medium-term 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 fades. The Council expects the 3 per cent inflation target to be met in 2014. In order to reach a higher level of employment and mitigate cost pressures on companies, 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 has fallen into recession and growth is likely to resume next year as the country’s export markets recover. The latest economic data appear to confirm that domestic demand has remained subdued and external economic activity has weakened further. In the Monetary 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 in recent weeks confirmed the Government’s 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. The December issue of the Quarterly Report on Inflation will contain the Monetary Council’s detailed assessment of the effects of fiscal measures on inflation and the real economy.

Perceptions of the risks associated with the economy have fallen significantly, with country-specific factors and regulatory changes both contributing to the positive developments in Hungary’s risk indicators. Consistent with its earlier view, the Monetary Council considers 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 Monetary 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 effects of cost shocks wane. The improving 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 data becoming available in the coming months confirm that the improvement in financial market sentiment persists and the medium-term outlook for inflation remains consistent with the 3 per cent target.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 14 November 2012.

Monetary Council