25 March 2014 - At its meeting on 25 March 2014, the Monetary Council reviewed the latest economic and financial developments and voted to reduce the central bank base rate by 10 basis points from 2.70% to 2.60%, with effect from 26 March 2014.

Since August 2012, the Monetary Council has reduced the central bank base rate significantly

These reductions in the base rate were justified by the low inflation environment, subdued inflationary pressures over the medium term and a degree of spare capacity in the economy. Perceptions of the risks associated with the economy were also generally supportive. In the Council’s judgement, the significant reduction in the base rate implemented so far has helped the Bank achieve the inflation target over the medium term and has contributed to the strengthening of domestic economic growth. The Council’s aim remains to maintain a balanced and conservative approach to monetary policy. In addition to the priority of meeting the inflation target, the Council also takes into account the condition of the real economy and incorporates financial stability considerations into its decisions. A marked and sustained shift in perceptions of the risks associated with the Hungarian economy may influence the room for manoeuvre in monetary policy.

Looking ahead, inflation is likely to move in line with price stability; disinflation is expected to slow gradually

In the Council’s judgement, inflation is likely to remain below the 3 per cent target in 2014, before moving into line with the medium-term inflation target from 2015. The inflation rate has been at historically low levels in recent months. Subdued inflation in external markets, the degree of unused capacity in the economy, the fall in inflation expectations and the reductions in regulated prices, implemented in a series of steps, have contributed to the development of a low inflation environment. However, the weaker exchange rate of recent months has passed through gradually to the prices of core inflation items, which in turn points to higher underlying inflation. Capacity utilisation is likely to rise gradually as economic activity continues to recover. Household consumption, however, which is relevant in terms of inflation pressures from the domestic real economy, is likely to grow only slowly, and therefore the real economic environment is expected to continue to have a disinflationary impact, although to a declining extent. In addition, the loose labour market and the adjustment of inflation expectations also suggest that moderate wage growth is likely to continue, which in turn will contribute to inflation moving in line with the Bank’s inflation target looking forward. The low inflation environment may help the Bank’s inflation target to better anchor the nominal path of the economy.

The Council judges that the Hungarian economy returned to a growth path in 2013. Looking ahead, economic growth is likely to continue

Economic activity picked up gradually in the past quarters, with output rising across a wide range of sectors. Looking ahead, Hungarian economic growth may continue in a more balanced pattern than previously. Rising exports are likely to play an important role as a source of growth in the coming years, supported by new production capacity in the automobile industry brought into production and the improvement in competitiveness, in addition to the recovery in economic activity abroad. Domestic demand is expected to strengthen in the coming years. Investments are likely to pick up further, reflecting the improvement in the outlook for activity, the easing in credit constraints due to the Bank’s Funding for Growth Scheme and the increasing use of EU funding. However, household consumption is likely to grow only gradually, even as disposable income increases. Propensity to save is expected to remain high, reflecting the ongoing reduction in debts accumulated during the years prior to the crisis and the slow improvement in credit conditions.

Hungary’s external debt is expected to fall further

The external financing capacity of the Hungarian economy continued to rise towards the end of 2013 and the external debt ratios fell significantly. The external surplus is likely to remain high in the coming years as the trade surplus stabilises at a high level, despite accelerating growth in consumption and investment. The improvement in the terms of trade and the pick-up in export growth as external demand recovers are likely to play a dominant role in this. The transfer balance is expected to fall slightly, due to the new budget cycle of the EU, but is likely to remain above levels recorded in previous years. With the external financing capacity remaining high, the external debt ratio is likely to fall further, which in turn will reduce the country’s vulnerability.

The Hungarian risk premium did not change significantly in the past quarter, but volatility increased in financial markets

Due to the Fed’s decision to further reduce the pace of its asset purchases, the increased focus on the vulnerability of some emerging economies and the escalation of the conflict between Ukraine and Russia, global investor sentiment has been volatile in the past quarter. Domestic risk premia have been little changed since publication of the December issue of the Bank’s Quarterly Report on Inflation. The CDS spread and the spreads on foreign currency bonds fell slightly, long-term yields rose modestly and the exchange rate depreciated, accompanied by significant volatility. The volatility of the major risk indicators increased relative to previous quarters. Nevertheless, Hungary’s position is fundamentally strong compared to other emerging market economies. The country’s persistently high external financing capacity and the resulting decline in external debt are reducing its vulnerability. In the Council’s judgement, a cautious approach to policy is warranted by uncertainty related to the global financial environment.

The macroeconomic outlook is surrounded by both upside and downside risks

The Monetary Council identified three alternative scenarios around the baseline projection of the MarchReport on Inflation, which might significantly influence the future conduct of monetary policy. In the alternative scenario assuming a persistently low external inflation environment and a slower-than-expected recovery in external demand, the inflation target may be achieved with looser monetary conditions than assumed in the baseline scenario. In the risk scenario assuming an unfavourable external environment and higher investor risk aversion, inflation moves in line with price stability in the medium term under tighter monetary conditions than implied by the baseline projection. A third scenario, assuming a pick-up in domestic employment and consumption, resulting in weaker domestic disinflationary pressures, also implies a tighter monetary policy stance.

After reviewing the projection in the March Report, the Council judges that there remains a degree of unused capacity in the economy and inflation is likely to move in line with the target in the medium term. The negative output gap is expected to close gradually at the monetary policy horizon, and therefore the disinflationary impact of the real economy is likely to decrease looking forward. In the Council’s judgement, there remained some scope for a cautious reduction in interest rates in the context of heightened uncertainty in global financial markets; however, a smaller reduction in interest rates than previously was warranted by the increase in uncertainty. Considering the substantial reduction in interest rates so far, changes in perceptions of the risks associated with the economy and based on currently available information, the central bank base rate has significantly approached a level which ensures the medium-term achievement of price stability and a corresponding degree of support for the economy. In case of a significant deterioration in global financial market environment, the Council will see no scope for continuing the easing cycle.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 April 2014.

Magyar Nemzeti Bank

Monetary Council