22 May 2006

In the projections for economic trends outlined in the May 2006 issue of the Quarterly Report on Inflation, inflation is consistent with price stability over the medium term, and falls to a level around the 3% target. However, the Council’s judgement is that future government actions, their focus as well as the market’s response to them may cause a deviation in inflation developments from the central projection.

Data released over the past couple of months imply a low inflation environment. According to the indicators of trend inflation, as yet there is no clear evidence of inflationary pressure emerging in the Hungarian economy; last year’s underlying developments did not show signs of a turnaround over the period to April.

In assessing the future outlook for inflation, more factors must be taken account of than in the past. A number of influences point to a marked rise in inflation. Others, however, are offsetting, acting as a brake on inflation.

The Monetary Council continues to consider the weaker-than-earlier exchange rate and the high oil price as the key inflationary factors. And this year’s increase in the statutory minimum wage has also put upward pressure on inflation. The smaller-than-expected disinflationary effect of the VAT cut and the sharp rise in, often volatile, vegetables prices in recent months are unlikely to add to inflationary pressures and therefore they are viewed as being less relevant for monetary policy.

The most important factor pointing to moderate inflation is the marked slowdown in market services price inflation since early 2006. In the Council’s judgement, the adjustment of market service prices is of key importance for price stability to become more firmly based. The low level of inflation expectations is another positive development. Factors acting as a drag on inflation are also observable in the labour market. Simultaneously with the pick-up in private sector productivity growth, there has recently been a more modest expansion of labour demand, which is conducive to the adjustment of wages to the low inflation environment.

Due to the considerable risks to Hungarian economic balance, the likelihood that a correction – triggered either by economic policy or the market – will occur in a different way than set out in the Report cannot be neglected, which may change significantly the real economic outlook.

Volatility has increased in international capital markets in recent months, which has had an adverse effect on emerging country asset prices. Asset price fluctuations themselves do not pose a threat to the inflation target; however, if the risks of global developments pushing inflation away from the target increase, the Council will take this into account in its monetary policy decisions.