23 May 2005

Statement by the Monetary Council

Having reviewed the May issue of the Quarterly Report on Inflation, the Monetary Council is of the opinion that fundamentally favourable trends in inflation continue to be of key importance in the Hungarian economy. The steady fall in sinflation has been attributable to several macroeconomic trends, including increasingly marked labour market wage adjustment to a low-inflation environment and a moderate increase in all the components of core inflation. In addition to permanent factors, disinflation is further assisted by increasingly robust competition in certain categories of tradables following Hungary’s EU accession last year.

In the Council’s opinon, disinflation and the consolidation of a low-inflation environment will continue in the coming 18 months. Based on rising demand, which is consistent with capacity at the whole-economy level, no inflationary pressure is expected to materialise in 2005 or 2006. Despite a moderate increase envisaged for next year, the growth rate of domestic absorption, unlike vigorous domestic demand in previous years, is likely to lag behind GDP growth in both years. Permanent disinflation has also been also supported by easing labour market tightness and rising labour market reserves, which are also likely to be conducive to a further reduction in wage inflation. Overall, in the Council’s judgement, if the current trends beneficial to inflation outlook persist, the inflation targets for end-2005 (4%) and end-2006 (3.5%) can be met.

In setting the base rate, the Monetary Council assessed a number of mainly indirect risk factors which may, over a period relevant to monetary policy, interfere with the consolidation of the low-inflation environment, despite favourable inflation prospects.

First, at this juncture it cannot be clearly judged whether inflation expectations, playing an important role price and wage-setting decisions, have generally adjusted to the low inflation environment. A low inflation environment requires that wage developments are fully consistent with the expected fall in inflation.

Second, indirect upside risks to inflation due to economic imbalance and a potential decline in international investors’ willingness to take risks continue to be significant. In this respect, although the relevant risk indicators for emerging countries remain low, the recent months have seen a change in assessments of risks in the global financial marketplace: there has been a perceptible increase in investor uncertainty. In the global environment increasingly surrounded with uncertainties, financial investors may attach greater importance to a worsening in domestic equilibrium indicators.

By contrast, the fall in oil prices and the greater-than-expected decline in external demand may point to stronger disinflation over the period ahead.

Developments in external equilibrium play an important role in assessments of Hungarian economic performance. The country’s external financing requirement is expected to fall in 2005, due to rising household savings. Next year, the external financing requirement may continue to fall, if the general government deficit is reduced as outlined in the convergence programme.

The credibility of fiscal adjustment, an important requirement for the future adoption of the euro, plays a crucial role in assessments of risks facing the Hungarian economy.