24 January 2012
At its meeting on 24 January, the Monetary Council reviewed the latest economic and financial developments and voted to leave the central bank base rate unchanged at 7.00%.
In the Council’s judgement, the Hungarian economy is likely be stagnant next year, with growth expected to resume only in 2013. The level of output will remain below its potential over the entire forecast period. As the effects of the indirect tax increases and the exchange rate depreciation wane, the disinflationary impact of weak domestic demand is likely to become the dominant factor shaping inflation.
The increases in VAT and excise duties are likely to lead to a significant increase in the price index in 2012. Fiscal compensation will cushion the effect of the inflationary effect of the minimum wage increase on labour costs; however, the weaker exchange rate, reflecting increased perceptions of the risks associated with the Hungarian economy, is leading to a deterioration in the inflation outlook. In addition to the consumer price index, the Monetary Council is also closely monitoring developments in tax-adjusted core inflation, which continues to indicate relatively modest inflationary pressures in the economy.
The slowdown in global growth and the euro-area debt crisis point to a weaker outlook for activity in Hungary’s export markets, which in turn may dampen export growth and contribute to a deterioration in the outlook for Hungarian economic growth. The escalation of the euro-are debt crisis and the risks faced by the European banking sector have led to a tightening in domestic credit conditions. In the current uncertain economic environment, the weaker outlook for growth and tighter credit conditions are restraining investment. Consumption is likely to remain persistently low, reflecting the weaker exchange rate, the uncertain prospects for income growth and the indirect tax increases. The Government’s measures to ensure that the target for next year’s budget deficit is met are also likely to act as a significant brake on domestic demand growth, but at the same time are necessary to improve Hungary’s risk assessment.
Recent events surrounding a loan agreement between the Government and the IMF have been the most important factor shaping perceptions about the economy: for example, the change in the Government’s communication about its intention to submit a formal request for an IMF loan and statements by government officials in response to messages calling for changes to legislation found to be in conflict with EU law. Hungary’s indicators continued to deteriorate as tensions between the Government and the IMF and EU increased. Subsequently, after reaching its height during the particularly turbulent period of 4 and 5 January, this negative trend reversed and began to improve with the Government’s communication in favour of an agreement. The Government’s increasing commitment to reach an agreement with the IMF and EU has resulted in an improvement in perceptions about the economy, with this improvement in perceptions becoming dominant in recent days. However, increased uncertainty and high market volatility have remained.
Monetary policy can best contribute to economic growth by maintaining a predictable economic environment, ensuring price stability and preserving the stability of the financial system. If necessary, the Monetary Council is ready to use the instruments at its disposal to meet these objectives.
In light of increased perceptions of risk and the upside risks to inflation, the Monetary Council has decided to leave the base rate unchanged. If perceptions about the economy and the outlook for inflation deteriorate significantly further, it may prove necessary to raise interest rates again.
The abridged minutes of today’s Council meeting will be published at 2 p.m. on 15 February 2012.
The Council’s assessment of performance in meeting the inflation target in 2011
Annual average inflation was 3.9% in 2011, down 1% on the previous year. During most of the year, inflation fluctuated near the upper bound of the +/-1% tolerance band around the Bank’s 3% inflation target.
Unprocessed food and oil price shocks starting at the end of 2010 were the most important factors contributing to inflation remaining above the target in 2011 H1. Persistent rises in world food prices fed through into domestic processed food prices and domestic fuel prices began to reflect higher global oil prices. As a result of these effects, the consumer price index hovered near 4% in H1. The second-round effects of the cost shocks had only a modest impact on the consumer price index, due to the downward effects on prices and wages of weak domestic demand and loose labour market conditions.
Although the consumer price index fell in H2 as the inflationary impact of the cost shocks waned and domestic demand remained weak, the increases in indirect taxes again led to a pick-up in inflation. The increase in perceptions of the risks associated with the Hungarian economy beginning in late summer resulted in a sharp depreciation of the forint exchange rate, which in turn contributed directly to increases in the prices of imported goods. However, due to weak domestic demand, firms were able to increase prices of many products only to a limited extent. As a result, the inflationary effect of the much weaker exchange rate was modest overall.
In the long term, monetary policy can best contribute to the predictability of the economic environment and economic growth by maintaining price stability and ensuring the stability of the financial system. The indicators of the longer-term inflationary outlook showed moderate inflationary pressures throughout the year. Under the monetary conditions maintained in 2011 and with domestic demand remaining persistently weak, the risk of inflationary shocks leading to longer-term second-round effects is low. The Monetary Council will continue its efforts to ensure that the consumer price index is consistent with the inflation target in the medium term.
MAGYAR NEMZETI BANK
Monetary Council