Just like in September, Júlia Király, Deputy Governor of Hungary’s central bank (NBH) voted at the October policy meeting to raise the base rate by 25 basis points to 6.25%, the minutes of the 25 Oct meeting showed on Wednesday. In assessing the various interest rate policy options, the overwhelming majority of members (i.e. the other six members) agreed that under the current circumstances the Monetary Council should continue with its wait-and-see approach. Several members thought, however, that if external conditions did not improve tightening monetary conditions may not be avoided later on.
Council members agreed that slack domestic demand continued to put strong downward pressure on prices. Repayment burdens prompted households to adjust their balance sheets and, as a result, a further decline in domestic purchasing power could not be ruled out over the short term. Credit conditions for companies continued to tighten and corporate sector profitability continued to decline. The slowdown in external demand was already reflected in domestic macroeconomic data.
In the Council’s judgement, the uncertainty surrounding the inflation projection had increased, due to external factors and domestic economic policy measures. Members were of the view that the medium-term outlook could be reassessed during the production of the December inflation projection, after actions by the European Union to deal with the sovereign debt problems within the euro area were announced and new information was reviewed.
Several members argued that the upward effects on inflation from the indirect tax increase and the depreciation of the forint exchange rate in recent weeks might only be temporary. However, members held the unanimous view that monetary policy should closely monitor potential pass-through into the consumer price index.
One member noted that the significant increase in the minimum wage could add to costpush inflationary pressure. Another member argued that in the current circumstances monetary policy should focus mainly on developments in core inflation adjusted for taxes.
Other members, however, emphasised that the Bank’s price stability objective had to do with the overall consumer price index and previous experience suggested that it was necessary to keep core inflation below the inflation target in order to maintain price stability.
On another argument, the Government’s tax measures represented a price shock which was unlikely to wane on the policy horizon, and carried the risk that expectations of persistently high prices could develop.
Dilemma ahead of the EU summit
Members of the Monetary Council agreed that forecasting future changes in perceptions of the risks associated with the economy was the most important source of uncertainty for decision making.
Some members concluded that sovereign debt problems in several euro-area periphery countries might ease over the short term after the details of actions by the European Union were agreed and announced. As a result, investor sentiment might improve in the near term, which could lead to an increase in demand for forint-denominated assets and an appreciation of the forint exchange rate.
Recession and other risks
By contrast, several members noted that, along with the unpredictability of the international environment, early repayments of foreign currency loans and the 2012 government budget gave rise to uncertainties. For some members, the good news was that the level of government deficit continued to be very low compared with other European countries. One member, however, emphasised that the deterioration in the longer term outlook for growth might jeopardise the sustainability of the fiscal path.
Moreover, borrowers’ interest in the early repayment option was subdued, in which banks’ behaviour might play a role. Some members drew particular attention to the fact that several leading politicians had held out the prospect of expanding the range of opportunities for early repayment of foreign currency debt. If this were to occur, it would adversely affect Hungary’s risk perceptions.
On one argument, an increasing number of analysts suggested that the euro-area economy might enter a recession next year, which could also adversely affect Hungary over the medium term.
Several members cautioned that funding problems within the euro-area banking sector had intensified and there was a risk that lending would stall. Some members thought that the depreciation of the forint against other currencies of the CEE region and the results of the latest government securities issues reflected an increase in perceptions of the risks associated with forint-denominated assets.
Rate decision options
In assessing the various interest rate policy options, the overwhelming majority of members agreed that under the current circumstances the Council should continue with its wait-and-see approach. The latest real economic developments would warrant an easing of monetary conditions, but the sharp deterioration in global risk perceptions and financial stability risks prevented the Council from carrying it to effect. It was also the unanimous view of the majority of members that the medium-term outlook for inflation could be assessed after actions by the European Union to deal with the sovereign debt problems within the euro area and the Hungarian Government’s economic policy measures were announced.
Members’ views were divided on future desirable monetary policy conditions and their communication. Some members felt that the fact that the European Central Bank was expected to reduce interest rates in the near future called for maintaining the present wait-and-see approach and, consequently, the premium on forint-denominated assets might rise.
On one argument, Hungarian monetary policy was unable to respond to external shocks arising from the euro-area sovereign debt crisis. However, several members thought that if external conditions did not improve and the increase in Hungary’s risk perceptions persisted, inflation risks might increase and tightening monetary conditions could not be avoided later on.
One member cautioned that higher inflation and reducing debt though inflation could not represent a realistic economic policy alternative. The Bank’s mission and mandate did not allow for this to happen; and in a small, open country where the state was indebted to a significant degree in foreign currency this could not be a successful strategy.
After the discussion, the Chairman invited members to vote on the proposals put to the Council. Six members voted to maintain the central bank base rate at 6.00% and one member voted to raise it by 25 basis points.
The Council will hold its next policy meeting on 29 November 2011. The minutes of that meeting will be published at 14:00 CET on 7 December 2011.
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