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Four members of Monetary Council vote to keep rates on hold on August 23

Four members of the National Bank of Hungary’s (MNB) monetary council voted to keep the base rate on hold at 5.25% at a rate-setting meeting on August 23, the condensed minutes of the meeting published on Wednesday show.

There were two other options, one to cut the base rate by 25 basis points and one to raise it by 25 basis points.

Deputy governors Csaba Csáki, Ferenc Karvalits, Júlia Király and Judit Neményi voted to keep the base rate on hold at 5.25%.

MNB governor András Simor and deputy governor Péter Bihari voted to raise the base rate to 5.5%, while Tamás Bánfi voted to reduce it to 5%.

Although inflation is to forecast stay above the 3pc midterm target by the bank's latest Inflation Report and Hungary's risk assessment worsened, the majority of Council members judged that policy tightening was not currently justified by the recent adverse developments. In the current uncertain environment, the Council had no adequate information to enable it to start a tightening cycle, and adopting a wait-and-see approach was likely to be a smaller mistake than deciding to start raising interest rates unduly.

Several members argued that the risk premium and the fluctuations in the forint exchange rate, a key factor determining the risk premium and the inflation path, were driven by uncertainty surrounding the government's economic policy. Consequently, any favourable shift could only be expected after the Government's plans were published. Some members, however, argued for an immediate monetary tightening, saying that increasing inflationary pressures, as discussed in the Report, could be contained at small real economic costs in the current environment, as the exchange rate appreciation associated with a policy tightening could even stimulate the economy through a pick-up in domestic demand.

Those arguing for a rate rise said that the higher inflation projection in the Report alone warranted policy tightening and the Council had no evidence that would point to a change in the future behavioral pattern of economic agents. Due to weakening of the forint and rises in imported material prices, inflationary pressures may have increased somewhat. They admitted that a fiscal adjustment could affect positively the inflation path in the Report, but said that the Monetary Council could not take such an economic policy turnaround for granted in advance, neither would such government measures be enough to bring inflation down towards the medium-term target. On another argument, the baseline projection in the Report might well underestimate future movements in commodity prices, which, in turn, might add to inflation risks.

Monetary council members agreed that the pick-up in economic growth this year output would remain below its potential level and the unemployment rate would remain elevated on the horizon relevant for monetary policy. While members agred that the disinflation process could be expected to come to an end, but the majority said that the future path of inflation may turn out to be better than the projection outlined by the Bank's staff in the latest Inflation Report, primarily because the output gap might be larger and might have a stronger effect than that assumed in the Report. Consequently, inflation might come close to the 3pc target.

In assessing recent inflation developments, it was argued that the behavioral patterns observed in the economy, which underlay the projection in the Report, could well be overwritten by the events that had taken place in the wake of the crisis, namely stronger-than expected balance-sheet adjustment by the banking and household sectors. Accompanied by constrained credit supply, household saving might remain high, which might act as a brake on inflation on the demand side.

Some members took the view that the lower-than-expected GDP data suggested the output gap might be larger than projected in the Report. Based on employment and earnings data, no inflationary pressure could be identified in the labour market. Several members noted that the distribution of risks around the baseline projection in the Report might be more balanced, and it was encouraging that inflation expectations had fallen despite the adverse macroeconomic outlook, which had not been experienced before.

Some members thought that, due to the recent volatility of the exchange rate, the depreciation of the forint had a weaker effect on the tradable sector and that the recent pattern of durables price inflation, contributing to the disinflation process, was not taken into account in the current projection model.

Several members noted that perceptions of the risks associated with the Hungarian economy had increased since early May. The spread on Hungarian foreign currency bonds over German bonds had risen sharply, and movements in CDS spreads compared unfavourably with those in other countries of the central and eastern European region. The rise in CDs spreads was particularly evident when looking back over a longer period. (MTI – Econews)