Hungarian prime interest rate raised

The Monetary Council of the National Bank of Hungary increased the prime interestó rate by 25 basis points to 5.5 percent on Monday with effect from November 30. The base rate had stood at 5.25 percent since April 27.

The council made a nearly unanimous decision, according to András Simor, governor of the National Bank. He noted that the last time the body had increased the base rate was in October 2008.

At its Monday meeting, the Monetary Council reviewed the latest economic and financial developments. In its Council’s judgement, the Hungarian economy is likely to continue to recover from recession over the forecast period; however, output will remain below its potential level.

The bank communiqué states that the Council expects inflation to rise in the short term, due to significant cost-push shocks hitting the economy. Under unchanged monetary conditions, inflation may remain above the 3% target for a sustained period. In the Council’s view, there are risks that inflation expectations will rise due to persistently above-target inflation and that the cost-push shocks will have second-round inflationary effects.

Hungarian economic growth continues to be driven by industrial sales on the back of strong external demand. Labour demand in the exporting sectors has increased, which has led to a rise in employment. Domestic demand may also begin to pick up in the course of 2011. Household consumption is expected to increase, due to the reduction in the personal income tax burden and improvements in employment. Investment is expected to increase as a result of a couple of projects undertaken in the manufacturing sector. However, investment activity may be restrained by heightened uncertainty surrounding the current business environment due to the imposition of sector-specific windfall taxes.

The Council notes that it is important that price and wage-setting decisions are consistent with significant spare capacity remaining in the economy and loose labour market conditions, despite the temporary upward effects on inflation.

Perceptions of the risks associated with the Hungarian economy have increased recently, due partly to the fall in global risk appetite and partly to country-specific factors, and particularly to a decline in the predictability of the economic environment. The latter is also reflected by the fact that since the middle of October Hungary’s risk premium has risen by more than in other countries with similar risk profiles.

The Monetary Council has decided to raise the base rate in light of inflation remaining persistently above the 3% target as well as the upside risks to inflation. It may be necessary to increase the base rate further in the coming months in order to meet the inflation target.