Press release on the Monetary Council meeting of 18 July 2017

18 July 2017

At its meeting on 18 July 2017, the Monetary Council reviewed the latest economic and financial developments and decided on the following structure of central bank interest rates with effect from 19 July 2017:

In the Council’s assessment, Hungarian economic growth picks up over the forecast horizon. Some degree of unused capacity has remained in the economy, but this is likely to be gradually absorbed as output grows dynamically. The inflation target is expected to be achieved in a sustainable manner from early 2019.

In June 2017, inflation eased to 1.9 percent. The moderation in inflation primarily reflected the decline in the price index for fuel, due in part to base effects. Core inflation rose to 2.4 percent. Developments in the Bank’s measures of underlying inflation remained stable, in line with expectations. The expansion in domestic employment, the tight labour market as well as increases in the minimum wage and the guaranteed minimum wage at the start of the year have led to a general, dynamic rise in whole-economy wages. The upward effect of this on costs is being offset by the reduction in employers’ social contributions and in the corporate income tax rate early this year. In line with the Bank’s expectations, there has not yet been any upward pressure on inflation from wages. Global inflation started to rise at the end of 2016, but has moderated in recent months. Price indices of the external environment and particularly that of the euro area are likely to remain low for a prolonged period.

The consumer price index is likely to remain near its current level over the remainder of this year. To a smaller extent, the expansion in household consumption is expected to lead to higher core inflation and, to a greater extent, to a reduction in the trade surplus. Moderate imported inflation and historically low inflation expectations as well as the VAT rate cuts, announced for next year, have been slowing the rise in domestic prices. In the baseline projection, the 3 percent inflation target is expected to be achieved in a sustainable manner from early 2019.

According to recent monthly data, Hungarian output growth continued in the second quarter of 2017. Industrial production rose significantly in May; and the sector’s performance is expected to pick up in 2017 as a whole. Robust growth in construction is likely to continue in the coming months. In May, the volume of retail sales picked up. Labour demand remained strong. Employment was broadly unchanged during the spring of 2017 and the unemployment rate remained at historically low levels. Driven by the continued expansion in household consumption and the strong growth in investment activity, the increase in domestic demand will continue to play a central role in economic growth. Hungary’s current account surplus is expected to fall over the forecast horizon in response to rising domestic demand. Economic growth this year will also be supported by the fiscal budget and the stimulating effects on investment of EU funding. The Monetary Council expects annual economic growth of between 3–4 percent over the coming years, to which the Bank’s and the Government’s measures to stimulate economic growth contribute substantially.

The Funding for Growth Scheme ended at the end of March 2017. After it was phased out, the transition to lending under market conditions is ensured by the Bank’s Market-Based Lending Scheme introduced in early 2016 and extended in 2017. At the tender held in the second phase of the Scheme in July, commercial banks raised their lending commitment by one-third. This will ensure that growth in lending to SMEs is maintained in the upper half of the 5–10 percent range, deemed necessary by the MNB for sustainable economic growth.

Sentiment in international financial markets has been calm for most of the period since the Council’s latest interest rate decision. Risk appetite was influenced mainly by expectations related to the Fed’s and the ECB’s monetary policy. Market expectations on both the ECB’s and the Fed’s interest rate path shifted up. Overall, risk indicators were unchanged and developed market equity indices fell. The amount of liquidity crowded out due to the introduction of an upper limit on the stock of three-month deposits continued to have a marked influence on domestic money market rates. As a result, the three-month BUBOR remained at a historically low level. The interbank yield curve steepened. Yields on short-term government securities up to one-year maturity were little changed, while there was an increase at the long end of the yield curve of Hungarian government securities. Three and five-year yields are near record low levels. Hungary’s strong external financing capacity and the decline in external debt are contributing to the sustained reduction in the vulnerability of the economy. Forward-looking domestic money market real interest rates have fallen significantly over recent years and are expected to remain in negative territory for a prolonged period. In the Council’s assessment, a watchful approach to monetary policy is still warranted due to uncertainty in the global financial environment.

At its meeting in June 2017, the Council set a HUF 300 billion upper limit on the stock of three-month central bank deposits as at the end of the third quarter of 2017, in order to preserve the amount of liquidity crowded out of the deposit facility, and thereby to maintain the loose monetary conditions achieved. The MNB has managed uncertainties related to liquidity developments in the banking sector using fine-tuning operations introduced in October 2016 and extended with longer maturities in March 2017. The limit set on the three-month deposit stock and its potential future change are considered to be integral parts of instruments. The Bank continues to aim to maintain loose monetary conditions and provide a corresponding degree of support to the economy through money market rates. The Monetary Council intends to ensure that the limit imposed on the stock of three-month deposits exerts its expected effect on monetary conditions efficiently. The limit is set quarterly. On the next occasion, a decision on its level as at end of the fourth quarter of 2017 will be made in September 2017.

In the Council’s assessment, some degree of unused capacity has remained in the economy, but this is likely to be absorbed gradually as output grows dynamically. Over the forecast period, the inflation target is expected to be achieved in a sustainable manner from early 2019. If the assumptions underlying the Bank’s projections hold, maintaining the current level of the base rate and loose monetary conditions achieved through the change in monetary policy instruments for an extended period is consistent with the medium-term achievement of the inflation target and a corresponding degree of support to the economy. In the Council’s assessment, the external environment continues to pose a downside risk to inflation. If inflation remains persistently below the target, the Council will stand ready to ease monetary conditions further using unconventional, targeted instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 2 August 2017.

MAGYAR NEMZETI BANK
Monetary Council