Press release on the Monetary Council meeting of 19 December 2017

19 December 2017

At its meeting on 19 December 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 20 December 2017:

In the Council’s assessment, in parallel with the pick-up in domestic demand Hungarian economic output is close to its potential level. Growth of the Hungarian economy will continue to be dynamic in 2018, then it will slow down. The inflation target is expected to be achieved in a sustainable manner by the middle of 2019.

In November 2017, inflation stood at 2.5 percent and core inflation at 2.7 percent. In the autumn months, inflation was basically in line with the September Inflation Report projection; however, core inflation fell short of the forecast. The difference was mainly attributable to the price dynamics of market services. The Bank’s measures of underlying inflation remained unchanged compared with the summer months and continued to be significantly below core inflation. The expansion in domestic employment, the tight labour market as well as increases in the minimum wage and the guaranteed minimum wage 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 still not yet been any significant upward pressure on inflation from wages. Oil prices have risen in recent months. In the euro area, underlying inflation will continue to be moderate in the coming years as well.

According to our current projection, following a temporary rise in November, the consumer price index is likely to decline again to close to 2 per cent at the end of 2017, then in the first months of 2018 it will level off at the bottom edge of the tolerance band. Over the medium term the second-round effects resulting from buoyant domestic demand, increase in wage costs, as well as higher commodity prices will point to the increase in domestic core inflation. However, moderate external inflation and inflation expectations stabilising at historically low levels, as well as subsequent reductions in employers’ social contributions, the VAT rate cuts, announced for next year, are slowing the rise in prices. In our projection, the inflation target can be achieved sustainably by the middle of 2019.

The Hungarian economy grew by 3.9 percent in the third quarter of 2017. Industrial production and the volume of retail sales picked up in October. Labour demand remained strong: employment was close to historically high levels in August-October 2017. The unemployment rate continued to fall.

Looking ahead, the general strengthening of domestic demand will continue to play a central role in economic growth. Robust growth in construction and the expansion in the performance of the service sector are likely to continue in the coming months. Hungary’s current account surplus is expected to fall in 2017-2018, driven by rising domestic demand. Economic growth this year will also be supported by the fiscal budget and the stimulating effects on investment of European Union funding. In the Council’s assessment, GDP growth will approach 4 per cent in 2017 and 2018, then it will slow down from 2019 onwards according to the current projection. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

Sentiment in international financial markets has, on the whole, been positive in the period since the Council’s previous interest rate decision. News of negotiations between the EU and the United Kingdom, favourable projections for global growth and the European political events were the main factors influencing investors’ appetite for risk. In December, the Fed decided to further increase the base rate; however, market prices suggested no major change in interest rate expectations. Looking ahead, the European Central Bank is likely to maintain loose monetary conditions for an extended period. Investors’ perceptions about the Central and Eastern European region continue to be positive. Due to the different inflation paths expected in the countries of the region and the different characteristics of inflation targeting regimes, market prices suggest that the timing of central bank actions will differ.

Yields in the domestic money and capital markets declined to their historic low. Short-term yields are at a level close to or below zero. The liquidity crowded out due to the introduction of an upper limit on the stock of three-month deposits, the reduction in the overnight central bank deposit rate, as well as the increase in the size and the average original maturity of the stock of central bank swap instruments providing forint liquidity have had a marked influence on short-term yields. Long-term yields have decreased significantly in the last three months, which is mostly the result of the MNB’s forward guidance and the announcement of the central bank interest rate swap instruments and the mortgage bond purchase programme in November. The Hungarian yield curve shifted downwards markedly in a regional comparison as well; however, it is still steep in international comparison.

In the Council’s assessment, maintaining the loose monetary conditions for an extended period are necessary to achieve the inflation target in a sustainable manner. To this end, the Monetary Council maintained the base rate, the overnight collateralised lending rate, the one-week collateralised lending rate at 0.9 per cent, and the overnight deposit rate at -0.15 per cent. In the Council’s assessment, the gradual limitation on the stock of three-month deposits has fulfilled its role and the HUF 75 billion year-end upper limit on the stock will not be reduced further. In line with maintaining monetary conditions, the Council set a HUF 400-600 billion band for the targeted average liquidity crowded-out for the first quarter of 2018, which is equal to that of the fourth quarter of 2017. On the next occasion, the Council will decide on the amount of liquidity crowded out in March 2018 and will adjust the stock of central bank swap instruments accordingly.

The Council’s aim is that the loose monetary conditions have their effect not only at the short but also at the longer end of the yield curve. To ensure this, in November, the Council decided to introduce two unconventional instruments from January 2018, which will constitute an integral part of the Bank’s set of monetary policy instruments. In harmony with the Council’s forward guidance the new instruments contribute efficiently to the maintenance of loose monetary conditions over a prolonged period. Accordingly, the Council will introduce unconditional interest rate swap (IRS) facilities with five and ten-year maturities, the maximum allotted amount of which has been set at HUF 300 billion for the first quarter of 2018. In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. The Council expects an increase in mortgage bond issuance and an improvement of market activity due to the measure. The maximum allotted amount for the security purchase programme amounts to 50 per cent of the ever-prevailing mortgage-bond stock on the market. Both programmes will contribute to an increase in the share of loans with long periods of interest rate fixation, thereby improving financial stability. After several rounds of consultation with banks, the Magyar Nemzeti Bank will make a decision on the operational details of the programmes until 22 December 2017, and will inform market participants about this in a release.

The inflation target is expected to be achieved in a sustainable manner by the middle of 2019. In the Council’s assessment, maintaining the base rate and the loose monetary conditions at both short and long ends for an extended period is necessary to achieve the inflation target in a sustainable manner. The Council will closely monitor developments in monetary conditions and will ensure the persistence of loose monetary conditions over a prolonged period by using the extended set of monetary policy instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 10 January 2018.

MAGYAR NEMZETI BANK

Monetary Council