Press release on the Monetary Council meeting of 19 September 2017

19 September 2017

At its meeting on 19 September 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 September 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. In the September projection, the inflation target is expected to be achieved in a sustainable manner one additional quarter later, i.e. by the middle of 2019, following a delay of half a year indicated in the June projection.

In August 2017, inflation rose to 2.6 percent and core inflation to 2.8 percent. The increase in core inflation mainly reflected base effects and temporary effects, such as changes in the prices of tobacco and dairy products. In line with the Bank’s expectations measures of underlying inflation were around 2 percent, significantly below the level of 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 not yet been any significant upward pressure on inflation from wages. The rise in global inflation which started at the beginning of the year has stalled, and consumer price indices in some economies have fallen. The European Central Bank revised down its projection for euro-area inflation again. External inflation, particularly in the euro area, is likely to remain low for a prolonged period.

In the coming months, the consumer price index is likely to decline again from its current level to the bottom of the tolerance band by the end of 2017. Core inflation is expected to decrease in the second half of next year as the temporary effects wane. Looking ahead, the Bank’s measures of underlying inflation are expected to be around 2 percent. 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. According to the projection of the September Inflation Report, the price stability target can be achieved sustainably one quarter later, i.e. by the middle of 2019.

Growth of the Hungarian economy continued in the second quarter of 2017. Industrial production stagnated in July due to factory shutdowns in the summer. A reversal and gradual pick-up in industrial production is expected towards the end of the year. Robust growth in construction and the expansion in the performance of the service sector are likely to continue in the coming months. Retail sales growth slowed somewhat in July. Labour demand remained strong: employment was at historically high levels in the second quarter of 2017. The unemployment rate remained at a low level. The general 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 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

Sentiment in international financial markets has, on the whole, improved in the period since the Council’s previous interest rate decision. Besides to an escalation in geopolitical risks, favourable macroeconomic data and negotiations about Brexit also had an effect on risk appetite. Investors’ perceptions about the Central and Eastern European region continued 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 pricing suggests that the timing of central bank actions will differ. 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. The three-month BUBOR fell to a new historic low. The yield curves for the interbank and government securities markets shifted downwards. Three and five-year yields on government securities are at their historical lows.

Achieved through the change in  monetary policy instruments, the earlier loose monetary conditions, necessary to meet the inflation target in a sustainable manner, have, on the whole, become tighter in recent months.  The repeated delay in the date of meeting the inflation target also warrants monetary easing. The Monetary Council decided on harmonised measures to ensure the adequate monetary conditions. In particular, the Council reduced the interest rate on the overnight central bank deposit by 10 basis points. In addition, it set a HUF 75 billion upper limit on the stock of three-month central bank deposits outstanding from the end of 2017. The stock of swap instruments will be increased in the coming period. The objective of the latter is to provide the loosening effect up to the longest possible section of the yield curve as soon as possible.

In the Council’s assessment the 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. The importance of the stock and maturity structure of swap instruments providing forint liquidity increases in the future.

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. The inflation target is expected to be achieved in a sustainable manner one additional quarter later, i.e. by the middle of 2019, following a delay of half a year indicated in the June projection. The Council lowered the overnight deposit rate by 10 basis points to -0.15 percent and left the base rate, the overnight and one-week lending rates unchanged. The Council considers that the external environment continues to pose a downside risk to inflation. In the Council’s assessment, maintaining the base rate and loose monetary conditions for an extended period are necessary to achieve the inflation target in a sustainable manner. The Monetary Council will continue to monitor closely the risks to inflation and developments in monetary conditions, and will stand ready to ease them further using additional unconventional, targeted instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 4 October 2017.

MAGYAR NEMZETI BANK

Monetary Council