Press release on the Monetary Council meeting of 20 June 2017

20 June 2017

At its meeting on 20 June 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 21 June 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 half a year later, from early 2019.

In May 2017, inflation eased to 2.1 per cent. The moderation in inflation mainly reflected the decline in the price index for fuel, due in part to base effects. 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 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 central bank’s expectations, there has not yet been any upward pressure on inflation from wages. The rise in global inflation which started towards the end of 2016 came to a halt in recent months. In relation to the euro area the European Central Bank has revised its inflation forecast down for the next years. Consistent with this, external inflation is likely to remain low for a prolonged period.

The consumer price index is likely to remain around its current level in the summer months and then to rise slowly as the end of the year approaches. 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 reductions, announced recently, 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 half a year later, from early 2019.

The Hungarian economy expanded dynamically, by 4.2 per cent, in the first quarter of 2017 relative to the same period a year earlier. The main contributors to growth were investment, industry and services, in addition to consumption. Based on available monthly data, Hungarian economic growth is likely to continue in the second quarter of 2017. Industrial production may weaken from its strong performance in the second quarter of 2016; however, the sector’s performance is expected to improve in 2017 as a whole. Robust growth in construction is likely to continue in the coming months. In April, the volume of retail sales continued to expand at a similar rate as at the beginning of the year. Labour demand remained strong. Employment rose slightly in the first quarter of 2017 and the unemployment rate remained at historically low levels. Driven by the continued expansion in household consumption and the pick-up in investment activity, domestic demand will play an increasing role in economic growth. Hungary’s current account surplus is expected to fall over the forecast horizon, driven by 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 stable annual economic growth of between 3–4 per cent 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 the beginning of 2016 and extended in May 2017. In consequence, growth in lending to micro, small and medium-sized enterprises may be maintained in the upper half of the 5–10 per cent range, deemed necessary for sustainable growth, over the medium term.

Sentiment in international financial markets was mostly favourable since the Council’s latest interest rate-setting meeting. Risk appetite was mainly influenced by the French elections, the oil price agreement between OPEC members in line with expectations and by expectations related to the Fed’s and ECB’s monetary policy. In the euro area, market expectations on the interest rate path shifted down, while the Fed’s expected interest rate path did not change markedly. Risk indicators and developed market equity indices did not change significantly overall. 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 shifted down slightly. Domestic short-term government security yields were little changed, while there was a decline at the middle and the long end of the yield curve of Hungarian government securities. Three and five-year yields were around 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.

In the Council’s assessment, the operation of the monetary policy instruments, extended in July 2016, has been successful; 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. 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 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 Bank 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 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 half a year later, 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, downside risks to inflation have increased with the change in the external environment. 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 5 July 2017.

MAGYAR NEMZETI BANK

Monetary Council