Press release on the Monetary Council meeting of 21 November 2017

21 November 2017

At its meeting on 21 November 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 22 November 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 by the middle of 2019.

In October 2017, inflation decreased to 2.2 percent and core inflation to 2.7 percent. Both headline and core inflation came in somewhat below the Bank’s and the market’s expectations, with the moderate dynamics of services and tradables prices accounting for most of the difference. The Bank’s measures of underlying inflation declined compared with the previous month and continued to be 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 still not yet been any significant upward pressure on inflation from wages. Oil prices have risen in recent months. Global underlying inflation continues to be moderate. External inflation, particularly in the euro area, is likely to remain low for a prolonged period.

Following a temporary rise, the consumer price index is likely to decline again 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 related to changes in tobacco and dairy product prices fade. 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. In the September projection, the inflation target can be achieved sustainably by the middle of 2019.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017. In September, industrial production increased relative to a year earlier at a rate similar to those in previous months, the volume of retail sales picked up. Labour demand remained strong: employment was at historically high levels in the third quarter of 2017. The unemployment rate continued to fall. The general increase in 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 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, been positive in the period since the Council’s previous interest rate decision. Monetary policy decisions by the world’s leading central banks and the latest macroeconomic data were the main factors influencing investors’ appetite for risk. The balance sheet reduction programme of the Fed has started in October 2017; however, market prices suggest no major change in interest rate expectations. In October, the European Central Bank announced that it would slow the pace of its asset purchases from January 2018. Nevertheless, persistently loose monetary conditions are expected in the period ahead. Market participants anticipate the ECB’s first interest rate hike to occur even later than previously thought, in the middle of 2019. 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.

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. Therefore, the importance of the stock and maturity structure of central bank swap instruments providing forint liquidity will increase. In the future, the Council will decide on the amount of liquidity crowded out on a regular frequency and will adjust the stock of central bank swap instruments accordingly.

The reduction in the overnight deposit rate in September, the amount of liquidity crowded out due to the introduction of an upper limit on the stock of three-month deposits and central bank communication addressing longer-term yields had a marked influence on domestic money market rates. In addition, the stock of central bank swap instruments providing forint liquidity continued to increase and the average maturity of outstanding swap contracts lengthened, in line with the Council’s aim. The three-month BUBOR was at its historic low. Long-term yields have declined in the government securities and interbank markets since the previous interest rate decision, and therefore the difference between short and long-term yields has narrowed. However, the yield curve is still steep in international comparison.

The Council considers it important 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, 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.

Accordingly, the Council will introduce unconditional interest rate swap (IRS) facilities with five and ten-year maturities, the allocation amount of which has been set at HUF 300 billion for the first quarter of 2018. The IRS facilities will be available for counterparty banks at regular tenders from the beginning of January 2018. In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation. The Magyar Nemzeti Bank will make a decision on the operational details of the programmes in December 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. 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 loose monetary conditions for an extended period are 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 6 December 2017.

MAGYAR NEMZETI BANK

Monetary Council