Press release on the Monetary Council meeting of 22 August 2017

22 August 2017

At its meeting on 22 August 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 23 August 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 July 2017, inflation rose to 2.1 percent and core inflation to 2.6 percent. The increase in core inflation adjusted for the effects of indirect taxes primarily reflected the change in processed food prices. 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 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. The external inflation environment, particularly in the euro area, is likely to remain low for a prolonged period.

The consumer price index is likely to rise temporarily in the coming months, before easing back to around current levels by the end of the 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.

The GDP data for the second quarter of 2017 showed that Hungarian economic output growth continued. Industrial production rose again in June; and the sector’s performance is expected to be buoyant in 2017 as a whole. Robust growth in construction is likely to continue in the coming months. In June, the volume of retail sales rose. Labour demand remained strong: employment grew further in the second quarter of 2017 and the unemployment rate remained at historically low levels. Driven mainly by the strong growth in investment alongside continued expansion in household consumption, 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 stable 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 mixed in the period since the Council’s previous interest rate decision. Risk appetite was influenced mainly by the release of macroeconomic data and expectations related to the monetary policy of the world’s leading central banks. Market expectations for the timing of policy tightening by the ECB have shifted out. Investors’ perceptions about the Central and Eastern European region improved, which led to an appreciation of local currencies. Inflation has been rising in the countries of the region. However, in light of the changed monetary conditions and the different inflation targets, 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. As a result, the three-month BUBOR remained at a historically low level. The interbank yield curve flattened. Yields on short-term government securities up to one-year maturity were little changed, while there was a slight 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, it is the maintenance for an extended period of the current level of the base rate and the loose monetary conditions achieved through the change in monetary policy instruments earlier, which 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. The Council will stand ready to ease monetary conditions further using unconventional, targeted instruments to ensure the monetary conditions necessary to meet the inflation target in a sustainable manner.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 6 September 2017.

MAGYAR NEMZETI BANK

Monetary Council