Press release on the Monetary Council meeting of 23 May 2017

23 May 2017

At its meeting on 23 May 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 24 May 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. Inflation reaches the central bank target sustainably from the first half of 2018.

In April 2017, inflation eased to 2.2 per cent. The moderation in inflation mainly reflected the decline in the price index for fuel, due primarily to base effects. Developments in the Bank’s measures of underlying inflation remained stable, in line with expectations. Inflation is likely to remain close to the current level over the coming period. Whole-economy wage growth is likely to pick up further, reflecting the dynamic expansion in employment, the tight labour market and the wage agreement at the end of 2016. The upward effect of this on costs is likely to be offset by the reduction in employers’ social contributions and in the corporate income tax rate. To a smaller extent, this is expected to lead to higher core inflation and, to a greater extent, to a reduction in the trade surplus through an expansion in household consumption. In the baseline projection, inflation reaches the 3 per cent level consistent with price stability in a sustainable manner from the first half of 2018.

The Hungarian economy expanded dynamically in the first quarter of 2017. Gross domestic product grew by 4.1 per cent relative to the same period a year earlier, according to preliminary data. In March 2017, industrial production rose significantly. In addition, construction output also grew strongly and growth is expected to continue over the coming months. The expansion in the volume of retail sales continued in March. Growth in the value of imports outpaced that in the value of exports. As a result, the trade surplus decreased in March. Labour demand remained strong. Employment rose slightly in the first quarter of 2017 and the unemployment rate remained at historically low levels. In parallel with strong wage growth, household consumption is likely to grow dynamically, which will be supported by the compensation of consumption deferred from previous years as well. Hungary’s current account surplus is expected to fall significantly 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, which was launched in June 2013, ended at the end of March 2017. After the Scheme is phased out, the transition to lending under market conditions is ensured by the Bank’s Market-Based Lending Scheme. 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, but deteriorated at the end of the period. Risk appetite was mainly influenced by developments in geopolitical tensions, the Fed’s and ECB’s monetary policy, the US government’s actions, the election outcomes in Europe and the aftereffects of the abandonment of the exchange rate floor in the Czech Republic. Risk indicators did not change significantly overall, while developed market equity indices typically rose over the period. 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 consequence, the three-month BUBOR remained at a historically low level. The interbank yield curve became flatter and yields fell markedly. Domestic short-term government security yields were little changed, while there was a significant decline at the middle and the long end of the yield curve of Hungarian government securities. As a result, three and five-year yields reached 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 March 2017, the Council set a HUF 500 billion upper limit on the stock of three-month central bank deposits as at the end of the second 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 swap instruments with maturities of 6 and 12 months, introduced in March, were used with success, with strong demand by banks at the FX swap tenders. The Council considers the limit on the three-month deposit stock and its potential future change an integral part of monetary policy instruments. The Bank continues to aim to maintain loose monetary conditions and provide 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 efficiently. The limit is set quarterly. On the next occasion, a decision on its level as at end of the third quarter of 2017 will be made in June 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. Over the forecast period, inflation reaches the target sustainably from the first half of 2018. 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. The Monetary Council monitors developments in monetary conditions and markets. 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 7 June 2017.

MAGYAR NEMZETI BANK
Monetary Council