Press release on the Monetary Council meeting of 28 March 2017

28 March 2017

At its meeting on 28 March 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 29 March 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 following the temporary slowdown last year, but this is likely to be gradually absorbed as the economy grows. Inflation reaches the target sustainably from the first half of 2018.

The increase in inflation, mainly driven by base effects, continued in February 2017. However, the Bank’s measures of underlying inflation remained stable, in line with expectations. The price index is likely to rise temporarily further slightly over the next month, and then to fall below the target from the spring months as the base effects at the beginning of the year fade. 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 last year. 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.

Hungarian economic growth continued in the fourth quarter of 2016. In January 2017, the volume of retail sales picked up and industrial production rose relative to the same period a year earlier. Construction output grew strongly in January following the sharp decline in the previous year; and output growth is expected to continue in the coming months. Labour demand remained strong. Employment continued to increase and the unemployment rate fell to a historic low. 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.

The Funding for Growth Scheme, which was launched in June 2013, will close at the end of March 2017. The programme achieved its goal, by facilitating financing for nearly 40,000 companies, it contributed greatly to the dynamic growth in SME borrowing which amounted to 12 per cent last year. The transition to lending under market conditions is assisted by the Bank’s Market-Based Lending Scheme. Under this programme, credit institutions have committed to expanding their lending by HUF 170 billion this year. As a result, growth of between 5–10 per cent in lending to SMEs is expected to be maintained. Economic growth this year will also be supported by the 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 divergence of monetary policies across the world’s major central banks has continued since the Council’s latest interest rate-setting meeting. The US Fed continued its tightening cycle, in line with expectations, while the ECB, being the most relevant for Hungarian monetary policy, continues to maintain its loose monetary policy conditions. The majority of developed market equity indices and yields on long-term government securities rose. The amount of liquidity crowded out following 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 and short-term yields in the government securities market fell slightly. Domestic long-term yields rose somewhat, in line with global trends.

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 substantially 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 toolkit, 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. In the second quarter, banking sector liquidity is likely to decline more strongly than previously, due mainly to the maturity of swap contracts related to the conversion of household foreign currency loans into forints and the rollover of maturing foreign currency-denominated government bonds in forints. For this reason, 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 over the past two quarters, and thereby maintain the loose monetary conditions achieved. In addition, the Council extended the existing range of swap instruments providing forint liquidity with 6 and 12-month facilities. 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 following the temporary slowdown last year, but this is likely to be absorbed gradually as the economy 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 12 April 2017.

MAGYAR NEMZETI BANK

Monetary Council