Press release on the Monetary Council meeting of 18 September 2018

At its meeting on 18 September 2018, the Monetary Council reviewed the latest economic and financial developments and decided on the following structure of central bank interest rates with effect from 19 September 2018:

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 3 October 2018.

In the Council’s assessment, in parallel with the pick-up in domestic demand Hungarian economic output is close to its potential level. Growth of the Hungarian economy will pick up further in 2018, then, if the assumptions of the current projection hold, it will slow down gradually from 2019. The inflation target is still expected to be achieved in a sustainable manner from mid-2019.

The Magyar Nemzeti Bank’s (MNB) single anchor is inflation. Under the flexible inflation targeting regime, the Monetary Council takes account of all factors influencing inflation developments on the five to eight-quarter horizon of monetary policy. These may include developments in commodity prices, changes in the external inflation environment, labour market conditions, the position of the real economy, developments in the exchange rate and credit market conditions. By taking into account all these factors, the Bank is able to assess the likely magnitude and persistence of future price changes, which in turn determines the monetary policy response.

Incoming macroeconomic data for the past quarter were in line with the Bank’s expectations. In August 2018, inflation stood at 3.4 percent, while core inflation decreased to 2.3 percent. Volatile fuel and unprocessed food prices were the main factors contributing to the increase in inflation in the summer months. Inflationary pressures from wages continue to be moderate. According to the European Central Bank’s (ECB) projections, underlying inflation will continue to be moderate in the euro area in the coming years as well.

If the assumptions in the September projection hold, the consumer price index will remain above 3 percent in the short term. From September, the increase in excise taxes will also contribute to upward pressure on inflation, in addition to fuel and unprocessed food prices, while core inflation excluding indirect tax effects will remain stable around 2.5 percent. With inflation expectations anchored at low levels, second-round effects are not expected to arise. According to our projection, rising consumption will lead to a gradual increase in underlying inflation. As temporary effects fade, the inflation rate is expected to ease back again, and the rise in underlying inflation will ensure that inflation meets the 3 percent target in a sustainable structure from mid-2019.

The Hungarian economy grew strongly, by 4.8 percent in the second quarter of 2018 relative to a year earlier. Data on economic activity suggest that robust economic growth is likely to continue. Labour demand remains strong. The unemployment rate has fallen to a historically low level. Lending to the corporate and household sectors continued to expand in July; however, proportion of long-term, fixed-rate lending to corporates continues to be low.

Looking ahead, economic growth is expected to continue across a broad range of sectors. The general strengthening of domestic demand will continue to play a central role in economic output developments. In the Council’s assessment, GDP growth will be 4.4 percent in 2018, higher than last year, then, if the assumptions of the current projection hold, it will slow down gradually from 2019. Meanwhile, the country’s current account balance is expected to remain in positive territory over the longer term as well.

Sentiment in international financial markets has been volatile in the period since the Council’s previous interest rate decision. Developments in international trade policies and events related to vulnerable emerging countries influenced investors’ appetite for risk. Asset price volatility increased in domestic financial markets as a consequence of the volatile international financial market sentiment. The Bank assesses these developments in light of their relevance to its primary objective, i.e. the sustainable achievement of the inflation target, focusing on their persistence. The current volatile international environment continues to suggest a more cautious approach. The monetary conditions in the euro area may remain loose. The ECB’s decisions may have a significant influence on the Magyar Nemzeti Bank’s monetary policy.

The Bank’s primary objective is to achieve the inflation target in a sustainable manner. For this reason, in the Council’s assessment, maintaining the loose monetary conditions is necessary. The Council, however, reviewed its monetary policy instruments and is prepared for the gradual and cautious normalisation of monetary policy.

In order to maintain the loose monetary conditions, the Monetary Council held the base rate, the overnight collateralised lending rate and the one-week collateralised lending rate at 0.9 percent and the overnight deposit rate at -0.15 percent. The Council left the average amount of liquidity to be crowded-out for the fourth quarter of 2018 unchanged, at least at HUF 400-600 billion. On the next occasion, in December 2018, the Council will decide on the amount of liquidity to be crowded out and will take this into account in setting the stock of central bank swap instruments.

Consistent with the practice of leading central banks, the MNB is also prepared for the gradual and cautious normalisation of monetary policy. The set of unconventional instruments affecting short-term yields will be simplified, and the Monetary Council will publish the background material to the Bank’s instrument strategy. In addition, the set of unconventional instruments affecting long-term yields will be fine-tuned.

The set of central bank instruments affecting short-term yields will become more simple and transparent after the Council’s decision to phase out the three-month deposit facility by the end of 2018. The current HUF 75 billion stock of three-month central bank deposits will decline to zero by the end of December 2018. The interest rate remunerated on required reserves and preferential deposits will remain equal to the central bank base rate. In the future, required reserves will be the main policy instrument. Furthermore, in its background material to the Bank’s instrument strategy, the Monetary Council will communicate about the future role of the individual unconventional monetary policy instruments. Looking forward, the Bank will adjust the monetary conditions necessary to achieve the inflation target in a sustainable manner by creating an optimal combination of two of its instruments: swaps providing forint liquidity and the interest rate corridor.

As part of the fine-tuning of the unconventional policy instruments affecting long-term yields, the Council made a decision to phase out the monetary policy IRS tenders and the mortgage bond purchase programme by the end of 2018. The Council set the annual maximum stock of monetary policy IRS for 2018 at HUF 1,100 billion. The mortgage bond programme will be ended in two stages: purchases in the primary market will continue until 31 December 2018 and purchases in the secondary market until 30 September 2018. In the meantime, the Funding for Growth Scheme Fix (FGS fix) will be introduced. The MNB will sterilise the liquidity provided under this programme by a preferential deposit facility bearing interest at the central bank base rate. This will contribute to developing a healthy structure for SME lending, while having a neutral impact on liquidity developments.

The Monetary Council will launch the FGS fix with a total amount of HUF 1,000 billion in early 2019. With the new programme, the Council’s specific objective is to raise the proportion of long-term, fixed-rate lending to SMEs to an adequate level. In contrast with previous phases, the Bank will sterilise excess liquidity supply arising from lending under the FGS fix by using the preferential deposit facility. The Bank will publish the most important features and introduction aspects of the programme in the form of a background material.

The Council is prepared for the gradual and cautious normalisation of monetary policy, which will start depending on the outlook for inflation. The inflation target is still expected to be achieved in a sustainable manner from mid-2019. To ensure this, in the Council’s assessment, maintaining the base rate and the loose monetary conditions is necessary.

MAGYAR NEMZETI BANK

Monetary Council

Budapest, 18 September 2018