Press release on the Monetary Council meeting of 22 May 2018

22 May 2018

At its meeting on 22 May 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 23 May 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 in 2018, then, if the assumptions of the current projection hold, it will slow down gradually from 2019. The inflation target is expected to be achieved in a sustainable manner by the middle of 2019.

In April 2018, inflation stood at 2.3 percent and core inflation at 2.5 percent. Inflation and core inflation developments were in line with the Bank’s expectations. The Bank’s measures of underlying inflation continued to be around 2 percent and remained 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 had led to a general, dynamic rise in whole-economy wages, which continued into early 2018. The upward effects of this on costs are being offset by the reduction in employers’ social contributions at the beginning of the year and in the corporate tax rate in 2017. In line with the Bank’s expectations, there has not yet been any significant upward pressure on inflation from wages. Oil prices continued to rise over the past month. According to the ECB’s projections, underlying inflation will continue to be moderate in the euro area in the coming years as well.

If the assumptions in the March projection hold, the consumer price index will remain in the lower half of the tolerance band in the coming months. Over the medium term, buoyant domestic demand and the increase in wage costs will point to an increase in domestic core inflation. However, moderate external inflation and inflation expectations stabilising at historically low levels, as well as subsequent reductions in employers’ social contributions and the VAT rate cuts this year, are slowing the rise in prices. If the assumptions of the current central bank projection hold, the inflation target can be achieved sustainably by the middle of 2019.

The Hungarian economy expanded dynamically in the first quarter of 2018. Gross domestic product grew by 4.4 percent relative to the same period a year earlier, according to preliminary data. In March, industrial production decreased and construction output rose at a slower pace on annual basis following the outstanding data describing the previous period. The volume of retail sales grew markedly. Labour demand remained strong. The unemployment rate decreased to a historically low level. Strong credit growth continued in March. Outstanding lending to the corporate sector increased by 10.3 percent relative to a year earlier. In the household sector, annual growth in lending was 2.7 percent. A significant part of this was related to the expansion in housing loans.

Looking ahead, the general strengthening of 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. From a historically high level of 6 percent in 2016, Hungary’s current account surplus relative to GDP is expected to fall to below 2 percent in 2018, driven by rising domestic demand. However, it is expected to remain in positive territory over the longer term as well. Economic growth this year will also be supported by the fiscal budget and the stimulating effects on investment of European Union funding. In the Council’s assessment, GDP growth will be above 4 percent in 2018, higher than last year, then, according to the current projection, it will slow down gradually from 2019. The Bank’s and the Government’s measures contribute substantially to this year’s economic growth.

Sentiment in international financial markets has been highly volatile in the period since the Council’s previous interest rate decision. The dollar appreciated significantly and US long-term yields rose. As a consequence, appetite for risk in emerging markets deteriorated, which in turn also had an impact on developments in Central and Eastern European markets. Due to the different inflation paths expected in the countries of the region and the different characteristics of inflation targeting regimes, market prices suggest that monetary policy stances by regional central banks will continue to differ. The Monetary Council’s guidance about the maintenance of loose monetary conditions over an extended period remained unchanged, however the market yield curve shifted upwards. Yields in the FX swap, interbank, and government securities markets rose and market volatility increased. The Bank assesses these developments in light of their relevance to its primary objective, the sustainable achievement of the inflation target.

In the Council’s assessment, maintaining the loose monetary conditions for an extended period is necessary to achieve the inflation target in a sustainable manner. To this end, the Monetary Council maintained 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 will maintain the HUF 75 billion upper limit on the stock of three-month deposits. In addition, in March, the Council set the average amount of liquidity to be crowded-out for the second quarter of 2018 at least at HUF 400-600 billion. Furthermore, the Council stated that the actual amount of liquidity to be crowded out must reach a level sufficient to ensure the maintenance of the loose monetary conditions for an extended period. The Magyar Nemzeti Bank increased the stock of fine-tuning FX swaps providing forint liquidity. On the next occasion, in June 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.

In March, the Monetary Council set the maximum stock of monetary policy interest rate swaps in the first half of 2018 at HUF 600 billion. The Council’s aim is 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 Bank will continue mortgage bond purchases and the monetary policy interest rate swap facility as programmes, continuously and for a prolonged period, and therefore they constitute an integral part of the set of monetary policy instruments. The Council considers the Bank’s mortgage bond purchase programme to be successful. Under the programme, the MNB purchased mortgage bonds amounting to more than HUF 150 billion up to the middle of May. Transactions in the primary market accounted for more than one-third of total purchases. As a result of the measures, spreads of mortgage bonds over yields in the government securities market fell sharply and turned negative on average. The decline in financing costs encouraged issuance in the primary market, thereby facilitating the increase in fixed-rate lending. The Monetary Council focuses on the relative position of domestic long-term yields relative to international yields when evaluating the two programmes.

In the current volatile financial market environment, the fundamentals of the Hungarian economy continue to be stable. The country’s external debt has declined significantly, and its net lending position continues to be strong. Its fiscal position is sustainable, the budget deficit is low, the government debt-to-GDP ratio is contracting, associated with a significant decline in the foreign currency debt ratio.

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 the loose monetary conditions at both the short and long ends for an extended period is necessary to achieve the inflation target in a sustainable manner. In line with the Council’s forward guidance, the current set of instruments contributes efficiently to the maintenance of the loose monetary conditions over a prolonged period and to an improvement in financial stability. 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 current set of monetary policy instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 6 June 2018.

MAGYAR NEMZETI BANK

Monetary Council