Press release on the Monetary Council meeting of 27 February 2018

27 February 2018

At its meeting on 27 February 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 28 February 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 continue to be dynamic in 2018, then it will slow down from 2019 if the assumptions underlying the current projection hold. The inflation target is expected to be achieved in a sustainable manner by the middle of 2019.

In January 2018, inflation stood at 2.1 percent and core inflation at 2.5 percent. Inflation and core inflation were in line with the Bank’s expectations. The Bank’s measures of underlying inflation remained unchanged overall and continued to be significantly below core inflation. 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 at the beginning of the year and in the corporate tax rate in 2017. As last year, there were moderate price movements in the service sector at the beginning of 2018, thus, in line with the Bank’s expectations, there has not yet been any significant upward pressure on inflation from wages. Oil prices fell significantly following the rise in recent months. According to the European Central Bank’s projections, underlying inflation will continue to be moderate in the euro area in the coming years as well.

According to our current projection the consumer price index will level off at the bottom edge of the tolerance band in the first months of 2018. Over the medium term, buoyant domestic demand, the increase in wage costs, as well as the second-round effects resulting from higher commodity prices 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. In our projection, the inflation target can be achieved sustainably by the middle of 2019.

The Hungarian economy grew by 4.4 percent in the fourth quarter of 2017. Industrial production and the volume of retail sales continued to grow in December. Labour demand remained strong: employment was at historically high levels in the final quarter of 2017. The unemployment rate fell further. Strong credit growth continued. Outstanding lending to the corporate sector increased by some 10 percent relative to a year earlier. Within this, the stock of lending to SMEs grew even more strongly. In the household sector, annual growth in lending was close to 2 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 5.5 percent observed earlier, Hungary’s current account surplus is expected to fall to around 2 percent in 2018, driven by rising domestic demand, and to remain in positive territory over the longer term. 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 around 4 percent in 2018, as in 2017, then it will slow down from 2019 if the assumptions underlying the current projection hold. The Bank’s and the Government’s measures contribute substantially to economic growth.

Sentiment in international financial markets has, on the whole, deteriorated in the period since the Council’s previous interest rate decision, accompanied by increased volatility. Macroeconomic data releases and expectations related to future monetary policy of the world’s leading central banks were the main factors influencing investors’ appetite for risk. The Fed decided to maintain interest rates at the end of January. Market participants continue to expect the next interest rate increase to take place in March. Looking ahead, the European Central Bank is likely to maintain loose monetary conditions for an extended period. Investors’ perceptions about the Central and Eastern European region continue to be positive. Due to the different inflation paths expected in the countries of the region and the different characteristics of inflation targeting regimes, market prices suggest monetary policy stances by regional central banks will continue to differ.

The short end of the market yield curve shifted upwards, while the Bank’s guidance about the maintenance of loose monetary conditions over an extended period remained unchanged. Hungarian long-term yield spreads rose amid the increase in yields in international financial markets over the recent period. Over a longer horizon, however, spreads relative to the euro area and the region decreased significantly.

In the Council’s assessment, maintaining the loose monetary conditions for an extended period are 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, the one-week collateralised lending rate at 0.9 per cent, and the overnight deposit rate at -0.15 per cent. In line with maintaining monetary conditions, while keeping the HUF 75 billion upper limit on the stock of three-month deposits, the Council set a HUF 400-600 billion band for the targeted average liquidity crowded-out for the first quarter of 2018, which is equal to that of the fourth quarter of 2017. On the next occasion, in March 2018, the Council will decide on the amount of liquidity to be crowded out and will adjust the stock of central bank swap instruments accordingly.

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 started targeted mortgage bond purchases in January and held its tenders of the unconditional monetary policy interest rate swap facility. In view of the experiences gained from the first tender, the Bank fine-tuned the details of the programme to achieve more effective monetary transmission, as a result of which tenders held in February were in line with the Bank’s aims. The MNB will continue mortgage bond purchases and the monetary policy interest rate swap facility as programmes, continuously and for a prolonged period, thus they constitute an integral part of the set of monetary policy instruments. In harmony with the Council’s forward guidance, the new instruments contribute efficiently to the maintenance of loose monetary conditions over a prolonged period and to an improvement in financial stability. The Monetary Council focuses on the relative position of domestic long-term yields relative to international yields when evaluating the programme.

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 short and long ends for an extended period is necessary to achieve the inflation target in a sustainable manner. 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 extended set of monetary policy instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 14 March 2018.

MAGYAR NEMZETI BANK

Monetary Council