Press release on the Monetary Council meeting of 22 March 2022

22 March 2022

At its meeting on 22 March 2022, 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 March 2022:

The primary objective of the Magyar Nemzeti Bank (MNB) is to achieve and maintain price stability. Without prejudice to its primary objective, the Magyar Nemzeti Bank preserves financial stability and supports the Government’s economic policy, as well as its policy on environmental sustainability.

The Russia-Ukraine war that broke out at the end of February fundamentally changed the global economic outlook. Due to the geographical proximity and a larger share of trade with the two parties involved, the events are expected to have a greater effect on the European economy, especially in the Central and Eastern European region. Reaching decade highs, inflation continued to rise in a number of countries. The war is causing additional inflationary effects through rises in commodity and energy prices, which have been aggravated by a repeated increase in supply disruptions.

Global investor sentiment has deteriorated sharply due to the war. Risk appetite has been driven by news on the war, rising commodity and energy prices, an increase in inflation risks, central banks’ monetary policy responses, and the consequences of the coronavirus pandemic. As a result of the war and the sanctions imposed on Russia, commodity prices have been exceptionally volatile since the previous interest rate decision: global oil prices have first risen to an eight-year peak of nearly USD 130 before adjusting, accompanied by high volatility. Gas prices in Europe have risen to their historic peak in the period.

The world’s leading central banks adopted a tighter monetary policy stance even amid increasing risks to economic growth and inflation. The Federal Reserve started raising the policy rate in March. Decision makers pointed out that they might begin to reduce the stocks of government securities and mortgage-backed securities at their forthcoming meetings. Consistent with its earlier communication, the European Central Bank will discontinue its Pandemic Emergency Purchase Programme (PEPP) until the end of the first quarter of 2022. In addition, in March, the Governing Council decided to withdraw its asset purchase programme (APP) at a faster pace than planned earlier. In the CEE region, the Polish central bank held a policy meeting last month, and it further raised its key policy rate. The central banks in the region took measures aimed at stabilising the market to offset the adverse effects of the Russia-Ukraine war on the financial market.

The recovery of the Hungarian economy was strong throughout 2021. Hungarian GDP rose by 7.1 percent in 2021, representing a significant expansion which is at the forefront in Europe. Strong economic growth continued at the beginning of 2022, in the period leading up to the outbreak of the Russia-Ukraine war. In January, industrial production and construction output exceeded their pre-pandemic levels. The unemployment rate remained low in international comparison.

The Hungarian economy continues to have a strong ability to grow. However, a high level of uncertainty surrounds the short-term economic outlook. In the coming quarters, economic activity will be strongly influenced by the war, the policy of sanctions implemented and the governments’ responses to this extraordinary situation. The repercussions of the war have their strongest restraining effect on economic growth directly through trade channels and disruptions in international production chains. In addition, rises in commodity prices and companies’ costs as well as a generally high level of uncertainty also restrains growth. The dual nature of economic growth is expected to persist in the coming period. Strong domestic demand may partly offset the adverse effects of the Russia-Ukraine war on growth. Exports are expected to make a smaller-than-expected contribution to GDP growth in 2022 because of the fragmentation of supply chains. From the end of 2022, Hungarian exports might grow again as external markets and supply chains recover, which will be supported by the utilisation of new export capacities built up in recent years. Household consumption will be bolstered by an increase in wages and by the government measures aimed at boosting household income. Investment growth is likely to slow; however, the investment rate remains high. Depending on the duration of the war and the policy of sanctions, GDP is likely to expand at a slower rate than expected, by 2.5-4.5 percent in 2022, then by 4.0–5.0 percent in 2023, and by 3.0–4.0 percent in 2024.

In February 2022, annual inflation was 8.3 percent and core inflation stood at 8.1 percent. Headline inflation and core inflation rose by 0.4 percentage points and 0.7 percentage point, respectively, from the previous month. After January, a wide range of products and services were repriced to a greater-than-usual extent in February, too. Food prices continued to exhibit a double-digit increase in February relative to the period a year earlier. The price indices of core inflation sub-items generally rose. Government measures affecting fuel, certain essential food product and residential energy prices cushion the spillover of the increase in global commodity prices into domestic inflation. However, inflation expectations are high.

In the coming quarter, strong negative supply effects are likely to raise inflation. The short-term path of inflation will depend on the duration of the war, the extent and persistence of sanctions, as well as the governments’ responses. Rises in energy and commodity prices are expected to raise inflation further on the expenditure side. As a result, inflation is likely to begin to decline later, in the second half of the year. Annual inflation is expected to be between 7.5 and 9.8 percent in 2022. Core inflation will rise further in the coming months. With the fading of the first-round effects of the war and the sanctions, the decrease in external inflationary effects and as a result of the central bank’s proactive measures, inflation is expected to return to the central bank tolerance band in the second half of 2023 before reaching the central bank target of 3 percent in the first half of 2024. The consumer price index is expected to be 3.3–5.0 percent in 2023, before falling in line with the inflation target from 2024.

The government deficit and the government debt-to-GDP ratio shifted to a declining path in 2021. The government debt-to-GDP ratio decreased to 77.3 percent at the end of 2021 from a level of 80.0 percent at the end of 2020. The Russia-Ukraine war has increased budgetary risks through several channels, but following a gradual decline mainly due to economic growth, the debt ratio may fall to 70 percent towards the end of the forecast period. Weak external demand on the export side and high energy prices on the import side both point to a deterioration in the trade balance. Overall, the current account balance is expected to deteriorate this year. The external balance may start to improve rapidly from 2023, as a result of which the current account balance may turn positive by the end of the forecast period.

The Russia-Ukraine war has posed a much higher risk than usual to the outlook for inflation. The increase in inflation risks warrants a further tightening of monetary conditions. Consequently, the Monetary Council deems it necessary to continue the general tightening of monetary conditions and to continue the base rate tightening cycle by a larger increment than before. The base rate will gradually catch up to the level of the one-week deposit rate evolving in the coming months. Maintaining tighter monetary conditions for a longer period is warranted to manage increasing second-round inflation risks resulting from persistently negative supply effects. The MNB continues to stand ready to respond quickly and flexibly by setting the interest rate on the one-week deposit instrument if warranted by short-term risks in financial and commodity markets.

In order to anchor inflation expectations and mitigate second-round inflation risks, according to today’s decision of the Monetary Council, the central bank base rate was raised by 100 basis points to 4.40 percent. The overnight deposit rate was increased by 100 basis points to 4.40 percent, and the overnight and the one-week collateralised lending rates were increased by 100 basis points to 7.40 percent. The MNB will continue to set the one-week deposit rate at weekly tenders.

The Bank places even greater emphasis than previously on ensuring that short-term rates in every sub-market, particularly in the swap market, and at all times develop consistently with the level of short-term rates deemed optimal by the Monetary Council. To that end, the MNB has been actively using its swap instrument providing foreign currency liquidity from the beginning of March.

The Monetary Council attaches great importance to ensuring that every element of the Bank’s monetary policy toolkit supports the return to price stability. The Monetary Council still finds it crucial to maintain stability in the government securities market. Accordingly, the Council is ready to intervene with occasional and targeted government securities purchases if necessary, which does not imply a change in the monetary policy stance.

In the Council’s assessment, the outbreak of the Russia-Ukraine war has led to a further increase in upside risks to inflation: continued rises in commodity and energy prices point to a persistently high external inflation environment. In addition, elevated inflation may persist for longer as a domestic inflationary effect if strong price dynamics are built into economic agents’ expectations, resulting in second-round inflationary effects.

Mitigating increased fundamental inflation risks and driving expectations appropriately have necessitated the continuation of the tightening of monetary conditions, and the base rate tightening cycle by a larger increment than before. The base rate will gradually catch up to the level of the one-week deposit rate evolving in the coming months. Maintaining tighter monetary conditions for a longer period is warranted to manage increasing second-round inflation risks resulting from persistently negative supply effects. In the current turbulent period in financial markets, a key task for the MNB is to ensure market stability, in addition to meeting its primary objective of price stability. Over the past month, the Council has increased the room for manoeuvre in monetary policy by widening the interest rate corridor, which is crucial in the current situation. If necessary, the MNB stands ready to intervene using every element in its monetary policy toolkit to ensure financial market stability. The Monetary Council will continue the cycle of interest rate hikes until the outlook for inflation stabilises around the central bank target and inflation risks become evenly balanced on the horizon of monetary policy.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 6 April 2022.

MAGYAR NEMZETI BANK
Monetary Council