Press release on the Monetary Council meeting of 25 October 2022

25 October 2022

At its meeting on 25 October 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 26 October 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 risk of recession in the global economy has increased further due to the prolonged Russia-Ukraine war, the European energy crisis and the generally rising interest rate environment. The effects of the exceptional drought in Europe are expected to push inflation rates up further over the short term; however, signs of an impending turnaround in commodity markets have clearly appeared. Growing recession risks, alongside falling global energy and commodity prices and international freight costs, point to a moderation in global inflation from 2023.

International investor sentiment remains unfavourable. Expectations for interest rate hikes by the world’s leading central banks, fears of recession, the European energy crisis and concerns about the Russian-Ukrainian war have generally led to an increase in risk aversion. Global prices of most commodities have fallen in recent months but remained at high levels. Global oil prices rose slightly. Gas futures prices in European markets have declined significantly following summer peaks.

As for the Federal Reserve and the European Central Bank, market pricing and decision makers’ communications also suggest further interest rate increases. In the CEE region, the Czech and the Polish central banks did not continue to raise their policy rates. The Romanian central bank raised its policy rate by 75 basis points, exceeding expectations.

High-frequency data show that the Hungarian economic growth has been clearly slowing since early June. Industrial production increased in August, with construction output remaining unchanged on a year-on-year basis. A slowdown has been seen in the annual growth rate of retail sales since the spring. The labour market continues to be tight, and the unemployment rate is low. The economic slowdown and the effects of high energy prices are increasingly reflected in a general deterioration in sentiment indicators.

The components of domestic demand are expected to be the main contributors to growth throughout this year. In 2023, growing precaution and a higher level of energy prices than before will cause household consumption to decrease. Rising costs and more uncertain demand prospects induce companies to postpone investments, while the rescheduling of public development projects will also restrain investment activity. Net exports are expected to make a positive contribution to GDP growth again from the end of 2023 as external markets and supply chains recover. Hungary’s GDP is expected to grow by 3.0–4.0 percent in 2022, by 0.5–1.5 percent in 2023, and by 3.5–4.5 percent in 2024.

In September 2022, annual inflation was 20.1 percent and core inflation stood at 20.7 percent. Nearly 85 percent of the 4.5 percentage point increase in inflation was due to rises in the prices of regulated products and services and of food. The monthly change in demand-sensitive inflation, which better reflects developments in the demand environment, has slowed down. Inflation expectations remain elevated, while expectations of increases in retail prices have fallen as demand weakened.

In the autumn months, inflation in Hungary has mainly been fuelled by items outside the scope of monetary policy. As a result of the exceptional drought and the pass-through of high energy prices, inflation will rise further at a declining pace in the coming months. The easing of external inflationary pressures, the slowdown in global economic growth and the downward pressure on prices, resulting from shrinking domestic demand, are expected to become more pronounced in domestic inflation from early 2023, leading to a gradual turnaround in price growth. Tight monetary conditions contribute to avoiding second-round inflationary effects and anchoring inflation expectations. There are symmetric risks to the outlook for inflation. The consumer price index may average between 13.5–14.5 percent in 2022. Domestic inflation will decrease slowly in the first half of 2023, and then more significantly from the middle of the year. The consumer price index will return to the central bank tolerance band in the first half of 2024.

The measures announced by the Government and their implementation are expected to ensure the achievement of this year’s budget deficit target indicated by the Ministry of Finance. Thus, the government debt-to-GDP ratio will decrease to close to 76 percent of GDP by the end of 2022. The current account deficit is expected to continue rising temporarily in 2022 due to the import-increasing effect of high energy prices. Nevertheless, the increasing surplus in items of the current account excluding the energy balance, falling energy prices and growing adjustment in the energy market might lead to a rapid improvement. By 2024, with the normalisation of the global economic environment and the pick-up of the production of significant new export capacities built in recent years, the external balance position is expected to improve significantly.

In line with its previous communication, the Monetary Council kept the base rate at 13.00 percent at its meeting today. In addition, the O/N deposit rate and the O/N collateralised borrowing rate were left unchanged at 12.50 percent and 25.00 percent, respectively.

The current 13 percent level of the base rate, resulting from the Bank’s cycle of base rate hikes, is adequate to manage fundamental inflation risks. With the real interest rate turning positive, slowing domestic demand in 2023 is expected to reduce inflation. By raising the required reserve ratio, holding central bank discount bond auctions and launching a longer-term deposit instrument from 1 October, the MNB has significantly reduced interbank forint liquidity in order to further increase the effectiveness of monetary policy transmission. Over half of this liquidity is now tied up in permanently sterilised assets.

In the current turbulent environment in financial markets, ensuring market stability is key to achieving the primary objective of price stability. The targeted and temporary measures taken by the Bank in mid-October support the management of market risks and promote a balance between supply and demand in the foreign exchange market. By raising the upper bound of the interest rate corridor by 950 basis points, the tighter interest rate conditions on overnight quick deposit tenders and foreign exchange swaps are raising short-term rates and properly influencing interest-sensitive capital flows. The impact of non-interest-sensitive market developments is offset by the Bank’s commitment to directly meeting major foreign currency liquidity needs arising from covering net energy imports in the coming months. The MNB continues to take into account considerations regarding the adequacy of foreign currency reserves. In recent months, domestic economic agents have begun to adjust in the energy market through a decline in energy consumption. This, along with a fall in energy prices, allows to maintain balance in the foreign exchange market by providing less foreign currency liquidity than earlier expected.

In the Monetary Council’s assessment, maintaining the current level of the base rate for a prolonged period is consistent with the achievement of the price stability objective over the monetary policy horizon. The instruments applied over the past month, designed to drain interbank liquidity, are effective in strengthening monetary policy transmission. Additionally, maintaining market stability in a rapidly changing risk environment is also crucial to achieve price stability. The MNB continuously assesses economic and financial market developments and will continue to use the instruments introduced in mid-October as long as it is warranted by the maintenance of market stability and developments in risk perceptions. Tight monetary conditions will be maintained over a prolonged period, which will ensure that inflation expectations are anchored and the inflation target is achieved in a sustainable manner.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 November 2022.

MAGYAR NEMZETI BANK
Monetary Council