Press release on the Monetary Council meeting of 25 July 2023

25 July 2023

At its meeting on 25 July 2023, 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 July 2023:

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 global economic outlook continues to be characterised by duality. Output growth is expected to slow in developed countries. Meanwhile, growth in emerging countries is likely to be similar to last year. In most countries, labour markets are tight. Among the major economies, annual economic growth in China was below expectations in 2023 Q2. The easing of the energy crisis in Europe points to an improvement in the outlook for economic activity on the Continent. However, the ongoing Russia-Ukraine war and the persistently high inflationary environment are posing downside risks to growth.

Global inflation rates have continued to fall. The slowdown in global economic activity, the correction in energy and commodity prices and the fall in international freight costs point to a further decline in inflation rates. However, core inflation indicators, generally falling at a slow pace, suggest that achieving price stability again may take longer than earlier expected.

Risk appetite has been volatile since the June policy decision. The temporary deterioration in global investor sentiment in the first week of July was followed by a quick reversal. In terms of international data, domestic financial markets showed a stronger reaction than regional ones to US labour market and inflation data as well as movements in the dollar exchange rate. Oil prices have risen slightly, while European gas prices have fallen over the past month. The uncertainty due to the Russia–Ukraine war continues to have a negative impact on investor sentiment.

Communications by the Federal Reserve’s (Fed) and the European Central Bank’s (ECB) decision makers suggested that interest rate hikes were likely to continue. Nevertheless, based on market expectations, both central banks are nearing the end of their tightening cycle. Central banks in the CEE region have not changed their monetary conditions; however, a professional debate on the timing of interest rate cuts has recently begun in the region.

In 2023 Q1, Hungary’s GDP declined by 0.9 percent. Industrial and construction output as well as the volume of retail sales continued to fall in May. Monthly production indicators and high-frequency data also suggest that the decline in Hungary’s economic performance continued in the second quarter. The household confidence indicator remains at a low level. The labour market remains tight, and the unemployment rate is low.

In 2023, declining annual average real wages, rising corporate costs and cautious consumer and investment decisions all contribute to a decline in domestic demand, while net exports support output growth. In parallel with declining inflation, rising real wages are expected to support a pick-up in GDP growth from the second half of the year. This year’s economic performance is also expected to be improved by the correction in agricultural growth after last year’s drought. Hungary’s GDP is expected to grow by 0.0–1.5 percent in 2023, by 3.5–4.5 percent in 2024 and by 3.0–4.0 percent in 2025.

The rapid decline in inflation continued in June. Consumer prices rose by 20.1 percent in annual terms and core inflation stood at 20.8 percent. The consumer price index fell by 1.4 percentage points compared to May, primarily reflecting a slowdown in the rate of increase in food and tradables prices. Core inflation slowed across a wide range of products. As a result, this indicator declined by 2.0 percentage points from the previous month. Services inflation eased for the first time since July 2021. Inflation expectations of both households and companies fell.

In the coming months, domestic inflation and core inflation will continue to decrease at a rapid pace. During 2023, the disinflationary effect of tight monetary policy, falling global commodity prices, declining domestic consumption and the Government’s measures to strengthen market competition will become increasingly apparent. Disinflation is likely to continue to accelerate. As a result, inflation is expected to reach single digits by the end of the year, while core inflation may fall at a slightly slower pace. The consumer price index may return to the central bank tolerance band in early 2025. Annual inflation may fluctuate between 16.5–18.5 percent in 2023, 3.5–5.5 percent in 2024 and 2.5–3.5 percent in 2025.

The fiscal deficit will continue to decline this year. The budget appropriation for the 2023 deficit is 3.9 percent. Based on the 2024 Budget Act, the accrual-based deficit target is 2.9 percent in 2024 and 1.9 percent in 2025. The government debt ratio is expected to fall from 73.3 percent at the end of 2022 below 70 percent by the end of 2023, and then below 65 percent by the end of the forecast horizon, driven by nominal GDP growth and a declining deficit.

The external balance has continued to improve further. The current account balance registered a significant surplus in May 2023, primarily due to a trade surplus of EUR 1.3 billion, a historic high. The trend-like improvement in the external balance has been driven by the more favourable energy balance and terms of trade, the adjustment of domestic demand and strong export growth. This year, the current account deficit is expected to be more favourable than projected in June, being below 2 percent of GDP as the trade balance improves. In parallel with the utilisation of new export capacities built recently and a normalising global economic environment, the trade balance and net lending will continue to improve in 2024.

In the Monetary Council’s assessment, it is necessary to maintain tight monetary conditions in order to achieve price stability. At today’s meeting, the Council left the base rate unchanged at 13 percent. The current level of the base rate is adequate to manage fundamental inflation risks.

In the Monetary Council’s assessment, the still favourable risk environment has enabled the Bank to continue the normalisation of the interest rate environment at the previous pace. In accordance, the Council decided to reduce the interest paid on optional reserves by 100 basis points, from 16 to 15 percent at today’s meeting, with effect from 26 July. In addition, the O/N collateralised lending rate serving as the top of the interest rate corridor was lowered by 100 basis points to 17.5 percent. According to the Council’s assessment, it is also warranted to reduce the interest rate on the one-day quick deposit tenders and foreign exchange swap tenders by 100 basis points.

In the Monetary Council’s assessment, looking ahead, strengthening monetary policy transmission is also an important factor of achieving price stability. For this reason, the Bank will use the instruments to absorb interbank forint liquidity on a long-term basis in the coming period.

In the Monetary Council’s assessment, maintaining the current level of the base rate will ensure that inflation expectations are anchored and the inflation target is achieved in a sustainable manner. Looking ahead, financial market stability is also key to achieving price stability. In the current environment, a cautious and gradual approach is warranted. The MNB is constantly assessing the effects of international financial market developments on the domestic risk environment, incoming macroeconomic data and developments in the outlook for inflation. If the improvement in risk perceptions persists, the Bank will continue the gradual convergence of the interest rate conditions of one-day tenders to the base rate at the previous pace.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 9 August 2023.

MAGYAR NEMZETI BANK
Monetary Council