Press release on the Monetary Council meeting of 26 September 2023

26 September 2023

At its meeting on 26 September 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 27 September 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.

In 2023 Q2, economic growth in the European Union slowed to 0.4 percent in annual terms, while growth accelerated in the US and China. The short-term economic outlook is surrounded by downside risks. The persistently high inflationary environment, the ongoing Russia-Ukraine war and generally increasing geopolitical tensions continue to be a source of significant uncertainty to the outlook for economic activity globally, and particularly in Europe.

Global trends point to continued disinflation. Weakening global economic demand, lower commodity prices compared to the previous year and the correction in international freight costs suggest a continued decline in inflation rates. Renewed and significant rises in oil prices may stall disinflation. This, combined with the effects of core inflation indicators generally decreasing more slowly suggests that achieving price stability again is expected to be a protracted process.

Global risk appetite has deteriorated since the August policy decision. Investor sentiment was driven by incoming macroeconomic data releases and expectations for interest rate policies of the world’s leading central banks. At its rate-setting meeting in September, the Federal Reserve (Fed) left monetary conditions unchanged. By contrast, the European Central Bank raised its policy rate by 25 basis points. Based on market expectations, the Fed is nearing the end of its tightening cycle, while the ECB has reached it. In the CEE region, the Polish central bank lowered its policy rate by 75 basis points to 6.00 percent in September, while based on market expectations, the Czech and Romanian central banks may begin cutting their interest rates later.

Hungary’s GDP declined by 2.4 percent year-on-year in 2023 Q2. The main contributor to the downturn in economic performance was the decline in industrial and construction output and market services, while agricultural performance and that of the health and social care sector moderated the decline. On the expenditure side of GDP, net exports and government final consumption made positive contributions to growth, while household consumption and gross fixed capital formation declined sharply. In July, the volume of industrial output and retail sales fell further, while construction output rose. Of the manufacturing sub-sectors, production volumes increased in vehicle production and in the manufacture of electrical equipment. Based on high-frequency data, the gradual increase in domestic economic activity has begun in the third quarter. The household confidence indicator remains at a low level. The labour market remains tight, the unemployment rate is low.

In 2023, low economic performance has mainly reflected high inflation and the stalling of government investments. Falling real wages due to price rises and consumer and investment decisions becoming cautious have led to a decline in domestic demand. However, this year’s economic performance is expected to be improved significantly by the correction in agricultural growth after last year’s drought. The real wage index, turning positive, is also expected to contribute to a slow pick-up in performance towards the end of the year. Hungarian exports may also rise in 2023, and imports are expected to fall due to the decline in domestic demand items and lower energy prices. As a result, net exports are expected to make a positive contribution to economic growth in 2023. Declining inflation and the recovery in domestic demand components are likely to support GDP growth in 2024 and 2025. With the pick-up in the production of new export capacities built recently, Hungary’s export market share is expected to increase further. In our current projection, Hungary’s economic performance is expected to be in the range of (-0.5)–0.5 percent. In 2024 and 2025, Hungary’s GDP is expected to expand by 3.0–4.0 percent.

The widespread and general decline in domestic inflation continued in August. Consumer prices rose by 16.4 percent in annual terms and core inflation stood at 15.2 percent. The consumer price index was 1.2 percentage points lower than the level in July, primarily reflecting the slowdown in the rate of growth of processed food and tradables prices, although fuel price inflation rose. Core inflation slowed across a wide range of products and services, so the indicator declined by 3.3 percentage points from the previous month. The recent repricing reflected in inflation and core inflation matched the historical average usually seen in August.

In the coming months, domestic CPI inflation and core inflation will continue to decrease. Tight monetary policy, lower commodity prices compared to last year, subdued domestic consumption and the Government’s measures to strengthen market competition are expected to have an increasingly broad-based disinflationary effect. Annual inflation is expected to reach the 7–8 percent territory towards the end of the year. The inflation path expected for next year has shifted upwards slightly compared to the June forecast due to the carry-over effect of higher fuel prices. The consumer price index is expected to return to the central bank tolerance band in 2025. Annual inflation may fluctuate between 17.6–18.1 percent in 2023, 4.0–6.0 percent in 2024 and 2.5–3.5 percent in 2025.

The fiscal deficit will continue to decline this year. With the macroeconomic path, and particularly the path of consumption, being substantially weaker than expected, the deficit is likely to be above this year’s target of 3.9 percent. The exact level of the deficit will be largely influenced by developments in expenditures around the end of the year. The government debt ratio is expected to fall from 73.3 percent at the end of 2022 to nearly 70 percent by the end of 2023, to be followed by annual declines of 2.5 percentage points.

There has been a rapid and substantial improvement in the external balance. In July 2023, the current account was close to balance. The significant improvement in the external balance position has been driven mainly by lower energy prices compared to the previous year, the adjustment of energy consumption and shrinking import intensity due to subdued domestic demand. In parallel, with a pick-up in vehicle and battery production, buoyant exports have also supported the improvement in the trade balance. From 2024, the favourable external balance position is expected to persist, reflecting the utilisation of new export capacities built recently and a normalising global economic environment. Overall, the current account deficit is expected to fall below 1 percent of GDP in 2023, with the balance expected to improve further over the forecast horizon.

The Monetary Council highlighted three alternative scenarios around the baseline projection in the September Inflation Report. In the Council’s risk assessment, the inflation outlook is surrounded by upside risks, while the outlook for growth is characterised by downside risks. The risk scenario featuring decelerating global economic activity is consistent with a lower growth and inflation path compared to the baseline scenario. In the alternative scenario assuming a withdrawal of capital from emerging markets, the inflation path is higher and the growth path is lower. The risk scenario featuring a faster recovery in consumption is consistent with higher growth and inflation paths compared to the baseline scenario.

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. Taking a cautious approach to changing the base rate is warranted in order to address fundamental inflation risks. With the acceleration of disinflation, the domestic real interest rate will move to positive territory in September, then it will continue to rise gradually.

With a decrease of 100 basis points in the effective interest rate, the Monetary Council concluded the normalisation of the extraordinary interest rate environment. Following today’s decision, the base rate will become the effective central bank interest rate. In addition, according to the Council’s decision, the interest rate corridor became symmetric, with a band of +/- 100 basis points around the base rate.

In line with the Monetary Council’s decision today, the central bank’s set of monetary policy instruments will be changed and simplified. From 1 October, the reserve account will be available to banks without an upper limit and the Bank will remunerate the part bearing interest at the base rate. The Bank will announce its longer-term instruments to absorb interbank forint liquidity, i.e. the long-term deposit facility and the central bank discount bill, at the base rate in the coming period. In the Council’s assessment, one-day FX-swap quick tenders remain an important element of strengthening the monetary transmission; therefore, the central bank will continue to use this instrument. The lower bound of the interest rate corridor serves as a guidance regarding the interest paid on FX-swap quick tenders. The Bank will publish a separate information release on the technical details of the changes on its website.

Following today’s decision, the gap between the interest conditions of one-day deposit tenders and the base rate has closed. Therefore, the normalisation of the extraordinary interest rate environment introduced in October 2022 has been concluded and thus monetary policy enters a new phase. In order to achieve price stability in a sustainable manner, monetary conditions need to remain tight. With the appearance of risks surrounding global disinflation and volatility in international investor sentiment, a cautious approach to monetary policy is warranted. The Council is constantly assessing incoming macroeconomic data, the outlook for inflation and developments in the risk environment, and it will take decisions on changes in monetary conditions based on these factors, if warranted.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 11 October 2023.

MAGYAR NEMZETI BANK
Monetary Council