Press release on the Monetary Council meeting of 24 October 2017

24 October 2017

At its meeting on 24 October 2017, the Monetary Council reviewed the latest economic and financial developments and decided on the following structure of central bank interest rates with effect from 25 October 2017:

In the Council’s assessment, Hungarian economic growth picks up over the forecast horizon. Some degree of unused capacity has remained in the economy, but this is likely to be gradually absorbed as output grows dynamically. The inflation target is expected to be achieved in a sustainable manner by the middle of 2019.

In September 2017, inflation stood at 2.5 percent and core inflation at 2.9 percent. Headline inflation fell slightly short of our expectation, with the decline in volatile unprocessed food prices accounting for the difference. Core inflation was in line with the September Inflation Report projection. The Bank’s measures of underlying inflation rose slightly compared with the previous month, but continued to be significantly below the level of 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 and in the corporate income tax rate early this year. In line with the Bank’s expectations, there has still not yet been any significant upward pressure on inflation from wages. The rise in global inflation which started at the beginning of the year has stalled, and consumer price indices in some economies have fallen. External inflation, particularly in the euro area, is likely to remain low for a prolonged period.

In the coming months, the consumer price index is likely to decline again from its current level to the bottom of the tolerance band by the end of 2017. Core inflation is expected to decrease in the second half of next year as the temporary effects related to changes in tobacco and dairy product prices fade. Looking ahead, the Bank’s measures of underlying inflation are expected to be around 2 percent. Moderate imported inflation and historically low inflation expectations as well as the VAT rate cuts, announced for next year, have been slowing the rise in domestic prices. In the September projection, the inflation target can be achieved sustainably by the middle of 2019.

According to monthly data, Hungarian economic growth continued in the third quarter of 2017. Industrial production increased in August. Fluctuations in industrial output in the summer months has mainly reflected the different timing of factory shutdowns compared with last year. Robust growth in construction and the expansion in the performance of the service sector are likely to continue in the coming months. Retail sales growth picked up in August. Labour demand is still strong: employment was at historically high levels in the summer of 2017. The unemployment rate remained at a low level. The general increase in domestic demand will continue to play a central role in economic growth. Hungary’s current account surplus is expected to fall over the forecast horizon in response to rising domestic demand. Economic growth this year will also be supported by the fiscal budget and the stimulating effects on investment of EU funding. The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

Sentiment in international financial markets has, on the whole, been positive in the period since the Council’s previous interest rate decision. Expectations about the monetary policy of the world’s leading central banks were the main factor influencing investors’ appetite for risk. The Fed’s interest rate path expected by the market did not change significantly. The European Central Bank is still likely to maintain loose monetary conditions for an extended period. Market participants expect the first interest rate rise to occur later than previously thought. Investors’ perceptions about the Central and Eastern European region continued 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 pricing suggests that the timing of central bank actions will differ.

The amount of liquidity crowded out due to the introduction of an upper limit on the stock of three-month deposits continued to have a marked influence on domestic money market rates. In addition, the stock of central bank swap instruments providing forint liquidity continued to increase and the average maturity of outstanding swap contracts lengthened, in line with the Council’s aim. The three-month BUBOR fell to a new historic low. The yield curves for the interbank and government securities markets shifted downwards. Overall, yields on long-term government securities have fallen since the previous interest rate decision. However, the steepness of the yield curve continued to be high in international comparison, which signs there is still room for reducing long-term yields further.

In the Council’s assessment, the gradual limitation on the stock of three-month deposits has fulfilled its role and the HUF 75 billion year-end upper limit on the stock will not be reduced further. Therefore, the importance of the stock and maturity structure of central bank swap instruments providing forint liquidity will increase, the objective of which is to provide the loosening effect up to the longest possible section of the yield curve. In the future, the Council decides on the amount of liquidity crowded out on a regular frequency and adjusts the stock of central bank swap instruments accordingly.

In the Council’s assessment, some degree of unused capacity has remained in the economy, but this is likely to be absorbed gradually as output grows dynamically. 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 loose monetary conditions for an extended period are necessary to achieve the inflation target in a sustainable manner. However, the September Inflation Report indicated downside risks to inflation. The Council judges that the likelihood of these materialising has increased recently. It is important for the Council to ensure that the low interest rate environment exerts its favourable effect as long as possible. To achieve this, it is necessary to reduce long-term yields and as a result the steepness of the yield curve, which will also promote the expansion of loans with long interest rate fixation. The Council will stand ready to ease monetary conditions further and is considering unconventional instruments to be used accordingly.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 8 November 2017.

MAGYAR NEMZETI BANK

Monetary Council