Press release on the Monetary Council meeting of 19 June 2018

19 June 2018

At its meeting on 19 June 2018, the Monetary Council reviewed the latest economic and financial developments and decided on the following structure of central bank interest rates with effect from 20 June 2018:

The Magyar Nemzeti Bank shifted to inflation targeting regime in 2001. Inflation targeting is a monetary policy framework where the central bank’s primary objective is to achieve price stability, which it seeks to reach with a publicly announced inflation target. Since 2007, the Magyar Nemzeti Bank has set its medium-term inflation target consistent with price stability as a 3 percent increase in consumer prices. The conditions for price stability are assumed to hold if economic agents can expect over a longer period with confidence, that inflation remains steadily around the target. From 2013, the fiscal turnaround achieved in previous years has made it possible to improve the efficiency of inflation targeting. The ±1 percentage point tolerance band around the target, introduced in March 2015, allows the Monetary Council to look through any deviation of inflation from the target in the event of temporary cost shocks, thereby mitigating the real economic costs of achieving and maintaining price stability. The time horizon considered by the Council is 5 to 8 quarters.

In addition to the priority of the price stability objective, the flexible inflation targeting strategy provides a framework where the central bank not only focuses on inflation, but also takes into account financial stability and real economic considerations, in line with its mandate. After 2013, inflation fell significantly below the 3 percent target; therefore, promoting financial stability and stimulating the real economy through underlying developments were fully consistent with the achievement of the inflation target, without jeopardising it. The extension of the Bank’s micro- and macroprudential authority, the conversion of foreign currency loans into forints, the Self-financing Programme, the Funding for Growth Scheme, then the Market-Based Lending Scheme contributed successfully to restoring the monetary transmission mechanism impaired during the crisis, to strengthening financial stability and to providing a corresponding degree of support to the real economy. During 2018, however, inflation is likely to be close to the inflation target again, and therefore the Bank’s policy focus shifts back to its primary mandate, to the achievement and maintenance of price stability.

The Magyar Nemzeti Bank takes account of all factors influencing inflation developments on the horizon of monetary policy. These may include developments in commodity prices, changes in the external inflation environment, labour market conditions, the position of the real economy, the developments in exchange rate and credit market conditions. By taking into account all these factors, the Bank is able to assess the likely magnitude and persistence of future price changes, which in turn determines the monetary policy response. The Magyar Nemzeti Bank’s single anchor is inflation.

In the Council’s assessment, in parallel with the pick-up in domestic demand Hungarian economic output is close to its potential level. Growth of the Hungarian economy will pick up further in 2018, then, if the assumptions of the current projection hold, it will slow down gradually from 2019. The inflation target is still expected to be achieved in a sustainable manner from mid-2019, as the temporary, inflation boosting effects of oil price changes fade.

In May 2018, inflation stood at 2.8 percent and core inflation at 2.4 percent. Rising fuel prices were the main factor contributing to the increase in inflation. In line with the Bank’s expectations, measures of underlying inflation continued to be around 2 percent and remained 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 had led to a general, dynamic rise in whole-economy wages, which continued in the first quarter of 2018. The upward effects of this on costs are being offset by the gradual reduction in employers’ social contributions and in the corporate tax rate in 2017. In line with the Bank’s expectations, upward pressures on inflation from wages continue to be moderate. Oil prices rose significantly over the spring and were considerably higher than in the previous year. According to the ECB’s projections, however, underlying inflation will continue to be moderate in the euro area in the coming years as well.

If the assumptions in the June projection hold, the consumer price index will temporarily rise slightly above 3 percent in the coming months, reflecting the increase in oil prices. With inflation expectations anchored at low levels, higher oil prices are unlikely to generate second-round effects. Over the medium term, rising consumption leads to a gradual increase in underlying inflation. However, moderate external underlying inflation and inflation expectations stabilising at historically low levels, as well as multistage reductions in employers’ social contributions and the VAT rate cuts this year, are slowing the rise in prices. The inflation rate is expected to moderate back again as the direct effects of oil price increases fade, and the increase in underlying inflation will ensure that inflation meets the 3 percent target in a sustainable structure from the middle of 2019.

The Hungarian economy grew strongly, by 4.4 percent, in the first quarter of 2018 relative to a year earlier. On the expenditure side, consumption and fixed investments were the main factors contributing to growth. In April, industrial production increased and construction output rose at a somewhat moderated pace on annual basis following the outstanding data for the previous period. The volume of retail sales grew markedly. The performance of services improved across a wide range of sub-sectors and made an increasing contribution to economic growth. Labour demand remained strong. The unemployment rate fell to a historically low level. Lending to the corporate and household sectors continued to expand.

Economic growth continues in a balanced structure. Looking ahead, the general strengthening of domestic demand will continue to play a central role in economic output developments. The build-up of new export capacities and the pick-up in services exports are likely to contribute to export growth and, consequently, to an increase in Hungary’s export market share. The country’s current account balance relative to GDP is expected to remain in positive territory over the longer term as well. Economic growth this year will also be supported by the budget and the stimulating effects on investment of European Union funding. In the Council’s assessment, GDP growth will be 4.4 percent in 2018, higher than last year, then, if the assumptions of the current projection hold, it will slow down gradually from 2019. The Magyar Nemzeti Bank’s and the Government’s measures contribute substantially to this year’s economic growth.

Sentiment in international financial markets has been highly volatile in the period since the Council’s previous interest rate decision. Expectations related to the policy stance of the world’s leading central banks, domestic political events in Europe and global trade policy developments influenced investors’ appetite for risk. The Fed continued its gradual tightening of monetary conditions. The dollar has appreciated significantly and US long-term yields have risen further over recent months. As a consequence, appetite for risk in emerging markets deteriorated. This, associated with a generalised increase in volatility, led to sharp movements in some countries and had an effect on Central and Eastern European markets as well. The ECB decided to end its asset purchase programme in December, therefore the exerted direct effects on the long end of the yield curve will be smaller. However, policy interest rates remain unchanged at least until the summer of 2019, and therefore the monetary policy environment in the euro area may remain loose. The ECB’s decision may have a significant influence on the Magyar Nemzeti Bank’s monetary policy.

Asset price volatility also increased in domestic financial markets in response to turbulence in international markets. The Bank assesses these developments in light of their relevance to its primary objective, i.e. the sustainable achievement of the inflation target, focusing on their persistence. Due to the different inflation paths expected in the countries of the region and the different characteristics of inflation targeting regimes, market prices suggest that monetary policy stances by regional central banks will continue to differ.

In the Council’s assessment, maintaining the loose monetary conditions is necessary to achieve the inflation target in a sustainable manner. To this end, the Monetary Council maintained the base rate, the overnight collateralised lending rate and the one-week collateralised lending rate at 0.9 percent and the overnight deposit rate at -0.15 percent.

The Council will maintain the HUF 75 billion upper limit on the stock of three-month deposits. In addition, the Council set the average amount of liquidity to be crowded-out for the third quarter of 2018 at least at HUF 400-600 billion. Furthermore, the Council stated that the actual amount of liquidity to be crowded out must reach a level sufficient to ensure the maintenance of the loose monetary conditions. The Magyar Nemzeti Bank increased the stock of fine-tuning FX swaps providing forint liquidity. On the next occasion, in September 2018, the Council will decide on the amount of liquidity to be crowded out and will take this into account in setting the stock of central bank swap instruments.

In June, the Monetary Council set the maximum stock of monetary policy interest rate swaps in the first three quarters of 2018 at HUF 900 billion. The Bank will continue mortgage bond purchases and the monetary policy interest rate swap facility as programmes, and therefore they constitute an integral part of the set of monetary policy instruments. The Council considers the Bank’s mortgage bond purchase programme to be successful. As a result of the measures, spreads of mortgage bonds over yields in the government securities market fell sharply and turned negative on average. The decline in financing costs encouraged issuance in the primary market, thereby facilitating the increase in fixed-rate lending.

The fundamentals of the Hungarian economy continue to be stable. Accompanied by dynamic growth, the country’s external debt has declined significantly, and its net lending continues to be persistently strong. Its fiscal position is sustainable, the budget deficit is low and the public debt-to-GDP ratio has been contracting. The foreign currency debt ratio has fallen sharply. The debt cap rules, to be introduced in the autumn, will facilitate healthy, sustainable growth of housing loans.

The Magyar Nemzeti Bank’s single anchor is inflation. The inflation target is still expected to be achieved in a sustainable manner from mid-2019, as the temporary, inflation boosting effects of oil price changes fade. In the Council’s assessment, maintaining the base rate and the loose monetary conditions is still necessary to achieve the inflation target in a sustainable manner. The current volatile international environment suggests a more cautious approach. The Council will ensure the maintenance of loose monetary conditions, necessary to achieve the inflation target in a sustainable manner, by using the current set of monetary policy instruments.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 4 July 2018.

MAGYAR NEMZETI BANK

Monetary Council