Press release on the Monetary Council meeting of 26 July 2022

26 July 2022

At its meeting on 26 July 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 27 July 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 Russia-Ukraine war, a possible new wave of Covid-19, high commodity prices and ongoing disruptions in supply chains increase recession risks in global economy. The recent effects of financial market developments and persistently high commodity and energy prices as well as the worsening European drought, point to a prolonged period of high external inflation.

There has been a general deterioration in investor sentiment since the end of June. Risk appetite has been driven by news on the war, expectations for interest rate increases by the world’s leading central banks, concerns caused by persistently high inflation, fears of recession and developments related to the coronavirus pandemic. Global prices of most of major commodities remain at high levels. By contrast, certain metals and oil prices have declined since the June interest rate decision.

In response to persistently high inflation, monetary conditions have been tightened further by the world’s leading central banks as well as the region’s central banks. At its policy meeting in July, the European Central Bank raised its policy rate by 50 basis points, and ceased its asset purchase programme (APP) on 1 July. In the CEE region, the Polish central bank raised its key policy rate by 50 basis points and the Romanian central bank by 100 basis points.

Hungarian economic growth has been slowing; however, annual dynamics remain buoyant. In May, industrial production and construction output continued to expand on an annual basis. The turnover of retail stores also rose at a double-digit rate in May relative to a year earlier. The labour market continues to be tight, and the unemployment rate remains low. Following a strong growth in the first half of 2022, real time data suggest a considerable slowdown in growth, which reflects the phase-out of single income support, restrained government investment and companies’ rising costs in addition to the deterioration in external economic activity.

The time profile and structure of domestic GDP growth have strongly shown a dual nature in 2022. The rate of economic growth is likely to slow in the second half of the year. Components of domestic demand, particularly household consumption, are expected to contribute to growth this year. By contrast, net exports are likely to hold down the expansion. Looking forward, however, consumption and investment dynamics are also expected to slow considerably, while net exports are expected to make a positive contribution to GDP growth again as external markets and supply chains recover. Despite the temporary slowdown, the investment rate is expected to stabilise at a high level of above 27 percent on the forecast horizon. Hungary’s GDP is expected to grow by 4.5–5.5 percent in 2022, by 2.0–3.0 percent in 2023, and by 3.0–4.0 percent in 2024.

In June 2022, annual inflation was 11.7 percent and core inflation stood at 13.8 percent. Food prices rose at a rate above 20 percent relative to the same period a year earlier. Repricings in June continued to be much greater than the level in recent years. Generally rising costs continue to quickly feed through to consumer prices. The Government’s measures affecting fuel and household energy prices are providing a cushion against the spillover of the increase in global commodity prices into domestic inflation. However, inflation expectations remain elevated.

The rise in energy, commodity and food prices continues to quickly feed through to consumer prices. Price dynamics are expected to peak during the autumn months and then to decline at a modest pace. The future course of price cap measures and the Government’s announcements regarding the household prices of electricity and natural gas are expected to have a significant effect on the timing of the peak and the subsequent inflation path. Preventing second-round effects and anchoring inflation expectations are crucial in terms of achieving the inflation target. Inflation is expected to return to the central bank tolerance band at the end of 2023, as the first-round effects of war tensions abate, external inflationary effects moderate, the inflationary effects of the tax measures announced in June fade and as a result of the proactive central bank measures, and then to meet the 3 percent central bank target in the first half of 2024.

The measures announced by the Government and their implementation are expected to ensure that the fiscal objectives will be met this year and next. As a result of economic growth and declining deficit, the government debt-to-GDP ratio may fall from 76.6 percent at the end of the previous year to below 75 percent in 2022, followed by further declines of around 2.5 percentage points each year. The current account deficit is expected to temporarily rise further in 2022. The deterioration in the trade balance this year is likely to reflect the deterioration in the terms of trade due to high energy prices, the slowdown in external markets, and imports in connection with buoyant domestic demand. However, significant new export capacities have been built in recent years, and as a result, the external balance is expected to improve quickly as the global economic environment normalises. The economy’s net lending position may return to positive territory at the end of the forecast horizon.

Upside risks to inflation have strengthened further since the June interest rate decision, while the risk of second-round inflationary effects has increased. The situation in financial markets has recently increased the risk of persistent inflationary effects, posing a clear threat to price stability. In order to avoid the above risks, it has become necessary to tighten monetary conditions further; therefore, the Monetary Council decided to raise central bank interest rates by 200 basis points on 12 July. A combination of the central bank measures and the Government’s expenditure-side budget measures have together mitigated financial market risks.

In the Monetary Council’s assessment, it is warranted to tighten the base rate in a decisive manner in order to anchor inflation expectations and mitigate second-round inflation risks. The MNB continues to stand ready to respond quickly and flexibly by setting the interest rate on the one-week deposit instrument if warranted by the rise in short-term risks in financial and commodity markets.

 According to today’s decision of the Monetary Council, the central bank base rate was raised by 100 basis points to 10.75 percent. The overnight deposit rate was increased by 100 basis points to 10.25 percent, and the overnight and the one-week collateralised lending rates were increased by 100 basis points to 13.25 percent. According to the Monetary Council’s assessment, it is warranted to increase the interest rate on the one-week deposit instrument by the same measure as in the base rate.

The Bank considers it crucial that short-term rates in every sub-market, particularly in the swap market, and at all times develop consistently with the level of short-term rates deemed optimal by the Monetary Council. To that end, on 8 July 2022, the MNB started the use of swap tenders providing foreign currency liquidity within quarters and holds tenders on a daily basis. By maintaining an active presence in the market, the MNB enhances the effectiveness of monetary policy transmission, thereby supporting the achievement and maintenance of price stability.

The Magyar Nemzeti Bank started the cycle of interest rate hikes one year ago, first among the central banks in the European Union. The further rise in inflation and persistent inflation risks warrant the decisive continuation of the tightening cycle. The MNB continuously monitors developments in financial market risks as well and stands ready to intervene in a decisive manner using every instrument in its monetary policy toolkit, if necessary. Maintaining tighter monetary conditions for a longer period is warranted to manage increasing second-round inflation risks resulting from persistently negative supply effects. The Monetary Council will continue the cycle of interest rate hikes until the outlook for inflation stabilises around the central bank target in a sustainable manner and inflation risks become evenly balanced on the horizon of monetary policy.

The abridged minutes of today’s Council meeting will be published at 2 p.m. on 10 August 2022.

MAGYAR NEMZETI BANK
Monetary Council