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Inflation Target Will not be met in 2018

While Hungary’s central bank now says that the inflation target will be met only in 2019 and is continuing with its dovish monetary policy, international analysts are warning about a possible “inflation shock”, claiming that maintaining the current extremely loose monetary conditions might ultimately result in a more aggressive tightening later on.

The National Bank of Hungary (MNB) lowered its inflation forecast for 2017 to 2.4% in its quarterly Inflation Report released on June 22, down from 2.6% in the previous report published in March. According to the report, the mid-term inflation target will not be met next year as stated in the earlier report; it now says only half a year later, in 2019, will the 3% target be reached. As for 2018, the central bank lowered its inflation forecast to 2.8%. 

According to the latest available data released by the Central Statistics Office (KSH), consumer prices were 2.1% higher on average in May 2017 than this time last year, while on a month-on-month basis, inflation increased by 0.2% on average.

The MNB has left its predictions for GDP growth unchanged from the previous report: It forecasts 3.6% economic growth for this year, 3.7% for the next, and 3.2% for 2019. Growth projections by the MNB, by the way, are significantly different from those of the government for 2017 and 2018: The latter projects 4.1% and 4.3%, respectively, and a mere 1.6% in 2019.

Domestic Demand

The MNB expects domestic demand to play an increasing role in economic growth, driven by household consumption and the pick-up in investment activity. Investments could grow by 15.8% this year, on a low base, followed by a 11.1% growth next year, and a more moderate 4.3% expansion in 2019.

The upswing in investment will be driven by the increase in the absorption of EU transfers and the pick-up in household investment, the central bank added in the report.

The economic growth in the coming years will be accompanied by a continuous decline in the unemployment rate, the Inflation Report reads, with the 4.2% rate in 2017 potentially falling to 3.8% by 2019.

At the latest rate-setting meeting on June 20, the Monetary Council left the 0.9% base rate unchanged; at the same time, it set a HUF 300 billion limit on the stock of three-month deposits, the central bank’s main sterilization instrument, for the end of the third quarter. Three months earlier, the limit set for the 3-month deposits was HUF 500 billion for the end of Q2. In an accompanying statement, policymakers noted that they believe the extended set of monetary policy tools operating since July 2016 have been a success, and consider the limit set on the three-month deposits and its eventual future changes an organic part of the set. The council will take a decision on the three-month depo limit for the end of Q4 at a policy meeting in September. At the meeting, the Monetary Council also left the interest rate corridor unchanged, with the O/N collateralized loan rate at 0.90% and the O/N central bank deposit rate at -0.05%.

Unconventional

The Monetary Council has left the base rate on hold since signaling an end to an easing cycle at its policy meeting at the end of May 2016. However, rate-setters have made use of “unconventional, targeted” instruments to ease monetary policy further. At its latest meeting, the council repeated its earlier stand on keeping the base rate on hold “for an extended period”, while staying prepared to ease monetary conditions with unconventional instruments.

However, London-based analysts warn about the possible outcome of maintaining such loose monetary policy, which, as they state, is contrary to monetary policies in other European Union countries, where policy makers focus on the date and pace of raising key rates.

“We think inflation will surprise the (Monetary) Council on the upside next year, raising the risk that policymakers fall behind the curve, which could ultimately result in more aggressive monetary tightening,” analysts of London-based Capital Economics wrote in a note that was released after the latest rate-setting decision of the Monetary Council.

As, according to the MNB, monetary policy is set to remain extremely loose over the rest of this year, William Jackson of Capital Economics says the council’s “extremely dovish” post-meeting press statement provided further evidence that policymakers are as yet untroubled by growing signs of capacity constraints. As for possible actions from the Monetary Council for the rest of this year, Jackson thinks the MNB will definitely continue its loose monetary policy; however, it is likely to start a tightening cycle in 2018. Capital Economics forecasts that Hungary’s central bank will raise the base rate to 2% by the end of 2018.

Diana Pasquale, head economist in charge with emerging markets at the investment division of Morgan Stanley emphasized that the “loosening” rhetoric of the MNB is outstanding among the central banks of the Central and Eastern European region. She added, however, that in spite of a significant economic expansion in Hungary, Morgan Stanley does not expect the MNB to launch a tightening cycle before the end of 2018.