Despite its previous communication, the Monetary Council of the MNB did not step on the brake: at its latest rate-setting meeting, it reduced the base interest rate by 25 basis points to 6.75%. The decision corresponds to preliminary analyst expectations: while a month ago it seemed that the central bank would stop interest rate cuts for a while, the developments of the past weeks made it seem more likely it wouldn’t do so.
MNB Deputy Governor Virág Barnabás announced at the interest rate meeting a month ago that, since the risks in the external environment were very strong, limiting the central bank’s room for maneuver, a new phase in domestic monetary policy would begin in July.
The fact that it didn’t end up like this can be attributed to the favorable domestic and international environment: all signs point to the fact that the Federal Reserve, the American central bank, will finally cut interest rates in September.
This is important because even the slightest relaxation by the Fed relieves the pressure on emerging markets, providing the MNB with room for maneuver before further interest rate cuts. This was shown at the end of last year when the market priced in 3-4 interest rate cuts by the Fed, and because of this, the forint was also stronger than it is now.
At a background discussion following the latest Monetary Council meeting, Virág argued that strict monetary policy was still the key to achieving sustainable inflation. He added that it was a constant task to keep inflation anchored around 3%, which is the target of the central bank.
According to him, the cornerstones of strict policy are inflation risks, the development of Hungary’s risk perception, the country’s position in the region, and the change in the international monetary policy environment. He reminded that a new phase in domestic economic policy began in June, according to which the council decides on the base interest rate month by month.
Based on the current information, market analysts expect another one or two interest rate cuts. This trajectory could be considered realistic, Virág said, adding that from an 18-month perspective, the interest rate risks are significantly downward.
“The interest rate cut was supported by the still favorable inflationary processes. The rate of price increase has been within the central bank’s tolerance band for months, and although the inflation of services substantially increases the rate of inflation, there is no primary price pressure behind it, but rather the pricing practices of companies,” says Dániel Molnár, senior analyst at Makronóm Intézet.
“Although inflation may accelerate in the coming months due to base effects, the extent of this is not expected to be significant. Starting from the beginning of next year, the pace of inflation may slow down again and reach the central bank’s target by the summer of 2025,” he adds.
For this reason, the positive backward-looking real interest rate previously considered necessary by the central bank can be maintained even with lower interest rates, Molnár believes. He adds that there would still be room for two further interest rate cuts of 25 basis points, but three cuts should not be excluded either, as a result of which the central bank could reduce its base rate to 6% by the end of the year.
“So far, there has been no break in the interest rate reduction cycle. While at first it seemed after the June meeting that the central bank would wait for a while with further easing, in the last two weeks interest rate expectations have clearly moderated,” agrees Márta Balog-Béki, senior analyst at MBH Bank.
“For the time being, we maintain our expectation that the base interest rate may decrease to 6.5% by the end of the year, but there are downside risks in whether the market processes of the next few weeks and the incoming international and domestic macro data provide the opportunity for several interest rate cuts,” she says.
Equilor’s senior analyst, Zoltán Varga, also argues that since the last interest rate meeting on June 18, several favorable developments have enabled the rate cut. On the one hand, although core inflation rose in June, headline inflation fell to 3.7%. On the other hand, Hungary’s risk assessment has improved slightly, and the recently announced government measures, although they might have an inflationary effect, could bring the budget deficit target closer, according to the analyst.
The forint strengthened slightly against the euro and, to a greater extent, the dollar. Expectations of an interest rate cut in the United States increased significantly, which is an important aspect for the MNB regarding its scope for interest rate cuts. The president of the European Central Bank has also cautiously hinted that its interest rate cut cycle may continue in September.
According to Varga, the MNB may take a pause in August and then continue the interest rate-cutting cycle at its policy meeting on Sep. 24, depending on the decisions of the ECB and the Fed that month.
This article was first published in the Budapest Business Journal print issue of July 26, 2024.
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