Central Bank Ends Rate Hike Cycle but Deploys Other Tools

In a rather unexpected move, the central bank’s Monetary Council brought the cycle to a conclusion at its latest rate-setting meeting on September 27. The council raised the key rate by 125 basis points to 13% and, right after the decision, MNB Governor György Matolcsy announced the end of the tightening cycle.

In doing so, the MNB closed its most prolonged rate-hiking period in 30 years. As it was the first in the region to start such hikes, it has become the first to end them, despite the central bank expecting inflation to accelerate further.

“We are not going any further because there is no point in going higher than a double-digit base rate, and there is also favorable data coming from the global inflationary environment,” Matolcsy said at a press conference following the rate decision.

Analysts unanimously described the 125-basis point hike as surprising, and opinions on winding up the rate hiking cycle vary.

Gergely Suppan, senior analyst at Magyar Bankholding, drew attention to the fact that the strict monetary conditions will remain even after the interest rate hikes are stopped. He noted that the forint has recently reached historic lows against the euro, despite the pace and severity of interest rate hikes in the recent period showing a “commitment” against inflation that is almost unique in the world.

Exchange Rate Drivers

Suppan said that the exchange rate of the Hungarian currency is not primarily driven by the interest rate but rather by the changes in gas prices (which significantly worsens growth prospects), the strengthening of the dollar, global risk aversion, and the uncertainties of the EU embargo and payment disputes.

He reminded that the central bank had also decided on liquidity-restricting measures at the last interest rate meeting, which supports the fact that there is no longer a need to raise interest rates significantly, even though inflation may still rise considerably for the remainder of the year, Suppan said.

The analyst noted that, due to the conflict in Ukraine, the sanctions against Russia, and the very low level of Russian gas deliveries to Europe, the rise in European energy prices had continued substantially, making the easing of short-term inflationary pressure still unlikely.

Moreover, a significant rise in inflation is expected due to the extension of utility cuts above average consumption, energy prices expected to continue rising at current levels, continued repricing in some product areas, and a sharp rise in company costs, Suppan wrote.

Dániel Molnár, an analyst at the Makronóm Institute, believes that the end of the interest rate hike cycle was “not necessarily expedient in the current uncertain economic environment” and that the MNB should continue raising interest rates until the peak of inflation is visible, which could occur by the end of this year at the earliest.

Energy prices continue to show significant volatility, which affects the prices of all products. Normalization cannot be expected until the end of the Russo-Ukrainian war and the lifting of sanctions. If that does not happen, the situation will result in permanently high energy prices and thus inflationary pressure, as well as a worsening of the balance of payments, Molnár warned.

He believes the continuation of interest rate increases is also necessary because it supports the exchange rate of the forint, which in turn has an impact on inflation through the prices of imported products.

‘Unorthodox’ Return

Péter Kiss, investment director of Amundi Alapkezelő Zrt., explained that the MNB is returning to the use of its former “unorthodox” monetary policy tools and will primarily try to influence short-term interest rates by managing interbank liquidity, but he says it is questionable how foreign investors will evaluate this.

This will be especially difficult to explain when, according to the central bank’s forecast, inflation may rise until the end of the year, and it may not fall back to the target range until 2024, Kiss noted.

He accepted that the central bank had successfully carried out this liquidity policy in the past in a low-interest rate environment. However, it is questionable how successful the old-new approach would be with high and still rising inflation in the short term. That is especially so when the leading developed market central banks are about to get rid of non-conventional instruments and are obliged to increase interest rates in the fight against inflation, Kiss said.

In the meantime, the MNB has raised its inflationary forecast in its September Inflation Report. According to this, domestic inflation will continue to rise in the fall months, and this year it may average between 13.5–14.5% overall. Inflation will decrease slowly in the first half of 2023 and then more significantly from the middle of the year. The consumer price index may be in the range of 11.5–14% in 2023 and will return to the central bank tolerance band in the first half of 2024, at between 2.5–4%, the MNB says.

Numbers to Watch in the Coming Weeks

The Central Statistical Office (KSH) was due to release its first estimates for August’s industrial output yesterday (October 6), with the August performance of the retail sector also due to be published on the same day. The September consumer price index will be out on October 11. August construction sector data will be posted on October 14.

This article was first published in the Budapest Business Journal print issue of October 7, 2022.