The Monetary Council of the National Bank of Hungary (MNB) cut its base interest rate by 50 basis points to 7.25% on May 21. In addition, it lowered the overnight deposit interest rate by 50 basis points to 6.25% and reduced the O/N secured loan interest rate to 8.25%.
At the press conference following the decision, MNB deputy governor Barnabás Virág spoke very cautiously about the second semester, emphasizing that “we are in no rush,” meaning that the second half of the year is expected to bring much smaller relaxation measures.
By the end of next month, the base interest rate will be 6.75-7% (that is, a cut of between 25 and 50 basis points may come in June), but Virág did not want to make any reference to the likely interest rate at the end of the year. He noted that the MNB will address this issue once the June inflation report has been published.
The cautious and patient easing of monetary conditions in Hungary continued in May; the size of the move was similar to that of April, ING Bank analysts noted in commenting on the move. Besides the base rate, the central bank maintained the symmetry of the interest rate corridor with 50 bp cuts at both ends.
“Given that market expectations of the upcoming decision were virtually unanimous this time around, the actual outcome did not contain any surprises. The Monetary Council decided to recycle the messages from the previous rate-setting meeting. The ‘rinse and repeat’ process implies a hawkish stance across the board,” they wrote.
While the press release and the background discussion following the decision did not contain any unexpected, eye-opening messages, ING analysts found two new elements of emphasis in the communication.
The first relates to the Federal Reserve’s monetary policy. Previously, the central bank focused on the timing of the expected easing cycle, but now the message is more about the expected divergence between the Fed and European Central Bank policy, which may lead to a persistently higher U.S. interest rate environment and possibly increased volatility in emerging markets, ING says.
“With this kind of change, the Monetary Council has made itself independent of the decisions of the Fed and the ECB while acknowledging that possible money market instability created by this divergence could cause headaches in the future,” they noted.
The second focus was on local (and global) services inflation and the risks to the inflation outlook, according to ING Bank. It notes that, while these issues had been highlighted in previous months, the Monetary Council put more emphasis on the sticky nature of services inflation and the bad habit of backward-looking repricing patterns that limit the disinflation process.
Moreover, this pricing decision goes against the central bank’s desire to anchor inflation expectations at a lower level. The latest survey showed that the decline in inflation expectations has come to a halt, and it remains high at around 8%, according to the MNB’s calculations, twice the upper limit of the inflation target tolerance band).
“All in all, the focus on services inflation risks and the divergence of key monetary policymakers now serve as risks that warrant the MNB remain on the side of caution and patience,” ING analysts assume.
“In our opinion, the press conference following the decision can be said to have had a neutral tone; the guidelines indicated in April have not changed substantially,” Márta Balog-Béki, senior macroeconomic analyst at MBH Bank, said in a press release. She believes that the central bank can reduce interest rates by another 50 basis points in June, and then in the second half of the year, it will only ease interest conditions to a minimal extent.
“Thus, we expect a basic interest rate of 6.25% by the end of the year. In the following months, the annual rate of inflation will gradually increase again, and geopolitical tensions and the volatility of international investor sentiment also justify a prudent and cautious monetary policy. In addition, market expectations regarding the Fed’s key rate also limit the MNB’s room for maneuver. The markets are pricing in two interest rate cuts overseas, but compared to the Fed, a significant interest rate premium may be necessary in Hungary,” Balog-Béki opined.
Equilor analysts explained the elements the MNB will monitor in the coming period. Among international factors, disinflation is strong, but at the same time, inflation in services remains high. Geopolitical conflicts could increase energy market volatility and cause disruptions in global value chains.
The willingness to take international risks has improved, but, at the same time, the expected divergence between the monetary policy of the ECB and the Fed may result in an increase in volatility in emerging markets through the global interest rate environment.
Among the domestic processes, deputy governor Virág highlighted that, since the beginning of the year, inflation has been within the central bank’s 2-4% tolerance band, but domestic service inflation is also high, and the central bank will pay special attention to this in the coming months, Equilor thinks.
The improvement in the country’s risk perception was based on the revival of economic growth, the high current account surplus, and the historically high foreign exchange reserves. In the next period, the MNB will likely continue to focus on inflation, the international monetary policy environment, country risk assessment, and financial market stability, Equilor wrote.
This article was first published in the Budapest Business Journal print issue of May 31, 2024.
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