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Central Bank Takes Action as Risks Moderate

Analysis

Although the National Bank of Hungary did not change the base rate at its most recent meeting on April 25, it narrowed the upper end of the interest rate corridor. The decrease in the risk of extreme scenarios made the move possible, according to the central bank’s deputy governor. However, modifying the base interest rate is not on the agenda at this stage.

The Monetary Council of the Hungarian National Bank (MNB) held the 13% level of the central bank’s base rate at its latest rate-setting meeting. However, it narrowed the interest rate corridor, reducing the upper edge by 450 basis points from 25% to 20.5%.

The central bank’s base interest rate has been at this level since last September, and the council also kept the one-day deposit interest rate at 18%. The lower edge of the interest rate corridor was left unchanged at 12.5%. The decisions met analysts’ expectations.

Among the factors that made the decision possible, MNB deputy governor Barnabás Virág highlighted that gas and electricity prices had fallen significantly in Europe, gas reservoirs are at an adequate level, the end of the interest rate cycle of the major central banks is within sight, and capital inflows have been observed in emerging markets.

Among the internal factors, the foreign exchange market has stabilized, the government securities market is stable, auction demand is adequate, the balance of payments has improved, and the EU agreement has been reached, Virág said at a press conference following the decision.

The deputy governor noted that the current level of the base interest rate is adequate to manage fundamental inflation risks, so its modification is not on the agenda. He said a strong, lasting downward trend in inflation would be necessary before any cut could follow.

Step on the Path

When asked whether the Monetary Council’s decision could be considered an easing, the vice president said it was an important step on the path the MNB embarked upon in October. The data of the following months will decide how it should proceed, he added.

He underlined that the central bank is applying “a prudent and cautious approach” to the interest rate reduction of overnight deposit tenders. It will continuously evaluate the durability of the improvement in risk perception, external balance processes, and the preservation of market stability, Virág said.

Concerns related to the international banking system are being evaluated. The market environment, central bank interest rates, and investor risk-taking are also important points to be factored into the decision-making process.

Virág pointed out that in Europe, a general trend in inflation could be observed, but core inflation had moderated less. In Hungary, inflation peaked in January, and the decline in food price inflation continued in April.

In the coming months, the consumer price index is expected to decrease at an increasingly rapid pace. The strengthening of base effects from the middle of the year will contribute to this. The disinflation path will continue at a faster rate than in recent months from the second quarter on, he said.

The central bank’s move and the proceeding announcement made a week before the actual decision represented a complete communications turnaround. Previously, the central bank had emphasized its strictness and raised the required reserve ratio as a sign of this, according to Gábor Regős, head economist at Makronóm Intézet.

Meaningful Change

The reduction to the top of the interest rate corridor does not significantly affect the market loan interest rates, as this is more affected by the interest rate of the overnight deposit instrument. At the same time, it does indicate a meaningful change, the economist argues.

The 450-basis point reduction can be considered a firm step and suggests that the actual easing may begin at a definite pace in the coming months, Regős says. He adds that the market was not surprised by the move, as evidenced by the fact that the forint exchange rate did not react substantially to it.

However, according to the economist, the central bank’s forward-looking guidance does not contain a clear indication for the coming months. Although the MNB announcement emphasizes the need to maintain a strict monetary policy, it also states that, during subsequent interest rate decisions, the Monetary Council will consider the durability of the improvement in risk assessment and will decide on any change to the overnight deposit instrument’s interest rate based on this.

The guidelines, therefore, do not definitively say that there will be an interest rate cut in May, but neither do they say that it is entirely out of the question.

“According to our expectations, the one-day deposit interest rate will not decrease in May, but only in June or July, if the risk assessment allows it, i.e., the EU negotiations are progressing properly. At the next meeting, however, a further lowering of the ceiling of the interest corridor is not excluded,” Virág had said after the decision was taken.

This article was first published in the Budapest Business Journal print issue of May 5, 2023.

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