Central Bank to Carry on With Rate Hikes

For the first time since late 2008, the base rate in Hungary is again in the two-digit territory. At its rate-setting meeting on July 26, the Monetary Council of the National Bank of Hungary (MNB) raised its key rate by 100 basis points to 10.75%.

“It is warranted to tighten the base rate in a decisive manner in order to anchor inflation expectations and mitigate second-round inflation risks,” the Monetary Council said in a statement following the decision, adding that Hungary’s economy was expected to slow in the second half of the year.

MNB’s deputy governor Barnabás Virág said a government decision to scrap price caps on energy for higher-usage households would add three percentage points to the expected inflation rate over the 12 months to August 2023. The MNB will carry on with its interest rate moves “until we can see a clear turnaround in inflation,” Virág said, emphasizing that the bank’s focus was on curbing inflation and second-round impacts even as the economy was set to slow.

The decision is in line with analysts’ expectations, and the tightening of the monetary conditions will most likely continue in the coming months, according to them.

Analysts polled by international news wire Reuters now see the base rate rising to 12% by the end of 2022, which would be its highest level in nearly two decades. Some analysts project even higher rates.

Upside Risks

“Overall, we expect interest rates to rise to 13% later this year [...]. We think the risks are probably skewed to the upside, particularly if European energy supply is severely disrupted, global growth concerns rise, and the forint comes under further pressure,” Capital Economics said in a note after Tuesday’s rate hike, according to Reuters.

András Horváth, head analyst at Magyar Bankholding, stated that the interest rate decision “roughly corresponded to market prices.” He thinks that the base rate may rise to a peak of 11.75% in the fall and remain at this level for a certain period. The one-week deposit rate and the base rate are expected to be reduced in the second half of 2023 at the earliest.

As a result of the conflict in Ukraine, the rise in energy, raw material and food prices continued, so the easing of short-term inflationary pressure is still unlikely, he opined. The current global inflation is mainly increased by the sharp rise in the prices of goods necessary for living, but this alone will slow down economies due to the decline in purchasing power. Therefore, it would be worthwhile avoiding over-tightening the monetary conditions, which makes the work of central banks especially difficult, Horváth warned.

Zoltán Varga, senior analyst at Equilor Befektetési Zrt., pointed out that, in terms of achieving the inflation target, it is crucial to avoid second-round effects and to anchor inflation expectations.

According to the analyst, inflation is expected to return to the central bank’s tolerance band at the end of 2023 as a result of the subsidence of the first-round effects of war tensions, the moderation of external inflationary effects, the fading of the inflationary impact of the tax measures announced in June and the proactive actions of the central bank. He predicts that the base rate will reach the central bank’s 3% target in the first half of 2024.

Varga pointed out that the Monetary Council’s announcement did not contain any surprising news; the MNB is still committed to raising interest rates decisively to curb inflation.

Forint Vulnerability

According to Orsolya Nyeste, Erste Bank’s leading macroeconomic analyst, inflation risks, the vulnerability of the forint exchange rate, and significant interest rate hikes already priced in by the market justified the strong step by the MNB.

The decision-makers are still not in an easy situation since the cutback in utility cuts announced a few weeks ago will further increase inflation. In a rising inflationary environment, breaking down high inflation expectations will not be an easy task, Nyeste wrote.

Overall, the interest rate decision did not bring any significant surprises: interest rates rose as expected, and rate hikes will continue in the coming months - she concluded.

According to Dávid Németh, head of the macroeconomic unit of K&H Bank, based on the current outlook, the interest rate hike cycle may end in December, with a base rate of around 13%. He recalled that, based on the previous communication from the central bank, tightening would continue until inflation reached its peak.

The current interest rate hike is still necessary due to inflationary pressure, he said. In June, the main indicator was already 11.7%; moreover, the core inflation calculated without variable energy, food, and official prices amounted to 13.8%, which points to intense price pressure, he added.

The interest rate hike is also necessary for the forint exchange rate to stabilize or strengthen, he opined, referring to the fact that the performance of the currency is greatly influenced by how the negotiations between Hungary and Brussels regarding EU funds go.

Numbers to Watch in the Coming Weeks

June retail trade data will be published on August 3. The Central Statistical Office (KSH) will release the June industrial output figures on August 5. The July consumer price index will come out on August 9, and the June performance of the construction sector will be published on August 15. On August 17, the flash estimate of the gross domestic product will be out for the second quarter.

This article was first published in the Budapest Business Journal print issue of July 29, 2022.