Lower-than-expected Inflation to Speed Interest Rate Cuts?

Analysis

The year-end brought a positive surprise with inflation data that was more favorable than expected. Due to the lower index, the National Bank of Hungary (MNB) might accelerate its interest rate cuts, at least temporarily, Deputy Governor Barnabás Virág indicated at a recent press conference.

December’s inflation data outperformed the expectations of analysts: while their consensus was for a reduction of around 6%, consumer prices were, in fact, only 5.5% higher in the last month of 2023 than a year earlier. Such a level had not been registered since June 2021.

Compared to the previous month, average consumer prices decreased by 0.3%, according to data released by the Central Statistical Office (KSH).

Compared to December 2022, a price rise of 4.8% was recorded for food, which last happened in September 2021. Within food, the highest increase was for sugar, up 42.1%, with 17.2% for chocolate and cocoa, 16.1% for non-alcoholic beverages and 14.1% for coffee. Electricity, gas and other fuels became 13.9% cheaper. From November 2023, however, food prices decreased by 0.1%.

Comparing last year overall to 2022, consumer prices were up by 17.6% on average, within which the highest price increase of 25.9% was seen in food. A price rise of 22.1% was recorded for electricity, gas and other fuels, 18.6% for other goods, including motor fuels and lubricants, 15.4% for alcoholic beverages and tobacco, 13.2% for services, 8.3% for clothing and footwear and 5.6% for consumer durables. Consumer prices increased by 18.3% on average among pensioner households.

Core inflation (which strips out the more volatile prices for food and energy) was put at 7.6% in December, down from 9.1% when measured year-on-year but up 0.2% compared to November.

A Pleasant Surprise

The fresh data is a pleasant surprise, according to Erste Bank analyst János Nagy. He recalls that food products showed a decrease of 0.1% on a monthly basis, so their annual index was 4.8%. Vehicle fuel prices fell further (by 3.6% on a monthly basis), once again providing substantial support for continued disinflation.

Less good news from the point of view of the persistence of disinflation is that service inflation actually rose by 0.6% in December. This is considered a seasonally high value for the last month of the year. On an annual basis, service prices rose by 8.1%, Nagy says.

“The combination of the slightly decreasing price index and the still supportive base effect again brought a significant decrease in the annual index,” Nagy says. “At the beginning of this year, the supporting role of the base effect persists, and it is expected that, despite the already much higher monthly price increases, which will be driven by the increase in the excise tax in addition to the revaluations at the beginning of the year, the annual index may slow down further,” he believes.

Thus, annual inflation might drop below 5% as early as January, but it will probably not last at that level. As the supporting base effect wears off, the annual index may return to above 5% in the second quarter at the latest, and is expected to remain there for the rest of 2024. Slightly increasing or stagnant figures may be published throughout the year, starting from spring. The analyst cautions that it is uncertain whether December 2023 or December 2024 will have the lower value.

MBH Bank head analyst András Horváth takes a slightly more optimistic view. He agrees that the increase in the price of alcohol and tobacco products, as well as the price increase that can still be observed in significant sections of the services sector, moderates the process of the decrease in inflation.

However, overall, and despite the increase in the excise tax on fuels at the beginning of 2024, this year’s annual inflation rate may be 4.1%, and in the third quarter, it might reach 4%, which would be within the central bank 2-4% target band for the first time. That said, the repricing decisions made by market participants in the first two months of the year may carry risks, Horváth acknowledges.

All Eyes on the MNB

According to Erste’s Nagy, the MNB is expected to cut the base interest rate by another 75 basis points at its first meeting this year to 10%. Although the issue of more aggressive interest rate cuts may flare up again due to the current data, the suffocation of disinflation expected in the spring will probably force the central bank to reconsider the interest rate cut strategy around March, so further acceleration is not viable until then, according to Nagy.

“The latest inflation data confirms the previous expectations about the ongoing disinflation processes and enables monetary policy to continue the loosening cycle that has begun and to reduce interest rates further at the current pace,” Horváth argues.

The Monetary Council will meet to decide on interest rates for the first time this year on Jan. 30.

“Based on the currently available information, there are just as many arguments in favor of lowering interest rates by 75 basis points or 100 basis points at the interest-rate meeting at the end of January,” Deputy Governor Barnabás Virág said at a Euromoney conference in Vienna recently.

As international newswire Reuters noted, Virág was indicating that the central bank could speed up the rate of monthly interest rate cuts from the 75 basis points cuts it has used in recent months. But Virág also stated that, even if this acceleration takes place, it would only be temporary, for one to three months. Regarding the time interval for the acceleration to the 100 basis point cut, he said: “I think it would be too early to judge because it depends on the data.”

This article was first published in the Budapest Business Journal print issue of January 26, 2024.

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