Monetary Relaxation to Continue at Same Pace

Analysis

In line with expectations, Hungary’s central bank cut the base rate by 75 basis points at its regular policy meeting on Nov. 21. According to analysts and the bank’s communication, this pace of interest rate cuts may continue for months to come.

At its latest rate-setting meeting, the Monetary Council of the National Bank of Hungary (MNB) reduced its key interest rate to 11.5%. Analysts unanimously expected this step, as the central bank has made several clear indications about the pace at which interest rate cuts may continue in recent weeks.

“Improving macroeconomic fundamentals and the international environment support the continuation of interest rate cuts at the rate of 75 basis points in October,” said MNB vice president Barnabás Virág a few days before the interest rate decision.

The MNB started reducing its benchmark interest rate in May, which it had drastically raised to 18% last October due to financial stability considerations. Employing a series of 100 basis point cuts, it had relaxed the rate to 13% by October of this year.

At that time, it normalized its tools, restored the guiding nature of the base interest rate, and narrowed the interest corridor, symbolically indicating that the period of emergency interest rate increases was over. At the same time, it switched to a slightly more cautious pace and continued to reduce the base rate by 75 basis points.

The 75-basis-point cuts have worked well for the MNB, as the steady decline in inflation confirmed that there is no need to reduce the rate of easing too firmly, and the forint exchange rate has also remained stable.

Several Month Forecast

The MNB is now cautiously forecasting the interest rate path a few months in advance. At a recent press conference, Virág said that the base interest rate could be below 10% for the first time since it started heading north in February 2024. This indicates that, if nothing unexpected happens, the benchmark interest rate will be reduced by 75 basis points twice more.

The central bank has created a so-called positive real interest rate rule, which states that the benchmark rate has to be above the latest available inflation rate. Based on the expected inflation path, the 75 basis point pace will be able to fit into this. It is also very likely that the Monetary Council will review the pace only once the Inflation Report is next published, in March 2024.

Based on the central bank’s communication, a similar schedule of 75 basis point cuts can be expected until February, agrees Amundi’s investment director Péter Kiss.

He also points out that the central bank’s aim with the guidelines could be to cool the expectations of a reduction by a greater extent than at present, thereby strengthening the monetary policy commitment to positive and rising real interest rates.

“All this also improves the central bank’s credibility, which is necessary if the central bank wants to continue reducing the base rate with a strengthening or at least a stable forint exchange rate,” he concludes.

Thus, according to expectations, the key rate will drop to 10.75% by the end of this year, and it could be at 6% by the end of 2024. “Based on our forecast for the inflation path, we can see a continuously positive real interest rate next year, but its rate will gradually decrease from 4% at the beginning of the year to around 1% by the end of the year,” Kiss believes.

Cautious Approach

The MNB also presented a cautious approach. As deputy governor Virág said after the rate-setting meeting, “We cannot sit back; we cannot declare victory over inflation.”

With the acceleration of disinflation, the real interest rate has continued to rise, which, according to the central bank, helps to reduce inflation further, a cornerstone of the central bank’s policy. The benchmark rate may drop below 11% by the end of the year and be in single digits in February 2024, according to Virág.

According to Gábor Regős, senior economist at the Makronóm Institute, the central bank’s presentation sends a mixed message: on the one hand, it states that disinflation must continue, as the inflation target is still far away; on the other hand, it claims that a cautious approach is needed, which indicates strictness.

In the presentation, the MNB stated that the base interest rate will fall below 10% in February 2024, which means strong relaxation is expected at the beginning of the year: the monthly rate, assuming a uniform relaxation, could be 50 or 75 basis points, Regős predicts.

According to the economist, this is a less strict tone, which means a definite relaxation. As a guideline, the maintenance of a positive real interest rate was also stated, and based on this, it is expected that the rate of the base interest rate will follow the development of inflation, especially if there are no unexpected events.

According to Regős, this rather strengthens the strict policy. However, it is not a unique approach: the European Central Bank and the U.S. Federal Reserve both seek to maintain positive real interest rates.

This article was first published in the Budapest Business Journal print issue of December 1, 2023.

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