In a move that surprised many, the MNB’s Monetary Council cut its base rate by 75 basis points; the majority of analysts had expected a 50-basis-point cut.

According to the MNB’s briefing issued following the decision, the step was made possible by the strong disinflation process and the reduction of external vulnerabilities. Global risks and the volatility of international investor sentiment will continue to require a cautious and prudent approach in the near future, and the MNB will make its decisions in accordance with this and the incoming data, the central bank says.

The retrospective real interest rate, which entered positive territory in September, may rise in the coming period, which, according to the MNB’s assessment, could help disinflation further.

September was something of a milestone in the monetary policy; since May, the MNB had cut back the one-day deposit instrument, which was introduced as a guiding rate in the midst of the financial market turbulence last October, by 100 basis points per month in five steps, the last element of which was the closing of the two interest rates.

However, September was also important for another reason: it was the first month in seven years when the real interest rate returned to positive territory, meaning inflation was already lower (12.2%) than the base interest rate, which will surely determine the central bank’s actions in the next period.

Positive News in View

According to the forecasts, there will likely be a more significant positive real interest rate (in other words, the difference between inflation and the interest rate) in the economy by the end of the year: the rate of inflation is expected to decrease to around 7-8%, and the MNB may cut the base interest rate back to approximately 11%.

Many, if not the majority, of the central banks of developed or developing countries, including the Hungarian national bank, consider the maintenance of a positive real interest rate an essential tool for reducing inflation, Gyula Pleschinger, a member of the Monetary Council, told leading business news publication Világgazdaság [Global Economy].

This may further increase tensions between the central bank and the government. While the MNB sees a positive real interest rate as a means of reducing inflation, according to Minister of Economic Development Márton Nagy (a former deputy governor of the central bank), this hinders the start of consumption and growth. He believes that the MNB only pays attention to inflation.

Pleschinger believes that the exact amount of real interest rate needed in Hungary largely depends on the global environment. He recalled that when yields rise rapidly in large developed markets, the danger of fluctuation in emerging markets increases.

He noted that a recently published study by the International Monetary Fund, analyzing more than 100 cases, showed that those central banks that applied a strict monetary policy and kept the exchange rate stable were successful in suppressing inflation. This requires a positive real interest rate.

No Stimulation Necessary

The central bank previously launched credit and capital programs to stimulate the real economy, so the question now is whether similar steps can be expected next year. Pleschinger told Világgazdaság that incentive programs are not currently on the agenda; the MNB is instead focusing on its primary task, the suppression of inflation, and the stability of the financial system.

“Since the central bank’s expectations, similarly to our own, is that inflation may drop very sharply by the end of the year, and given the vulnerability of the domestic economy, we expect it to continue the reduction of the base interest rate in the last months of the year,” said Gergely Suppan, head analyst at MBH Bank. “It might drop to 11% by December, possibly with minimal downside risks.”

He thinks that the reduction cycle may continue in 2024. As the central bank considers it necessary to maintain a positive real interest rate, Suppan expects the base interest rate to drop to 6% by the end of next year.

As for the expected 11% interest rate at the end of this year, Pleschinger of the MNB emphasized that this level could be reached if no unexpected events, such as the market turbulence of last fall, another war, or a drastic increase in energy prices, occurs and inflation actually falls to the 7-8% range by December.

According to Pleschinger, in the third quarter, the signs of the return of growth were already visible, especially in certain areas of industry and agriculture. However, for consumption and investments to rise permanently, the current inflation rate, and even that expected by the end of the year, is too high, so disinflation must continue into 2024, he concluded.

This article was first published in the Budapest Business Journal print issue of November 3, 2023.