EU’s highest interest rate in Hungary set to rise further

The National Bank of Hungary raised borrowing costs to an 18-year high this week, taking the European Union’s highest interest rate to 11.75%. Policy makers vowed to tighten monetary conditions further, in contrast with other central banks in the region.

The Monetary Policy Council of the National Bank of Hungary delivered yet another massive interest rate hike this week as policy makers seek to combat rampant inflation and put a floor under the nation’s sliding currency.
The central bank raised the benchmark interest rate by 100 basis points to 11.75%, the highest key rate in the European Union and the highest level seen in the past 18 years. The move was in line with broad market expectations.
The central bank has lifted the base rate by 1,100bp from 0.75% since June 2021, when it began its monetary tightening campaign, being a frontrunner among European central banks.

Decisive steps
Central bankers flagged they would continue to raise rate in “decisive” steps going forward. This trend is in contrast with monetary policy direction in other countries in central and eastern Europe, where policy makers are looking to end their respective tightening cycles.
“The further rise in inflation and persistent inflation risks warrant the decisive continuation of the tightening cycle,” the central bank said in a post-decision statement.
Central bank Deputy Governor Barnabás Virág said after the rate meeting that the evaluation of inflation prospects and second-round effects, as well as seeing how Hungary's negotiations on an agreement with the European Commission on funding matters develop would be key in shaping the future of Hungarian interest rates.
The government of Prime Minister Viktor Orbán is embroiled in a standoff with Brussels over democratic values, the rule of law and corruption. The EU has withheld vital development funds from Budapest, demanding compliance with the bloc’s requests and standards.
Some economists see the base interest rate peaking at around 14% by year’s end, with monetary easing kicking off toward the end of the first half of 2023 the earliest.

Boosting monetary transmission
The central bank also introduced measures to boost monetary transmission in financial markets by reducing excess liquidity. As per the central bank’s new decisions, the required reserve rate for banks will increase to 5% from 1%. The bank will also hold regular discount bill auctions and will introduce a long-term deposit instrument to sterilize liquidity in the banking system at longer maturities. The measures may halve the amount of cash commercial banks keep in the central bank’s one-week deposit facility, Virág said.
Analysts see the steps as an effort on the part of the central bank to support the forint by restricting liquidity in the banking system.

Forint strengthens
The forint jumped as much as 1.4% against the euro in the wake of the rate decision and the central bank’s statement, which was the biggest daily gain in almost a month. The move pared the forint’s decline to 10.3% since the start of Russia’s invasion of Ukraine in February, the third-biggest decline among emerging market currencies after the Turkish lira and the Argentine peso.
The positive impact of the massive rate hike may yet prove short-lived as the central bank has been struggling to contain the nation’s runaway inflation. With the forint under pressure and external financing conditions tightening, the risks remain skewed towards a shorter and sharper increase in rates in the coming months.