The National Bank of Hungary raised massively the EU’s highest key interest rate as it seeks to tamper runaway inflation and bolster the forint. Analysts expect policy makers to continue raising borrowing costs as the war in Ukraine continues to rattle markets.
The Monetary Council of the Hungarian National Bank (NBH) raised the central bank base rate by 100 basis points to 4.40% this week, in what was the steepest rate increase in years. Hungary resumed raising the effective interest rate after the central bank said that the war in neighboring Ukraine would lead to a sharply deteriorating inflation outlook.
Members of the Monetary Council also decided to raise the overnight and one-week collateralized loan rates by 100 basis points to 7.40% this week.
Since the start of the current tightening cycle in June 2021, the NBH has raised the base rate by 380 basis points. The one-week deposit rate, which has become the effective monetary policy tool, has risen from 0.6% to 6.4% in the same period.
The central bank published its updated Inflation Report this week, which raised the average annual inflation forecast for 2022 to 7.5%-9.8%. In February, consumer prices jumped 8.3% from a year earlier.
The short-term path of inflation will depend on the duration of the war, the extent and persistence of sanctions, as well as government responses, according to the central bank.
The mid-term inflation target of the central bank is 3.0% with a +/-1pp tolerance band. Rate setters expect inflation to return to around the target in the second half of 2023 and reach the target in the first half of 2024. Price increases will slow down due to "the fading of the first-round effects of the war and the sanctions, the decrease in external inflationary effects" and "the central bank's proactive measures."
In a statement released after the meeting, the Council said that the Russia-Ukraine war has “posed a much higher risk than usual” to the outlook for inflation. The increase in inflation risks warrants a further tightening of monetary conditions. Consequently, the Monetary Council deems it necessary to continue the general tightening of monetary conditions and to continue the base rate tightening cycle by a larger increment than before, the bank added.
Deteriorating growth outlook
Due to the effects of the war and sanctions, the central bank lowered the economic growth outlook for 2022 to 2.5%-4.5% from 5.1% previously on the back of energy price increases, supply chain shocks and declining investment and consumption. Actual growth will largely depend "on the duration of the war and the policy of sanctions," according to the NBH. Hungary’s economic fundamentals were strong before the war, and preliminary data from the first two months foreshadowed a growth of 6%, NBH Deputy Governor Barnabas Virág said after the policy meeting on March 22. He added that negative interest rates would be the smallest in Hungary when the tightening cycle ends. At the same time, the central bank noted that economic fundamentals will remain stable, the external balance will recover quickly, and a high investment rate will lead to higher economic growth again in the longer term.
Rates to rise further
Analysts unanimously expect the central bank to continue raising borrowing costs in the short run. Forward-rate agreements show that money market traders expect the effective rate to climb 150 basis points in three months.
The central bank could raise the base rate to rise by another 100 basis points at the upcoming meetings, according to a research note published by Capital Economics. The base rate and short-term interbank interest rates could rise to 8% by the end of 2022.
Hungary’s key interest rate may peak at 7%, according to analysts at OTP Bank Nyrt., who flagged in a report on Wednesday that risks to their forecast are tilted to the upside as even more tightening may be needed to bring inflation under control.
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