Hungarian Central Bank Ends Year on Cautious Note

The National Bank of Hungary left its monetary policy unchanged at this year’s last meeting of the Monetary Policy Council in a signal that rate-setters are applying caution in light of continued risks to global investor sentiment and a resurgence of the coronavirus pandemic. While a slowdown in inflation and a rally in the forint would warrant lower interest rates, the recession triggered by the crisis is a cause for caution.

The central bank kept the key interest rate at 0.6% and the overnight deposit rate at minus 0.05% at its meeting earlier this week, in line with general market expectations. It also signaled it would maintain the difference between the base rate and its most influential tool, the 1-week deposit rate that currently stands at 0.75%. “The increase in risk aversion vis-a-vis emerging markets continues to pose the greatest risk in terms of the outlook for inflation,” the central bank said in a statement. “It’s the central bank’s clear intention to prevent the current uncertain global market environment from causing an increase in upside risks to inflation.”
The central bank’s primary mandate is to ensure that inflation is as close to its medium-term target of 3% as possible. Supporting the nation’s economic output with monetary policy tools comes second to this objective.

Rate cut unlikely
The central bank’s comments prove that market expectations for a rate cut in the short term are unfounded. Some investors have started to speculate that the agreement reached between Hungary and the European Union over the bloc’s budget, the resulting rally in the forint and slowing inflation would prompt a cut in the 1-week deposit rate.
In September, the central bank unexpectedly raised short-term interest rates to respond to a selloff in the forint that was fueled by two earlier cuts to the base rate and to combat rising inflation. “We need to maintain cautious monetary policy due to uncertainty surrounding the inflation outlook,” central bank Deputy Governor Barnabas Virág said in an online briefing following Tuesday’s rate meeting.

Forint and inflation promising
The forint has recovered to its strongest level since August in recent days after Hungary and the EU reached a compromise on the bloc’s budget. Hungary’s headline inflation dropped further in November, helped by lower fuel prices. Annual consumer price growth was 2.7% in November, below the central bank’s medium-term target of 3%. Core inflation, which strips out volatile energy prices, showed a marginal increase of 0.1 percentage point to 3.9% year on year. Analysts at ING Bank expect inflation will drop further on base effects and the lack of demand-driven inflation. As a result, they see headline inflation coming close to 2% in the first quarter of 2021.
“The central bank's cautious view for a volatile inflation path ahead makes us believe that the probability of bringing down the 1-week depo rate … in the first quarter of 2021 has shifted toward the second quarter of 2021 or later," economists at Morgan Stanley said after Tuesday's rate decision.

Updated GDP and inflation forecast
The central bank also published its quarterly Inflation Report this week, which contains the bank’s most recent GDP and inflation projections. In light of the resurgence of the coronavirus pandemic proving more deadly than the initial spring wave, the central bank cut estimates for economic growth next year. Policy makers see the economy contracting by as much as 6.5% in 2020 and expect a GDP growth of between 3.5% and 6% next year. Previously, the central bank forecast that the economy would expand between 4.4% and 6.8% in 2021. Inflation is expected to average 3.4% this year and 3.6% in 2021.

Government spending
The government is looking to boost economic performance by maintaining elevated spending next year. The Cabinet targets a budget deficit of 6.5% of GDP in 2021 after the shortfall is expected to be as wide as 9% of GDP this year. Central bank Governor György Matolcsy stressed the importance of economic recovery at a press conference on Tuesday but also called on the government not to sacrifice financial stability for economic growth. “It’s extremely important to restore economic growth but we should not forget the budget deficit either. We mustn’t listen to Sirens suggesting that the level of state debt and budget deficit doesn’t matter,” Matolcsy said. “Debt will always remain debt.”