The National Bank of Hungary delivered the biggest rate cut since 2008, surprising the markets with the size of the move. The monetary decision came after the forint weakened to levels never seen before.
The Hungarian central bank raised the base interest rate by 185 basis points to 7.75% this week and policy makers aligned the benchmark and one-week interest rates, ending the system of double rates introduced last year. The two ends of the interest rate corridor rose by 135 basis points, with the overnight deposit rate at 7.25% and the interest rate on covered loans at 10.25%.
The extent of the rate move surprised markets as it beat analyst expectations for a 50 basis point hike. Central bankers decided to speed up monetary tightening after the forint plunged to record levels against major currencies.
“Every percentage point, every basis point counts in the fight against inflation,” central bank Deputy Governor Barnabas Virág said. “The Monetary Council will continue raising interest rates as long as necessary. That’s the key to the decisions in the next period.”
The Hungarian currency weakened to 400 per-euro two weeks ago and has been hovering near record lows ever since. In addition to deteriorating international market sentiment, the forint was also sold heavily after the central bank signaled its intention to slow down the pace of interest rate hikes. Investors are also worried about Hungary’s deteriorating economic fundamentals and the country’s continued standoff with the European Union, which is holding up Hungary’s access to the bloc’s of billions funding.
Emerging markets analysts at Capital Economics in London noted that the forint remains under pressure from a number of factors, including the widening Hungarian current account deficit, the tightening global interest rate environment, and deteriorating risk sentiment among investors.
Double-digit interest rates
Economists at Morgan Stanley’s global financial services group revised their Hungarian interest rate forecast after this week’s decision by the National Bank of Hungary and now expect the base rate to peak above 10% this year. The highlighted that the central bank no longer used the reference to a gradual pace of tightening in its interest rate decision, which suggests a change in the MNB’s responsiveness, with the growth dynamics of the Hungarian economy moving down the priority list.
The analysts revised their interest rate forecast for the end of the third quarter of this year to 10.00% from the previously expected 8.90%. There is a high probability that the Hungarian central bank will raise interest rates by 25 basis points in October, which could push the base rate to 10.25% in the fourth quarter of this year, according to Morgan Stanley. In their view, the central bank could start an easing cycle from mid-2023, bringing the base rate to 7.50% by the end of next year.
Péter Virovácz, chief economist at ING Bank in Budapest, warned that risks are mounting for the Hungarian economy, turning the future gloomier. ING expects the year-on-year headline inflation peaking in September or October at a tad below 13%, before it starts a slow and gradual decline. They forecast an average inflation of 11% in 2022 and raised the 2023 outlook to 7.4% with both surrounded by further upside risks.
Despite the central bank carrying out the largest tightening cycle in the region, Hungarian assets have remained under pressure due to several political and geopolitical risks. “The only realistic point of the monetary policy impact remains the currency, in our view. To keep EUR/HUF stable, the central bank needs to continue its decisive tightening at least until inflation peaks. The forint continues to be our least favourite currency in the CEE region, but we continue to watch headlines signalling a turnaround in the Rule of Law and EU funds disputes that should unlock the hidden potential of the forint in the second half of the year (perhaps in September),” Virovácz said.
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