Hungary Delivers Unexpected Rate Hike as Forint Weakens to Record Level

The National Bank of Hungary surprised markets when it unexpectedly raised the key interest rate as monetary policy setters seek to put a floor under the sliding forint. In the face of double-digit inflation and massive wage increases, the central bank has to keep raising borrowing costs to keep Hungarian financial assets competitive.

The National Bank of Hungary (NBH) unexpectedly raised the country’s key interest rate by 50 basis points after the forint dropped to a record against euro this week. Policy makers increased the one-week deposit rate to 7.25%, the highest in the European Union. This was the second rate increase in three weeks. The consensus among economists was that the bank would keep borrowing costs unchanged, in line with an earlier message of keeping the pace of rate increases at 30 basis points a month.

Sliding forint
The NBH’s move comes after forint weakened to a record level earlier in the week, surpassing 400 per euro for the first time. The forint’s weakening was due to both international and local factors.
Amid souring sentiment on international markets, the Federal Reserve delivered a 75 basis point rate hike and the European Central Bank held an emergency meeting to discuss policy measures. European Central Bank President Christine Lagarde flagged the first rate hike since 2011 last week and stressed that euro area inflation expectations were "well anchored" with no risk of spiraling.
Turbulence on global markets typically puts pressure on emerging market currencies such as the forint.
On the home front, investors were spooked by several factors, including a message from the NBH that it would slow down the pace of rate increases, the government’s decision to levy extraordinary taxes on certain industries and the country’s standoff with the European Union.
The forint temporarily recovered after the announcement from the NBH only to start weakening again and hovered near the 400 level against the euro on Friday morning.

Double-digit inflation and wage increases
Hungary’s latest inflation reading showed that consumer price increased an annual 10.7%, the fastest pace in 21 years. To make matters more challenging for monetary policy makers, wages are also rising in the double digits, adding further inflationary pressure to the economy.
Wages in the Hungarian private sector wage growth was much steeper than the central bank's 2022 forecast in the first quarter, with some analysts projecting a 15% increase for the year. Several government measures stand behind the massive pace of wage increases, including a hike in the minimum wage, tax cuts for career starters and public sector wage bonuses.
Rapidly growing wages threaten to further fuel inflation at a time when massive rate hikes from the central bank failed to curb the surge in consumer prices.
The near-term outlook is not promising either, as food prices are poised to keep rising as a result of the war in Ukraine. This in turn, may force the NBH to raise borrowing costs higher than originally planned. "CEE inflation continues to rise and surprise to the upside," analysts at Goldman Sachs said in a research note. "We think that the broadening nature of price increases in the CEE reflects strong second-round effects from the inflation overshoot."
The Hungarian central bank sees rising wages as one of the key factors shaping the inflation outlook and warned that excessive wage rises could hurt the nation’s competitiveness in the longer term.
Relatively cheap labor is one of Hungary’s most appealing traits as an investment destination and a jump in wages may put the country at a disadvantage in the region. The bulk of Hungarian manufacturing output, the engine of economic growth, comes from labor-intensive industries such as car and machinery production and assembly. While Hungarian pay levels are still well below those in Western Europe, strong wage rises are emerging as a key concern for foreign investors.