Hungary Raises Interest Rates for First Time in 10 Years

The National Bank of Hungary hiked interest rates this week, becoming the first monetary authority in the European Union to start monetary tightening as it seeks to tame inflation in the aftermath of the COVID pandemic. The bank indicated it would continue to raise borrowing costs due to inflation risks.

The Monetary Council of the National Bank of Hungary (MNB) raised the key interest rate by 30 basis points to 0.90% on June 22, the first such move since 2011. Although widely expected, the extent of the tightening slightly exceeded market expectations of a 25-basis-point increase. The MNB became the first central bank in the European Union to raise rates in the aftermath of the pandemic as inflation levels are creeping upward globally.
Central bank officials had earlier flagged a possible rate hike to combat rising inflation, which hit a 2.5-year high in April and May and climbed well above the central bank’s 3.0% mid-term target.
The MNB also announced it would phase out certain crisis measures, including cheap loans for SMEs once the allocated HUF3 trillion fund is exhausted.

Tightening cycle
The MNB said it would review the need for more hikes on a monthly basis to tackle price pressures as the economy is recovering faster than expected. "The Monetary Council will continue the cycle of interest rate hikes until the outlook for inflation stabilizes around the central bank target and inflation risks become evenly balanced on the horizon of monetary policy," the MNB said in a statement.
Central bankers paved the way for this month’s rate change with deputy governor Barnabas Virág signaling last month the start of the tightening cycle. Virág said the MNB was planning to raise rates in "several steps" to contain inflation. In a statement released after the meeting, the Monetary Policy Council said it "launched a cycle of interest rate hikes to ensure price stability, to prevent inflation risks from having long-lasting effects and to anchor inflation expectations."

Inflation on the rise
Consumer prices rose by 5.1% in May, significantly exceeding the central bank’s target, and economists stressed that pressures from the reopening of the economy are mounting, which is set to fuel inflation and inflation expectations alike. The external environment is also adding to inflationary pressures as sustained rises in commodity prices and international freight costs point to a higher external inflation environment, the central bank highlighted.
The MNB raised its projection for annual average inflation in 2021 to 4.1%, from 3.8-3.9% in its latest quarterly Inflation Report. At the same time, the bank lifted its forecast for GDP growth this year to 6.2% from 4.0-6.0%.
Economists are in agreement that the current base rate hike will not be enough to combat inflation and the central bank is set to continue the tightening cycle in the coming months. Raiffeisen Bank chief economist Zoltán Török expects the base rate to reach 1.2% by the end of the year. Gergely Suppan, senior analyst at Takarékbank, forecasts a base rate of 1.25% by the end of the year and 1.50% from March next year.

Overheating economy
MNB Governor György Matolcsy repeatedly warned of the risks of an overheating economy and stressed that inflation must remain on a sustainable level. He also criticized the government for not cutting the budget deficit fast enough in its 2022 budget plan. Parliament approved a 5.9% deficit target, well above the 3% Maastricht ceiling.
In an article published on the website of daily Magyar Nemzet earlier this week, Matolcsy said the 5.9% deficit target in the 2022 budget was “a mistake” and could set the country on a course of “persistently high inflation.”
“The Hungarian economy does not require a high fiscal deficit to re-start in 2022, instead a return to the earlier path of balance is possible and necessary,” according to Matolcsy.
The governor noted that Hungary will likely reach pre-crisis GDP levels within one-and-a-half years, a far shorter period than the six-and-a-half years it took to recover after the 2008 crisis.