Hungary’s central bank delivers aggressive rate hike to help forint

Faced with surging inflation and a weakening currency, Hungary’s monetary policy maker took decisive steps this week. The central bank raised the one-week deposit rate by 70 basis points after hiking the benchmark interest rate hike 2 two days earlier.

The Hungarian National Bank (MNB) raised the benchmark interest rate by 30 basis points to 2.1% at a policy meeting on November 16, stepping up the pace of the tightening cycle from a 15 basis-point hikes in the previous two months. The bank pledged to continue the tightening as long as necessary. In a separate move 2 days later, central bankers raised the rate on one-week deposits by 70 basis points to 2.5% and said they would keep the rate on the one-week deposit facility “lastingly” above its benchmark base rate. “The one-week depo rate will exceed the level of the base rate as long as the commodity and financial market risks relevant to the inflation outlook prevail,” the bank said in a statement, adding there was no time limit for this decision. “As long as the above risks prevail, in the next steps of the base rate hiking cycle, the one-week deposit rate will be raised by at least as much as the base rate.”

Inflationary pressure
The persistent rise in external inflationary pressures and increasing second-round inflation risks have necessitated more extensive and longer-lasting monetary policy tightening, according to the statement after the meeting. Policy makers signaled they would continue to tighten monetary conditions on a monthly basis and noted that the central bank’s next quarterly Inflation Report, due out in December, “will be decisive in determining the further extent of interest rate hikes.” In a statement released after the November 16 policy meeting, the central bank stressed that the “Monetary Council will continue the cycle of interest rate hikes until the outlook for inflation stabilizes around the central bank target in a sustainable manner and inflation risks become evenly balanced on the horizon of monetary policy.”
The forint weakened significantly ahead of the November 16 meeting and inflation hit a nine-year high in October at 6.5%. The MNB expects headline inflation to rise above 7% in November and decline only slowly starting at the end of 2021. External factors accounted for 60% and internal factors for 40% of inflation, with both showing upside risks, MNB deputy governor Barnabas Virág said in a press briefing. The price cap on fuel introduced by the government has no impact on monetary policy, he added.
The market expects that the deposit rate hike will support the forint, which had weakened substantially before the bank’s rate meeting earlier this week, trading above 363 against the euro. The bank accepted HUF 7.7 trillion worth of funds into its deposit facility on Thursday and pledged a “more extensive and longer lasting” policy tightening to curb rising inflation risks and anchor inflationary expectations.

Slowing economy
Hungary’s economic performance has surprised on the upside in recent quarters, but third quarter data broke that trend. The Hungarian economy posted a below-consensus 0.7% quarter-on-quarter GDP growth rate in July-September. On a yearly basis, the volume of GDP was up by 6.1%. The data has prompted analysts at ING Bank in Budapest to downgrade their GDP forecast, saying that the 0.7% third-quarter performance and developments in the fourth quarter are a warning to be more cautious on the GDP outlook. “Given the shutdowns in industry and their negative impact on export activity, and considering the fourth wave of Covid-19, the fourth quarter economic performance could be somewhat weaker than we previously forecast,” according to ING. The bank added that the government mobilized significant fiscal resources for the last quarter of this year and the first quarter of next year to boost GDP growth. This may be able to offset partially the negative effects, although this stimulus to aggregate demand may also have a significant impact on import growth. ING lowered its GDP forecast to 7.0% YoY and 5.0% YoY in 2021-2022, respectively.
The GDP data may prompt the MNB to be more cautious and will likely continue to tighten monetary policy conditions in a ‘slow-but-steady’ manner, hiking the base rate by 30bp at its November rate-setting meeting, ING predicted.