Hungary’s Central Bank Kicks off Monetary Easing Cycle

The Hungarian central bank kicked off a cautious monetary easing cycle while stressing its commitment to combatting inflation, which is the highest in Europe. Analyst expect policy makers to proceed gradually and halt rate cuts if the economic and financial backdrop deteriorates.

The National Bank of Hungary cut interest rates this week, becoming the first central bank in Central Europe to loosen its monetary policy after a series of interest rate hikes delivered to shore up the forint.
The Monetary Policy Council, the bank’s decision making body, cut the interest rate on overnight deposits by 100 basis points to 17%. At the same time, policy makers left the base rate on hold at 13% in line with market expectations. After the move, Hungary’s reference rate still remains the highest in Europe. The bank also reduced the overnight collateralized loan rate by 100 basis points to 19.5% after a 450-basis point cut last month.

Cautious approach
In a press release published after the rate-setting meeting, the Monetary Policy Council stressed that it was necessary to maintain the current level of the base rate over a prolonged period, which will ensure that inflation expectations are anchored and the inflation target is achieved in a sustainable manner. “Looking ahead, financial market stability is also key to achieving price stability. In the current environment, a cautious and gradual approach is warranted. The MNB is constantly assessing incoming data and developments in the outlook for inflation, and is closely monitoring the effects of international financial market developments on the domestic risk environment. If the improvement in risk perceptions persists, the Bank will continue the gradual convergence of the interest rate conditions of one-day tenders to the base rate,” the release said.
National Bank of Hungary Governor György Matolcsy noted that the rate cut was the first step in the "normalization" of monetary policy. He cited declining energy prices, the improving current account deficit and domestic as well as international factors that had led to an improvement in the stability of financial markets. "If the improvement in risk perceptions persists, the MNB will continue the gradual convergence of the interest rate conditions of one-day tenders to the base rate, but the issue of reducing the 13% rate is not on the agenda," he said.
The market expects that the overnight rate and the base rate could converge sometime in the autumn and could reach 11% by the end of 2023 followed by a dip into single-digit territory in 2024.
“Despite the easing measures, we see a central bank which keeps defining the series of normalisation steps ahead as a function of financial market stability. In our view, this means that nothing is carved in stone, every meeting is a live meeting, where incoming data and changes in market sentiment are important,” economists at ING Bank in Hungary said in a research note.
Matolcsy noted that Hungarian inflation, the highest in Europe, was also driven by country-specific factors such as the price caps introduced by the government and a loose fiscal policy. He added that fighting inflation remained the top priority for the central bank. Hungarian consumer prices peaked in February at 25.7%. The government expects inflation to drop into the single digits by the end of the year but analysts remain skeptical.
The analyst team at ING Bank expects the base rate and the effective rate to merge at 13% in September. This would mean a series of 'copy-paste' decisions based on the May moves. In accordance with this merging, the interest rate corridor with a width of 300 basis points that existed before mid-October will also be restored, they said.