Hungary’s Central Bank Lays Groundwork for Monetary Tightening

Hungary’s central bank indicated this week it was planning to raise interest rates amid widespread market expectations for policy makers to affirm rate-hike plan. The interest rate hike, needed to stem soaring inflation, would be the first in the European Union since the outbreak of the pandemic.

The National Bank of Hungary said this week that it was ready for monetary tightening, a message that reaffirms the earlier guidance of the bank’s deputy governor about the likely start of rate hikes next month.

Hike on the horizon
Central bank Deputy Governor Barnabas Virág said last week that tighter monetary policy may be implemented as soon as next month in response to steeply rising consumers prices. The bank may raise its benchmark interest rate in June as part of a tightening cycle carried out in several steps, Virág added. “Inflation risks have unequivocally risen,” Virág said. “The central bank wishes to respond to sustained inflation risks via the benchmark rate.”
Virág’s comments are in contrast to monetary policy direction in most developed countries as the world’s major central banks say they will maintain loose monetary policy amid a bout of inflation they deem temporary.
Hungarian inflation jumped 5.1% in April, the highest rate of acceleration in the EU, surpassing the 5% peak the central bank had earlier projected. Even though inflation is forecast to slow in the summer, the central bank sees price pressures over the longer horizon, according to Virág.
Virág’s comments triggered a rally in the forint, which has become the best-performing currency in the world against the euro over the past month.

Reiterated message
The flagged tightening is a marked departure from the central bank’s wait-and-see attitude of recent years. “The Monetary Council reiterates that they are ready to tighten monetary conditions in a proactive manner to the extent necessary in order to ensure price stability and to mitigate inflation risks,” the Monetary Policy Council said in a statement after keeping the benchmark rate unchanged at 0.6%.
The bank noted that upside risks related to the outlook for inflation have generally increased. A sustained rise in commodity prices and international freight costs result in a higher external inflation environment. The renewed tightening of labor market capacities expected in certain sectors combined with dynamic wage growth have increased inflation risks.
The three-month Interbank rate in Budapest rose to 0.91% after Virág’s comments showing investors are pricing in another 52 basis points in hikes over the next six months.
“We expect the National Bank of Hungary to tighten this quarter (in June) but in contrast to our prior forecast, we are not looking for frontloaded tightening but rather gradual hikes. We pencil in four 15 basis-point hikes in the 1-week deposit rate this year,” analysts at ING Bank in Budapest said in a research note. They expect the benchmark rate to increase by 75 basis points this year and see the forint acting as a limit on the number/amplitude of hikes as any further strengthening of the currency will help to reduce upside risks in inflation. “We believe that the NBH will keep an eye on HUF appreciation and will see this as an important part of the decision-making process, using it as a trigger in a stop-and-go tightening cycle.”
Goldman Sachs forecasts a quarter-point hike in the benchmark rate in June, plus another 15 basis points in the third quarter while Citigroup sees more aggressive tightening, with the base rate doubling to 1.2% by September as a result of four consecutive 15 basis-point increases.

Bond purchases maintained
The central bank’s government securities purchase program has continued during the third wave of the pandemic. The central bank said that the program contributed to maintaining a “stable liquidity position in the government securities market and improved the effectiveness of monetary policy transmission.” In the Monetary Council’s assessment, government bond purchases remain crucial and the central bank will continue to use the program to the extent and for the time necessary. “Phasing out the program requires extraordinary caution to maintain market stability,” Barnabás Virág said.