National Bank Raises Prime Interest Rate Again

At its meeting on July 27, 2021, the Monetary Council of the National Bank of Hungary (Magyar Nemzeti Bank – MNB) reviewed the latest economic and financial developments and decided to increase the central bank base rate by 30 basis points to 1.20% in effect from the next day.

The goal of the measure is clear from this week’s statement by the Monetary Council, which says that “the primary objective of the Magyar Nemzeti Bank (MNB) is to achieve and maintain price stability.” With the measure, the central bank intends to send a strong message to investors that it is serious about the tightening cycle. In parallel to the increase in the benchmark rate, MNB also raised overnight deposit and lending rates by 0.3 percentage points.

It was second such move by the national bank in the face of soaring inflation in Hungary in the past few months. On June 22 this year, the Monetary Council already raised the prime interest rate by the same margin to 0.90%. That was the first base rate increase in ten years. It was announced at the time that this was not just a one-off monetary tightening, but the start of a cycle of interest rate rises until inflation returns to sustainable levels.

According an expert at the financial news site Portfolio.hu, such a hike may have been necessary due to the 5.3% inflation rate in June, which was already above 5% for the third month, much higher than the 3±1 percentage point target range. According to the expert, the Hungarian currency, the forint only strengthened briefly after the June hike, and the euro has underperformed in recent weeks, rising above HUF 360, but with this decision "the central bank has sent a strong message to the market."

The Hungarian currency, the Forint strengthened after this week’s decision, with the euro weakening from HUF 360.96 to HUF 359.27 before the decision, the CHF falling from HUF 334.02 to HUF 332.52 and the USD from HUF 306.06 to HUF 304.13. However, it seems like such MNB measures only bring temporary alleviation as the strengthening of the Hungarian currency basically disappeared within 24 hours and it will require a more positive international judgement of the Hungarian government’s economic policy for the Forint to strengthen. Let’s not forget that the weak currency in itself is an inflationary factor as it makes imported goods more expensive for Hungarians.

Talking to journalists after the latest interest rate increase, MNB Vice President Barnabás Virág made it clear that the Monetary Council is expected to keep raising interest rates for several months, after inflation is still expected to fall back to target only next year.

In parallel with the tightening of interest rates, the Monetary Council will continue to phase out long-dated instruments. In June, the MNB announced the end of the Growth Loan Program (NHP Hajrá) with the exhaustion of the credit line, and will next phase out the use of long-term covered credit instruments. It will also review its government bond purchase program in August.

Inflation is expected to gradually decline in the coming months, but is still expected to remain above the central bank's tolerance band until the end of the year. Inflation will fall back into the central bank's tolerance band in early 2022 and, as a result of the monetary policy tightening cycle, stabilize around the central bank's target from mid-2022.

Barnabás Virág explained this, among other things, by the fact that Hungary was able to open earlier due to the high level of oversold assets, which allowed inflation to pick up sooner. Provided there is no fourth wave or only a moderate adverse impact, the central bank expects growth to exceed 6% this year, followed by 5.5% next year. However, this will have unavoidable inflationary effects, which the MNB will proactively counteract by continuing the cycle of interest rate hikes.

Barnabás Virág pointed out that in June the central bank had sent a 'strong' message by raising the base rate by 30 basis points. Since the guidelines remain unchanged and the monetary council raised the interest rate by 30 points in July, it can be concluded that the 30-point pace will remain, although the vice-president did not specify this.

He said that the central bank would reassess the situation in the context of the next inflation report in September, and that a decision on the pace of the rate hike could be taken at that time.