The Hungarian National Bank (MNB) has became the first central bank in Central Europe to loosen its monetary policy, though its reference rate still remains by far the highest in the region.
The MNB's monetary council cut the interest rate on the one-day quick deposits (O/N rate) offered at daily tenders by 100bp to 17% but left the base rate on hold at 13% in line with analysts’ estimates. Policymakers also decided to reduce the bank's O/N collateralised loan rate further, by 100bp to 19.5% after a 450bp cut last month.
The Hungarian central bank had introduced the 18% O/N rate in mid-October at an emergency meeting in a record 5pp rate hike to shield the forint's slide.
In the statement issued after the meeting, policymakers stressed the importance of a cautious approach to further easing as inflation is still well over 20% and the economy contracted for the third straight quarter in the January-March on a quarterly basis.
"The MNB continuously assesses incoming data and the evolution of the inflation outlook, and closely monitors the impact of international financial market developments on the domestic risk environment", it added.
In the monetary council’s assessment, strengthening monetary policy transmission is also an important factor in achieving price stability and the central bank will use all available instruments to absorb interbank forint liquidity on a long-term basis, the statement read.
At a press conference, MNB Governor Gyorgy Matolcsy said the measure marked the start of the "normalisation" of monetary policy as both external and internal factors, lower energy prices and improving current account deficit, have led to a sustained and significant 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 question of reducing the 13% rate is not on the agenda", he added.
Analysts believe that the O/N deposit rate and the base rate could converge sometime in the autumn and could reach 11% by the end of 2023 and 6% by the end of 2024.
Matolcsy noted that inflation remains a public enemy as it leads to imbalances and constraints on economic growth, which in Hungary’s case means slower convergence. He stressed that it will be MNB’s top priority to fight inflation.
In the short run, high consumer prices may boost budget revenues, but it comes at a price of higher debt service costs, which are set to rise to HUF2.4 trillion (€6.4bn) in 2023 and to HUF2.6 trillion in 2024. Before the pandemic, interest expenditures of the budget totalled HUF900bn.
According to the central bank governor, a number of country-specific measures, such as loose fiscal policy after the pandemic and the price caps on food are to blame for Europe’s highest inflation.
Price caps on food staples lifted inflation by 3-4pp and the MNB continues to propose their phase-out, Matolcsy added.
Consumer prices in Hungarian peaked in February at 25.7 and fell to 24% in April, but are still three times higher than in the eurozone he added.
Core inflation has eased 0.9pp from its peak of 24.8% in April. Neither a 24% inflation, nor inflaton just below double-digits is acceptable in the long term, he concluded. The central bank's official inflation target is 3% with +/- 1% tolerance band.
Matolcsy said there is a close correlation between inflation and lack of productivity and competitiveness. There is a strong correlation between Hungary’s record food inflation and the lack of competitiveness of the country’s food industry, hence improving competitiveness is essential to bring down inflation.
The MNB governor welcomed the government’s 2024 budget plan as a step toward consolidation and stressed that measures against inflation can only be successful if fiscal and monetary policy move in the same direction.
The draft budget, to be submitted to parliament at the end of the month, targets a 2.9% deficit, but analysts say there are big question marks on how and in what phase the government will phase out windfall taxes. Under the December agreement with the European Commission on unlocking RRF funds, Hungary vowed to terminate special extra taxes slapped on a number of sectors in mid-2022.
MNB Deputy Governor Barnabas Virag confirmed the MNB’s earlier projection that disinflation will accelerate in the second half and the annualised data may come down to single digits at the end of the year. The improvement in the current account balance may be more favourable than in the March inflation report when the central bank forecast that the deficit may be halved from 8.3% of the GPD in 2022 to 3-4%, as energy prices made a sharp reversal.
The forint strenghtened against the euro from 377 before the rate-settling meeting to below 374 on Tuesday afternoon. Last week the market tested the MNB as the forint weakened from its strongest level in one year from 368.5 versus the euro to over 378 in a couple of days in anticipation of the monetary easing. Analysts warned that due to the vulnerability of the local currency, the MNB needs to follow a cautious stance in its monetary easing cycle.