Hungary c.bank highlights inflationary risks after rate hike

A few words omitted

On Tuesday, the MPC raised the base rate by 15 basis points to 1.8%, and the upper and lower ends of the interest rate corridor (overnight deposit and lending rates) were changed to the same extent. The decision was in harmony with both the central bank’s rhetoric and the market’s call.

"The Monetary Council is committed to achieving and maintaining price stability. In the decision-makers’ assessment, the inflation outlook continues to be surrounded by upside risks which might prove to be more persistent than earlier expected,” the MPC said in its official statement.

“For this reason, the Council considers it necessary to continue the monthly interest rate tightening cycle,” it added, but it no longer hints at the pace of the hikes (15bp) as a month ago when it said the fourth wave of the coronavirus pandemic and the risks it carries to economic recovery “warrant a continuation of the monthly interest rate tightening cycle with lower pace.”

The market did not buy this faint hint, though, and the forint eased further against key currencies after the publication of the statement.

Energy crisis

As a new element, the MNB also addresses the energy crisis as a risk factor.

“Global investor sentiment has deteriorated since the Council’s previous policy decision. Among already existing risks, the spread of the Delta variant of coronavirus, the shortage of microchips, and monetary policy messages of the world’s leading central banks have contributed to this. In addition, as new factors, the energy crisis and the emergence of risks related to the Chinese real estate market have also contributed to a worsening in investor sentiment. In commodity markets, another significant wave of price increases occurred in September. In the case of energy sources, the rise in prices was extraordinarily high.

“The price of natural gas has more than tripled since the beginning of the summer, while the price of electricity has more than doubled. World market price of crude oil rose to over USD 80. Overall, the US dollar appreciated against the euro and most emerging market currencies.”

The fourth wave of the coronavirus pandemic and the energy crisis are increasing the risks to the economic outlook.

In its assessment the MNB also addresses monetary tightening in the region. “In the CEE region, the Romanian and Polish central banks started to raise policy rates due to an increase in the inflation outlook, and the Czech central bank raised its policy rate more than expected by market participants.”

Risks to inflation

The bank reminds that in September 2021, annual inflation was 5.5%, and core inflation stood at 4.0%. Headline inflation rose by 0.6 percentage points and core inflation by 0.4 percentage points compared to the previous month. The rise in inflation was driven by price increases affecting a wide range products and services. The global pick-up in commodity prices is gradually appearing in consumer prices of a growing range of products, said the MNB, pointing to rising inflationary pressure.

Inflation is expected to rise further in the autumn months. The significant rise in commodity prices in recent weeks points to a higher inflation path in the short run than expected in September. The pass-through of increased commodity prices and freight costs into industrial goods prices is expected to be crucial in the case of underlying inflation. Core inflation is expected to be around 4% throughout the remainder of the year. The effects of the Bank’s tightening cycle will be clearly felt in 2022.

According to the September Inflation Report’s projection, inflation is expected to start to fall from the beginning of 2022 and to return to the central bank tolerance band in the second quarter, before stabilising around the 3% central bank target in the second half of 2022.

The risks to the outlook for inflation remain on the upside. Rises in commodity and energy prices as well as international freight costs continue to point to a higher external inflationary environment which is more persistent than previously expected. Demand-supply frictions emerging temporarily, and the renewed tightening of labour market capacities in certain sectors, combined with dynamic wage growth, also carry upside risks to inflation.

Overall, the MNB highlights upside risks to inflation at various points of its statement, and the “with lower pace” remark (15bp vs. 30bp previously) was omitted. These may indicate that the MNB will consider returning to a sharper tightening pace in the coming months.

Swap market and QE

The bank has sent a clear message in respect of FX swap market tensions, heralding further action.

“Maintaining an active presence in the market, the MNB has managed to cushion the spillover effects of tensions in international swap markets, thereby contributing to preserving the stability of monetary conditions. It remains a key priority for the MNB that short-term rates in every sub-market and at all times should develop consistently with the level of short-term rates deemed optimal by the Monetary Council.

“To this end, the MNB continues to phase out its FX swap facility providing forint liquidity in a dynamic way, taking into account developments in the swap market. In addition, the Bank will prepare further steps to preserve the stability of the swap market and the effectiveness of monetary policy transmission in the coming months.”

“In the Council’s assessment, a stable liquidity position in the government securities market remains crucial from the perspective of monetary policy transmission. In its September decision, the Council set the target amount of the MNB’s weekly purchases at HUF 40 billion. The MNB continues to use the government securities purchase programme taking a flexible approach to changing the quantity and structure of weekly purchases, to the extent and for the time necessary.

“If warranted by the maintenance of market stability, the MNB will stand ready to temporarily raise the volume of weekly purchases at any given time. The Bank will not sell the stock of government securities on its balance sheet, purchased government securities will be held to maturity. The Monetary Council will set the next target amount of weekly purchases for the following quarter in December.”

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