Economy 19 October 2021, 2:00pm

Hungary central bank raises rates 15 basis points

Portfolio

Hungary’s central bank (MNB) raised its base rate by 15 basis points to 1.8% on Tuesday, in line with previous communication and the market’s call. The question for the short term is how the market will assess that the MNB switched from 30bp hikes to 15bp steps while the forint has been persistently weak, and inflation rose to a nine-year high. Looking forward, the key question is when inflation could be back within the bank’s 2-4% tolerance band. The Monetary Council’s official statement to be published at 3 P.M. is watched extremely closely, as economic processes of the previous few weeks strengthened inflation risks to the upside.

The MPC has raised rates for the fifth consecutive month. As of Wednesday, the base rate is up at 1.8% from 1.65%. This is no surprise as last month the MNB switched to 15bp steps from 30bp previously, adding that this was to be the benchmark for the following months. A different outcome was not expected, although market processes did not entirely exclude such a scenario.

Over the last few weeks the forint has been persistently weak against key currencies. Halving the pace of the tightening did not exactly prop up the HUF, either, while central banks in the region tightened monetary conditions substantially. The forint eased back to last spring's level when the market had started to price in that tightening was ahead.

EUR/HUF

Inflation was not supportive, either. It rose to 5.5% yr/yr in September, a 9-year high, and CPI is extremely likely to rise even further in the following months. The central bank's measures of underlying inflation also jumped.

Analysts think headline inflation could reach 6.0% in the following months which would be yet another record. They believe CPI will bounce back from there and return to within the tolerance band (3.0% +/- 1ppt) and close in on the 3.0% medium-term target. What we have observed over the last few weeks could have a different outcome, though.

The persistently expansive fiscal and wage policy (personal income tax refund becoming certain, a larger-than-expected pension premium, full re-instatement of 13th-month pension to be brought forward, 20% minimum wage hike) in parallel with the energy crisis in Europe could keep inflation high for a more extended period.

Households are kept safe by the artificially regulated (lower) utility tariffs, while corporations will certainly adjust their prices to higher energy costs, and the sharp minimum wage hike will trigger the same response. Their price setting power will be significant, as domestic demand is on the rise and households will have HUF 1.2 trillion worth of extra income (pension premium and the 13th-month pension) between November 2021 and February 2022, a large part of which they will spend.

Analysts expect the MNB to continue to raise rates by 15 basis points even beyond the end of this year. Most banking analysts and economic research institutes forecast that the base rate will be upped to 2.4-2.5% in 2022, but forward rate agreements (FRAs) show that the market projects an even greater tightening.

The big question is whether the MPC will hint at upside risks to inflation in its official statement, address energy prices, and fiscal expansion, or if it will create a linkage between these issues and possible central bank responses. Any such indication could have a material impact on interest rate expectations.

The forint has depreciated versus the euro after the announcement of the rate decision, which indicates that although the outcome was as expected, the market is dissatisfied. EUR/HUF temporarily eased to 361 from 360, which suggests that in view of monetary conditions being tightened all over CEE and mounting inflation risks the market does not think 15bp hikes are enough. The official statement to be released at 3 P.M. is watched more closely than usually. Meanwhile, MNB Deputy Governor Barnabás Virág is to speak at Portfolio’s Budapest Economic Forum conference, another key item of interest for investors today.