Hungary central bank announces 17-18% rate hike

Official statement

The MNB has released the following statement on Friday morning, after it had some technical difficulties and the announcement to be made live at 8.30am by Deputy Governor Barnabás Virág from the International Monetary Fund's (IMF) general meeting in Washington never happened. Instead, a recorded footage was uploaded to the bank's Youtube channel.

The Monetary Council reviewed economic and financial developments and decided to raise the upper bound of the interest rate corridor, leaving the base rate unchanged. Accordingly, the Monetary Council raised the overnight collateralised lending rate to 25% and suspended the one-week collateralised loan, with effect from 8:45 a.m. on 14 October.

In the current turbulent period in financial markets, a key task for the MNB is to ensure market stability, in addition to meeting its primary objective of price stability.

The MNB stands ready to intervene using every instrument in its monetary policy toolkit to ensure these. The existing challenges warrant the use of targeted and temporary instruments.

To this end, from 14 October 2022, the MNB will announce one-day (T/N) foreign exchange swap instrument and overnight (O/N) deposit quick tenders on a daily basis at higher interest rate levels than before. The instruments used are designed to ensure the rapid and flexible implementation of tighter monetary conditions in the sub-markets considered key in terms of monetary transmission, i.e. both the interbank market and the swap market.

In addition, the Bank commits to directly meeting major foreign currency liquidity needs arising from covering the energy import, in the coming months. As current account items, other than the energy balance, are already positive overall,

the measure will have a substantial impact on the supply and demand conditions in the foreign exchange market.

"The MNB continuously assesses economic and financial market developments and will continue to use these instruments as long as warranted to maintain market stability," the bank added.

How will this result in an interest rate rise?

Foreign exchange swap tenders need to adapt to the pricing of the overnight deposit quick tenders. The upper edge of the interest rate corridor will rise substantially to 25%, the interest rate corridor will open upwards completely. To raise short yields, the MNB will introduce a targeted temporary instrument, a one-day quick tender with a rate of 18%, while in parallel the one-day swap tenders will resume with a rate of 17%. "These will be applied as long as necessary or until we see a stabilisation of the money market situation. I hope that will be a few days," Virág explained.

Analysts polled by Reuters said on Thursday they saw little alternative for the MNB but to return to raising interest rates.

Other liquidity tightening tools do not appear to be effective overall, and the domestic and international economic environment is not supportive at all, so even the loss of face by the central bank from restarting the rate hike, which was halted two weeks ago with a larger-than-expected 125bp raise to 13.00%, will have to be taken to stabilise the forint.

We argue that policy rates need to rise to at least 16-17% to stabilize FX, based on comparable experience of economies with large BoP funding needs,

JP Morgan said in a note on Tuesday.

Forint firms a lot

The HUF gained 2.5% after the announcement, going below 420 versus the euro.

Why has the forint weakened?

Financial market stability is necessary to be able to achieve price stability in the medium term, said Virág. The forint has also reacted sensitively to the deteriorating international environment and increased risk aversion. In the past two weeks, two effects have been behind HUF depreciation: the currency conversion related to the payment of energy bills and the taking of money market positions against the forint.

We cannot stand idly by and watch these two effects threaten the foreign exchange market and the achievement of price stability,

he added.

Inflation

Inflation in September fully met the central bank's expectations, with core inflation lower than expected, said Virág. Changes to the overheads reduction scheme and food inflation due to the summer drought accounted for 85% of the rise in CPI, he added. However, inflation could come close to peaking in the coming months for a variety of reasons.

Inflation may still rise slightly in the coming months, but we are getting closer to the tipping point,

he said.

Only market stability will bring price stability

In a turbulent environment, ensuring market stability is key alongside price stability, and the central bank is ready to use all its tools to intervene to do so. The current instruments will be used as long as the financial market situation justifies it, concluded Virág.