Hungary: Central Bank reduces base rate to new record low and signals end of cutting cycle in May
May 24, 2016
At its meeting on 24 May, the Central Bank of Hungary (NBH) decided to cut the base rate by 15 basis points from 1.05% to a new record low of 0.90%, meeting market expectations. On top of this, the NBH said that it plans to keep the rate at this level for an “extended period”, thus signaling the end of the prolonged rate cut cycle. The rate cutting cycle, which started in July 2012 and saw two extended interruptions, brought the base rate gradually down from 7.00% to its current level. The latest part of the interest rate cutting cycle only lasted from March to May, comprising an accumulated cut of 45 basis points. Moreover, in May, the Bank cut the overnight collateralized lending rate from 1.30% to 1.15% and left the overnight deposit rate at minus 0.05%.
Overall, the Bank stated that the outlook for inflation and the real economy pointed to keeping the base rate at 0.90% for a prolonged period. While inflation rose slightly in April, in the Bank’s assessment of inflationary pressures remains low amid subdued global inflation and a degree of spare capacity in the Hungarian economy. In fact, the NBH noted that Q1 GDP growth was disappointing and was partly dragged down by negative one-offs, including a slower absorption of EU funds, weakness in the construction sector and disruptions in industrial production. On a positive note, retail sales were robust in March and unemployment continued to decrease. Going-forward, the Bank sees that inflation will gradually rise to its 3.0% target in the first half of 2018. The increase in inflation will likely be sustained by rising wages and a pickup in economic activity, which will in part benefit from an expansionary budget for 2017.
Commenting on the NBH’s announcement to end the easing cycle, Nicolaie Alexandru-Chidesciuc, Economist at JPMorgan, noted:
“For us it is hard to understand what was the reason behind a rate-cutting cycle of only 45bp and what the NBH believes it achieved with these marginal rate cuts. Nonetheless, we believe that chances for another turnaround regarding the end of the cutting cycle are low. We have this view despite the fact that the central bank changed its mind previously after it announced the end of the cutting cycle and stated it has a firm intention to keep rates low for an extended period of time. Our opinion is based on the reality that the base rate is lower now and on our belief that the bank can relax monetary conditions without changing the base rate. We now assume that the base rate will be kept unchanged at 0.9% until end-2017 as we do not see inflation reaching the target over this horizon and thus the likelihood that the NBH will have to react is relatively low. There remains a chance for cuts in the base rate, but we think that substantial HUF strengthening and/or deepening imported deflation would be needed for that. In this context, the end of the cutting cycle does not mean the end of the easing cycle. […] We believe that the NBH will continue to ease monetary conditions, most likely by influencing the Bubor market.”