Hungary raises its policy rate by 200 basis points as the forint falls

Hungary’s central bank raised one of its key interest rates by 200 basis points to 9.75% on Thursday morning in a bid to halt the forint’s free fall.

The move – which leaves the one-week deposit rate, a short-term tool used to control market volatility, at its highest level in more than a decade – follows a 5% drop in the currency by against the euro over the past week amid a political tussle with Brussels.

Inflation and a gaping current account deficit are compounded by a spat between Budapest and the European Commission, which worries market participants. Government borrowing costs have risen sharply in recent days, with the yield on benchmark 10-year bonds hitting 8.7%, on fears that Hungary will struggle to strike a deal with Brussels on releasing funds to help its pandemic recovery.

The forint, which strengthened on Wednesday evening when the central bank signaled the move, remained volatile on Thursday morning, with wide swings in either direction.

“The reaction of the market today shows very well that the central bank does not have the answer to this conundrum; the government is doing it,” said Peter Virovacz, an economist at ING Bank. “The market is now waiting for the EU to say that it approves of the Hungarian concessions and that it is ready to conclude a deal quickly.”

Budapest has been at odds with the commission over its rule of law record and Brussels has withheld grants and pandemic recovery loans worth more than 15 billion euros. The commission has also launched a rule of law procedure that could block other billions in regular funding.

Prime Minister Viktor Orbán’s government has taken a somewhat softer tone on disputes with the EU in recent weeks. His chief of staff, Gergely Gulyás, told a press briefing on Thursday that the government was in “advanced” talks with the commission on the release of funds, and that Budapest was willing to adhere to the commission’s demands in several areas.

“We want to close discussions with the European Commission as soon as possible,” Gulyás said.

The central bank said it would continue to raise rates as long as inflation rose. Core tax-adjusted inflation, the bank’s preferred measure of enduring price trends, could hit 13-14% a year this year, it said in its latest inflation report.

Any hike in the one-week deposit rate is likely to fuel the central bank’s base rate, which is now at 7.75% after jumping 185 basis points last month. The next decision is June 12.

Inflation is at an annual rate of 10.7%, the highest level in more than two decades. “The central bank remains ready to use all its tools to intervene to ensure price stability,” National Bank of Hungary Deputy Governor Barnabás Virág said on Wednesday.

The Central European country’s currency underperformed its regional counterparts. It has lost more than 10% against the euro this year, while the Polish zloty has lost 4% and the Czech koruna has even appreciated against the single currency.

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