Base rate increase in Hungary to reduce inflation

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Base rate increase in Hungary to reduce inflation

The Monetary Council of the Hungarian Central Bank increased the base rate with an unexpected 185 basis points. Now analysts expect a base rate above 10% for the fall, which should help restrain inflation and the depreciation of HUF compared to EUR.

Base rate increased to 7.75%

The recent increase of 185 basis points is an unexpected as well as radical action, given that a 50-point increase is already considered dramatic. Now analysts project that the base rate can reach 10% in the fall, probably through 50 BP steps. The measure indicates a strict fiscal policy, which is supposed to stabilize the economy over the next 18 months.

The Central Bank’s base rate has a heavy influence on the rates offered by commercial banks, both for loans and deposits. When the base rate is high, giving loans to the state is a safer deal than giving loans to private investors, so commercial banks raise their interest rates for loans. As a result, businesses will be less inclined to start new ventures, which somewhat hinders economic growth.

At the same time, the interest rates for bank deposits also increase. Moreover, the higher base rate encourages investments in HUF, and as the number of HUF purchases grow, purchase price goes down, and inflation slows down too. This way the increased base rate has a positive effect both on exchange rates and purchase power in HUF.

Effects on SMEs in Hungary

The effects of the base rate increase on small and medium sized business in Hungary are multiple, and depend on previous business plans.

  • If a business was planning any action that required a loan, the loan now will be more expensive for them.
  • With an export-oriented production, the slowing inflation may reduce profits. E.g. if income is in EUR but business costs are in HUF, the slowing inflation will make for a profit below previous projection.
  • For an import-oriented business, the slowing inflation is a welcome relief. E.g. if they are buying the same item for the same EUR price, and they cannot raise prices, their profit has been decreasing, and now that process slows down.

Projections for H2 2022 and 2023

Since the growth outlook for the year had already been less than promising, and a high base rate had been expected, the radical increase does not significantly push back economical growth compared to previous projections. At the same time, when investments remain conservative and fewer new jobs are created, spending power does not increase, consumption decreases, and inflation is mitigated.

Since the main objective of the increase of the base rate was the mitigation of inflation, when inflation starts to decrease, hopefully sometime next year, the base rate can be lowered again. Analysts expect that after the base rate goes up above 10% by the end of October, it can go back to 7.5% by the end of 2023. While Hungarian economy is expected to grow at a 3-3.5% rate over the next 12 months, which is not too bad under current conditions, it can easily pick up speed by the end of next year.

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