(Bloomberg) -- Hungary’s central bank unexpectedly signaled its first potential step toward cutting the European Union’s highest key interest rate, with policymakers pointing to an outlook of rapidly slowing inflation. The forint dropped against the euro.
Deputy Governor Barnabas Virag caught investors by surprise after months of pushing back against government pressure to lower the 18% key interest rate to aid the recession-hit economy. Central bankers had until now cited inflation of above 25% — also the highest in the EU — and a wobbly currency as key obstacles to looser policy.
In an interview published on Wednesday, Virag said that market sentiment had improved so much recently that it had opened the way for a “multi-step” path to rate normalization. That could potentially begin next week with a “significant” cut to the top end of the rate corridor, which is now at 25%.
“The question of changing the 18% key interest rate can only be on the agenda of subsequent rate decisions,” he told the Vilaggazdasag daily, adding a “patient approach prioritizing market stability” was still needed.
The forint dropped as much as 1.8% against the euro after the comments, the biggest daily decline among emerging-market currencies.
The decision to cut the key rate — which is now set daily by the central bank — would be made at monthly policy meetings, the National Bank of Hungary’s press office told Bloomberg to clarify Virag’s comments. The next two rate meetings are slated for April 25 and May 23.
“The improvement in risk perceptions, if sustained, should open the door to cuts in the 1-day deposit rate in the next one to two months,” Morgan Stanley economist Georgi Deyanov said in a research note.
He said the base case was for a 100 basis-point key rate cut in June as the first move and then for it to converge with the 13% base rate by October.
The overnight deposit rate was created as an emergency intervention in October of last year to halt the slide of the currency after a record drop. The rate corridor’s ceiling was also lifted to 25% to allow for further potential rate hikes.
The rate has been held at 18% since then and has been key in the turnaround of the forint, which has gained more than 10% against the euro during that time, making it one of the best-performing currencies globally.
The central bank’s insistence on the need to keep its key rate so high — more than double the level of regional peers the Czech Republic, Poland and Romania — had sparked a public feud with Prime Minister Viktor Orban’s administration.
The government has called on the central bank to urgently cut the key rate to boost the real economy after a string of industrial and retail data indicated a deepening recession. Until now, policymakers had rejected the suggestion.
Inflation slowed for a second month in March but only slightly, with the headline data dropping to 25.2% from a high of 25.7% in January. Virag said that was in line with the central bank’s forecast for a “plateau” before a bigger drop in April and sharper disinflation from mid-year.
(Updates economist comment in seventh and eighth paragraphs.)
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