The Monetary Council of the National Bank (MNB) reduced the base rate by 50bp to 7.25% at its monthly rate-setting meeting on May 21, in line with forecasts and level with the rate cut a month earlier.

The MNB began its easing cycle a year ago from 18%, but it is nearing its end. Inflation is expected to pick up in the coming months after a steep disinflationary period from 25.7% in January 2023 to 3.7% in April 2023, and geopolitical tensions, along with the volatility of international investor sentiment, also justify a cautious monetary policy.

The interest rate corridor remained unchanged as the overnight deposit rate was reduced to 6.25% and the overnight collateralised loan rate to 8.25%, both cut by 50bp.

There was no other option on the table and the decision was unanimous, deputy governor Barnabas Virag said at an online presser after the meeting.

The rate cut was supported by the latest inflation data (3.7% in April) that remained within the central bank's tolerance band for the fourth month and investors' risk appetite also improved, which lent support to the local currency.

Over the past month, yield spreads have declined, partly driven by the rebound in Q1 GDP, the widening current account balance, and foreign exchange reserves standing at historically high levels.

In addition, interest rate expectations have also moderated slightly: forward rate agreements have come down from 6.5% in early May to around 6.3%.

Policymakers however argued that the volatile financial market environment and the inflationary risks continue to warrant a careful and patient approach. Future rate decisions will be made pending incoming macro data and developments in the risk environment in a "cautious and data-driven manner", according to the statement, echoing press releases of previous months.

At the press conference Virag said there is no rush to reduce rates, as uncertainties remain elevated. The expected divergence between monetary policies of the Fed and the ECB may lead to increased volatility in emerging markets through the global interest rate environment, he added.

Inflation in Hungary has fallen within the central bank's tolerance band of 4%. Still, it is set to rise temporarily in the middle of the year, due to base effects and high services inflation, which will be monitored closely in the future by policymakers. The decline in core inflation is set to end in Q2 and core inflation will fluctuate between 4.5-5.0% in the remainder of the year.

Anchoring inflation expectations, preserving financial market stability and disciplined monetary policy are crucial for the consumer price index to return into the central bank tolerance band sustainably from next year, according to Virag.

Curbing the practice of repricing of service inflation is important to anchor inflation expectations at a low level, which takes longer than expected. This will mitigate inflation-related risks and lead to sustainable economic growth at a faster pace, he argued.

Fielding questions on the MNB’s rate trajectory, Virag said the scope of further rate cuts in the second half is limited. He said the base rate dropping to the range of 6.75% to 7.00% in June "would be a realistic scenario," suggesting one more rate cut before a pause.

The tone of the press conference following the rate decision was neutral, unchanged from the guidance given in the previous month. The MNB will likely go ahead with another 50bp rate cut in June, but further easing will be minimal for the remaining part of the year, with the year-end rate falling to 6.25%, MBH Bank in a note after the meeting. 

The Fed's future rate decisions are set to limit the MNB's room for manoeuvre as Hungary may need a significant interest rate premium to maintain the stability of the currency, according to the forecast.

There was little movement on the FX market after the rate decision, with the HUF/€ exchange rate hovering around 385.40 after the announcement. A month earlier, the forint had been trading 2.3% lower.