The National Bank of Hungary left interest rates on hold on Tuesday and struck a hawkish tone with a warning it would be ready to use its policy tools if persistently higher inflation warranted such action.
The bank, led by Governor Gyorgy Matolcsy, an ally of nationalist Prime Minister Viktor Orban, needs to walk a fine line between supporting an economy hit by the coronavirus pandemic and keeping a lid on inflation, which has put the forint currency under pressure.
On Tuesday the bank slashed its GDP projection for 2020 and raised inflation forecasts for this year and next in its baseline scenario.
"The alternative scenario that presumes a 'W'-shaped recovery ... points towards slightly lower domestic inflation and considerably more subdued growth paths compared to the baseline scenario," the bank said in the inflation report.
In the other alternative scenario featuring an increase in risk aversion towards emerging markets, inflation is higher than in the baseline forecast, it added, without revealing policy implications.
The bank said core inflation excluding indirect taxes, a key inflation gauge, will be 3.7%-3.8% in 2020, 2.9%-3.1% in 2021 and 2.9% in 2022.
The forint has this week weakened towards its all-time lows of near 370 to the euro which it hit in April, during the peak of the first wave of the pandemic. The currency sunk to a five-month low and on Thursday traded at 365 to the euro.
Eszter Gargyan, an analyst at Citigroup, said if pressure on the forint increases, the bank could hike its rate on the one-week deposit to shore up the forint.
"The most likely step seems to be a hike in the 1-week deposit rate in Q4 from 0.6% to 0.9-1%, which combined with more bearish global growth outlook, may flatten the HUF curve," she said.
The bank holds a one-week deposit tender later on Thursday.
(Reporting by Krisztina Than; Editing by Raissa Kasolowsky)