Doubt reigns as Hungarian central bank reveals details of latest unconventional tool

By bne IntelliNews September 20, 2016

Hungarian rate setters capped its three-month deposit facility at HUF900bn (€2.9bn) until the end of the year, as they met on September 20, the Magyar Nemzeti Bank (MNB) announced. The move is the latest effort to use unconventional tools to loosen policy, as the benchmark interest rate - as expected - was held at a record low of 0.9%. However, analysts suggest it may not be enough.

Since rate setters lowered the benchmark interest rate by 15bp on May 24 - the third cut of an early year easing cycle - the MNB has repeatedly guided for long-term stability of the benchmark. At the same time, the central bank expects to stimulate the interbank market and ease monetary conditions by revamping the three-month facility.

While the interest rate decision was correctly anticipated by the market, the announced cap is lower than forecast. Estimates had suggested a cap of HUF1tn-1.5tn.

With the MNB having guided for the move since the summer, banks currently hold HUF1.63tn in the three-month deposit instrument. The central bank said it expects that at least HUF200bn-400bn will be crowded out. It also said in a statement that "the Monetary Council will stand ready to apply a stronger limitation to three-month deposits” to loosen monetary conditions further should it feel the need.

With economic indicators - especially concerning industry and investment - having disappointed in recent months, and inflation remaining in negative territory for the fourth straight month in August, the MNB’s push to loosen policy is not surprising. The jury, however, remains out regarding the efficiency of the MNB’s unconventional tools.

“In practice, the impact of the cap on overall monetary conditions is likely to be nuanced,” analysts at Capital Economics write in a note. They point out that in order to avoid the charge of excess reserves, banks are more likely to invest in government debt than to lend excess reserves to other banks – which would bring down interbank rates and loosen monetary conditions – or to increase lending to expand their balance sheet.

“Past form suggests that banks are likely to opt to invest in government debt," Capital Economics continues. "Weak balance sheets means they are unlikely to want to expand credit (indeed, bank lending has fallen for most of the past seven years)."

Indeed, yields on sovereign debt have fallen consistently since the move was announced earlier this year. Meanwhile, interbank rates have been steady.

At the same time, there is an increasing suspicion that the MNB could put its focus back on conventional monetary easing in the long run. "We see downside risks to [the MNB’s] GDP estimates, as well as the 2017 inflation outlook. Further easing measures to stimulate lending and reduce the cost of borrowing are thus possible in coming quarters,” Raffaella Tenconi at Wood & Co. argues.

Commerzbank predicts the central bank will lower the policy rate to 0.50% by the end of the year. Most analysts doubt GDP growth will reach the the MNB's forecast of 3%.

The central bank repeated its mantra, however, that it "intends to maintain the current level of the base rate for an extended period". It also reiterated its optimistic projection for 2.8% GDP growth for this year - around 0.5 pp higher than market consensus - and at 3.0% for 2017. It revised downwards, however, its CPI forecast from 0.5% to 0.4% for 2016, and from 2.6% to 2.3% for next year.

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