Hungarian rate setters surprised somewhat on March 22 as they delivered a small cut to benchmark interest rates, driven by mounting concern over weakening inflation.
The Monetary Council of the Magyar Nemzeti Bank (MNB) reduced the central bank base rate by 15 basis points to a new low of 1.2%. In line with guidance, the benchmark cut was accompanied by a reduction in the overnight deposit rate to -0.05%. The bank has concentrated on unconventional policy in a bid to encourage banks to buy local currency government debt in recent month, but dipping CPI has forced it back towards more conventional action.
The central bank has also made it clear that it is watching appreciation of the forint closely. Analysts suggest both issues are likely to force further easing in the coming months.
Although MNB officials had guided earlier this month that the benchmark was back in their sights, the cut was something of a surprise in coming so soon. However, it appears that policymakers feel the pressure is mounting too strongly, especially regarding inflation.
"We don't want to cut the base rate while we have room," the MNB's Deputy Governor Marton Nagy told bne Intellinews in February. "However, we may of course hit a wall," he added. At that time, the official hinted that rather than inflation, policy at the European Central Bank and National Bank of Poland are bigger influences.
However, with inflation struggling to keep its head above water and the forint strengthening, Marton Nagy said on March 10 that there was danger of the MNB missing its medium-term inflation target, and looser conditions were needed. The central bank’s statement accompanying the rate cut clearly noted that the cut was mainly triggered by the weak inflation outlook.
The MNB released a new inflation forecast the same day. The central bank dropped its prediction for 2016 to 0.3% from the previous outlook of 1.7%. Hungary’s consumer price growth slowed down more than expected in February, coming in at just 0.3% y/y.
"The sustainable achievement of the inflation target has made it necessary to implement a comprehensive easing of monetary conditions,” the rate setter's statement reads. It adds that the council will continue to use “all available tools” to combat inflation's undershooting of its target.
The cut to the benchmark was also likely driven by the European Central Bank's announcement of radical easing measures in mid-March. At the same time, Polish rate setters - the first to meet following the ECB action - were unmoved by their colleagues in Frankfurt and left the benchmark interest rate on hold at 1.5% on March 11, and offered little hint that a return to easing could be on the cards, despite the country having been suffering deflation for months.
The MNB followed the ECB down the rabbit hole to adopt negative rates with the move of the overnight central bank deposit rate to -0.05%. The Hungarian central bank thus becomes the first in emerging markets “dip its toes in the world of negative interest rates,” notes Capital Economics.
The rate setters also dropped the interest rate on the 3-month MNB deposit, and shifted the interest rate corridor, which became more asymmetric and narrower. The overnight lending rate moves to 1.45%, which corresponds to a 65bp cut from the previous 2.1%. "This measure should drive money market rates down to trigger HUF depreciation," note OTP analysts.
Capital Economics predicts that the 3-month rate will continue to play a more important role than overnight deposit rate in determining monetary conditions: “Both facilities are used to absorb the banking sector’s surplus of liquidity. Banks may face an incentive to place surplus liquidity in the overnight facility rather than the three-month facility because of its shorter maturity. But the lower interest rate clearly deters many banks.”
The central bank had insisted for months that it does not want to reduce the main interest rate, but wanted to concentrate on what Nagy described to bne IntelliNews as "more targeted unconventional tools". Capital Economics notes that by applying a straightforward interest rate cut, the central bank seemed to tone down references to unconventional easing.
The forint's reaction to the cut was immediate. The currency dropped 0.5% to HUF313 to the euro, while the long end of the yield curve fell 5-8bp. Unless that persists, however, more easing is likely.
"If despite today’s measures the HUF resumes its appreciation, the MNB cannot avoid cutting the interest rates further," OTP insists. "According to the new message from MNB 'interest rate cuts will continue as long as monetary conditions become consistent with the sustainable achievement of the inflation target'. As the HUF is still supported by the [5% or so] of GDP current account surplus, we expect the base rate to be reduced to at least 0.9% in the coming months."