Hungary shrugs off pressure to continue easing cycle

By bne IntelliNews January 30, 2013

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Shrugging off a weakening currency, continuing inflation risk, and warnings over the state of the Hungarian economy, the Magyar Nemzeti Bank cut its benchmark rate for the sixth consecutive month on January 29. Analysts claim the cycle has limited space to continue, but uncertainty abounds as the appointment of a new central bank governor approaches.

The government-appointed members of the monetary policy council (MPC) at the Hungarian central bank have outvoted outgoing Governor Andras Simor and his two deputies since August. Including the latest cut, its monetary easing cycle has now trimmed 1.5 percentage points from interest rates, despite Simor's warnings for more than a year over inflation and currency risk. On top of that, the currency has come under renewed pressure in recent weeks, and a line of rating agencies and international institutions have expressed worries over the economy and policy.

The continued easing cycle, now having brought rates down to 5.5%, is a gamble that the ongoing appetite of the markets for high yield assets will protect Hungarian yields and the forint, and that there will be no new shocks emanating from the Eurozone crisis to upset investor sentiment. However, with the government promising the economy will return to growth this year, despite all the signs to the opposite, it's apparently a bet Prime Minister Viktor Orban is ready to make with the economy ahead of elections in 2014. "Hungarian economic growth is likely to resume following last year's recession as the country's export markets recover," the MPC said in its statement accompanying the decision.

Echoing the statement issued in the wake of the last cut in December, the council commented that it "will only consider a further reduction in the policy rate if the medium-term outlook for inflation remains consistent with the bank's 3% target and the improvement in financial market sentiment is sustained."

However, while December saw the rate of price growth moderate by 20bp from the month before, at 5% inflation remained well above the MNB threshold, leaving the full year figure at 5.7%. However, the statement insisted: "The moderate pace of underlying inflation reflects the disinflationary impact of weak domestic demand."

Analysts at Erste pointed out the elephant in the room. "[W]e think that it is difficult to assess what exact effects the government's policies will have on inflation in the longer run. Therefore, the MPC's commitment to reaching the inflation target may still be questioned, and thus, the continuing decrease of the policy rate may have a negative impact on the EUR/HUF rate."

While the markets have swallowed the easing cycle while liquidity drives appetite for riskier assets, the identity of Simor's successor - the long time adversary of the government will see his term end on March 3 - has started to dominate. The likelihood of a new governor close to the government - and most especially the fact that controversial Economy Minister Gyorgy Matolcsy, who has said the next governor should "bravely use unorthodox tools" is long standing favourite - has the market fretting that the cuts could plough on regardless.

Other similar statements from Matolcsy in recent weeks as he pitches for the post have brought increased pressure on the forint, and the latest cut came despite the fact that the currency spiked above the HUF300 to the euro threshold on January 28, its weakest since June. On the other hand, the government will welcome the cut as it prepares its return to the international debt markets for the first time in nearly 18 months.

Still, Orban has proved beyond any doubt in the last year that he will soldier on with his own programme regardless if possible, and it appears unlikely he'll rein in the easing cycle if he can avoid it.

"[T]he scale of the current easing cycle depends on how far the MPC can cut without provoking a sell-off in the markets and a sharp fall in the forint," suggest analysts at Capital Economics. "For now, the markets are pricing in a further 75bps of interest rate cuts (to 4.75%). We suspect it would take another sustained improvement in global risk appetite to allow interest rates to be reduced below this level without triggering a drop in the forint."

Nevertheless, just as they did throughout the 12 months or so of Budapest's flirtation with the IMF over a new loan programme, the markets still appear desperate to believe Hungary wants to return to orthodox policy. Jumping on a statement from Simor that: "...monetary policy instruments currently available allow enough room for maneuver ... and ... under domestic circumstances expanding the range of unconventional policy tools may provide effective support only during times of acute financial market stress," the forint actually recovered over 0.5% in afternoon trade.

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