As expected, Hungary's Monetary Policy Council announced another 25 basis point cut in interest rates on November 27, dropping the benchmark for the fourth consecutive month to 6%. Analysts expect the easing cycle to continue, despite an apparent plea from Magyar Nemzeti Bank Governor Andras Simor to the markets to bring it to a halt.
Simor had been resisting government pressure for months ahead of the first cut in August, insisting that inflation and currency risk is too great to allow the central bank to ease policy. However, with Hungary dropping into recession in the second quarter of the year, it was only a matter of time before old foe Prime Minister Viktor Orban leveraged the MPC format he has created, which sees government appointees occupying four of the seven seats.
That split in the MPC has grown with every month. "With Q3 GDP data (released earlier this month) showing that the economy is sliding deeper into recession, growth concerns pushed the external MPC members to vote to cut rates again," note analysts at Capital Economics.
"By contrast," they add, "we think the internal members probably all voted to keep rates on hold. After all, inflation at 6.0% last month remains well above target (admittedly, it is driven in large part by tax rises and food and energy inflation). And perhaps more importantly, the economy is still highly exposed to the external financing environment (and thus swings in investor sentiment) as a result of its heavy external debt burden."
Those external members have spoken frequently since August of an easing cycle, and they have now trimmed a full 100 bp from Hungarian rates, with meeting minutes - let alone Simor's post-decision comment (a regular one during the easing cycle) that the cut was passed by a slim majority - making it clear that the central bank members do not support the move.
Before August, Simor had frequently warned that a bailout deal with the IMF would not automatically reduce the risks sufficiently to allow a rate cut. Once the cycle kicked off, he was careful to note each and every month that an IMF agreement remains vital to limit those dangers.
Now, with the Washington-based lender having said it won't be back to resume talks this year and Budapest acting with increasing belligerence, Simor stated frankly that the market - which in the context of a step back in global risk perception has retained a benign stance towards Hungary - is too optimistic. Instead, he suggested Hungary is further away from a loan programme than when it kicked off the process with an application a full year ago.
That appears to be a clear attempt to refocus the markets back onto the government's current actions, which have alienated the IMF and hit at the banks once more. Those foreign financial houses are already angry over their treatment and clamping down on lending, thus threatening to further depress economic growth.
However, as analysts at Capital Economics point out. "For now, the markets don't seem to be paying much attention to events within Hungary itself. An IMF deal is looking increasingly unlikely, but at the same time market strains have eased. What's more, the markets barely flinched in reaction to S&P's decision to downgrade Hungary last week. Instead, easing tensions in local financial markets reflect an improvement in global risk appetite more generally."
Danske Bank notes that the immediate reaction to the decision followed similar logic. "Given that the rate cut was expected, the market reaction was quite limited. The Hungarian forint weakened slightly right after the announcement but the move up was perhaps less significant and the HUF was today supported by positive risk sentiment in financial markets today."
Simor's attempt to shift the spotlight back onto local events is sure to anger Orban, who will see it as a treacherous bid to push the markets into forcing Budapest to finally compromise on its erratic policymaking to agree a deal. That risks an escalation of the fight between the pair - at least until the end of Simor's term in March.
His replacement will clearly be a figure close to Fidesz. However, what action Orban may take against the central bank in a bid to strike at Simor is a question. At the very least, he's unlikely to ease the pressure for the external members to continue to humiliate the MNB governor with further rate cuts at the very least.
Simor also warned that the MPC sees the possibility for further cuts only if market sentiment improves further. "This might mean that we will see a break in monetary easing in December, if no further improvement is seen in CDS and bond yields," suggest analysts at Equilor. However, that presumes Simor speaks for a united MPC, which is anything but the case.
The external members have previously suggested that they see rates of 5%, or even lower, as the "equilibrium" interest rate (i.e. the rate which is consistent with stable inflation), Capital Economics points out. As Simor is clearly aware however, whether the easing cycle continues or not depends entirely on whether the financial markets let them.
Danske Bank suggests the effect of the rate cuts on inflation in particular should worry the market as much as anything else, because it will prevent them stimulating growth. In fact, the easing cycle could actually hold it back, they posit.
"Clearly, such an elevated level is worrying, particularly because lacklustre growth in the Hungarian economy reflects, to a large extent, deteriorating supply-side conditions," they write in a note. "Therefore, contrary to most places in Europe, monetary policy is unlikely to improve growth fundamentally with inflation getting seriously out of control. Furthermore, we remain concerned about the overall level of 'regime uncertainty' in Hungary. The Hungarian government has, over the past couple of years, shown an increasing lack of respect for the rule of law and the conduct of economic policy has been highly erratic. This is certainly not something that makes Hungary an attractive destination for foreign investment and this is visible in the continued weak investment performance."
Still, few expect Simor's tactics to prevent further cuts to work for the meantime. "Overall, we stick to our earlier forecasts," write analysts at Erste. "The policy rate may stand at 6% at the end of 2012 and we expect one 25bp reduction in each quarter of 2013. Nonetheless, risks are tilted towards a rate cut already next month."
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