Hungary c.bank always has one reason or another not to cut rates - Portfolio.hu Poll

“The aspects of monetary policy using inflation targeting and aiming for financial stability are once again beginning to point to entirely different directions," said Dániel Bebesy, portfolio manager at Budapest Fund Management, giving a concise explanation as to why he doesn’t believe lowering the base rate is a viable option next Tuesday. The above sentence is the essence of all the grievance the central bank has had for the past two years.

When Hungary fell into one of deepest pits of recession in Europe following the onset of the global crisis, the central bank was unable to help by cutting its key policy rate considering the fiscal stability situation. Then as the environment was turning friendlier, inflationary fears were beginning to build up: parallel with a fast-paced rise in commodity and food prices (and in light of the stubbornly high inflation expectations over the past few years) the NBH could not have cut the base rate and retain its credibility at the same time.

The past two months then brought pleasant surprises in this area too. The downside surprises in inflation were followed by subdued wage dynamics, increasing chances for a rate cut. Then EU policymakers have gone on their well-deserved summer vacation, but not before showing us that they haven’t got a clue what to do with the bloc’s debt crises.

The old-new story

"Poor growth outlook, still below-average capacity utilisation, struggling private consumption, negative output gap, uncompetitive interest rates on HUF loans, inflation returning to the target on the forecast horizon of monetary policy," lists György Barta, analyst at CIB Bank the arguments for a rate reduction. But he immediately adds: “Independently of the fact that inflation and real economy aspects would allow monetary easing, the external market conditions do not facilitate the decrease of risk premia. The Eurozone’s debt crisis is becoming more serious; there have not been any reassuring proposal for its solution and a potential further aggravation of the situation is harmful for Hungary’s financial stability conditions too - firstly via the endless firming of the Swiss franc, and secondly via our rising risk premium."

While the reaction of Hungarian assets to the debt crisis has been muted so far, but it is attributable not only to the relatively reassuring domestic fiscal trend, but also to the high premium, Barta points out. He added that the debt crisis exerted only a subdued impact so far and only indirectly, but as a small and open economy - with a bad fiscal record and towering state debt - Hungary is definitely not immune. In view of this the cautiousness of the central bank is absolutely understandable, he said.

The picture is not different if you look at Hungary from London.

“It's too early for the central bank to contemplate cutting interest rates. Admittedly, the domestic case for a rate cut is growing - given lower inflation and the still fragile domestic economy - but the international situation remains dicey. Cutting rates now would risk sending the HUF into a tailspin; something the NBH will avoid at all costs,".commented Nigel Rendell, analyst at the Royal Bank of Canada.

“Weak domestic economy = no demand pull inflationary pressure; lower global commodity prices = no imported cost push inflationary pressure; exchange rate under strain given euro-zone sovereign debt worries but should be temporary," said Darren Middleditch, economist at Capital Economics in London.

Inflation still warrants caution

Levente Pápa, analyst at OTP Analysis Centre in Budapest agrees with Rendell’s argument, saying that even the CPI data could hold some surprises. The September figures could already contain data that will signal future inflation more accurately, e.g. the trajectory of the diminishing food price shock, he said.

Zoltán Árokszállási, at Erste Bank also pointed out that caution is warranted over inflation. "The bigger-than-expected decline in the annual price index was brought about primarily by the positive changes in food prices, which was a region-wide phenomenon facilitated mostly by a faster-than-expected drop in vegetable prices. This also probably had to do with the e-coli case in Germany in May-June therefore it becomes a question whether food prices will drop according to seasonal impacts or not. Meanwhile, core inflation reached 3% yr/yr."

In Árokszállási’s view, due to the inflation outlook a rate cut could be possible “in the near future", i.e. the central bank may not decide on monetary easing even if the Eurozone was not going through its gravest crisis in its history right now.

It will getter better eventually

Despite the above there is a general agreement among the analysts polled by Portfolio.hu that the next rate move will be a cut.

The only person with a different view is György Barta, analyst at CIB Bank in Budapest. “While it is out of the question that the ever more frequently mentioned rate reduction will take place at the end of the year, we continue to stick to our view that the NBH will want to manage risks this year at unchanged rates."

Barta sees the base rate at 6.50% by the end of 2012, up 50 basis points from its current level. Dániel Orosz, Head of Strategic Analysis Department at AXA Group Hungary said “rising financial stability risks and the inflation risks caused so far by external shocks continue to underpin my view that if a pessimistic scenario materialised even a rate hike could become a possible option."

“There’s no need for increase in the short term and no scope for cut (owing to currency concerns)," said Middleditch of Capital Economics.

The majority, however, believes that sooner or later the NBH can return to monetary easing, but two-thirds of the respondents project that such move will not be made before next year.One of the exceptions is Nigel Rendell at RBC who expects a 25-bp cut already in Q4 this year. “Some of the MPC are angling for a rate cut and recent comments from Governor Simor have become more dovish. Once the external environment is a little calmer and Hungarian inflation looks set to head into the lower half of the 2-4% target band, the NBH should be able to slice 25bp off the repo rate," he said.

Rendell also believes that after the next reduction interest rates will remain flat at 5.75% in 2012. “However, the evidence is growing that a cut may be possible assuming the inflation picture continues to improve. Economic growth remains heavily dependent on external demand. A rate cut in early 2012 is possible assuming international factors allow," he added.

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