Hungary c.bank holds base rate tight in stormy season

Although one of the seven Monetary Council members (Deputy Governor Júlia Király) voted in September to hike the base rate by 25 basis points, the market has not given much of a chance of hawks gaining majority in the MPC. In the end the majority voted to keep rates unchanged today, but we would not exclude the possibility that some voted for monetary tightening.

The picture on monetary policy has just become more blurred over the past few weeks. Basic assessment shows that based on the outlook on inflation and economic growth the MPC may even decide to ease but once we focus on financial stability issues we’ll find that it may not be able to avoid hiking rates.

No real novelties have arisen in connection with inflation and GDP growth over the past month. The rate of increase at consumer prices turned out as expected; the real economy performance strengthened somewhat (retail sales and the output of the construction sector were up month on month and export growth also corrected upward), but the international environment remains slack, which casts a shadow on Hungary’s future.

Meanwhile, the group of financial stability aspects has just become bigger. As the forint eased to over 300 versus the euro, risks of a drastic HUF depreciation have intensified and government securities yields have risen palpably.

But there are further factors of uncertainty at play, namely the latest signals from policymakers. The government cannot and does not want to guarantee the forint’s exchange rate, Prime Minister Viktor Orbán said earlier this month. He and other government officials also said distressed foreign currency debtors could expect further assistance from the state in the next six months or so. But these remarks and plans do pose further risk to financial stability since they would hurt the capital position of the banks and/or reduce foreign currency reserves, not to mention the risk to public debt reduction goals.

So it is not by chance that the risk of a credit downgrade by one or more credit rating agencies cannot be shrugged off. There is even more on the line in the Eurozone, the leaders of which are trying to figure out how to take Greece into controlled default while making sure that it does not contaminate other distressed economies via financial channels.

Based on the above we see two extreme scenarios. The first is that the EU will muddle through its difficulties, while the lending activity of banks will decline, due to which the economies will embark on a lengthy period of cutbacks that will lead to a permanent recession. In this case the central bank - on the assumption that local economic policy risks will abate - might as well decide to cut rats.

Under the second scenario, a financial crisis will sweep through Europe before the aforementioned would become a reality, and this will make the most vulnerable countries, including Hungary, shake like dry leaves on an autumn tree.

Under such circumstances we should not be surprised that the central bank has given up its effort to make at least cautious interest rate path projections. The background of today’s rate decision will be partly revealed by a press conference to be held by NBH Governor András Simor and the MPC’s official statement - both due at 15:00 CET.

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• economy,
• interest rate,
• base rate,
• monetary council,
• mpc