Analysts foresee Hungary hike rate in Dec - Portfolio.hu Poll

“The Monetary Council decided to raise the base rate by 50 basis points in view of the upside risks to inflation and increased perceptions of the risks associated with the economy. If the outlook for inflation and risk perceptions remain persistently unfavourable, it may prove necessary to raise interest rates further in the coming months," the Monetary Council wrote in a release issued after the November rate hike. The document also declared that "the decision by the Government that it would conduct talks with the International Monetary Fund led to only temporary improvement in market sentiment, which deteriorated again following the move by Moody’s to downgrade Hungary’s sovereign debt rating. In this situation, the Monetary Council considers it important that an agreement between the Government and the international organisations as well as between the Government and the Banking Association is reached as soon as possible."

The government and the Banking Association have in fact finalized the agreement on assistance to foreign currency mortgage holders, however talks with the IMF have been once again disrupted .

For the moment being, the next chapter of the story (that is, whether talks between the parties will resume in January as planned) is anyone’s guess. Reflecting these risks, the value of the Hungarian currency tumbled 3 notches vs. the euro very quickly, while uncertainty is tangible amid silence on the government side.

Our poll was conducted prior to news that talks between Hungary and the IMF were suddenly disrupted. Given this information, analysts would have probably given different forecasts.

Another 50-bp rate hike may not be the last one

In similar fashion to the November hike, the National Bank of Hungary may raise the base rate by another 0.5 bp to 7% on December 20, a tightening that would bring monetary conditions almost up to par with market expectations. Still, it is possible that even such a move would not yet mark the end of the rate hike cycle," AXA analyst Dániel Orosz said.

And risks indeed remain numerous: the eurozone is hovering on the verge of recession, which may necessitate a review of Hungary’s economic growth forecasts downwards into the red range. This, in turn, could require further cost-cutting on top of an already gigantic fiscal adjustment of HUF 1,400.

“Until talks with the EU and the IMF reach the home stretch, details leaked from the negotiating table may generate hectic fluctuations in the pricing of Hungarian assets," the analyst noted with insight, as news of disrupted IMF talks came only later. “New legislation on how the NBH is functioning may even cause talks to reach a deadlock, and it is certain to draw unwanted attention from the internationla press and investors, thus keeping the forint under pressure and raising rate hike expectations," he said.

Why this is currently critical

Foreign investors’ assessment of Hungary is critical as they had increased exposure in Hungarian assets to unprecedented levels earlier in 2011, just before the eurozone crisis became apparent - thus there is plenty of room to reduce their positions should bad news take center stage. (Please see a related Portfolio.hu article here)

Early next year, Fitch and S&P are scheduled to complete credit reviews of Hungary, however this will be looming over Hungarian assets as a major uncertainty factor until the reviews are actually published. Any move that could potentially threaten the structural integrity and independence of Hungary’s central bank, and therefore the country’s financial stability, can be seen as a decisive factor in the decisions of the EU, the IMF, rating agencies, or foreign institutional investors.

Even worse could be a further deterioration of global sentiment or the local impact of any external shocks. These could potentially include such as (1) escalation of the eurozone debt crisis, (2) “hard landing" in China which is currently not at all priced in by markets, and (3) escalation of political tension in the Middle East.

Already priced in

With November’s rate hike the NBH has begun to converge to money market and bond pricing, which could continue in December as the market has already priced in a further hike; that is the EUR/HUF rate is hovering above 300, with only a minor decline in implied volatility," Sándor Jobbágy of CIB Bank noted. In light of the emphatic last sentence of the previous rate hike (see above), and the fact that the decision was unanimous, monetary tightening is likely to continue.

Talks with the IMF and the EU remain a decisive factor in 2012 interest rate trends. A successful conclusion of talks could mark the end of a rate hike cycle, Takarékbank’s Gergely Suppan said.

Bebesy Dániel, analyst with Budapest Fund Management noted that while a trend change is not apparent in risk premia, one cannot ignore the fact that most emerging countries are currently in a rate cut cycle. Romania has just witnessed a rate cut, and Poland’s National Bank is also inclined towards easing in spite of a sudden jump in inflation. “Despite the likelihood of recession next year, tightening is the right thing to do in Hungary," Bebesy argued, noting that in addition to an adverse global environment Hungary is further bogged down by a major credibility gap in economic policy, which is an additional uncertainty factor. And there is a price to be paid for that to foreign investors whose money keeps the country going.

More emergency hikes on the horizon - Goldman Sachs

Analysts at Goldman Sachs expect the MPC to hike policy rates again by 50bps, raising the base rate to 7.0%, in line with consensus expectations.

“This hike will be driven by very similar reasons as last month, as the MPC tries to reduce the continued pressure on the Forint and to stem the risk of capital outflows. But while in November these risks were amplified by a sovereign rating downgrade, this time most pronounced risk arise from a break-up of preliminary negotiations with the IMF and the EU over a new financing arrangement."

“At the same time, domestic news, like those related to the new NBH law, and external news related to the situation in the Eurozone continue to weigh on the Forint and the perception of Hungary, seen as very exposed to the external situation. That, in turn, continues to reduce disposable income and consumption for those burdened by FX debt."

The analysts noted, however, that headline inflation is accelerating on the weak forint and still high commodity prices; it now stands at 4.3% (compared to the 3.0% target).

“It will increase even more with a VAT hike in January, but very weak domestic demand should reduce the pass-through to core inflation. Even then, price pressures will persist due to a large hike in the minimum wage; headline inflation is expected to reach about 5.7% by end-2012."

“This situation leaves the NBH with very little room to manoeuvre, even as the economy is expected to slow in 2012 following weaker growth in the Eurozone" (the MPC will know the latest NBH projections, forthcoming in the next Inflation Report, and GS expect them to show a much less optimistic growth forecasts and higher inflation).

“The MPC has thus a limited choice of staying on hold and risking even more HUF weakness or hiking rates and supporting the currency, at the expense of higher borrowing costs. In the situation where demand for credit is limited anyway and banks unwilling to lend due to the losses sustained on the mortgage prepayment scheme and the need to deleverage, we believe the MPC will rather opt for another hike."

Since GS analysts do not expect the situation in the Eurozone to stabilize soon or the IMF/EU negotiations to proceed smoothly, even after the government “removes the most contentious provisions from the new NBH law", they expect the NBH to continue with its emergency hikes.

Following Tuesday’s meeting, they expect the Hungarian MPC to hike by 100bps more (market pricing currently suggests expectations of 75bps more in hikes) bringing the cumulative hike to 200bps, “in line with our initial expectations; more clarity on the Eurozone and the new IMF/EU financing should help the NBH reverse these hikes by the end of 2012."

Faster than expected resolution of the EZ problems, progress with the IMF/EU negotiations, as well as some HUF strengthening would “reduce the incentive to hike in 2012; even more pressure on the Forint and problems with external financing, in the absence of a new financing agreement could mean even more aggressive tightening by the NBH."

Only 25-50 bps rate hikes are likely in the coming months - 4Cast

Gábor Ambrus, analyst at 4Cast in Sofia believes, despite widespread expectations for another hike to be delivered on 20 Dec, that “the odds are strong that the MPC will leave the base rate on hold at 6.50%."

He agrees with markets and other observers that the MPC may tighten rates further.

“The base rate may rise by 25-50bp in the coming months but the MPC will not be in a rush to deliver these increases and it will need strong arguments both from CPI and the country's risk metrics before acting," he wrote in a note on 14 Dec, i.e. before the IMF and the EC walked out of the preparatory talks with Hungary.

The MPC hiked rates by 50bp in November in a unanimous vote, mainly on grounds of a strong worsening in Hungary's risk metrics but also to some extent on risks that the CPI target could be overshot on the policy horizon. The MPC's statement made it clear that risks remain skewed to further tightening, but Governor Simor was very explicit on the press conference that followed the rate setting meeting that this would need both a worsening of the inflation outlook and further deterioration in Hungary's risk metrics, Ambrus reminded.

“As far as the inflation outlook is concerned, the December CPI report will have a key bearing on what the MPC will think. In our view the November CPI print has not changed the underlying trend; core CPI has ticked up but this acceleration was a natural consequence of the weak forint - the pass through has not been anything more than one should have expected."

Ambrus has no doubt that CPI is going to shoot up further and he expects it to average well in excess of 5% in 2012, “as the direct impact of the excise tax hikes (and more may come here) and the VAT hike will be augmented by the persistent weakness of the local currency - this latter will have an influence on the inflation path over the policy horizon as well."

At the same time, Ambrus highlighted that Hungary’s growth outlook has worsened significantly - “further fiscal restrictions, the shock the ongoing Eurozone crisis has caused to key export markets will knock GDP into the red in 2012 and the output gap is expected to run deeply in the red for several years."

In his view, the expected IMF assistance will also ensure that fiscal restrictions continue uninterrupted and “this will weigh on growth while reducing fiscal risk premia."

Against this backdrop, and considering that rates were hiked by 50bp in November, pushing real yields well into the restrictive territory, he believes the MPC can “have faith that the output gap will bring CPI back to target on the policy horizon."

“Overall, there has been no additional worsening in Hungary's risk metrics since the last rate hike took place that would warrant policy action," Ambrus added.

In sum, after a 50bp hike already in place, the analyst believes that the MPC is “neither in a rush to hike on CPI grounds, nor it is in a rush to hike on the grounds of adverse country specific risk metrics."

He admits however, that “given the persistent tensions in Europe and the persistent weakness this may imply for the local currency, the MPC may in the future have to raise rates."

Ambrus does not think however that they will increased them by more than 25-50bp.

“Hungary is the exception to the rule in the region right now, having hiked its policy rate last month by 50bp to 7.0%," commented Gillian Edgeworth, analyst at UniCredit in London in a research note.

She sees the policy rate on hold this time around - “50bp rate hikes to make up for shortfalls within the government in terms of delivering an IMF programme is not a strategy that can work for too long while market pressures do not justify a larger hike."

“At that time of writing (Sunday) relative to the NBH's end-November rate decision, EUR/HUF is lower, the government has managed some domestic auctions, foreign holdings of HGBs have stabilised and sovereign CDS spreads are moderately lower. That said a rate hike is likely to be discussed."

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