Hungary c.bank to cut rates further today, focus on funding measures - analysts

Limitations to two-week window to be taken today?

In view of the market pricing about a 30-35bp with fixings already below base rate, Peter Attard Montalto, a London-based strategist at Nomura, noted that once again, “we seem to be in the case of a "steady as she goes" and the MPC surprising the market to the slightly "hawkish" side by not taking the option of doing more."

Attard Montalto believes there is a probability of only around 20% of a larger-than-25bp move but he would caution against the view that not doing more is a sign of orthodoxy.

He pointed to the central bank’s new Lending and Growth Scheme where banks could borrow from the NBH at 0% interest to lend to SMEs. He also noted that other actions are being taken with liquidity and further policy changes seemingly happening on the run and announced in interviews. “Hence, the non-orthodoxy is already well in established. As we've always said, the base rate is no longer really relevant anyway."

The strategist noted that at this point it is not clear if the limitations of the two week window will be undertaken today, “given, in particular, the many legal and logistical questions surrounding the limitation of foreign banks access to it."

“Not moving forwards with the limitations again would likely be seen by the market as positive. (However, incorrectly in our view, it is just an issue of when it is implemented.) Equally, there seems to be insufficient agreement between the banks and MNB for the start-up of the SME program. We also doubt that a household credit support program is either ready at this stage or indeed would be announced at a main MPC meeting," Attard Montalto added.

With the limitation further down the line of the two week window, he urged to watch for larger cuts by stealth.

“One possibility could be to widen the band between the two week and O/N rate (currently 5.00% and 4.00%, respectively). However we think the chances of this happening at this stage are low."

Broadly unchanged MPC statement seen

As such, Attard Montalto just expects a rate cut and a statement that is probably broadly unchanged since the last meeting. With no new policy expected, no press conference or Q&A will likely occur.

“The statement should continue to sound conservative, project inflation to remain low and within the target range over the forecast horizon, argue against a currency devaluation (even if this is the real policy behind the scenes) and promote the MPC’s role in trying to support government policy and credit growth within the confines of inflation stability."

The strategist still expects rates being cut to 4.00% but again indicated that this is largely irrelevant given the other measures that are occurring. Overall, he noted that what we have now is a central bank that is now targeting inflation, growth, credit, government policy, government funding and NBH cost all at once and the unorthodoxy has only just begun as Governor Matolcsy said himself last week.MPC to cut in May too

Magdalena Polan, analyst at Goldman Sachs in London also expects the Monetary Council to lower rates this week by another 25 bps today, but she said this was in line with market pricing.

She thinks that this cut will be motivated by the very same reasons as the previous ones:

• domestic demand is still weak and the NBH is determined to stimulate forint lending and growth, also through liquidity-based measures.
• inflation is already below the NBH’s 3% target, it should fall even more in 2Q2013 and the NBH’s own forecast shows it staying near the target in the medium term;
• the external environment has been fairly supportive recently: market reaction to the bank funding plan was generally positive (though the most recent proposals weakened the forint, more below) and demand for government bonds has been solid.

Looking ahead, Polan sees one more 25bp cut in May, bringing the policy rate to 4.50%. “And while we still see the easing cycle stopping there, we also acknowledge that the risk of more cuts has increased recently. On the domestic side, the fast fall in headline inflation means that (ex post) real rates are now higher. This not only means relatively less easing in real terms but also more attractive real returns on Hungarian assets. IT also suggests that the NBH can consider easing more without putting undue pressure on the external funding outlook. On the external side, the additional easing in Japan and heightened expectations of another ECB cut also point towards lower risk to bond demand even under lower NBH rates."

HUF remains key limit for easing

Still, the analyst continues to think that the HUF will remain the key limit on more easing for now.

“This is because the stock of private FX debt is still very high and the NBH is still working on the measures to promote redenomination into forint or on providing banks with FX funding using its own FX reserves. The proximity of the next elections also suggests that the government and the NBH would like to avoid the political cost of prolonged HUF weakness. Similarly, demand for Hungarian assets - and thus maintaining a certain rate differential - will be an important limit on the NBH’s rate outlook."

Focus on HUF lending boost, FX debt cut and more

For these reasons, Polan thinks that the NBH will also “focus on measures to stimulate HUF lending, reduction in FX debt, and support demand for HUF bonds through other means, without cutting policy rates."

In her view, the recent funding package is just the first step, noting that it was much less ambitious than the original plans outlined by the new Governor before his appointment, expecting the NBH to try to implement other measures.

“This may involve redirecting liquidity towards government debt or the overnight deposit facility, such as the proposal (revealed on April 18) to convert the NBH two-week bills into deposit and restrict their availability to domestic banks only. This would help secure HUF funding for the government, allowing it to issue less FX debt. And, importantly, it would also cut the cost of monetary sterilization and the NBH’s losses as the stock of two week bills/deposits would fall and any liquidity absorbed through the overnight deposits would be remunerated at a lower rate," she said.

Bearish view on HUF supported

Polan noted that these measures and their likely impact on local rates support her bearish, long-term view on the forint.

“Once implemented, the NBH’s measures should narrow Hungary ’s interest rate differential while also reducing - to some extent - the economy’s sensitivity to the exchange rate. The latter should gradually increase the NBH’s and the government tolerance for HUF weakness."

“Also, the fall in the NBH’s FX reserves would reduce its ability to absorb external shocks in the future, making the Forint more susceptible to changes in external risk sentiment or outlook on G3 rates. In the meantime, the uncertainty over the NBH’s plans and the lack of detail of the already proposed measures will also weigh on the forint," Polan concluded.

Goldman Sachs strategists currently recommend a long EURHUF position.

A rate decision will be announced at 13:00 and a press statement will follow at 14:00, both London time. The next meeting will be on May 28.

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