(Adds comment by JPMorgan, Citi on page3) The Monetary Council of Hungary’s central bank (NBH) has lowered the benchmark policy rate to a new all-time low of 4.75% on Tuesday. The market was expecting this 25-basis-point rate reduction, whereas some analysts in London thought a 0.5 percentage point cut was also on the cards. The Monetary Council, however, stuck to its “usual" easing pace in effect since August.
“As expected the MPC cut rates by 25bp, less than the market expected and the statement will most likely retain somewhat of a 'hawkish' edge that the market will mistake for expectations of orthodoxy going forwards.
“In reality there was little upside for Matolcsy to go faster than this given the focus of policy will now be elsewhere in liquidity and credit provision. Overall this move will be supportive for HUF. There was no other changes in monetary policy at this time.
“As we feared the MNB has not yet dealt with all the logistics of altering the liquidity provisions at this time though this should be more a timing issue, not a sign of orthodoxy. It will come - and more. In the short term this is supportive for HUF however. With no new policy here will be no press conference."
“Falling inflation and an economy struggling to escape from recession mean that further interest rate cuts are likely in Hungary. But we remain of the view that currency concerns will prevent aggressive steps to ease policy.
The National Bank of Hungary’s (NBH’s) decision to cut its benchmark interest rate by 25bps to 4.75% this lunchtime never seemed in doubt. Inflation fell to a record low of 2.2% in March, and we expect it to remain below target over the next year or so.
“Meanwhile, the latest activity data suggest that the economy remains in recession (although the pace of contraction may have eased slightly).
“Just as importantly given Hungary’s large stock of foreign currency debt, the forint has strengthened against the euro since the last MPC meeting.
“But while the MPC appears to be moving cautiously with regards to interest rates, it seems fixated on using other instruments to stimulate the economy. Most important among these is the “Funding for Growth" scheme, unveiled at the start of this month. There are three prongs to this scheme: to provide cheap forint loans to SMEs, to help SMEs convert their FX debts into forint, and to use a portion of the National Bank’s foreign currency reserves to reduce the country’s short-term external debt.
“The scheme still appears to be in the midst of negotiations between policymakers and the banking sector to flesh out details. But as we argued when the scheme was unveiled, the key point is t hat the overall sums involved will make only a small dent in Hungary’s overall level of external debt (which would remain extremely high).
“More recently, governor Matolcsy outlined plans to restrict foreigners’ use of the National Bank’s two-week bill. The details of how this would work are still very sketchy. In public, it has been proposed on the grounds that it would reduce the government’s budget deficit. (Hungary’s banking sector has a surplus of liquidity, so the NBH’s benchmark facility absorbs liquidity. This has a cost to the NBH in the form of interest payments which are ultimately borne by the government.)
“As it happens, we think these are rather flimsy grounds to change the benchmark facility. We estimate that the savings would amount to less than 0.1% of GDP annually. The NBH probably hopes that banks would purchase riskier assets such as bonds or extend credit instead, which would be positive for growth.
“For our part, we’re concerned that such restrictions could lead to an outflow of much-needed foreign capital, putting downward pressure on the forint. So far, it doesn’t look like this is happening. But it does underline the point that monetary policy has become increasingly unpredictable under the new-look MPC.
“In the meantime, Hungary’s heavy foreign currency debt burden means that it remains one of the most exposed economies in Emerging Europe to a deterioration in global risk appetite. For now, there appears to be little in the way of the MPC’s pursuit of lower interest rates. However, we rema in concerned about the sustainability of the recent loosening of policy. Ultimately, we think a souring in investor sentiment could force the MPC to halt - and even reverse - its easing cycle in order to shore up the forint."
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