Fed taper casts a shadow over easing in Hungary: base rate at 3%

The 17th successive rate cut could be a bore in a different environment, but the current circumstances make it anything but - despite the fact that another 20 bp cut was practically taken for granted. While relentless monetary easing may not yet come to an end with the move, the imminent Fed taper is making the rate cuts increasingly exciting.

3% no longer the rock bottom

Hungary's long unbroken series of rate cuts has been driving expectations for the bottom line to ever lower levels. Today, most analysts no longer see 3% as the absolute lowest level possible. The fact that expectations are trickling down to 2.5% is particularly interesting in light of earlier signals from the central bank that the base rate cannot realistically be expected to fall below Hungary's CDS. The latter is currently at about 270 bp, or in a wider time frame, it can be said to be fluctuating around 300 bp.

Of course this is not a strict rule, as a 5-year default risk indicator is not directly comparable to a short-term yield - especially as long-term yields have for a while refused to follow the path of the base rate, stuck at approximately 6%. Yet for a small country like Hungary where country default spread is in the 3% to 4% range, there is a realistic danger of overcutting the base rate.

Yield trends also indicate that the benefit of recent rate cuts may no longer be that much. The only thing that has helped bring Hungary's moribund private sector lending back somewhat into life is the government's Lending Programme for Growth, a factor has nothing to do with the base rate, while the cost of government financing has not become lower.

What will the taper bring?

That is, the benefits of a dovish monetary policy line for the real economy are questionable, while risks are clearly rising. Ever since the Fed has started discussing the possibility of tapering off its monetary easing program, a shadow has been hanging over emerging markets. And while the CEE region has been holding out relatively well, yields show that Central Europe is not immune to the tapering either.

Some analysts do not rule out the possibility that the Fed may start tapering as soon as this week. In light of this it is little wonder that the analysts are expecting Hungary's central bank to start rate hikes in the near future. The uniqueness of the situation is evident considering that this is the first time when during an easing cycle in progress everyone is expecting an imminent (i.e. within a few months) rate hike. This suggests investors indeed see the current rate policy as excessive, in the sense that the he current interest rate level is facilitated by a unique global situation of massive excess liquidity.

At the same time, investor patience indicates market players are increasingly accepting of Hungary's rate policy, warranted by the current unusual global market situation. While earlier it was often mentioned that a swift rate hike in the future could result in a major credibility loss for the NBH, observers are much less critical now. It seems the market is pricing the possibility of rate hikes in expectations without any concern. What could pose a threat to the NBH is possible scenarios of (1) a major shock to markets necessitating greater monetary policy adjustment to tapering in countries with excessively low interest rates, (2) lack of symmetry in monetary policy whereby the central bank is reluctant to take prompt rate hike action when necessary.

Inflation report coming

Tuesday's rate decision was made by rate-setters who already knew the findings and forecasts in the latest inflation report. The Monetary Council's comments on the rate cut will be released at 3 p.m. along with a summary of the inflation report which will be published in detail on Thursday. Overall, the inflationary outlook is unlikely to limit room for further rate cuts.

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• inflation,
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