ANALYST VIEW - Which way forward for Hungary's central bank?

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Nóra Szentiványi / Saad Siddiqui, J.P. Morgan, London

The analysts expect the Hungarian central bank to maintain an accommodative stance at today’s policy meeting, with emphasis on the base rate remaining low for an extended period.

“Recent upside surprises on inflation and wage growth are unlikely to trigger a material change in the NBH’s stance as the risk of exceeding the 2%-4% CPI target band remains low. Until the spring 2018 parliamentary elections we think the NBH is likely to remain focused on achieving 3%+ GDP growth and is prepared to accept higher inflation to this end," they said in recent research note.

“This is likely to mean fully utilizing the ±1%-pt tolerance band around the 3% target with a view to achieving that target over a longer horizon. The recent increase in risk appetite following the Fed’s “dovish" rate hike, coupled with a slow-moving ECB, also plays into the NBH’s hands and should support the low-for-long message despite stronger reflation."

The analysts also expect the NBH to announce a larger-than-consensus reduction in the 3-month deposit cap to HUF 525 bn, but would not interpret this as a more dovish signal.

Their forecast implies a HUF 225 bn reduction in the deposit cap, which would be a larger cut than the HUF 150 bn implemented in 1Q17—when the cap was reduced to HUF 750 bn—and also a larger cut than consensus expects (HUF 150 bn cut to HUF 600 bn).

Szentiványi and Siddiqui argue this would not signal a more accommodative policy stance.

“This is because the structural surplus liquidity of the banking sector will decline by just over HUF 200 bn in 2Q17, on our estimates, due to autonomous factors and the central bank’s programs (e.g., FX swap maturities related to past mortgage conversions, sovereign FX debt repayments and the end of the Funding for Growth Scheme). Interbank rates are likely close to their trough (3-month Bubor has fallen 81bp since last July, to 0.21%) and we see little scope for additional easing to be delivered through the deposit cap. Instead, the NBH’s focus is likely to be on preventing a rise in market rates and preventing HUF appreciation by keeping FX implied rates low through HUF liquidity-injecting FX swaps."

“The NBH is likely to rely on HUF liquidity-injecting FX swaps to keep monetary conditions loose and offset negative liquidity shocks."

Since October 2016, the NBH has been injecting a substantial amount of liquidity through FX swaps, which temporarily expand the central bank’s balance sheet. The amount of liquidity support provided through these instruments rose to HUF 550 bn in March from HUF 400 bn in February and an average HUF 383 bn in 4Q16.

“In addition to offsetting negative liquidity shocks, the FX swaps instrument have the added benefit of keeping a lid on FX implied yields and containing HUF appreciation pressures stemming from Hungary’s persistently large current and extended basic balance surpluses (5% of GDP)."

As regards strategy, J.P. Morgan holds UW positions in Hungarian local bonds and HUF in the GBI-EM Model Portfolio. “The macro drivers of HUF rates underperformance against higher yielding EM rates remain in place, while the NBH’s resistance against HUF appreciation is likely to continue."

Peter Attard Montalto, Nomura, London

The strategist believes that today’s MPC meeting should see further easing along new vectors. He watches forward guidance on BUBOR and the duration of EURHUF swaps especially.

Attard Montalto thinks “it would be a mistake to interpret the MNB’s rhetoric since the last meeting, that they are broadly happy with BUBOR around current levels, as a sign of the end of easing. 3m BUBOR is one key component in the monetary stance but part of a much wider rates complex that is likely to now come into focus."

“It is possibly to ease without further reductions in BUBOR (though that can happen as a second order effect too). In the same way the policy rate has been unchanged since May last year yet monetary conditions have been markedly eased since that time," he added.

The strategist thinks the MNB will look to further ease conditions at its meeting today (even as inflation climbs) “as weak 2016 growth data point to a weak 2017 and with uncertainty over the scale of effect the structural funds and external reflation narrative can have on Hungary."

“Equally, they may look for more pressure for a weaker HUF in both nominal and (given the current account surplus, more importantly) in real terms."

In his opinion, the MNB wants a high inflation, weak currency path to competitiveness and higher potential growth.

“That said, we think further easing will be presented as necessary to ensure inflation is anchored at target in the medium run."

Policy focus now will be to convince the market that BUBOR fixings will be unchanged for longer as opposed to lowering the fixings themselves. As such, we believe the MNB will be looking to flatten the curve as the next key method of monetary easing.

As such, Attard Montalto sees the following actions on the table from most likely to least likely to occur:

• Stronger rhetoric around where BUBOR will be in the medium run including year-end, anchored around the inflation forecast of the MNB and them seeing medium run anchored inflation.
• Forward guidance on the 3m depo rate cap volume level out for 6m, instead of to the end of the following quarter.
• A lengthening of the Monday EURHUF swap tenor to 3m or 6m (though longer is possibly on the table but unlikely to be offered) from 1m currently to help aid a flattening of the FRA curve and reduce 6m vs 3m BUBOR spread from 9bp towards zero.
• A small reduction in the level of the 3m depo cap from HUF750bn to HUF700bn.
• A 3y HIRS again to flatten 2s5s (this seems unlikely at this stage, given more focus on the front end but possible later in the year as ECB tightening begins to be set in play for start 2018).
• Duration swaps (this seems unlikely given their limited effectiveness the first time and a lower priority for the MNB on 5s10s vs front end).

A key issue here, the strategist said, is the MNB’s views on the whole curve.

He thinks ultimately “the MNB would want the whole curve to be completely flat at BUBOR levels to reduce government funding costs (also an aim) but clearly this is a pipe dream and so the focus and targets are sequential from the front end first."

Pasquale Diana, Morgan Stanley, London

Diana reminded that in recent communication, the NBH has been indicating that monetary policy stimulus has approached its limits, and that fiscal policy should pick up the baton now.

“While it seems to us that there is quite enough stimulus in the economy already, one should keep in mind that the NBH subscribes to the 'high pressure' economy view (see here) - namely, that the economy's potential is a function of how much stimulus policy-makers apply. Therefore, keeping policy loose (or even loosening it further) can boost its potential growth according to this view."

Diana said it is difficult to say with confidence what the NBH will do in March, and beyond.

“With growth set to accelerate and inflation broadly at target, further monetary stimulus seems unwarranted. At the same time, a large external surplus allows the NBH significantly more degrees of freedom than central banks that face a similar macro backdrop."

Diana thinks rate hikes are not on the agenda, but also believes that the NBH will lower the 3M cap less aggressively from here (possibly HUF 100 billion at most on March 28).

“Beyond this, we see the NBH embarking on a gradually less dovish stance, as the data suggest would be appropriate."

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