Economy 13 December 2018, 12:24pm

May Hungary's Team Matolcsy be threatened with 'forint gun' in 2019?

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The Monetary Council of the National Bank of Hungary (MNB) will have to make a statement again, while an increasing number of analysts doubt that it will be able to maintain the current interest rates by the end of 2020. Firstly, it will be key when the European Central Bank (ECB) makes its move, as the MNB is likely to follow suit. Secondly, some analysts argue that the forint exchange rate will also be worth watching, as no matter how steadfastly the MNB would try to keep the base rate on hold at 0.9%, it will be rather difficult to do so if EUR/HUF crosses north of 340.

MNB could find itself in a vice

The inflation data published on Tuesday should theoretically smoothen out some wrinkles on rate-setters’ foreheads, as CPI decelerated more than expected to 3.1% yr/yr in November from 3.8% in October. This makes it highly unlikely that the headline index will be stuck on top of the +/-1 percentage point tolerance range of the CPI target. Core inflation, however, which is watched more closely by the market, has not dropped just yet and was flat at 2.6% yr/yr last month. The central bank’s measures of underlying inflation also testify that inflationary pressure has been slowly building up therefore - if we take a closer look - it would be premature for the central bank to sigh in relief.

Pressure on the MNB may dissipate some in view of the Nov CPI print, but it remains a question whether the bank could be relaxed about the fundamental inflationary processes. Several analyst houses have recently started to voice concerns about rising inflation. J.P. Morgan, for instance, highlighted that core inflation keeps going up in Hungary and Poland.

As regards the growth rate of core inflation, analysts emphasise that it is the highest in Hungary. It gives reason for additional concerns that lending growth is also the most significant in Hungary, and real estate prices are also on the rise. Overall, the economy is running a risk of being overheated, while the MNB has no inclination yet to tighten monetary conditions.

Looking forward, experts believe that core inflation could be hovering around the upper end of the central bank’s tolerance range (i.e. between 3% and 4%) in 2019. Further acceleration could be fuelled primarily by increasing consumption and wage hikes therefore the index could cross north of 3.0% sometime in early 2019 and could reach 3.5% on annual average next year.

Over the last few months, others have also started to have doubts whether the MNB will be able to keep interest rates this low even in 2019. The latest economic outlook by the OECD also warned that there is a risk of overheating, adding that “the stimulatory macro-economic policies should be tightened gradually."

The OECD projects that rates will be raised in the first quarter of 2019, to help contain inflation expectations.

It also warned that higher-than-expected wage increases could de-anchor inflation expectations and require a sudden tightening of monetary policy, thus harming growth.

The forint could be the weapon of the market

Analysts at J.P. Morgan say the overly loose monetary policy could lead to serious market pressure in 2019. Therefore they are Underweight on the HUF vs. the PLN.

We think that low real yields in 2019 will put the forint under pressure in 2019

, the project.

The U.S. investment bank believes that HUF weakening will be probably triggered by foreign investors’ capital withdrawal, as the Hungarian currency is currently “overpositioned" in the region relative to yields, because significant capital inflow into government securities, while funds were withdrawn from the Polish and Czech markets. Meanwhile, the nominally low government security yields could stoke the interest of speculative capital, i.e. shorting Hungarian government securities could be an attractive option amidst the capital flight, they added.

The analysts believe that the rising pressure on the market could be caused by the forint easing to 330 against the euro in the first quarter of 2019. And that is not going to be the end of it. By the end of June, EUR/HUF will be at an unprecedented 335 and then it is projected to weaken further to 340 in Q3.

This, of course, would not be a dramatic HUF easing since it would correspond to a less than 5% depreciation compared to current levels. Its significance would be that the forint would be at a record low. And in that case, the analysts project, the weaker forint could start to pass through to inflation and reaching a new psychological level would also be embarrassing for the MNB.

As a result of the above, J.P. Morgan expects the MNB will be forced to raise its base rate by 20 basis points to 1.1% in the third quarter of 2019, and further by 40 bps to 1.5% by the end of the year.

Due to the persistent growth of the economy beyond its potential, record low unemployment, strong wage growth and accelerating core inflation the current default approach of monetary policy cannot stay justified for long

, J.P. Morgan sums up its outlook.

We have already seen the first signs of monetary tightening, as the MNB announced that it will phase out its interest rate swap tenders and mortgage note purchase programme by the end of the year. Analysts believe the next step could be a raise to the -0.15% overnight deposit rate or a fine-tuning of FX swaps.

UniCredit does not believe the Hungarian central bank will be forced to raise rates in 2019 just yet. On the other hand, if global investor sentiment turns for the worse, the forint could get under pressure again as it is currently the cheapest in the region to short the forint. The bank’s analysts also noted, though, that as of mid-2019 the bank could become less sensitive to swings in the forint exchange rate, and in case of a potential HUF sell-off it may let short interbank rates go slightly higher at most.

The MNB should keep its eyes peeled already

Besides inflation and the EUR/HUF exchange rate, the MNB’s rate-setters could find guidance in the European Central Bank’s (ECB) policy, as well. Member of the Monetary Council repeatedly said that they are closely monitoring ECB moves and they will take these steps into consideration when timing a potential tightening move.

The official rhetoric in Frankfurt is that current interest rates could remain on hold at least until the summer of 2019, but the ECB’s governing council is scheduled to hold its policy meeting on Thursday. The question is whether they will make a change to this rhetoric or not, in view of the weaker macroeconomic data released over the last few months. Theoretically, the ECB should end QE in December, but if they wanted to fine-tune the promise to cut bond buys the time is now.

If ECB President Mario Draghi applies a more cautious tone today, the Hungarian MPC might be emboldened that it should indeed try and put off the first rate hike as far in time as possible.