Economy 25 February 2019, 12:48pm

Final countdown begins: Hungary c.bank to do an about-face

Portfolio

After it turned out two weeks ago that tax-adjusted core inflation, a key metric of the National Bank of Hungary (MNB), reached the critical level at 3.0%, the final countdown to the launch of monetary tightening was practically afoot. The last time the central bank tightened monetary conditions was in December 2011 therefore the upcoming move is a crucial one even in historic terms. Analysts polled by Portfolio do not expect the turnaround to be announced at Tuesday’s policy meeting yet, but they do project it to happen at the next policy meeting in March. Regardless of the move, however, we should expect a slow process, not to mention that global risks could still change things around.

How did we get to the imminent U-turn?

Monetary policy took a turnaround took place last year. In January 2018, the MNB moved towards loosening monetary conditions, but global developments upset the scene and in June, the bank was forced to admit it would not be able to paddle upriver forever.

After the June policy meeting, the Monetary Council said the existing loose monetary conditions would not be possible to maintain over the 5-8-qurater policy horizon. That was the first major step towards tightening.

What followed was a few months of a game called ‘Juggling with Words’, while inflation kept on accelerating in Hungary. While the headline figure was driven (up until November) by rising fuel prices, measures of underlying inflation clearly showed that price pressure in the local economy was gradually mounting.

The rate at which the inflationary pressure was growing could have caught even the MNB by surprise, and the wording of its post-meeting statement in December indicated a clear step towards tightening, as the Council said the price statistics of the following months would be key. Previously, the MPC kept stressing that the sustainable achievement of the inflation target could be expected by mid-2019, but the December statement no longer suggested that

The Central Statistical Office (KSH) released its CPI data for Dec18 in mid-January, and the MNB published its own measures of underlying inflation which clearly showed a further rise in price pressure. The last straw was placed on the back of monetary policy by January’s inflation stats which showed an unexpected further acceleration to core inflation, and

core CPI ex indirect taxes picked up to 3.0% from 2.9%, and this was the level to which MNB Deputy Governor Márton Nagy had previously linked the start of monetary tightening to.

Nagy told a Euromoney conference in mid-January that if core inflation reaches 3.0% or higher, this is proof that inflation has reached the [central bank’s] target sustainably.So, we can declare inflation has reached the central bank’s target therefore the MNB will shortly need to tighten monetary conditions, i.e. the final countdown has begun.

We have reached a key turning point. The last time the MNB tightened monetary conditions was in December 2011. Since then it has been on a practically relentless easing streak (via conventional and unconventional tools).

Final countdown begins

So, the start of monetary tightening is at the gates. By that we don’t mean a hike to the 0.9% base rate (so-called benchmark policy rate), because the MPC is unlikely to touch that for a while. Instead, a gradual reduction of FX swaps providing forint liquidity to banks, a hike to the overnight deposit rate should be expected. The MNB made that clear already in the minutes of the 18 September 2018 policy meeting.

Looking forward, the Bank would adjust the monetary conditions necessary to achieve the inflation target in a sustainable manner by creating an optimal combination of two of its instruments: swaps providing forint liquidity and the interest rate corridor.

Analysts polled by Portfolio do not think that the MNB will announce specific tightening measures at its upcoming policy meeting on Tuesday. They believe it is more likely that such announcements will be made at the 26 March meeting, by which time the Monetary Council will have the latest Report on Inflation to lean on, and it will also have to decide then on the amount of liquidity to be crowded out and would take this into account in setting the stock of central bank swap instruments.

Zoltán Török , analyst at Raiffeisen Bank in Budapest, expects the Council statement to already contain an indication to the future tightening (liquidity reduction), and that a major announcement will be made next month.

Péter Virovácz, analyst at ING Bank, thinks the MPC will wait one more month, and call tightening measures only in few of February CPI data next month.

Let’s not forget that the rhetoric of the European Central Bank is also changing, reflecting on weakening economic activity in the Eurozone. And that could still warrant the MNB to be cautious this month

, he added.

Gergely Suppan , analyst at Takarékbank, holds a similar view. He thinks a decision on the stock of FX swaps will be made in March. The MNB is not forced to make a move, as an increasing number of central banks are preparing for monetary easing.

Sándor Jobbágy , analyst at CIB Bank, has also stressed that the MNB will be given a good opportunity by the Inflation Report and updated macroeconomic estimates to start tightening monetary policy conditions via cutting liquidity.

Orsolya Nyeste , analyst at Erste Bank, underlined that although core inflation ex indirect taxes had reached the “magic" 3.0% in January, the rate-setters are likely to hold on for now, as they want to see the index remaining above 3.0% persistently before starting normalisation. She added that because of the likelihood of this wait-and-see attitude, we might not have a tightening measures announced in the first quarter, although she thinks that a moderate raise to the O/N deposit rate at the end of March is on the cards.

The start of normalisation via FX-swaps may be pushed off to the second or third quarter, though. The external market environment is supportive. Yields on developed markets are low, and the ECB is also likely to change its guidance soon therefore the date of the first rate hike by the ECB could also be put off to next year. This implies that the MNB still has the possibility to start normalisation this year and see it through slowly and gradually

, she commented.

The economists in the survey agree that the MNB will soon start tightening by reducing liquidity via a cut to FX swaps providing forint liquidity. They do not necessarily have the same view about how much interest rates can change this year. The only one projecting a hike to the 0.9% base rate was Gábor Regős, analyst at Századvég, while the majority believe that the lower end of the interest rate corridor, i.e. the O/N deposit rate (which is regarded as the benchmark more than the base rate) will not be raised significantly, either.

Ágnes Halász , analyst at UniCredit Bank, thinks that the increase in price pressure manifesting in core inflation will be only temporary. She also believes that this, coupled with the downturn in global economic activity and the increasingly cautious large central banks’ subsequently softening plans for monetary tightening create a more favourable monetary environment for the MNB to maintain growth-stimulating and loose conditions both this year and next. As a result, she projects that the start of liquidity reduction could be accompanied only by a moderate raise to the O/N deposit rate this year. Halász forecasts the rate to be up at 0% by the end of 2019 from -0.15% currently.

Dániel Módos , analyst at OTP Bank, projects the sharpest tightening in interest rates this year. He thinks the 0.9% base rate will have a 0.7-1.1% symmetrical interest rate corridor by year-end, expecting the first step for March.

In our view, a symbolic tightening of monetary conditions will take place at the March policy meeting. This will be either a 15-basis-point hike to the O/N deposit rate and/or a reduction of FX swaps.

Módos adds that due to a downward shift in global economic growth and global interest rate expectations, the MNB will have to balance between the impacts of a rising domestic inflationary pressure and a deteriorating international environment in the short term, but the global environment will not knock it off of a tightening course.

There you have it. Tomorrow is a rate-setting day, but no major announcement can be expected just yet. Yet, we should keep a close eye on the wording of the MPC’s official statement.