ANALYST VIEW - Should we expect fakes and faints in next MNB bout?
CEE central bank will not rush to tighten monetary conditions
MNB Deputy Governor Márton Nagy told a conference in Vienna in mid-January that "if core inflation reaches 3.0% or higher, this is proof hat inflation has reached the [central bank’s] target sustainably."This has fuelled market expectations that the date when the central bank starts to tighten monetary conditions could be close. It also had an impact on the forint. The Hungarian currency’s outperformance in the first two months of the year gained traction from such market expectations. UniCredit, however, does not believe CEE central bank will be in rush to turn their policy around for several reasons:
- central banks consider the headline inflation figure rather than core inflation as the anchor, and the latter could remain under the respective targets up until the end of 2020. If the output gap peaks out and starts to drop in 2020, the tightening of labour market conditions stops and there is no risk of overheating from lending growth, the CEE central banks might keep interest rates low until the end of the current economic cycle.
- the central banks may try to soften the fall at the end of the cycle, and prevent growth from dropping below its potential;
- CEE central banks cannot cut their links to ECB measures, while UniCredit does not think the ECB will raise rates until the end of the cycle, and that could make the bed for lingering loose monetary conditions in the CEE region, as well. The analysts also believe that the ECB could pump further liquidity into the system with a new targeted programme in a bid to prevent liquidity from drying up.
- a further argument for the banks could be that monetary conditions may tighten also when CEE currencies appreciate. If the United States, for instance, does not impose protective duties on European cars, and the euro strengthens versus the US dollar, it could give a boost to CEE currencies. In that case, the central banks may argue that they can achieve tighter conditions also without interest rate hikes.
Inflation in Hungary could rise higher still next month due to base effects and the momentum in core inflation, projects Dan Bucsa, chief CEE analyst at UniCredit in London. However, March could mark the peak in headline inflation before 4Q19, when base effects from fuel prices could push inflation back above 3.5% if oil prices remain close to current levels, he added in a research note published on 8 March.
In UniCredit’s forecast, inflation remains inside the 2-4% target range this year and next. Nevertheless, Hungary’s latest inflation reading confirms that demand-side pressure remains strong. Core inflation adjusted for indirect tax increases is expected to peak only in April, remaining above headline inflation until July.
Core inflation could moderate afterwards as wage growth continues to slow in the public sector and wage expectations in the private sector are hit by external risks. Nevertheless, core inflation adjusted for indirect tax increases will remain higher than in Poland or Czechia this year and comparable to that in Romania, the other country in the region where wages have been rising in double digits
, said Bucsa.Rising inflation paves the way for the Hungarian central bank to start withdrawing some of the measures implemented to support liquidity and keep interest rates low, he said.The analyst expects the MNB to take the deposit rate to 0% from -0.15% on 26 March and announce targets to reduce HUF liquidity provided via FX swaps.
With the Funding for Growth Scheme (FGS) Fix kicking in, Bucsa expects the MNB to pump HUF 1.0 trillion at 0% into the banking system to boost lending to small and medium enterprises. As a result, the current amount of liquidity provided via FX swaps (roughly HUF 2 trillion) may be reduced.In anticipation, the MNB continues to shift the structure of swap maturity to shorter-term swaps. Those with maturities up to 6M exceed now HUF 1.2tn compared to HUF 0.1tn a year ago, he added.
“The Hungarian economy is one of the most vulnerable to external shocks among CEE economies and could underperform its regional peers if global trade and eurozone demand do not rebound strongly. In addition, some of the domestic growth drivers such as EU-funded investment, and the credit and fiscal impulses are likely to weaken or turn negative in 2019-20," he added.
The HUF has appreciated in anticipation of tighter monetary conditions, although interbank interest rates remained low and liquidity provisions did not decline (see chart above).
“A large extended basic balance, despite falling trade surplus, and better news regarding global trade (a deal between the US and China, no new tariffs on US imports of European cars) would further support the Hungarian currency," said Bucsa. That said, a lower EUR-USD and any additional growth risks in Europe could affect central European currencies. In addition, the HUF forward rate agreement curve is currently pricing too much tightening in short-term rates, and a flattening of the curve could affect the HUF, he added.
A slight tightening of monetary conditions should not have a big impact on HGBs. FX-adjusted, HGBs will remain the most attractive local-currency bonds in central Europe. At the same time, valuation looks tight compared to Poland at the longer end of the curve, given that POLGBs will receive much stronger support from local bond buyers, while HGBs with longer maturities rely overwhelmingly on foreign buyers.
What will happen to the forint if the MNB does not start tightening?
Commerzbank has also recently published a research note on the outlook of CEE currencies via analysing the PLN/HUF cross. The PLN-HUF cross has broken lower in mid-February with strong momentum, and the forint strengthened to its strongest level since the autumn of 2017.The proximate trigger was Hungary’s rating upgrade by S&P last week from BBB- to BBB, and some better news regarding the EU’s Article 7 proceedings against Hungary, said Tatha Ghose, a London-bases strategist at Commerzbank. But, the trend in PLN-HUF had been downward since well before.
However, the latest accelerated move doesn’t appear fundamentally supported, given the increasingly negative real interest rate in Hungary versus the rising real interest rate in Poland, he added.
One argument from the monetary policy side, Ghose, said could be that the MNB will soon respond to accelerating inflation with rate hikes. He added, though, that even if MNB were to tighten policy, it will likely not do so by enough to reverse the widening real interest rate differential between Poland and Hungary we witness in chart 2.
Another line of argument could be S&P’s upgrade, said Ghose. One of the prominent factors behind S&P’s assessment was the strong growth Hungary is enjoying. Indeed, Hungary is one of the few countries in the region which surprised positively even in Q4 - and S&P’s upgrade followed shortly.
As for the implications of a strong outlook for the forint, the analyst noted that the Hungarian labour market is quite stretched already, and the unemployment rate has gone flat recently, possibly reflecting that it cannot fall much further. This development has also coincided with acceleration in core inflation in recent months.
In other words, Hungary is one country where the traditional inflation response to a tightening labour market appears to be catching up. The economy could, in fact, be overheating - domestic inflation pressure is finally dominating external disinflation pressure.
The only really supportive argument for pronounced forint outperformance, Ghose said, would be that MNB will launch a comprehensive monetary tightening cycle soon, which will narrow the real interest rate differential versus Poland. But Commerzbank attaches a low probability to this scenario. Ghose expects the central bank to gradually tighten policy, but mainly via winding down QE tools - the resultant tightening of monetary conditions will not be enough to offset the inflation gap between Hungary and Poland. Hence, he expects EUR-HUF and PLN-HUF to rise in coming quarters from current levels.
