Hungary forint keeps falling like a stone - Should the MNB start to worry?

HUF hits one record low after another

After a temporary break, the forint started to ease significantly again versus the euro in the last few days. EUR/HUF was north of 333 on Wednesday morning. In the last week alone, the forint fell 1.2% against the single European currency, and it is now 3.8% weaker than at the end of 2018.

Interestingly enough, the HUF - at least up to this point - has been moving broadly in tandem with its regional peers, but the current easing wave makes the forint stand out in Central and Eastern Europe; the Hungarian currency is a clear underperformer now.

We have already addressed the reasons why the HUF has been doing so poorly. The MNB maintains an extra-loose monetary policy and it refrains even from suggesting that a rate hike is an option, not to mention that decelerating inflation could further embolden the central bank to stick to this stance. And then there's the worsening in global economic sentiment that only makes things worse.

The stats office (KSH) published the latest inflation data on Tuesday. The report shows that consumer prices in Hungary rose 3.1% year on year in August, whereas the consensus forecast of analysts polled by Portfolio ws for a 3.2% headline figure. This may be yet another nudge for the Monetary Council that it could ease further if it wanted to; it does not have to be concerned about inflation exceeding the bank's target. The question is how strong the pass-through of the weak forint to inflation will be via imports, but analysts are uncertain about this at this point. 

OTP says there is room for further easing

Underlying inflationary pressure seems to have topped out; monetary policy has enough room for manoeuvre, if necessary, analysts at OTP Bank noted in a research note published on Wednesday.

The closely watched constant tax core inflation stagnated at 3.2%. OTP’s filtered inflation (inflation without volatile items and all government measures) was 2.9% year on year, the same as the previous month’s figure. Underlying indicators clearly seem to have started to decline, the analysts added.

“This is in line with the deteriorating external environment (lower imported inflation) and the fact that the business cycle in Hungary may have passed its peak. In fact, our real economy projection assumes some slowdown in GDP growth and domestic demand (in particular household consumption expenditure) already for this year.”

The analysts underlined that the most important thing in the past few months’ data is that the ‘mostly underlying’ inflation indicators have started to decline, after a very rapid growth. Currently, OTP’s short-term trend inflation projection (eight months ahead) shows a much lower trajectory than the one in the bank’s medium-term forecast. Naturally, the short-term forecast models may overstate the movement in certain months, but all the incoming data since OTP’s medium-term forecast have pulled its inflation forecast down.

The rapid price level increase in seasonal foods prices is over, but the correction really misses our expectations. In the short run, it poses an upside risk to our headline inflation forecast, but it may drag down the headline next year, due to base effects.

Seasonal foods’ price trajectory seems unfavourable, but the inflation of the non-seasonal part of unprocessed foods was lower than OTP had expected. This was due to the prices of meat (fading effect of the African swine fever) and flour (declining wheat prices). As non-seasonal food prices’ development has much stronger correlation with processed foods prices (which is a component of constant tax core inflation), the analysts think the inherent structure of the incoming data is fairly favourable from a monetary point of view.

The incoming inflation data put the MNB in very comfortable position.

The central bank forecasted 3.7% constant tax core inflation for Q3 but it will be undershot, the analysts believe.

In the light of the changing external environment and the new inflation data, we think the BUBOR is likely to remain around its current level until 2020. Furthermore, if the external environment sharply deteriorates, the MNB has enough room for manoeuvre to ease monetary conditions (e.g. via FX swaps, QE).

Quite a different perception from abroad

J.P. Morgan has published a research note on the link between inflation, the weak forint and monetary policy, but their perception is totally different from OTP's approach. Analysts at the U.S. investment bank say high core and weak FX remove space for MNB policy easing, but the risk the central bank eases regardeless cannot be neglected.

At J.P. Morgan they expect core inflation will remain above target throughout 2020, diverging from headline CPI, which will enter a (noisier) downward path. Additional downside moves in food and fuel components, coupled with irregular base effects, will likely push headline CPI below the 3% mark in September, rebounding temporarily to above 3% from November, only to dip back below the central bank’s target from 2Q20, settling in the 2.25-2.50%oya range in late 2020.

Beyond all the noise, core inflation (adjusted for the impact of indirect tax changes) is likely to prove resilient—backed by an economy that continues to expand clearly above potential, with an exhausted labour market and double-digit wage growth—so we expect it to linger above target throughout 2020, rising from the present 3.2%oya to an average 3.4% in 2020.

Composition wise, core is driven by strong services inflation, reflective of a strong domestic demand momentum. Market services inflation, which is more driven by domestic demand and wage dynamics remain very elevated at 4.2%oya, whereas goods prices—more attached to foreign demand and prices—have recently taken a significant slowdown, from around 2%oya in 1Q19 to 1.0%oya presently.

This slowdown in goods inflation has accounted for most of the recent deceleration in core inflation itself, particularly items such as vehicles (possibly with the recent weakness in sales across the continent leading to better pricing offers) and tech-related durable goods.

Within services, labour intensive items continue to reveal upward pressures, with our labour-intensive CPI index currently near 7%oya, stemming from strong wage growth, which are still running at a double-digit pace.

The central bank’s communication suggests the MPC is again tempted by the lure of easier policy. At its monetary policy meeting in late August, the Monetary Council, empowered by the decline in core inflation and the dovish turn in DM central banks, wrapped the usual statement with a somewhat more dovish spin at the end. It mentions that downside risks to inflation are increasing, and that the outlook for inflation will be “a decisive factor in the necessity of further measures”.

Since then, Governor Matolcsy was quoted in the media as advocating for a broad stimulus plan (to protect the country’s economic convergence with core Europe at a time of heighted external risks), including higher usage of fiscal reserves, new support to targeted industries exposed to the external slowdown and incentives for Hungarians abroad to return home to respond to labour supply constraints.

"Yet, high core inflation and trend FX depreciation remove space for MNB easing we think, even if there are some risks the MNB does it anyway."

From a macroeconomic standpoint, the case for easing is very weak: the monetary policy stance is already very loose, with very negative real rates topped up by a plethora of lending schemes and a corporate QE program, at a time when core inflation is above target, growth is running above potential, the labour market is exhausted and nominal wages are growing in double digits.

These factors combined with a weakening trend in the Forint will, we expect, make the MNB uncomfortable in easing policy further, in our view, saving whatever little firepower it still has for a situation of bigger need.

Yet at the same time, we cannot ignore the MC’s time-tested preference for easier policy and its communication, so we think there is a decent possibility (30%) that some new unconventional measures are unveiled in September (more lending programmes, QE, FX Swaps, for example).

That probability could rise further if the ECB over delivers on Thursday, which could cause some reversal in the Forint’s weakness. Looking ahead, if anything we anticipate further gradual Forint weakness and core inflation to reaccelerate, implying the space for easier policy will remain closed.