Winds have changed - How will the Hungarian central bank react?

The Hungarian central bank is expected to leave interest rates unchanged at its 22 October policy meeting, a decision underpinned by domestic inflationary processes, as well as by the external environment, says Ákos Kuti, Deputy-CEO of Danube Capital R&A Zrt. Hungary's consumer price index dropped to 2.8% yr/yr in September from 3.1% in August. Kuti also highlighted that the MNB is driven towards an on-hold decision not only by the diminished inflationary pressure, but also by global developments.

The European Central Bank (ECB) has decided on further monetary easing in September, and its new President, Christine Lagarde is also expected to maintain the loose policy stance. "The Federal Reserve has also eased monetary conditions, and after July this year it narrowed its interest rate band again in September. The market expects the Fed to lower rates further in October, although in September it projected unchanged rates for this year," commented Kuti.

Analysts polled by Portfolio believe the MNB will not alter rates in October, either. Sándor Jobbágy, economsit at CIB Bank, reminded that the bank in a base case scenario, the MNB decides on whether to change interest rate or other (e.g. liquidity) conditions on the basis of the quarterly Report on Inflation, the next of which is to be published in Decmeber. "Any divergence from this pattern may presumably occur only in the case of extraordinary events (e.g. an unexpected external shock)," he added.

The Hungarian central bank was apparently relaxed also about the extremely weak forint, according to the official MPC statement released after the September policy meeting. It underlined that other inflationary factors were counterbalancing the impacts of the HUF depreciation, and that the exchange rate is only one of the many factors affecting inflation and its influence is minor, noted Jobbágy. Since the previous rate-setting meeting, EUR/HUF has stabilised in the 330-335 range. 

Gábor Regős, head of the macroeconomic division at think tank Századvég Gazdaságkutató, pointed out, however, that although the September CPI print was reassuring for the MNB, as it returned to under the target (3.0%), this was caused by factors outside of core inflation. Core inflation gauging underlying processes accurately remained close to the upper end of the tolerance band, i.e. inflationary pressure did not disappear from the economy, he said.

Internal price pressure mounted: core inflation edged up to 3.9% yr/yr in September from 3.7% in August, and core inflation adjusted for the effect of indirect taxes, a key metric for the MNB, rose to 3.4% from 3.2%. "We expect core inflation to rise at a rate higher than headline inflation both this year and next, fuelled mainly by the wage pressure characterising the Hungarian economy," said Kuti.

The dual nature of the processes remained in September, as well: domestic factors fuel inflation, while external ones dampen it, said Regős.

Forint weakness is apparently here to stay, but the MNB is unlikely to act on it. Consequently, we don't expect monetary conditions to be changed in the foreseeable future, although both core inflation and the forint exchange rate might warrant such action

, added Regős, who thinks the ECB's recent monetary easing may persuade the MNB to maintain a wait-and-see attitude. 

Péter Virovácz, chief analyst at ING Bank in Budapest, thinks signs of deceleration are already visible in various segments of the economy, particularly in industry and construction. 

External risks did not abate meaningfully, i.e. the external disinflationary pressure keeps on mounting, added the analyst, who thinks that 

the official statement by the monetary council will once again stress caution and that the central bank remains in a data-driven mode.

Despite the contradictory inflationary processes the market is divided on whether the next move by the MNB will be tightening or easing. Whereas a sweeping majority of the analysts were previously expecting tightening, this unity in views is no more. This may have a great deal to do with the dovish statement published by the MPC after the September policy meeting. The rate-setting body said "previously symmetric risks to inflation became asymmetric in the last quarter. Downside inflation risks have strengthened further, reflecting the effects of the slowdown in European economic activity. Due to the measures taken by global leading central banks, the external monetary policy environment has become looser." This suggests that as soon as it gets a chance, the MPC will consider monetary easing as a viable option.

Virovácz thinks that cutting the overnight deposit rate back to its pre-March level would be a logical step. In his view, the continuation of the bond purchase programme might also be an option, but this time without sterilisation, i.e. the MNB could carry out an actual quantitative easing (QE). "The probability of the latter is greater," he said, citing MNB Deputy Governor Márton Nagy, who told Portfolio's Budapest Economic Forum last week that the balance sheet of the MNBamounts to 27% of current GDP, which provides room to manoeuvre.

Cover photo by  MTVA/on commmission by Gábor Juhász