It took almost a year, but "order" can finally be restored in Hungary
Goodbye, dual interest rate regime!
A year ago at the end of September, the MNB's Monetary Council ended the rate hike cycle at 13%, but the uncontrollable weakening of the forint warranted an immediate 500 basis point rate hike three weeks later. Several economic policy makers have said in recent days that Hungary was on the brink of an exchange rate crisis a year ago, which could have pushed it towards a sovereign default if not properly managed.
The MNB has managed the 18% benchmark interest rate by introducing a new instrument, as the one-day deposit rate has temporarily become the benchmark instead of the base rate. It remained at 18% until May this year, and has since been lowered at a rate of 100 basis points per month.
The central bank signalled earlier that it would lower the benchmark rate by another 100 bps after its September policy meeting, so the surprise would be if it didn't. This means that
after almost a year, the benchmark rate and the base rate will be at the same level again.
The central bank has already announced that it may decide to simplify the monetary policy toolbox at its September meeting. It is not yet clear what this will mean in practice, but it is possible that the one-day deposit rate regime will be abolished and the base rate will be used as a benchmark again. There have also been hints that the interest rate corridor could be made symmetric. In other words, it is almost certain that Tuesday's meeting will be a busy / noisy one, especially with the release of the central bank's latest inflation and GDP forecasts.
The historic moment is expected to arrive on Tuesday, when the benchmark interest rate will become effective again at 13%, Orsolya Nyeste said. According to the Erste Bank analyst, in terms of the effective interest rate level, we will be exactly where we were at the end of September last year, and where the central bank planned to end the rate hike cycle. Fortunately, the macroeconomic environment and risk perception are quite different now. This time last year, inflation was rising sharply and we had only a rough idea of where and when it would peak, while our external position deteriorated in a way that seemed unsustainable, largely due to the explosion in energy prices.
"Inflation has been on a downward path for some time now, disinflation may accelerate in the fourth quarter, while our external balance has turned into surplus or is improving at a much faster pace than previously expected. The negative interpretation of the latter is that not only the consolidation of energy prices but also the contraction in domestic demand is supporting the rebalancing, meaning we are paying the price in weak growth," Nyeste added. In her view,
with the outcome of the policy meeting almost a certainty, the main focus of attention on Tuesday may be on the communication on the further path of interest rates, the new central bank forecasts and the revision of the toolbox.
Brand new toolbox or just fine-tuning?
According to Nyeste, it will also be important to see what instrument the central bank will put behind the base rate as the effective interest rate again, as preliminary information suggests that policy makers are still considering a short-term instrument. An interesting question for the next six months could be whether the central bank sees the time as right to extend the maturity of the main sterilisation instrument.
The restructuring of the toolbox was foreshadowed by Deputy Governor Barnabás Virág at the 61st Itinerant Conference of Economists in Eger last week. The benchmark instrument could be a short (in the words of Virág, practically one-day), deposit-type instrument, presumably of the availability type (i.e. not tender-type), and the interest rate corridor could be a band of plus or minus 100 basis points around the benchmark rate, wrote Zoltán Árokszállási.
In other words, according to Equilor's analyst, the interest rate on the existing overnight collateralised loan could be cut to 14% from 16.5%, and the interest rate on the O/N deposit to 12% from 12.5%. Since the effective instrument was previously O/N, it is logical that the new instrument should also have this maturity, as this is the best way to ensure that the change in the direction of monetary policy stance mentioned by the Deputy Governor, which is neutral in terms of monetary policy stance, takes place.
According to Péter Kiss, analyst at Amundi, he biggest issue ahead of Tuesday's decision is also the transformation of the toolkit, and he expects the central bank to be cautious and gradual in this area, i.e. it may not immediately announce a revolutionary toolkit.
I believe that the one-day deposit quick tender will be phased out as part of the promised simplification of the toolbox. It will be replaced by the reserve account, given that the central bank will pay the base rate on excess reserve too, added Péter Virovácz, analyst at ING Bank.
He thinks the biggest communication challenge in this regard is for the central bank to make it clear to foreign investors that the one-day deposit quick tender (now 14%) will not be replaced by the plain overnight tender (the bottom of the interest rate corridor, expected at 12%), i.e. that the decision expected in September does not imply a 200 basis point effective rate cut. Indeed, a wrong interpretation by the markets could create very serious turbulence in the interest rate markets (swaps and FRAs) and put the forint under selling pressure.
What next?
The biggest question at the moment is when the central bank will start to cut the base rate, added Péter Koncz, an expert at Századvég Economic Research Institute. He pointed out that the 13% interest rate is still very high by regional standards, almost double the Czech or Polish rates. The central bank's position is complicated by the fact that high interest rates impose a huge extra burden on the budget and also significantly reduce lending, which, combined with falling inflation, would justify monetary easing, but other factors should also be taken into account.
In the remainder of the year, we expect only a 150-200 basis point cut in interest rates, due to the sovereign risks that have increased in recent weeks, said Zsolt Becsey, analyst at UniCredit Bank. He added that in addition to the fragile fiscal situation, the heralded purchase of Budapest Airport could worry investors. Even apart from the latter, it is increasingly certain that the European Commission will open an excessive deficit procedure against the country next year, which could further increase concerns about EU funds.
In my view, the central bank is also leaving open the possibility to take agile decisions in the coming months in the light of new incoming data and information. In practice, this could mean that the next rate cut is not set in stone and anything from a hold to another 100 basis point cut could be possible, said Péter Virovácz.
No specific guidance is expected on the future path of interest rates, but the central bank is likely to emphasise the need to maintain tight monetary conditions on a sustained basis, and that in the months ahead it will decide on the size of the steps to be taken on the basis of new data and information (data-driven mode), commented Mariann Trippon, analyst at CIB Bank.
And in the new phase of the easing cycle, it remains of paramount importance that interest rate cuts are implemented at a pace that does not endanger market stability and the exchange rate, she stressed.
What will happen to the forint?
In principle, the expected decision should not trigger an exchange rate reaction, as the market has priced in the merger of the base rate and the previous benchmark rate. It is mainly the MNB's communication that could bring fluctuations in the exchange rate, the question is what future interest rate path the Monetary Council will project.
The MNB should be cautious as a larger-than-expected 75 basis point interest rate cut by the Polish central bank has triggered a sharp weakening in the zloty. There is still high volatility in the forint exchange rate, which could lead to forint depreciation in the event of a fall in interest rates and adverse political news or macroeconomic developments, said Koncz at Századvég. He noted that while the central bank has no exchange rate target, it may be interested in a stronger forint in the name of combating inflation.
Analysts are split on where the forint could go by the end of the year, with almost everyone agreeing that we have already had the strongest exchange rate this (below 370), while some believe that the 400 psychological level could come back into focus in the autumn. Zoltán Árokszállási, for example, says that
we have probably already seen the weakest forint exchange rate at the beginning of the year, but a weakening from current levels is likely by the end of 2023.
Cover photo: Shutterstock
