Hungary’s central bank: playing with fire

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Only last week, Nomura’s Peter Attard Montalto warned that Hungary’s central bank “appears to be playing with fire” in its insistence that “Hungary is different” and that – with inflation at all time lows – it can continue its rate cutting policy regardless of the bigger world out there.

Montalto published that on Thursday, when the forint had recovered from the worst of the buffeting it received earlier in the week, to trade in a range around Ft308 to the euro.

Alas for Budapest, within three working days his words seemed all too prescient: on Monday it was a case of another week, another significant wobble, as the forint lurched from its rather short-lived comfort level to within a whisker of Ft312 to the euro by mid afternoon. It later regained some ground to around Ft311 – a loss of 1.2 per cent on the day.

It must be frustrating for the government to see the currency caught up in the turmoil that has swept through emerging markets this year. After all, employment is picking up and there are real signs of recovery.

True, critics say inflation is being artificially held down by price caps, that employment figures are distorted by public works schemes and that Hungarians employed abroad are still being counted at home.

Even so, the budget deficit is under control and, with exports yielding record trade surpluses and order books growing, most agree the economy is likely to grow by 2 per cent in 2014.

Isn’t that all good enough?

Quite possibly not, says Montalto. “In a nutshell, the market is slowly waking up to the looming real-rate overcutting story,” he told beyondbrics.

Thanks to low inflation, the central bank seems wedded to rate cuts regardless of all else. This from Montalto’s note:

The room and need to cut rates further on the domestic macro front remains clear. The officials we spoke to see inflation remaining subdued for an extended period together with a negative output gap throughout the MNB’s forecast horizon. Possible further ECB easing (both this week and in the rest of the year) was another reason to see room to cut. That is combined with a strong view that “Hungary is different” (from everyone else, particularly higher beta EMs) and also that the recent EM “wobble” is temporary and should calm down as the market realises “Hungary is different”.

Rhetoric will clearly be a key part of the strategy to open up the space to cut, though the MNB does not consider that that is what it has been doing recently.

Montalto reckons the central bank now views the “financial stability bite point” for the forint as being in the region of Ft340-350 to the euro – a long way from last week’s weakest point of Ft314. On top of this, the bank “seems to want to play down the “political” implications of a weak HUF on household consumption,” Montalto argues, as it judges that the weak currency no longer affects monthly loan repayments as it did formerly, as a large proportion of foreign currency household debt is no longer truly free floating.

Hence the MNB’s coolness when pressure on the forint built up early last week.

Montalto wrote:

All this means that, both at current spot market levels and also during the recent lows, the MNB sees no need to hike rates. Nor is there any need to intervene in the currency under normal market conditions, and the Bank seems to be concerned that such a move might send a message of panic to the market, and that actually Hungary wasn’t different at all.

Montalto believes that the monetary council members see their target base rate as 2.5 per cent – as in Poland – and that barring a collapse of the forint to 340 or more to the euro, they are intent on shaving away until they reach this goal.

As he put it:

Overall, then with the MNB framework clear, the two key calls to make are: (1) whether MNB rhetoric that “Hungary is different” can really work in calming expectations ex-ante, and (2) a call on the external environment. The two factors can be seen as being linked and so a partial fudge may emerge that would allow for the MNB to be (extremely) lucky and be able to cut. That said, we should consider that if EM is in an episodic wobble over the coming months, even year, each cut will mean the next wobble weakens the economy further and leaves it at greater risk of outflows. In following this strategy, the MNB appears to be playing with fire, in our view.

Treasury officials may well have been surprised by the forint’s slump on Monday. Given the current nervousness on global markets, unless the monetary council shows less ideological zeal for cutting rates, they could be in for more surprises in the weeks to come.

Back to beyondbrics

Related reading:
[video] EM: It feels like a rout, FT
EM central bankers: guiders, reactors and mavericks, beyondbrics

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