Hungary Surprise Rate Cut Sends Yield to Year-Low

Hungary’s borrowing costs tumbled to the lowest level in a year before a bond auction tomorrow as investors bet on further interest-rate cuts after the central bank’s surprise reduction last week to fight recession.

Yields on three-year government forint bonds dropped to 6.732 percent on Sept. 3, the lowest since September 2011, according to data compiled by Bloomberg. Investors demanded 6.75 percentage points more to hold Hungarian debt rather than similar-maturity German bunds on Sept. 3, the narrowest spread since the end of October. The Debt Management Agency is offering 45 billion forint ($200 million) of debt due in 2015, 2017 and 2022, according to data from the agency on Bloomberg.

The Magyar Nemzeti Bank cut rates by 25 basis points to 6.75 percent on Aug. 28, citing Hungary’s slide into its second recession in three years. Rate reductions may continue as the four Monetary Council members appointed by Prime Minister Viktor Orban’s government outvote central bank President Andras Simor and his two deputies, according to Peter Attard Montalto at Nomura International Plc. Traders are betting on additional cuts of as much as 50 basis points before year end, according to forward rate agreements.

“The rate cut lifted the bond market,” Sandor Jobbagy, a Budapest-based analyst at Intesa Sanpaolo SpA’s CIB Bank unit, wrote in e-mailed comments yesterday. “The move also strengthened expectations for further easing this year.”

Economic Contraction

Hungary’s economy contracted 0.2 percent in the second quarter from the previous three months and shrank 1.2 percent from the year-earlier period, the central statistics office in Budapest said on Aug. 14. The data show that the economy is in recession and the slowdown in export demand hurts the growth outlook, the Monetary Council said in a statement on Aug. 28.

The nation’s benchmark rate is still the highest among central bank benchmarks in the European Union, helping to prop up the forint as the government struggles to obtain a bailout from the International Monetary Fund and the European Union 10 months after requesting the aid.

Forward-rate agreements used to wager on interest costs in three months fell six basis points to 6.39 percent yesterday, the lowest since September 2011. The FRAs traded 50 basis points below the Budapest Interbank Offered Rate, indicating expectations for a half-percentage point cut in the benchmark rate.

‘Extremely Slowly’

Orban’s government held a first round of talks with the IMF and EU in July after delays caused by a dispute over legislation threatening the independence of the central bank. A separate plan to tax the bank’s transactions approved in July risks complicating the negotiations on a credit line again, Eszter Gargyan, a Budapest-based economist at Citigroup Inc., wrote in a research report yesterday.

IMF-EU negotiations “will proceed extremely slowly, but this should not stand in the way of the rate cutting cycle in the near term, which will be favored by a weak economy,” Raffaella Tenconi, a London-based economist at Bank of America Corp., wrote in an e-mailed report Sept. 3. “We expect a further 75 basis points of easing by year end,” Tenconi wrote.

The Monetary Council voted to ease rates by a “tight” margin even as Hungary faces delays in meeting inflation goals, Simor said Aug. 28. Of 18 economists in a Bloomberg survey, 17 said the bank would leave rates unchanged while Lars Christensen from Danske Bank A/S predicted the cut.

Rising Inflation

Hungarian inflation, the fastest in the EU, accelerated to 5.8 percent in July from 5.6 percent in June, moving further from the central bank’s 3 percent target. The pace may slow to the goal in 2014, Simor said in July.

The government doesn’t comment on central bank decisions, the Economy Ministry’s press office wrote in an e-mailed response to questions from Bloomberg yesterday. Simor declined to answer reporters’ questions last week in Budapest on the breakdown of the Monetary Council’s vote, ahead of the publication of the meeting’s minutes on Sept. 12.

“The impact of each individual rate decision can only be grasped in a very limited way,” the central bank wrote in an emailed response to questions from Bloomberg yesterday. “Monetary policy mostly takes its effect over a time horizon of four to eight quarters. It’s only possible to assess their impact after analyzing money and capital markets and changes in the real economy taken together.”

Hungary will continue aid talks with the EU and IMF this month, Zoltan Csefalvay, a state secretary at the Economy Ministry, said yesterday in an interview in Krynica, southern Poland, without specifying a date.

Definite Bailout

Hungary will “definitely” obtain a credit line from the IMF by the end of 2012, Antal Rogan, who heads the ruling Fidesz party’s lawmakers in parliament, said in an interview published in Magyar Nemzet today. The Cabinet may have to look for new sources to replace revenue from the tax on central bank transactions as the bank’s losses may have to be reimbursed by the state in the following year, Rogan added.

The government is working on its responses to IMF and EU policy proposals made following a week of negotiations in July, Orban told reporters in Budapest today.

The forint weakened 0.3 percent to 285.25 per euro by 4:23 p.m. in Budapest, extending its slide since Hungary’s rate cut on Aug. 28 to 2.6 percent and paring its gains this year to 10 percent, the most worldwide after the Chilean peso. The zloty has gained 6.7 percent in 2012 and the koruna advanced 3.2 percent.

The forint weakened after Bruxinfo reported today that the European Commission may start a legal case against Hungary because of the country’s financial transaction tax.

Hungary’s 3-year bond yields were little changed at 6.804 percent today.

ECB Decision

Hungary’s debt agency raised more than planned at its last auction on Aug. 23 as borrowing costs dropped to an 11-month low. Hungary’s three-year yields have fallen 3.6 percentage points from a 2 1/2 year high of 10.3 percent on Jan. 4. That narrowed the yield premium over Czech notes of the same maturity to 610 basis points from 830 in January, according to generic prices compiled by Bloomberg.

The European Central Bank will announce its interest rate decision after Hungary’s auction tomorrow, which may damp demand, CIB’s Jobbagy said.

For Hungary “our base case is for 25 basis points of rate cuts in the rest of this year, which will depend on the speed of IMF talks and developments in the euro area crisis,” Jobbagy said.

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