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Hungary Cuts Near End Amid Contagion Threat: East Europe Credit

Hungarian Parliament Building
Passengers wait at a bus stop on Batthyany Square, opposite the Hungarian parliament building in Budapest. With Prime Minister Viktor Orban facing elections on April 6, central bank policy makers led by his former economy minister said that a deterioration in the market environment would rule out further easing after yesterday’s cut. Photographer: Akos Stiller/Bloomberg

Hungary is winding down interest-rate reductions after 20 straight months of cuts as contagion from neighboring Ukraine left the nation’s bonds the worst emerging-market debt after Russia and Turkey this year.

The forint had its biggest intraday gain in three weeks as the central bank said rates were approaching a level consistent with its 3 percent inflation target after lowering the benchmark to a record 2.6 percent, as predicted in a Bloomberg survey of economists. Hungarian bonds lost 3.8 percent this year in dollar terms through yesterday, surpassed only by ruble and lira securities among 32 nations in the Bloomberg Emerging Market Local Sovereign Index.

Hungarian rates may put forint-denominated assets at risk should the conflict between Russia and Ukraine spark a broader regional selloff. With Prime Minister Viktor Orban facing elections on April 6, central bank policy makers led by his former economy minister said that a deterioration in the market environment would rule out further easing after yesterday’s cut.

“Hungary’s real rates of interest may shrink to near zero by 2015 and that would certainly not be enough to lure investors,” Zoltan Szucs, a money manager at Aegon NV’s unit in Budapest, who helps oversee 2 billion euros ($2.8 billion) of assets, said by e-mail yesterday. “The forint is becoming increasingly less worth holding and, in case of potential emerging-market turbulence, may deeply underperform.”

Beyond Control

The forint gained 0.5 percent to 311.68 per euro yesterday, paring this year’s slide to 4.7 percent, the biggest depreciation among 24 emerging-market currencies tracked by Bloomberg after the Argentine peso, the ruble and Chilean peso. The currency declined less than 0.1 percent to 311.85 at 11:13 a.m. in Budapest today.

The forint’s slump has been spurred by a reduction in Federal Reserve stimulus and the crisis in Ukraine, and is beyond the government’s control, Economy Minister Mihaly Varga said in an interview with Gazdasagi Radio on March 18. Varga succeeded Gyorgy Matolcsy, who became central bank president after helping lead Orban’s self-described “unorthodox” economic policies, which cost Hungary its last investment-grade credit rating in 2012.

The ruling Fidesz party is set to win next week’s election, according to all opinion polls, after a campaign focused on mandated energy-price cuts reduced the inflation rate to zero. Orban has also used his four-year term to forge closer ties with eastern nations, including a 10 billion-euro loan from Russia to build nuclear reactors, which the premier said helps reduce Hungary’s borrowing costs.

Election Rates

With parliamentary as well as municipal and European elections scheduled this year, policy makers will try to keep financing costs low “to show that Fidesz is the party that brought low inflation, and low interest rates,” Demetrios Efstathiou, a London-based strategist at Standard Bank Group Ltd., said by e-mail yesterday.

While the rate-cutting cycle is “as good as done,” investors should expect no rate hikes “any time soon,” Efstathiou said.

The monetary authority will probably cut rates by another 10 basis points, according to Phoenix Kalen, a London-based strategist for emerging markets at Societe Generale SA. The regulator would refrain from further monetary easing if the forint weakened to between 325 and 330 per euro, or if Hungary’s five-year bond yields rose by 100 basis points from current levels, Kalen said by e-mail yesterday.

More Resistant

While the rate-cut cycle is approaching the end, the exchange rate is “very far” from a level which would threaten financial stability, news website Index reported today, citing central bank Vice President Adam Balog.

The yield on the five-year notes fell three basis points, or 0.03 percentage point, to 5.02 percent today, compared with a record low 4.41 percent on Jan. 13, according to data compiled by Bloomberg. The yield was 121 basis points above Polish notes of similar maturity yesterday, versus a three-year low of 85 basis points on Jan. 16.

Hungary’s fundamentals make it more resistant to external shocks than emerging peers, the central bank said yesterday. The nation’s current-account surplus reached 2.4 percent of gross domestic product in the third quarter and Orban has cut the budget deficit below the EU’s 3 percent to GDP limit to reduce the biggest debt burden in the east of the trading bloc.

Forint Risks

“It certainly doesn’t make sense to stop now,” Kalen said. Rates are “more likely” to go to 2.5 percent, she said. Hungary’s inflation rate will rise to the 3 percent target in 2015 from an expected 0.7 percent this year, the Magyar Nemzeti Bank said in forecasts published on its website yesterday. Government debt is forecast to rise to 79 percent of GDP this year from 78 percent in 2013, according to European Commission estimates published last month.

The government will want to avoid a “substantial” forint depreciation before the election, Gabor Korompay, a Budapest-based currency trader at Raiffeisen Bank International AG, said by phone yesterday.

“Of course they can’t do much if Russia invades Ukraine and emerging markets slide, but they can control forint-specific risks, at least until the vote,” Korompay said. “The central bank also doesn’t want to forint to plummet.”

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