Draghi Weighing More QE Gives Hungary Reason to Resume Rate Cuts

  • Deflation, ECB asset purchases seen raising rate-cut chances
  • Hungary will probably keep benchmark rate at 1.35% on Tuesday

The European Central Bank isn’t alone in weighing the effects of fading inflation on monetary policy in the region.

As economists predict ECB President Mario Draghi will have no choice but to add stimulus as soon as this year to bolster price growth, some investors say this will give policy makers in Hungary room to embark on their third round of interest-rate cuts since 2012. While the Budapest-based central bank will stand pat Tuesday, easing may resume in the first quarter of 2016, according to investment firm Diofa Alapkezelo Zrt.

"We are calculating with that scenario," said Miklos Borbely, who helps oversee the equivalent of $1.37 billion as chief investment officer at Diofa Alapkezelo, a unit of FHB Jelzalogbank Nyrt., in Budapest.

The slump in commodity prices is hampering efforts by policy makers to stoke inflation and ensure a recovery takes hold across Europe. For Hungary, rate cuts would help revive an economy set for the slowest growth in eastern Europe and lower government borrowing costs at a time when Prime Minister Viktor Orban is taking steps to rebuild his popularity. Speculation the Federal Reserve will hold off from raising rates until next year also removes a barrier to more easing, Borbely said.

“Negative inflation, signs of an economic slowdown, together with potential dovish Fed meetings this year and further ECB asset purchases could pave the way for more cuts,” he said.

Looser Policy

Hungary’s monetary authority will keep its benchmark rate unchanged at 1.35 percent for a third month on Tuesday, according to all 18 economists in a Bloomberg survey. Borbely assigns a 35 percent probability to further easing starting from the first three months of 2016, taking the rate to 1 percent. Nomura International Plc strategist Peter Attard Montalto sees a 50 percent likelihood for a similar cut happening following an extension to the ECB’s bond buying program.

Money markets concur. Forward-rate agreements used to wager on future interest rates show bets for ten basis points of reductions over the next six months, a shift from expectations for nine basis points in increases six weeks ago.

Rate cuts may not be the only option in the bank’s toolkit to loosen policy. Just days after introducing a new three-month benchmark instrument last month, policy makers lowered the rates on overnight deposits and loans by 25 basis points, while a mandatory 2 percent reserve ratio will replace a series of multiple rates as of Dec. 1.

‘Proxy QE’

"There is a lot they can still do," Montalto said by e-mail. "We call it proxy QE. They have been lucky to have the conditions to do this."

Central bank President Gyorgy Matolcsy vowed in July to keep the main rate at the record low for a "very long" period. Economic growth is poised to fall to 2.9 percent this year, the least among five eastern European nations, after expansion of 3.6 percent in 2014 surpassed peers, according to estimates compiled by Bloomberg.

The slowdown comes as Orban regains the backing of voters with his campaign to tackle Europe’s biggest refugee crisis since World War II, including raising a razor-wire fence on the border and taking legal measures that have drawn criticism from human rights groups. His Fidesz party’s support climbed to 34 percent among eligible voters in September from 29 percent in August, according to a Nezopont poll cited by the Magyar Idok daily.

Currency Strength

Consumer prices are on a downward trend again after ending a deflationary spell in May. Prices fell by an annual 0.4 percent in September, compared with central bank estimates for them to stay unchanged this year and return to inflation of 1.9 percent in 2016.

The forint’s outperformance in recent months may compel policy makers to rethink policy and resume rate cuts, according to Gabor Ambrus, a London-based economist at Royal Bank of Scotland Group Plc. The currency has gained 1.5 percent against the euro since the end of June, the biggest advance among 24 emerging-market currencies. It traded 0.1 percent weaker at 310.45 per euro by 12:55 p.m. in Budapest.

"The central bank will become increasingly uncomfortable with currency strength," Ambrus said. "If the forint gets closer to 300 per euro, perhaps on the back of more ECB QE and no Fed hike in December, we believe that the central bank will relaunch its easing cycle."

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