Hungary Tests Investors With Rate Cut as Recession Deepens
Hungary’s deepening recession prompted the central bank to unexpectedly lower the European Union’s highest benchmark interest rate as policy makers test investors’ tolerance for lower borrowing costs, said economists from London to Budapest.
The Magyar Nemzeti Bank cut the two-week deposit rate to 6.75 from 7 percent percent yesterday, the first decrease since April 2010. It will probably ease policy further this year as concerns about the lack of economic growth outweigh accelerating inflation, economists at Morgan Stanley, Danske Bank A/S (DANSKE), Equilor Zrt., and Capital Economics Ltd. said.
Policy makers have been divided on when to start cutting rates, with some arguing that the start of bailout talks opens the way to lower rates to spur growth after the economy sank into its second recession in four years. The non-executive members of the Monetary Council probably overcame objections about the inflation outlook and the pending bailout talks, said Pasquale Diana, an economist at Morgan Stanley (MS) in London.
“We think that the four external members have chosen to use the leeway offered by the better risk environment, and it is conceivable that the same members may vote to cut as long as they feel it is warranted by the risk backdrop, regardless of whether an IMF deal is struck or not,” Diana wrote in an e-mail yesterday.
The forint weakened 0.7 percent to 282.98 per euro as of 12:13 p.m. in Budapest, after sliding the most in more than a month yesterday. The currency has gained 11.8 percent this year, the second-best performance among more than 20 emerging-market currencies tracked by Bloomberg, as investors speculated that Hungary will obtain an IMF bailout.
Forward-rate agreements used to wager on interest rates in one month traded little changed at 6.72 percent, after dropping 16 basis points yesterday to the lowest since November. The FRAs traded 19 basis points below the Budapest Interbank Offered Rate, to which they settle. The spread widened to 44 basis points yesterday, the biggest difference in almost three years. A basis point is 0.01 percentage point.
The “relatively strong” weakening of the forint after the rate decision “could warrant some cautiousness of the near-term outlook for the forint as expectations of monetary easing are built into the market,” Lars Christensen, an economist at Danske in Copenhagen, wrote in an e-mailed note.
The central bank will probably continue lowering interest rates, while avoiding “aggressive” cuts, as the growth situation “is very challenging,” according to Christensen.
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 data show that the economy is “technically” in recession and the sharp slowdown in external demand hurts the growth outlook, according to the Monetary Council.
Inflation, the fastest in the EU, accelerated to 5.8 percent in July from 5.6 percent in June, drifting further from the central bank’s 3 percent target. The pace of consumer-price increases may slow to the goal in 2014, central bank President Andras Simor said last month.
The inflation figures “are hard to reconcile with today’s decision,” Zsolt Kondrat, an economist at MKB Bank Zrt. in Budapest, wrote in an e-mailed note. Yesterday’s “decision was definitely a hazardous one that may pay off if everything goes fine within and outside Hungary this autumn but, certainly, this cannot be taken for granted.”
Some members of the council earlier rejected calls for lower rates because of the inflation outlook and pending the bailout talks. The government is set to resume talks with the International Monetary Fund and the EU to protect the economy from euro-area contagion and to lower financing costs.
Rate setters “are pre-empting the IMF agreement, which had previously been seen as a precondition for a rate cut,” Carolin Hecht, currency strategist at Commerzbank AG in Frankfurt, said in an e-mail today. The forint may come under pressure if market sentiment deteriorates, forcing the central bank to reverse the rate cut, she wrote.
Seventeen of 18 economists in a Bloomberg poll said the bank would leave rates unchanged while one forecast the cut. The Monetary Council also considered leaving rates unchanged before a “tight” decision, Simor said at a press conference yesterday.
“The message is clear: the Monetary Council is rushing to help out the economy that slipped into recession, while the inflation target is being pushed into the background,” Gergely Gabler, analyst at Budapest-based brokerage Equilor, said in an e-mail yesterday. “The central bank is seemingly testing the markets to gauge how negatively they react.”
The European Central Bank this month kept its main interest rate unchanged at a record-low 0.75 percent and the deposit rate at zero. Czech policy makers left their two-week repurchase at a record-low 0.5 percent on Aug. 2, while their Polish colleagues, who surprised the market with a quarter-point increase in May, also kept the benchmark rate at 4.75 percent on July 4.
Hungary’s government reaching a bailout deal may prompt rate-setters to cut borrowing costs to as low as 6.25 percent by year-end, according to Gabler.
Further easing hinges on avoiding the potential “build-up of second-round inflationary effects” and the continued improvement of risk perceptions about the Hungarian economy, the Monetary Council said in a statement.
“The inflation picture has deteriorated since our last inflation forecast, however the sustained weakness in the real economy acted in the opposite direction,” Simor said at a news conference in Budapest yesterday. “The improvement in risk perception widened monetary policy’s room for maneuver, though it’s obviously a question to what extent that can remain the case in the future.”
The cost of insuring Hungarian debt against default for five-years using credit-default swaps was 425 basis points, compared with 465 basis points a month ago and a peak of 630 basis points on June 5, according to data compiled by Bloomberg.
A rate cut may add momentum to the economy and would be accepted by investors, Ferenc Gerhardt, a monetary-policy maker, said in an Aug. 10 interview. Simor, speaking after last month’s rate decision, argued for a “cautious policy stance” until the outcome of bailout talks is known.
IMF and EU officials are focusing on untangling policies that contributed to an economic contraction in the first two quarters and the downgrade of Hungary’s credit to junk. The country is seeking a credit line of about 15 billion euros ($18.8 billion) from the international lenders.
“We wouldn’t rule out a further one or two 25 basis point rate cuts over the next few months but given the external financing risks hanging over the economy, anything more than this is unlikely without an IMF/EU deal in place.” William Jackson, economist at Capital Economics Ltd. in London, wrote in an e-mail.
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