Hungary Raises Rate-Cut Threshold in Matolcsy Surprise

Hungary’s central bank tightened the conditions for monetary easing after cutting borrowing costs to a record low, signaling a cautious approach at new head Gyorgy Matolcsy’s first rate decision that boosted the forint.

The Magyar Nemzeti Bank reduced the two-week deposit rate by a quarter-point to 5 percent yesterday, trimming it for an eighth month and matching the forecast of 25 of 29 economists in a Bloomberg survey. The cuts can continue if market confidence improves, policy makers said in a statement.

“While these are flexible self-imposed rules, we believe they refer to the Monetary Council’s preference of a stronger forint and lower government yields,” Janos Samu, economist at Budapest-based brokerage Concorde Zrt., said yesterday in an e-mailed note. “Given these considerations, we see a high chance of the council keeping the base rate unchanged next month.”

Hungary’s currency had weakened as Matolcsy’s appointment sparked speculation over the direction of monetary policy, including the possible use of reserves to stimulate the economy and reduce foreign-currency loans. The country is in its second recession in four years and the central bank yesterday said the inflation rate is headed below its 3 percent target “throughout” the horizon for monetary policy.

Currency Surge

The forint strengthened for a third day, rising 0.3 percent against the euro to trade at 303.51 by 10:08 a.m. in Budapest after jumping the most in more than a week after the rate decision yesterday. That pared the currency’s loss in the past month to 2.6 percent against the euro, the worst among more than 20 emerging-market currencies tracked by Bloomberg.

Yesterday’s comment from the central bank was a departure from last month, when policy makers said inflation in line with the 3 percent target and continuing “favorable market trends” are needed for further monetary easing.

Still, investors stepped up expectations for further rate cuts after yesterday’s decision. The main rate may drop to 4 percent in the next six months, forward-rate agreements indicate.

The bias in the Monetary Council is “clearly for key rate cuts,” while keeping an eye on the exchange rate, according to Nicolaie Alexandru-Chidesciuc, an analyst at JP Morgan.

The central bank will continue to test markets before deciding on unconventional measures, which may include a funding-for-lending program that provides companies with funding at below-market rates, he said yesterday by e-mail from London.

Inflation Forecast

The central bank yesterday cut its inflation forecast for this year while maintaining its economic-growth estimate. Inflation will be 2.6 percent rather than the 3.5 percent forecast in December, with gross domestic product expanding 0.5 percent, it said. Consumer prices may rise 2.8 percent next year, while growth may be 1.7 percent in 2014, it said.

Inflation was the slowest in almost seven years in February as the government cut household energy costs. The rate dropped to 2.8 percent, below the bank’s 3 percent target and down from 3.7 percent in January. The bank will publish its full quarterly inflation report tomorrow.

Yesterday’s rate cut was “supported by a very benign new inflation projection,” Pasquale Diana, a London-based Morgan Stanley economist, said in a report today. The bank “may well have cut by more at the March meeting, had it not been for a challenging risk backdrop.”

Investors were also watching for indications of Matolcsy’s self-styled unorthodox policies being introduced. There was no mention of unconventional tools in the statement.

As economy minister, Matolcsy nationalized private-pension fund assets and levied retroactive industry taxes, damaging investments, lending and growth and losing Hungary’s investment-grade credit rating.

‘Unorthodox’ Policies

Before his appointment, Matolcsy called for the “brave” use of “unorthodox” monetary-policy tools in December in a column in the weekly Heti Valasz, sending the forint to its weakest in seven months.

The central bank can support the government’s policies and boost the economy as long as it doesn’t jeopardize price and financial stability, Matolcsy said after his nomination on March 1. The bank should “review” buying government bonds on the secondary market, Economy Minister Mihaly Varga said in a interview published yesterday.

Since Matolcsy’s appointment, the Monetary Council was expanded by two members to nine, with Gyula Pleschinger, who was the new central bank chief’s deputy at the Economy Ministry and Balog, a former deputy state secretary for tax issues in Matolcsy’s ministry. Of the previous leadership, Ferenc Karvalits’s mandate expires tomorrow.

“The real surprise comes from an increasingly cautious assessment about the recent deterioration in risk indicators,” Eszter Gargyan, a Budapest-based economist at Citigroup Inc., said by e-mail. “While the council remains overall in a dovish mood, based on growth and inflation outlook, the wording of the statement signals the possibility of a pause in rate cuts next month if there is no improvement in key risk indicators.”

Before it's here, it's on the Bloomberg Terminal.