Hungarian Interest-Rate Party Wraps Up With Surprise Cut

Investors are signaling confidence that inflation in Hungary will stay subdued and the forint will stabilize after the central bank’s surprise conclusion to Europe’s longest interest-rate cutting cycle.

The yield on the benchmark 10-year forint bond fell to a record yesterday in the second-biggest drop among 24 emerging markets monitored by Bloomberg. The National Bank of Hungary, which lowered its key rate a larger-than-forecast 20 basis points to an all-time low of 2.1 percent, said it will keep borrowing costs at that level through the end of next year unless the 3 percent inflation goal is in jeopardy.

While the market expects inflation to revive after prices fell 0.3 percent in June from a year earlier, the biggest drop since 1968, Hungary will benefit from subdued price growth across Europe, said Gabor Nemeth, a money manager at Aegon NV. The central bank sees pressures remaining moderate for an extended period because of unused capacity in the economy, the Monetary Council said in a statement after the decision.

“Inflation will certainly rise from the current level near zero, but price growth is low everywhere,” Nemeth, who helps oversee 2 billion euros ($2.7 billion) in assets at Aegon in Budapest, said by e-mail yesterday. “They played the end well and they maintained their credibility by staying above the 2 percent level signaled earlier.”

The forint gained 0.2 percent to 307.22 per euro by 1:18 p.m. in Budapest, the strongest in four weeks. Hungary’s currency has weakened 3.3 percent against the euro this year, the worst performance among 14 emerging markets in Europe after the Russian ruble. The 10-year bond extended its gains, cutting the yield by four basis points to 4.15 percent.

Inflation Outlook

The central bank, which cut borrowing costs for the 24th consecutive month, bringing the main rate down from 7 percent in 2012, forecasts an average inflation rate of zero this year and 2.5 percent in 2015. In the euro area, Hungary’s main trading partner, prices rose 0.5 percent in June from a year earlier.

While Hungary’s “weak” potential growth will probably help keep inflation on target, the plan to hold the benchmark rate steady poses the risk of a weaker forint when developed-nation central banks such as the Federal Reserve start tightening their policy, said Viktor Szabo, a money manager at Aberdeen Asset Management Plc in London.

Growth in Hungary’s gross domestic product will probably slow to 2.5 percent in 2015 from 2.9 percent this year, according to the bank’s projections.

“At some point volatility will increase, and in such a scenario current Hungarian yields will not look attractive in the emerging-market universe,” Szabo, who helps manage more than $13 billion in emerging-market debt, said by e-mail yesterday.

Yields Tumble

The yield on Hungary’s 10-year bonds fell 327 basis points since the rate cycle began in 2012 through yesterday, the biggest drop in the period among emerging markets. That narrowed the premium over German bunds to 3.02 percentage points, less than half the spread at the start of the cycle.

While inflation may reach the central bank’s 3 percent target in the second half of 2015, the forint will probably stay in the range between 300-310 in the next six months, said Sandor Jobbagy, a Budapest-based analyst at CIB Bank Zrt., a unit of Intesa Sanpaolo SpA.

“The exchange rate won’t be a threat for inflation for now because of the low inflation of Hungary’s trading partners,” Jobbagy said by e-mail yesterday. “For now, neither domestic demand nor wages are posing a risk.”

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