Hungary Weighs Rate Cuts in About-Face Spurred by Asset Gains

  • Rate reduction unlikely before May, vice governor says
  • `Positive risk premium shock' fueling asset gains, Nagy says

Hungary’s central bank is considering cutting its benchmark interest rate, Vice Governor Marton Nagy said, reversing a stance from January and prompting investors to sell the forint and increase bets on lower borrowing costs.

Following a slower-than-forecast pickup in inflation, Nagy said policy makers were considering reducing the three-month deposit rate, though they wouldn’t act until May at the earliest. Speaking to reporters in his office in Budapest Wednesday, he added that policy makers were committed to using “unconventional” tools to achieve further monetary easing at their next meeting in March. Last month he ruled out rate cuts and said the alternative measures would remain the bank’s main focus.

The central bank left the benchmark unchanged for a seventh month on Tuesday, and Nagy said he and his colleagues discussed the possibility of future rate cuts. The regulator is monitoring the effects of unconventional easing measures that it’s already put in place, as well as inflation, asset prices, and steps taken by the European Central Bank, he said.

“Both conventional and non-conventional tools are under consideration for monetary easing,” Nagy said. “At the same time, it’s too early to talk about a rate cut in March or April.”

Forint Falls

The forint dropped 0.7 percent to 310.1 per euro by 10:56 a.m. in Budapest after Nagy’s comments, while the Polish zloty strengthened. Six-month forward-rate agreements, which are used to wager on Hungarian borrowing costs, showed bets for 28 basis points in reductions to the benchmark rate, double the amount of cuts seen last week.

“We had not expected the rate cut possibility to even arise before official forecast changes have been made,” Commerzbank researchers including Tatha Ghose said in a note. “Yesterday’s meeting strengthens our view that the central bank will cut rates from 1.35 percent to 1 percent by mid-year.”

The central bank has been under pressure from investors, who pushed up the forint 2.4 percent against the euro this year through Tuesday, making it the currency the world’s third-best performing after the Japanese Yen and Myanmar’s Kyat. The yield on Hungary’s 10-year bonds fell to a 3.24 percent Wednesday, compared with 3.62 percent a month ago.

CPI ‘Surprise’

Hungary’s success in cutting its external vulnerabilities, including by phasing out household foreign-currency loans, as well as the economic-growth outlook, has helped spur currency gains. Coupled with the drop in oil prices, that resulted in a “surprise” in inflation data, Nagy said. Consumer prices rose 0.9 percent in January from a year ago, still below the central bank’s 3 percent medium-term goal.

“The inflation data has come in lower and lower” than expected “and this increases the probability that the inflation forecast will be cut” in the central bank’s next report in March, Nagy said. “Primarily this, but also Hungary’s positive risk premium shock, open the way open for easing of monetary conditions.”

Nagy reiterated that, as a next step, policy makers will look to adjust the central bank’s interest-rate corridor. In another effort at monetary easing, the regulator is also in talks with lenders about steps to generate trading on the inter-bank BUBOR rate, which has traditionally matched the benchmark rate, he said.

Unconventional Tools

Following Tuesday’s rate decision, he said the Monetary Council raised, by 300 billion forint ($1.1 billion), the limit of interest-rate swaps offered to banks that proportionately boost their Hungarian government debt holdings, which has fueled a drop in yields.

Policy makers lowered the interest rate offered on overnight deposits and charged on loans in September by 25 basis points to 0.1 percent and 2.1 percent, respectively, as they sought to increase the cost of parking excess liquidity at the central bank compared with buying government bills. Cutting the lower bound into negative territory may be considered at some point, Nagy said. The central bank has also offered free funding for lenders and taken on part of the credit risk in exchange for banks boosting lending.

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