Hungary Succumbs to Economic Reality in Restarting Easing Cycle

  • Policy makers lower benchmark rate to record 1.20 percent
  • Reduction also takes overnight deposit rate below zero

Hungarian central bankers, who have spent recent weeks backing away from a pledge to keep their main interest rate unchanged, gave up the last remnants of their resistance and surprised the market by bringing forward cuts to combat persistently below-target inflation.

Policy makers in Budapest cut the three-month deposit rate to a record 1.20 percent from 1.35 percent, the National Bank of Hungary said Tuesday in a conference call with reporters. Only one of 19 economists in a Bloomberg survey forecast a cut, to 1.25 percent, with the rest predicting no change. Central bankers also pushed the overnight deposit rate to minus 0.05 percent, below zero for the first time, and said they were ready to ease monetary conditions further if necessary.

Under pressure to boost inflation that’s deep below their target and with investors stepping up bets for easing, Hungarian central bankers abandoned their vow to keep rates unchanged through the end of next year. Their move was also hastened by the European Central Bank’s new monetary stimulus this month, which raised the prospects of the country’s assets attracting inflows that would further strengthen the forint and drive prices even lower.

"It appears the central bank has been deliberately trying to tone down market expectations for monetary easing only to deliver a surprise rate cut and weaken the forint’s exchange rate,” Gergely Urmossy, an economist at Erste Group Bank AG in Budapest, said by phone. He sees the main rate dropping to 0.75 percent. “The longer the easing cycle is drawn out, the longer the central bank will be able to limit forint appreciation pressures.”

Forint Weakens

The forint fell 0.2 percent to 311.57 per euro by 6:22 p.m. in Budapest, having slid to 313.10 earlier Tuesday, the weakest since Jan. 29. The currency has gained 1.4 percent this year, the fifth-most among 24 emerging-market currencies tracked by Bloomberg. Forward-rate agreements used to wager on borrowing costs in three months were at 1 percent, showing that investors are betting on further rate cuts.

Central bankers only recently signaled a willingness to cut rates. In January, Vice Governor Marton Nagy ruled out lowering the benchmark, only to say last month that policy makers would consider a reduction no earlier than May while they adjust the so-called interest-rate corridor.

‘Comprehensive Easing’

The monetary authority on Tuesday also cut the premium it charges on overnight collateralized loans by half a percentage point to 0.25 percent. That narrowed its difference with the overnight deposit rate to 1.5 percentage points. Central bankers pledged to review the rate corridor each time they made a decision about the benchmark rate.

Policy makers said they were ready to do more.

“The sustainable achievement of the inflation target has made it necessary to implement a comprehensive easing of monetary conditions,” the rate-setting panel said in a statement. “The Monetary Council remains ready to use every instrument at its disposal to contain second-round inflationary effects. Interest-rate cuts will continue as long as monetary conditions become consistent with the sustainable achievement of the inflation target.”

Part of the justification for the surprise rate cut is the changing outlook for inflation. An hour after the decision, the central bank released its latest forecast, cutting its prediction for price growth to an average 0.3 percent from 1.7 percent for this year and to 2.4 percent from 2.6 percent for 2017. Consumer prices rose 0.3 percent in February, compared with central bankers’ 3 percent medium-term target. The prediction for economic growth was raised to 2.8 percent from 2.5 percent, according to a website statement.

Rate Outlook

“The cut was triggered primarily by the weaker inflation outlook,” London-based economist William Jackson of Capital Economics Ltd. said in an e-mail. “Against this backdrop, further monetary easing seems likely.” He predicts the benchmark will fall to 1 percent by the end of the year, “although there’s a risk of more aggressive easing.”

The least surprised by Tuesday’s move was Agata Urbanska-Giner, the only economist in the Bloomberg survey to predict a rate cut, who cited the need by policy makers to combat inflation and further lower debt-financing costs by making it less appealing for banks to park their excess liquidity at the central bank following the adjustment of the interest-rate corridor.

“We expected a rate cut in March, it was a logical sequence of events,” Urbanska-Giner, a London-based analyst at HSBC Holdings Plc, said by phone after the decision. “There is definitely more to come. Expect another 20 basis-point cut to 1 percent in the policy rate until mid-2016.”

The central bank has complemented a program of free funding to lenders with new offers and regulations to jumpstart lending and buoy growth. That includes three-year interest-rate swaps, where the regulator takes on part of the credit risk if banks boost borrowing in return. It’s also trying to channel lenders’ deposits at the central bank into sovereign bonds to cut government borrowing costs as another part of its unconventional-policy arsenal.

“Today accelerated the narrative of reaching a looser point of monetary policy accommodation,” Peter Attard Montalto, an economist at Nomura Plc in London, said by e-mail. “What happened today was that we basically got to where we thought the MNB would end up in May -- the timing is the surprise.”

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