Hungary Monetary Easing Still a Long Way Off

Hungary’s interest rates are the highest in the European Union. Even though market sentiment is improving, as evidenced by the rapid appreciation of the Hungarian currency, the central bank is expected to keep rates unchanged for a long time to ensure that fundamentals are solid enough for monetary easing to commence.

The National Bank of Hungary (NBH) delivered the European Union’s most massive monetary tightening over the past year and a half, raising borrowing costs to 13% in response to skyrocketing inflation and a rapid weakening of the forint. The bank has made it clear on several occasions that it will keep a tight rein over monetary conditions until there is a material and permanent improvement in the general risk sentiment. Policy makers focus on a combination of external risks (war, global monetary policy, energy, general investor sentiment) and internal risks (EU funds, current account imbalance) to gauge developments in risk sentiment.

Light at the end of the tunnel
There has been a lot of improvement in Hungary’s economic situation lately. Lower energy prices translated into improving economic indicators, which in turn led to a more positive investor sentiment regarding Hungary. The December trade balance showed a deficit of only EUR 154m (vs EUR 1.2 billion in November while the fourth quarter (preliminary) current account deficit came in at EUR 3.95 billion, a EUR 0.52 billion improvement over a quarter.
In addition, there’s a strengthening consensus among analysts that inflation may have peaked in January at 25.7% year-on-year.
The forint strengthened to close to 380 per euro, after flirting with the 450 level late last year and hovering around 400 seen before the last rate-setting meeting. The forint now maintains a number one position within the CEE region and it may continue to outperform. A weaker US dollar should improve the outlook for the region as a whole, gas prices are again testing new lows, and the rate differential in Hungary is at attractive levels. Analysts at ING Bank in Budapest are positive about the outlook for the forint and expect the currency to make further gains.

Patience is a virtue
Analysts almost unanimously expects the central bank to keep interest rates unchanged at this month’s rate-setting meeting scheduled for February 28 even if the data suggest that the time may be right for a change. The ongoing debate over the reforms needed to unfreeze access to EU funds is a major risk factor for Hungary’s economy and risk profile. “We expect the National Bank of Hungary to keep its composure at its 28 February meeting and wait for more hard evidence before it starts to communicate about any upcoming pivot,” analysts at ING Bank said in a research note. “In such an environment, we see the central bank keeping its guard up, sending hawkish messages and patiently waiting for more proof of improvement regarding external, internal and political topics. The targeted, temporary measures will continue as well, as any abrupt change to the structure or to rates could reverse the gains made by the forint, which would hinder the central bank’s task to reach the inflation target over the monetary policy horizon,” according to the note.
A trend-like change in external and internal risk sentiment could lead to a better situation by the time the March rate-setting meeting takes place. However, the NBH is likely to wait at least until April to deploy any changes. Even if easing starts during the second quarter, the process will be gradual and slow.
ING sees the central bank starting regular rate cuts during the fourth quarter, strictly taking care of the real interest rate to remain positive.