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Almost There: Central Bank Readies for Normalization

With the February core inflation accelerating to a six-year-high of 3.5%, and headline inflation being one percentage point above the mid-term goal of 3%, the National Bank of Hungary (MNB) is closer than ever to the start of a normalization process.

To the surprise of many analysts, headline inflation accelerated to an annual 3.1% in February, up from 2.7% in January, data released by the Central Statistical Office (KSH) shows. Prices rose by 0.6% from the previous month in February. Core inflation and tax-adjusted core inflation (a new anchor for the central bank) were also on the rise, which is mainly attributed to higher food and fuel prices.  

“The increase was driven primarily by the food category, as well as tobacco and alcohol, where prices increased due to an excise tax hike. Fuel prices decreased on an annual basis, but they also rose in February compared to the previous month,” KSH commented on the data.  

In February 2019, compared to February 2018, food prices increased by 5.2%. The price of alcoholic beverages and tobacco rose by 7% on average, within which tobacco prices rose by 9.6%. Prices of clothing increased 2.1% and consumer durables prices edged up 0.7%. Household energy prices rose 1.2%, while service prices were up 2.7%. Prices in the category of goods that includes vehicle fuel inched up 0.6%.

In January-February 2019, prices rose by 2.9% compared to the first two months of last year.

Above Expectations

According to ING Bank analyst Péter Virovácz, the rise in consumer prices in February was way above expectations. He said that the acceleration was mainly due to higher food prices; in particular, higher tax rates on unhealthy food products lifted overall food prices. Fuel prices lifted overall inflation only by 0.1 of a percentage point. He noted that prices for services remained flat compared to January.

Core inflation, on the other hand, jumped to a six-year high, he emphasized. All main data lines are above the 3% medium-term target of the central bank, therefore if the MNB wants to act according to its pledge to keep watching the inflation rate, it should start a tightening cycle, Virovácz said.

He believes that the bank will start the normalization process in March by reducing the forint liquidity it earlier released to the market via its FX-swap facility and increasing short-term BUBOR (the Budapest Interbank Offered Rate, the average interest rate at which the commercial banks lend to one other).  

The latest data indicates increasing price pressure, which is clearly shown by the fact that both core inflation and the tax-adjusted core inflation rate were above 3%, Takarékbank analyst Gergely Suppan noted.

He, too, thinks that the central bank will start by reducing its FX-swap facility. This alone could lead to a stronger forint, as conditions in the global economy have been eased. Imported inflation can still be lower, which, together with a moderate strengthening of the forint, could slow down inflation in the second half of the year, the analyst concluded.  

Analysts at Takarékbank expect the annual inflation rate to average 3% this year, up from an annual average of 2.8% in 2018. The rate could remain lower if oil, energy and fuel prices stay near their current level in the longer run, while increasing domestic demand and a rise in salary costs could accelerate inflation. According to Suppan’s expectations, the base rate will remain unchanged until the middle of next year.  

Slowdown Expected

According to Erste Bank analyst Orsolya Nyeste, annual inflation might further accelerate in March, mainly due to changing vehicle fuel prices, but after this, a slowdown is expected. However, both the core inflation and the tax-adjusted core inflation might remain above the 3% target of the central bank in the upcoming months.

She expects that the normalization of monetary policy will start soon, with the Monetary Council first raising the one-day deposit rate. According to her, the three-month BUBOR rate will move closer to the base rate by the end of the year.

K&H Bank head analyst Dávid Németh predicts an annual inflation rate of 3.3% in March, then expects a slowdown until the end of the summer, to as low as 2.5%. By yearend, Németh thinks the rate will be at 3.5%, putting the average annual inflation rate at around 3%.  

He noted that the central bank is facing a difficult situation: while the inflationary pressure prompts tightening actions, the global environment is not favorable, which calls instead for maintaining the current dovish policy. Németh believes that the MNB, in spite of the accelerating inflation rate, will not start tightening monetary conditions in the next three months; action can only be expected nearer the end of the second quarter, he says.

Numbers to Watch in the Coming Weeks

On March 26, the Monetary Council of the National Bank of Hungary will hold its regular rate-setting meeting, with all eyes surely on the decision makers. As for the Central Statistical Office, its calendar is not particularly crowded for the next two weeks: January data from the construction sector was due to be published on March 14, just after this issue went to print, while the state of the labor market will be revealed on March 28, and the month will close with the release of the industrial producer prices for February.