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Central Bank Signals Tightening Policy

The National Bank of Hungary kept the base rate at 0.9% at its latest rate setting meeting. But more importantly, it revealed moves to simplify and fine-tune its set of policy instruments. Analysts say that it might signal the start of a tightening cycle in the longer run. In the short-term, however, the central bank is expected to stick to its dovish stance.

The Monetary Council of the National Bank of Hungary left the base rate on hold, keeping it at the record low 0.9% level that was first set back in the spring of 2016. The council also left the O/N central bank deposit rate at -0.15% and the O/N collateralized loan rate at 0.9% at the meeting on September 18.

But what caused a stir on the market was the accompanying statement. In this, the council announced that it had reviewed its monetary policy instruments and was “prepared for the gradual and cautious normalization of monetary policy, which will start depending on the outlook for inflation. [...] The set of unconventional instruments affecting short-term yields will be simplified, and the Monetary Council will publish the background material to the [MNB’s] instrument strategy. In addition, the set of unconventional instruments affecting long-term yields will be fine-tuned,” the council said.  

As for the inflation target, it is still expected to be sustainably reached in mid-2019. To ensure this, in the council’s assessment, maintaining the base rate and loose monetary conditions is necessary, the statement noted.  

Phasing Out

Another important decision the council made is a change in one of its main instruments. The council has decided to phase out the three-month deposit, previously the central bank’s main sterilization instrument.  

According to the statement, the current stock of three-month deposits will decline to zero by the end of December 2018. In the future, mandatory reserves will be the main policy instrument, the council said. The interest rate on mandatory reserves and preferential deposits will remain equal to the central bank base rate.

“Looking forward, the [MNB] will adjust the monetary conditions necessary to achieve the inflation target in a sustainable manner by creating an optimal combination of two of its instruments: swaps providing forint liquidity and the interest rate corridor,” the council added.

The council decided to phase out tenders of the MNB’s monetary policy interest rate swaps (MIRS) as well as its mortgage bond purchase program by the end of 2018. The council set the maximum annual stock of MIRS for 2018 at HUF 1.1 trillion. At present, MIRS stock stands close to HUF 935 billion. The mortgage bond purchase program will be phased out in two stages: purchases on the secondary market will continue until September 30, those on the primary market until December 31.

One Anchor

The council reiterated that inflation remains the MNB’s “single anchor”. However, under the flexible inflation targeting regime, rate-setters take into account all the factors that may affect inflation developments on the five- to eight-quarter horizon of monetary policy, it added. Among those factors the council included commodity prices, changes in the external inflation environment, labor market conditions, the position of the real economy, developments in the exchange rate and credit market conditions.

“By taking into account all these factors, the [MNB] is able to assess the likely magnitude and persistence of future price changes, which in turn determines the monetary policy response,” the council said.

Based on the statement, it is clear that the MNB has left behind its ultra-loose monetary policy stance, as it decided to drop those non-conventional instruments it introduced recently, and the tone of communication has also changed, Equilor said in a press release reacting to the monetary council’s decisions.

The planned changes in the MNB’s instruments can be seen as an early sign of tightening, said Erste Bank junior analyst Zsombor Varga, adding that in the medium-term, the conditions of the current loose monetary policy are expected to remain at place. According to him, a raise in the base rate would first be possible in 2020.  

Others are being more exact: CNBC, for example, quotes in its story on the matter several analysts saying they expect the first MNB base rate hike to come in the second half of 2019, although its median forecast sees no change in the base rate next year, and predicts an increase to 1.6% by the end of 2020.

Numbers to watch in the coming weeks

The second estimate of July retail trade data is expected to be issued today (Friday, September 21). The Central Statistical Office will publish employment and unemployment figures for the June-August period on September 27. First estimates of August retail trade will be out on October 3, followed by the August performance of the Hungarian industry on October 5.