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Core Inflation on the Rise, all Eyes on Rate-setters

With the latest inflation data released by the Central Statistical Office (KSH), we could see the start of a tightening cycle as early as March, some analysts say. Others, however, argue that the Monetary Council might consider a later start, as headline inflation is below the central bank’s target. Core inflation, on the other hand, jumped to 3.2%, a surprise to analysts.

Prime Minister Viktor Orbán has announced that he will propose György Matolcsy (pictured) for a second term as MNB governor.

Consumer prices were 2.7% higher on average in January than a year earlier, and basically remained flat from the previous month. Tobacco, alcoholic drinks, as well as food, were significantly more expensive in the first month of the year than a year earlier. The sharpest rise was in the price of tobacco products, with a 9.6% year-on-year increase.  

The biggest surprise in the data lies in the core inflation data: that figure jumped to 3.2% in January, up from 2.8% in December.  
Core inflation exceeded the mid-term inflation target of the National Bank of Hungary (MNB) of 3% for the first time in five years. Tax-adjusted core inflation, the central bank’s very own main core index, rose to 3% from December’s 2.9%.

After the latest inflation data was released, expectations that the MNB would start a tightening cycle soon were revived. Such expectations seem quite well-grounded, as just about a month ago, MNB deputy governor Márton Nagy claimed that the central bank could make a U-turn in its monetary policy if the core inflation measure reached or exceeded 3%.  

Cut in Liquidity?

While most analysts still expect the central bank to maintain its key rate at the record low level of 0.9% thorough the year, some think that the rise in the core inflation could soon lead to a cut in forint liquidity released by the MNB into interbank markets via its FX swap facility and an increase in the short-term BUBOR rates.

According to analysts at Bank of America-Merrill Lynch, the MNB will start a tightening cycle gradually, as it does not want to fuel a significant strengthening of the forint against the euro. As they put it, Hungary’s central bank is “not comfortable in periods when the forint strengthens below 310 against the euro, and at around 305 HUF/euro level it is likely to act pro-actively”.

Therefore analysts at BofA believe that, if the Hungarian currency strengthens too fast or goes too far, the MNB might slow down normalizing its monetary policy.  

External factors, such as trade conflicts affecting the European automotive industry and the weakening of the eurozone economies indicates that the MNB will choose a slow and gradual path. As a first step, the central bank might cut back its FX swap tool and, at the same time, it might increase its short-term BUBOR rate. The BofA, however, does not exclude the possibility of a base rate rise at the end of the third quarter or in the fourth quarter of this year.  

According to Morgan Stanley economist Pasquale Diana, taking into account the underlying inflationary pressure shown by the increasing core inflation makes it clear that the question is not whether the MNB will launch a tightening cycle, but rather it is when it will start.

Start of Normalization

Diana said that Morgan Stanley does not rule out a March date for the start of the normalization, adding that it is more likely that it will be gradual.  

It is clearly seen that the core inflation index has risen steadily in the past months and also at a faster pace than in neighboring countries, Commerzbank economist Tatha Ghose said. According to him, it would be “unimaginable” that the Polish or Czech central bank delayed an intervention in a similar situation.  

However, he sees that the MNB prefers to take a “wait and see” attitude and deploys verbal interventions instead of actual moves. It is a risk to the MNB’s credibility and the forint. “One could not blame the market if it became nervous in the interim if inflation did not show signs of softening,” Ghose said.

In the meantime, Prime Minister Viktor Orbán has announced that he would propose current MNB governor György Matolcsy (a key ally whom the PM once described as his “right hand”) for a second term. Matolcsy’s six-year mandate will expire on March 3.

By law, the governor is appointed by the President of Hungary, based on the proposal of the Prime Minister, which is followed a hearing before a parliamentary committee. There is two-term limit for the position.

Numbers to Watch in the Coming Weeks

A second reading of the retail trade data for December and for the full year of 2018 will be released on February 21. The Central Statistical Office will publish data on the labor market, referring to the November-January period, on February 22. But before that, on February 15, credit rating institute Standard & Poor’s will review Hungary sovereign debt rating; it is the first of the six reviews scheduled for this year by the three large credit rating agencies.