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Inflation is back, says OTP Treasury chief

MNB

The dilemma of inflation is back in Hungaryʼs monetary policy, due to a variety of factors such as the abstract risks of Brexit and the decelerating Chinese economy, claims Róbert Barlai, managing director of OTP Treasury, in a LinkedIn post, according to a press release sent to the Budapest Business Journal.

"Markets always confound expectations, especially when there is a high degree of consensus. Months of volatility and upheaval in the summer had promised a difficult autumn on the market and yet, once again, the exact opposite has happened. So far," Barlai writes.

"As I wrote several times in the spring and summer, the weak HUF runs counter to Hungarian fundamentals and the National Bank of Hungary (MNB) cannot remain silent (but raise the rate) if the depreciation of the HUF surpasses a certain level, given the predictable inflationary impacts," he adds.

Barlai expresses the view that the Hungarian national currencyʼs fluctuation this summer was the result of several international impacts, such as the collapse of the Turkish lira and sanctions on Russia, but notes that such factors became insignificant by early fall.

He adds that the MNB was correct in thinking that speculative anti-forint positions did not pose a threat to Hungaryʼs ultra-loose interest rate policy.

"Nevertheless, 4 or 5 months have passed since then and significant economic changes continue to take place behind the calmer market mood," Barlai observes. "In these last few months of 2018, investors and economic policymakers are focusing their attention already on the year to come. One of the most important factors is the expected evolution of the rate of inflation in Hungary," he argues.

Inflationary pressures

According to Barlai, the higher inflation path predicted for next year comes as a surprise compared to summer data, as all constituent parts of inflation posted higher figures than in summer. 

"Although transient effects will continue to contribute to higher inflation, core inflation will (also) march upwards, slowly but surely (2.8%). Furthermore, a wage increase that is significantly higher than efficiency improvements is expected to generate additional immediate inflationary pressures in the economy. This will be a departure from prior years," says Barlai.

"The rate of inflation is close to 4% today, yet the HUF is responding to the unchanged zero interest rate levels not by weakening but by strengthening," he continues. "Who would have foreseen this in the summer, when foreign investors put pressure on the central bank for keeping interest rates excessively low? Inflation is between 3% and 4% and interbank rates are actually at zero, but the HUF is unable to weaken," he adds.

Barlai claims that this might be the first time since Hungaryʼs change of political system that such a thing has happened, adding that if the MNB starts increasing interest rates, it will happen in slow, small steps, with the intention of merely following the European Central Bank (ECB) in its tightening measures. He argues that the MNB can be more tolerant towards a weaker HUF, since the inflationary effects of currency depreciation are weaker than a decade ago.

"It is very difficult to tell at this point what steps the ECB will take to cut back on loose monetary policy; after all, the growth outlook of the core countries has significantly weakened in the last two quarters," Barlai explains. "The situation is unique. Why? So far, the MNB has maneuvered with ease in the shadow of the major central banks as they conducted quantitative easing and maintained zero or negative interest rates," he adds.

"With euro area growth and the inflation outlook contracting, the ECB is likely to cut back on its tightening plans, and the MNB will find it difficult to hide behind this with a Hungarian inflation rate of around 3% to 4%. But one thing we can take for granted is that it will try," he predicts.

Unfavorable fundamentals

Barlai also observes that the key fundamentals for the stability of the forint - the foreign trade and current account balances - have changed unfavorably since spring.

"Analysts agree, for the time being, that the surplus may have shrunk but will not tip over into a deficit. This is something that will merit attention in the next few months. We have seen repeatedly that markets are not able to handle risks that are abstract, remote or difficult to price," he notes.

Barlai also lists the related risks, including uncertainty over Brexitʼs course and impact; global tightening and a shortage of liquidity; the Italian governmentʼs fiscal loosening plan at a debt ratio of 130%; the significantly decelerating Chinese economy, and the possible further depreciation of the Chinese yuan, which may put pressure on other emerging market currencies; whether the U.S. trade war is a short-term strategy for garnering votes or a long-term geopolitical strategy; as well as the U.S.ʼs second largest growth cycle ever.

"There is always a risk of corrections and trend reversals, and it is also true that several major risk factors in Hungary have dissipated or been dismantled by now," he says. "Still, if even just one of the above factors results in a significant economic deceleration globally or regionally, this may cause an external demand shock in Hungary (which is among the most open economies of the world) that could shift the central bank towards further ultra-loose monetary policy, resulting in low or even lower interest rates, a quickly expanding central bank balance sheet, and a weakening forint."

Barlai concludes his argument by saying that while the mood on the markets is good, the heightened vulnerability wonʼt be revealed.

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