Are you sure?

City sees dovish central bank a major risk for FX borrowers

A more dovish Monetary Policy Council that a planned change in the members' nomination process could potentially create would be a major risk for households burdened with significant FX debt because of a possible consequent HUF weakness, London-based emerging markets analysts said.

In a report on emerging markets outlook for 2011, Morgan Stanley said the government “looks intent” on changing the nomination process for MPC members “to ensure that no consultation with the MNB governor is needed”. This could be the prelude to putting in place four “government-friendly” appointees in early March, when four out of seven MPC members see their mandates expire, and the three more hawkish members on the council may suddenly find themselves in a minority.

More dovish policy as a result and a possible upward revision of the CPI target are significant risks on the negative side, mostly for FX, in terms of credibility and overall policy framework. “The paradox is that easier policy and a possible increase of the CPI target could weaken the currency to such an extent that the negative impact on FX borrowers would far outweigh the relief the economy would get from official rates being 50-100bp lower”.

“We do not think the new members would actually have to cut rates or change the CPI target explicitly in order to trigger an adverse market reaction ... it would be sufficient if they simply chose to deviate from the inflation forecast and started to adopt dovish rhetoric irrespective of what the macro numbers are suggesting”.

The market would “in all likelihood perceive” that as the sign that de facto, even if not de jure, the inflation targeting framework has been abandoned and the central bank “has lost its primary focus”.

“The risks around the March nominations appear asymmetric to us, i.e. the market could sell off in case of unorthodox policy more than it may rally on the back of policy continuation”, Morgan Stanley said.

On the fiscal side, “we think that there will be a surplus of nearly 6% of GDP in 2011”. That said, this is merely the result of the savings held in the mandatory pension funds returning into the state coffers, not a show of fiscal strength. In fact, the underlying fiscal position ex one-offs has worsened significantly, as also noted by the ratings agencies. Therefore, once the one-off effect of the reclassification of the pension funds under the government pillar is gone, and the crisis taxes expire, “we think the deficit will settle at around 6% of GDP, barring more consolidation measures being announced in the meantime”, Morgan Stanley said.

The cyclically adjusted primary balance is to swing to a deficit of 2.5% of GDP this year, from a surplus of 2.2% of GDP in 2010, they added. (MTI – Econews)