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Central bank may open unconventional toolbox

With the base lending rate at a lowly 1.35% but inflation still sluggish, the MNB may consider other means for loosening money supply.

The Monetary Council has kept the base lending rate on hold at its record low of 1.35%, where it has been since the bank signaled an end to the monetary easing cycle at a policy meeting in July 2015.

“The council constantly monitors whether the resulting looser monetary conditions ensure the sustainable achievement of the inflation target,” said the central bank in a statement released after its latest rate-setting meeting. MNB targets inflation at a midpoint of 3%. Hungary’s headline inflation rose to a 2015-high of 0.9% in December, up from 0.5% in November, while core inflation was steady at 1.4%. While the central bank’s own measures of underlying inflation “continue to indicate moderate inflationary pressures in the economy”, the recent fall in oil prices could lead to lower than expected inflation in the short-term, the MNB said.

The base rate has a decreasing role in practice; instead, the central bank is focusing on transforming its monetary tools for the future, as seen in the third phase of its self-financing program (introduced on January 12), analysts say. “In our view, non-conventional tools will continue to play a major role in the short-term, and the central bank has several reasons to avoid further rate cuts,” Equilor analysts highlighted in a note reacting to the MNB’s statement.

According to Equilor analysts, it is quite likely that the MNB will modify its 1.7% CPI expectations for 2016 downwards in its March inflation report, due to the still plummeting oil prices. (In December, the central bank calculated with an oil price of $45 per barrel, however, it plunged under the $30 per barrel mark recently). In spite of corrections in the inflation path, it is not likely that the central bank will further cut the base rate in order to liven up inflation, Equilor analysts said. In their opinion, the MNB will take a wait-and-see attitude until its March inflation report is published and the rate-setting meeting of the European Central Bank (also scheduled for March) has taken place. If the ECB announces further monetary loosening actions, and oil prices do not bounce back significantly from the current level, the MNB will have greater room to manoeuver and can start deploying its non-conventional loosening tools, the Equilor note predicts.

London analyst sees dovish stance

Analyst William Jackson at London-based Capital Economics also thinks that the MNB will retain its “extremely dovish stance and perhaps hint at looser monetary policy”.

“For one thing, the latest fall in oil prices means that inflation is likely to be weaker than in the National Bank’s latest forecasts, which were published in December. What’s more, despite the introduction of unconventional tools earlier this month, these appear to have had little impact; local currency government bond yields have held steady,” the analyst said, adding that the MNB is one of the harder central banks to predict. “But regardless of its next step, the big picture is that monetary conditions are set to stay extremely accommodative over the next 12-18 months,” Jackson said.

The Monetary Policy Council (MPC) is in no hurry to change the key rate, in either direction, say Erste Bank analysts Vivien Barczel and Gergely Ürmössy.

“Even though we see inflationary pressure building up within the economy, the subdued oil prices are likely to continue to hide these developments and prevent any pushing of the headline CPI to an uncomfortable level,” they added.

 “In our baseline scenario, we see the key rate unchanged at 1.35% until the end of 2017, as the inflation dynamics are unlikely to accelerate to the extent that would trigger a hawkish response from the MPC. In our alternative risk scenario, the MPC may reveal a dovish bias later, after international market sentiment has normalized. This scenario may prevail at the earliest in 2Q16, after the ECB announces further easing measures, and additional light is shed on the steepness of the Fed’s policy rate trajectory in March. In this case, we see room for 30-40bp worth of cuts. Therefore, the base rate can be cut to 0.95-1.05% in 3-4 steps,” cited the Erste Bank analysts as saying.

J.P. Morgan analysts say that while the MNB’s focus is likely to be on current unconventional tools, they believe that several other actions could also be part of an additional monetary easing. Firstly, they mention the possibility of introducing new regulatory measures requesting commercial banks to hold more government paper. Also, it is possible that the central bank will make interest rates swap (IRS) pricing more attractive if demand for long-term papers is limited. J.P. Morgan also said that it is possible that the central bank will cap the amount placed in the three months’ deposit, and thus force banks to place more in the overnight deposit facility and/or buy more government paper. Analysts with the London-based institutions do not exclude that the MNB will further cut the base rate by another 35 basis point in small, 10-15 basis point steps. “We believe the first cut is likely in March when the new inflation report is published,” they said.

Unconventional tools introduced thus far

Earlier this month the central bank announced it would phase out the two-week deposit facility by the end of April as part of a strategy to reduce reliance on foreign funding and to cut the government’s borrowing cost by encouraging commercial banks to buy state debt. The measure was to ease monetary conditions and provide an additional boost to the Self-Financing Program, a scheme that aims to draw banking sector liquidity out of central bank facilities and into government securities. The MNB also introduced interest rates swap (IRS) tenders in 2014, in order to boost banks’ incentives to buy government securities. At the beginning of January, the central bank said it would raise the amount by one-fifth at its IRS tenders.