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Further unconventional tools to be deployed

With the base rate of the National Bank of Hungary having been left unchanged, monetary conditions should loosen further, analysts agreed following the latest rate-setting meeting of the Monetary Policy Council.

In accordance with expectations, the MPC of the National Bank of Hungary (MNB) kept the key rate unchanged at 0.9% at its latest rate-setting meeting, but it lowered the upper end of the interest rate corridor to 1.05% from 1.15%, and left the lower end unchanged at -0.05%. The base rate has stood at its current record-low level since May 25, and the latest GDP and inflation data did not do anything to make the MNB rethink its stance on monetary policy. Therefore, it is more than likely that the current 0.9% will be around for the foreseeable future. Monetary conditions, however, are likely to loosen further.

Lowering the upper end of the interest rate corridor, which is the interest rate on overnight collateralized loans, was necessary because the forint liquidity of the Hungarian banking system has significantly decreased lately and banks’ net placement in overnight instruments was negative on several occasions. That means commercial banks were more active on the borrowing side of the MNB, so banks can fulfil their short-term liquidity requirements on the overnight market. The narrowing liquidity of the banking sector has been fine-tuned by the MNB through several instruments, for example, announcing two EUR/HUF swap tenders to the value of HUF 400 billion, Gergely Suppan, analyst with Takarékbank, reminded market watchers in a comment. According to him, the central bank has already signaled that its rate-cutting cycle is over, because a looser-than-expected monetary policy can stimulate economic growth sufficiently and, at the same time, the 3% inflation target can also be met. However, the analyst noted, the MNB wants to influence its monetary policy by limiting the access to its three-month deposit instrument: depending on the limits to be introduced in October, significant amounts of free liquidity might be transferred to the interbank market and to the state securities market. There will be a downward pressure on these markets, which means that the effective yields might be lower than the key rate, therefore the MNB will be able to loosen monetary conditions further without lowering the key rate. According to Suppan, the central bank is more likely to maintain the current level of the key rate for an extended period of time. “We expect that the interest rates will remain unchanged until mid-2018, while the importance of interbank interest rates might grow. The inflation target will probably not be met before mid-2018, and this, together with the sharp decrease in external debt and vulnerability supports the low interest rates. The ongoing quantitative easing of the European Central Bank, and the ever delayed rate-lifting by the Fed also supports the current key rate level, Suppan said.

“The Hungarian Monetary [Policy] Council kept its policy rate unchanged today but made various small tweaks to its toolkit in an effort to loosen monetary conditions, and with growth and inflation set to remain weak, the MPC will probably turn to straightforward interest rate cuts in the next 3-6 months,” William Jackson of London-based Capital Economics told after the MPC’s rate-setting meeting. “Despite leaving the policy rate unchanged, the central bank is clearly in an easing mood,” the analyst said, detailing that the interest rate on the (rarely-used) overnight lending rate was lowered by 10bps, to 1.05%, and commercial banks’ required reserve ratios were cut from 2% to 1%, both of which should loosen monetary conditions.”

Numbers to watch in the upcoming weeks

Inevitably, the most important macro data of the next two weeks will be the industrial production figures for October, to be released on November 8. On the same day, the Central Statistics Office (KSH) will also publish October inflation data. The first estimate of retail trade figures for September will be out on November 7. A few days before that, we’ll see how the rather weak construction sector progressed in the first three quarters of the year, as the number of construction permits will be released for this period by the KSH.

Surplus liquidity

These tweaks follow the announcement at last month’s MPC meeting that the national bank would cap the total amount of banks’ surplus liquidity that it would sterilize via the three-month deposit facility to HUF 900 bln by year-end, from HUF 1.6 trillion at the time of the meeting. In theory, that could loosen monetary conditions if commercial banks place the excess reserves that can no longer be deposited in the three-month facility in the overnight deposit facility, which has an interest rate of -0.05%. In practice, however, the cap on sterilization operations doesn’t, so far at least, appear to have had much impact on monetary conditions. Since last month’s Council meeting, overnight interbank interest rates (BUBOR) have actually risen, while longer-term interbank rates have fallen only a little (by 6-7bps), Jackson noted.

On the usual accompanying statement released by MNB after its rate-setting meeting, the London-based analyst noted a “subtle shift” in the language which suggests that the MPC may revert to conventional rate cuts if it decides to ease policy further. Last month’s statement mentioned that further easing (if warranted) would come via a smaller cap on three-month deposit operations, while this month’s statement made no mention of the possible tools that might be used to ease policy. The Capital Economics analyst thinks that inflation will remain below the 3% target in the forecast horizon.

Gergely Ürmössy, head analyst at Erste Bank said that the statement released by the MPC refrained from touching the formal three-month policy rate and aims to ease financial conditions by deploying unconventional measures. “We believe that by limiting the 3M deposit and providing additional forint liquidity to the market, the downward pressure on local interest rates and bond yields may intensify, especially on the short-dated ones,” Ürmössy said.

At the rate-setting meeting on October 25, the reserve requirement ratio was cut from 2% to 1%. This means that approximately an additional HUF 170 bln will flood the local money market. “This was definitely a surprise move,” Ürmössy noted. This shows that MPC likes to surprise markets and is willing to do anything in its power to meet its goals of lower rates and weaker forint. “The unpredictability and uncertainty stemming from it implies that interest rate, bond yield and exchange rate volatility should become elevated,” Ürmössy said. 

Hungary ‘frustrated’ by CETA collapse

Hungary’s Minister of Foreign Affairs and Trade Péter Szijjártó shakes hands with Canadian Senator George Furey in Ottawa on October 24. Szijjártó said Hungary is “frustrated” by the holdup in the signing of the EU-Canada Comprehensive Economic and Trade Agreement (CETA) at a press conference that day. “Who can we sign a trade agreement with if not Canada?” Szijjártó was quoted as saying. “It would be in the clear interests of Hungary, the Hungarian economy and Hungarian enterprises for the free trade agreement between the European Union and Canada to be signed as soon as possible,” he added. (Photo: MTI/KKM/Árpád Szabó)