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MNB surprises no one with rate cut

With inflation low and growth moving at a moderate pace, the National Bank’s reduction of the base lending rate to 1.95% is expected to be the first of several cuts.

With inflation near negative numbers over the last year, and room to grow in the pace of economic activity, the National Bank of Hungary showed no qualms in loosening the money supply by cutting the base lending rate 15 basis points to 1.95% on March 24.

The market absorbed the news well – in fact analysts had been expecting a 20bp cut in the rate – and the forint strengthened to 300 HUF/EUR for the first time in more than a year on that day. This was the MNB’s first rate cut since July, and analysts say they are expecting more in the next few months, perhaps throughout this year.

“CEE countries, especially Poland and Hungary, are facing many opportunities in 2015 to support real economic growth through monetary loosening and other central bank tools,” said Mónika Kiss, a senior analyst with Equilor Investment. “The desired level of inflation may be reached only by the beginning of 2017. A base rate cut of 15bp alone is not enough for a new stimulus, but market analysts believe that the Monetary Council might decrease the key interest rate to 1.5% in a couple of months.”

The rate cut came as the MNB sharply cut its forecast for 2015 inflation, now saying that consumer prices should stagnate this year, rather than increasing an average 0.9% as projected in December. The MNB on March 24 forecast 2016 inflation to average 2.6% annually, less than the 3% target, although the bank made the target easier to hit, by giving itself a +/-1 percentage point “tolerance bracket”.

Bracket better than target

Mariann Trippon, an analyst with CIB Bank in Hungary, called the bracket a good idea. “The change should be welcomed, as the a rigid inflation target can cause serious damage, but if the interest rate path became too flexible and unpredictable it would not affect inflationary expectations positively,” she said.

Like Kiss, Trippon said a base rate cut down to around 1.5% is likely, and she suggested that the rate may need to be cut lower if prices do not start to rise. “It cannot be predicted when the new cycle would end, as it chiefly depends on the macroeconomic data of the upcoming period and more importantly on the market processes of the upcoming period,” Trippon said.

“All in all, we expect monetary conditions to stay extremely loose in the long-term, and inflation should not reach the 2017 target. Therefore we expect low base rates for the upcoming period in Hungary.”

Kiss agreed that external factors cause some uncertainty. “The rate cut came amid the recent strengthening of disinflationary processes across Europe, which also affected domestic macro figures [...] chiefly due to the falling crude oil and food prices, as well as to exported deflation from the European Union,” Kiss said. “Central banks’ policies have been accommodating the trend: the European Central Bank started its bond buying program, therefore European yields are at record lows. Due to the low inflationary pressure, the expected increase in the [U.S.] Fed rate could be postponed to the second half of the year.”

GDP growth anticipated

As for its predictions of GDP growth, the bank was upbeat on March 24. “MNB expects a growth pace of 3.2% for this year, which could slow to 2.5% for 2016. Although the trend matches our own predictions, we believe that this year we will see growth of 2.5%, which will slow down to 2.1% in 2016,” Trippon said. “We believe that the growth pace of last year cannot be maintained. However, the structure of growth could become more balanced, and on the consumer side, the growth-driving role of investments can be taken over by retail consumption.”

Kiss also saw the bank’s estimate of growth as a bit optimistic. “We expect 2.7% annual growth in 2015 on the back of improved external demand and domestic lending stimulus. Household consumption recovery will be supported by low inflation, while net wage rises and the extension of the central bank’s Funding for Growth Scheme program could be the key contributors to GDP growth,” she said. “The favorable impact of EU fund inflows is likely to decrease from this year, but improving service balances and the revival in small- and medium-sized businesses might partly counterbalance it. Some local companies face risks of an escalation in the Russian-Ukrainian situation during the year.