The end of easing cycle in Hungary

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The end of easing cycle in Hungary, the first rate hike may come in the third quarter of 2015

The National Bank of Hungary cut base rate by 20bp from 2.3% to 2.1%, which was a surprise for the market. Additionally the governor of NBH, Mr. Matolcsy said that this is the end of the rate cut cycle and they would like to maintain the current base rate level till end-2015.

The decision is a little bit strange, as the NBH had moderated its base rate rate by 10bps month by month, so it was interesting why they speed up the end of the cycle. Probably one explanation might be, that the 2-weeks NBH bond will be abolished from 1st August and will be replaced by 2-weeks deposit instrument. It caused heavy interest in the short government bonds (especially for 3-months Tbills) which pushed the short yields to extremely low levels. The NBH could use this market environment for a bigger cut.

The NBH emphasized that the inflation may return to the inflation target (3% Y/Y level with the tolerance channel of +/- 1%pt) at end-2015, but if the Monetary Council sees that the inflationary outlook is changing, they will adjust the monetary policy.

It was not a surprise that the NBH would like to maintain the current historically low level for an extended period, and the statement confirmed our view that NBH’s tolerance zone might be quite wide, also in case of exchange rate level and also in case of inflation. It suggests for us that in a case of fast and substantially movement of the EUR/HUF pair, The NBH might use first the tools of verbal and foreign currency market intervention. We are slightly less optimistic than the NBH, as the start of FED and BOE rate hike cycle might force Hungary also to increase the base rate, although we expect that there might be couple of months postponement of the movement. So our base case is that first hike may come in summer 2015, but the cycle might be gradual a slow, so we expect that base rate might remain below 3% at end-2015.

The HUF reacted on the bigger than expected cut by weakening, but it started to strengthen on the news that the rate cut cycle is ended and reached the 100-days moving average. As the possible end of the rate cut cycle was already communicated by the leaders of the central in the last weeks, and it was also mentioned that base rate might keep above 2%, we think that it was mostly priced into the market. Additionally the strong forward guidance that base rate may remain at 2.1% till end-2015 means rather a loose monetary policy. So we didn’t change our exchange rate forecast, which means that EURHUF may continue the range trading (303 and 315), but the volatility of it might increase (and chance of extreme values in case of market turbulence) thanks to the NBH’s wide tolerance zone.