• As expected the Hungarian central bank kept its key base rate unchanged at 9.50% at today’s rate meeting.
    • The MNB has limited room to deliver rate cuts despite inflation dropping below 3% in March. The currency is weak, the financial markets are distressed and government bond auctions did not go that well last week.
    • We are looking for a possible cut of 25bp in Q3, but local risk factors are very high.

    Details: The MNB found no arguments for cutting its key base rate at today’s rate meeting. Hence the key rate remains unchanged at 9.50% - in line with expectations. From November last year to January this year, interest rates were lowered 2.00 percentage points, as to withdraw some of the extraordinary hike of 3.00 percentage points following the IMF package.

    Assesment & Outlook: Today’s rate decision reflects that the Hungarian central bank has limited room to manoeuvre in the current environment. The outlook for the Hungarian forint (HUF) is fragile despite a fairly good run on the back of rising global risk appetite since the beginning of March. EUR/HUF is heading back above 300, now trading around 299.

    Further, the economic challenges are very large for the new Hungarian administration. Gordon Bajnai, who took over as prime minister last week, announced yesterday that the government would raise the value added tax rate to 25% from 20% effective July 1 while reducing corporation's payroll taxes. Further he announced spending cuts worth HUF 400bn (roughly EUR 1.35bn). These adjustments aim to keep the budget deficit below 3% of GDP in 2009 – in line with IMF’s conditions.

    Higher VAT changes the inflation outlook. The Hungarian finance minister today said that inflation is likely to be 6.5%-6.7% y/y by year-end. He expects inflation to average 4.5% y/y in 2009 and 3.7% y/y in 2010. This makes it more difficult for the MNB to act with further cuts despite the slumping economy.

    Last week public debt auctions went rather bad, which reflects that market participants remain concerned about the outlook for the Hungarian economy and financial markets. The recent downgrade to ‘BBB-‘ from Standard & Poor’s probably did not help the sentiment – see comment here.

    Going forward we expect EUR/HUF to reach 310, 320, and 325 in 3M, 6M and 12M respectively. We expect one cut of 25bp in Q3 2009, but with the new government initiatives that push inflation higher, the window for monetary easing might be closing.