MNB probably stay on hold, while a rate hike could make sense

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Currencies: Hungarian PM leaves its post, the Czech PM might follow suit on Tuesday
Fixed Income: MNB probably stay on hold, while a rate hike could make sense

Hungary

The Hungarian forint started the week roughly 2% weaker around 303-305 after PM Gyurcsany announced his resignation on Saturday. Timing is a major surprise, but otherwise it looks to be the usual and so far successful election campaign strategy of the Socialist party. Socialists chose a new face as PM nominee before the 2002 elections and they won, then in 2004 they replaced him, Medgyessy with Gyurcsany, and the newcomer did the trick again and won the elections in 2006. Given the outlook for a deep recession in 2009, this move helps Socialists to minimise the loss of popularity over the next 12-months, while Mr Gyurcsany could become the kingmaker for the 2010 elections.

The most likely scenario is new, 2nd minority government of the Socialists helped by the Free Democrats until 2010. Free Democrats’ popularity is just 1%, well below the 5% threshold therefore early elections would be too dangerous for them. Socialists will choose new candidate on April 5 meeting and Parliament may vote on the new PM on April 14.

The formula is the Hungarian 'confidence vote on the PM', which is not very democratic in our view as it ignores the President completely, but nevertheless allowed by the Constitution. It means the Parliament votes on the new PM and the old one ousted by electing a new one. If the vote in unsuccessful, the Parliament is not dissolved, but parties will have another 40-days to find another PM. Very likely they will find one at first, in our view, but if not, they will likely do that in the next try as smaller parties would make a suicide with early elections.

Gyurcsany also said that new government will have a difficult job as it may need to engineer an even deeper spending cut than his one of Ft200-250bn. This could be a key info for markets because it may ease concerns about about the 3% deficit target set by the IMF program.

Central bank may be the winner of the current situation because they now have a reason to hike. Without this, it would be difficult to explain why we need tightening right after they finished the easing cycle. MNB announces rate decision at 1400 on Monday. Overall, the forint may remain weak for the next two weeks unless the central bank hikes the base rate today, but we do not expect significant depreciation of the currency given the majority of deputies are interested in having another minority government until the 2010 elections and the new government will likely tackle the problem of lower revenues.

Negative sentiment weighed on the Hungarian bond market as well. The long-end touched record high levels again as investors are getting concerned about the fulfillment of this year’s deficit target. We are less so and possible monetary tightening could also help the long-term outlook, so probably the long-end may not suffer much from here. The short-end however could do because the market has priced in only 50bps rate hike, while central bank may do more given the current risks.

Czech Republic

The Czech koruna rebounded on Friday as it basically tracked the firming Polish zloty. There were no domestic events, which could mark the price action. The start of the new week might be quiet interesting for the Czech currency. First, the forex market might react to rising political uncertainty both in Hungary and on the domestic political scene. The Czech government will face the confidence vote tomorrow and its prospects for surviving it were lowered during weekend when some rebel MP’s form ruling parties indicated they could vote against the government. Moreover, the week will start with very poor IP figures, which will show dramatic year-on-year decline. Finally, the koruna will be hardly happy from central bank comments as the CNB Governor Tuma said in a FT interview that Czech Republic could see its economy contract by as much as 2 per cent this year if the recession worsens in Western Europe.

Czech bonds were loosing on Friday and the yield curve flattened. The calendar of domestic events was empty and weakness of the bonds could have been more the result of fears from new auctions. There is a 10 bln 3-year auction this week and a 7 bln 15-year auction at the beginning of the April. The need for further financing was mentioned by the Central bank governor Tuma, who sees about 2% declines in GDP this year. We believe that the industrial output should post significant decline, which should be theoretically supportive for the Czech bonds. Nevertheless the political tensions in the region should prevent the market from trimming recent losses.

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