Hungary: cut now, worry later

The Hungarian central bank trimmed 25 basis points off the base rate on Tuesday, the fifth such easing in as many months.

The move, which leaves the benchmark rate at 5.75 per cent, raised a chorus of concerns among analysts that the dove-dominated monetary council could be heading towards a cut too far. This particularly given the forint’s weakening in the previous 24 hours, when – spurred by worries over who might take over at the central bank next spring – it lost roughly two per cent, slipped at one point on Tuesday morning to Ft290 to the euro.

“[Monday's] sell-off in the forint to a five-month low suggests that the markets may not tolerate, many further rate cuts. This is likely to be exacerbated by concerns over who the government will appoint as MNB governor when the current governor’s term expires in March next year,” wrote William Jackson, emerging markets analyst with London-based Capital Economics, in his note on the cut.

Nicholas Spiro, of Spiro Sovereign Strategy, was more explicit:

“This is an external member-led MPC that continues to throw caution to the wind. The doves on the Council are taking a sanguine view of the double-edged sword of risk sentiment,” he told beyondrics

The problem, as ever, is that debt-laden Hungary is surfing the merry waves of improving global, and particularly European, sentiment – and has therefore seen its risk premiums coming down – without making any sustainable reforms to its structural economic problems.

Indeed this very weekend the government performed the mother of all educational U-turns when Viktor Orban, the prime minister, abruptly abandoned much-vaunted plans to introduce tuition fees for university education after widespread, though peaceful, student protests. Quite how the funding for this gratuitous learning is to be sourced remains unclear.

Further, the economic policies introduced by economy minister Gyorgy Matolcsy are not only unorthodox, for many they are unnerving, unsound and unsuccessful. As Andras Simor, central bank governor warned last month, the rate of investment into the Hungarian economy “has been shrinking since 2009,” while the stock of net foreign direct investment has “barely increased” in the same period.

Meanwhile, GKI, a Budapest-based economic think tank has reduced its economic growth forecast for next year from 0.8 per cent to zero, blaming what it termed the “government’s anti-growth” measures.

And, as a backdrop to all this, are the rising concerns as to who will take over at the national bank next March, and rising fears that the new governor will implement yet looser, pro-growth policies.

“Now that it is increasingly plausible that the 2013 deficit will come in at 3 per cent of GDP, the government and the less and less independent central bank will care more about growth – favouring exports through weaker forint – than inflation, then the risks are that inflation expectations will remain high for the medium term,”” Gergely Palffy, of KBC Securities in Budapest, told beyondbrics.

For now, the markets appear to have taken the rate cut in their stride – the Hungarian currency trading at Ft288.2 to the euro in mid-afternoon London time.

But as Jackson at Capital Economics warns, in his view the eurozone crisis is set to escalate next year. “This will cause capital inflows to dry up, and put pressure on the forint. As such, there is a very real risk that central bank… could be forced to tighten monetary policy (again) in order to defend the currency.”

If, or when, it does, the jump in the base rate could well wipe out the sum of the easings undertaken since August this year.

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