Cenbank To Hike Rates On Monday Despite Amazing HUF Strength

The analysts forecast that the MPC's third interest rate raise this year will be the last in 2008, while they do not see major rate cuts in the remaining of the year, either. More the so, because in their view the staff of the NBH will take its inflation prognoses higher in its fresh Inflation Report to be published on 26 May. 

Only four out of the 20 analysts polled by Portfolio.hu expect the MPC to put a halt to rate hikes, while the rest believe the base rate will be pushed higher by 25 bps to 8.50%. 

Not wanting to change our tradition, in the following we give an overview of the arguments the two groups of analysts lined up to back up their expectations.

The minority, which expect the 8.25% benchmark rate to be left on hold, claim a ‘no change' decision is supported by the ever-larger muscles of the forint and the gradual ebbing of the global financial crisis. Moreover, they also claim that there is no threat of an expansion of the interest premium, as the European Central Bank (ECB) is holding its rates. Disinflation is happening, albeit at a slow pace, they say, and the rise in energy prices could be offset by abating inflationary pressure from the direction of agricultural products. Another argument from their part was that the March wage figures were acceptably good, and in view of these the leap at the beginning of the year may be regarded only as static, and there is a chance that wage dynamics gradually get back to normal.

One of the key arguments of those expecting a rate hike was that the quarterly Report on Inflation will probably have larger CPI figures than what the NBH currently expects. Some two thirds of the respondents project that the central bank will raise its forecasts for both the end-2009 yr/yr inflation (3.2%) and the 2009 annual average inflation (3.6%). Needless to say, this increases the chance that the NBH will miss its 3.0% 2009 inflation goal, which would make it extremely difficult for the MPC to explain why it put its rate hike cycle on hold.

“Without the inflation report the decision might be to hold rates due to the firming forint, but under the current circumstances we expect a raise and the phrase “wait and see" to appear in the MPC's communication," said Dániel Bebesy, portfolio manager and Budapest Fund Management.

“I sense a kind of paradigm change at the NBH, which started with the abolishment of the HUF band and then continued with a larger-than-expected rate hike and then another tightening when EUR/HUF was around 250. A rate increase now would unequivocally prove this change of philosophy, i.e. that - as regional experience show - you cannot achieve disinflation without a nominal exchange rate appreciation," he added.

“One final rate increase looks likely largely because the NBH wants to ensure that inflation is back to target in 2009," said Nigel Rendell, analyst at the Royal Bank of Canada in London.

István Zsoldos, analyst at Goldman Sachs in London, said the MPC really has no other choice but to hike rates.

“What else can they do with inflation forecast as it is?" Zsoldos sees the 2009 annual average inflation forecast taken up to around 4.0% from 3.6%.

Ivailo Vesselinov, analyst at Dresdner Kleinwort in London also believes the MPC will deliver a rate hike, saying “inflation concerns are likely to outweigh growth/HUF considerations."

Debbie Orgill, ABN Amro's analyst in London believes the MPC will take the base rate up by 25 bps on Monday, “due to still high inflation expectations and upward trend in core." 

Regarding the firming HUF we should underline that, in theory, this could be good news for the NBH in its fight against inflation and a suspension of its rate hike cycle could in fact be a logical response.

On the other hand, there are other factors to be considered. Firstly, the MPC has always been stressing that it will not react to short-term exchange rate fluctuations, so it would be really hard to sell a ‘no change' decision. More the so, because the central bank painstakingly avoids any open comments about exchange rate moves and is cautious not to overaccentuate the forint's position in its rate decisions.

Additionally, possible changes in the inflation projections by the NBH staff will definitely not take into consideration the HUF's sharp appreciation in the past (and perhaps in the coming) days, so the fresh prognoses could not be used to demonstrate the disinflationary impacts of a stronger forint.

“The NBH should demonstrate that a strong forint does not scare it and is willing to use its increased elbowroom created by the scrapping of the band to shut out upside inflation risks," said Gábor Orbán, analyst at Aegon Investment Fund Management. “Yields of long bonds indicate that the market does not really believe inflation could be below 4% ... or even below 5% by the end of 2009," he added.

Several analysts said next Monday's rate hike could be the last this year and many expect an opportunity will arise for the MPC to cut rates by year-end. The size of the expected monetary easing, however, has been shrinking in our polls. Looking at the median of the projections there may be no rate reduction at all. Chances are 50-50%, really.

“Rate cuts are off the agenda this year but there should be scope for substantial easing in 2009," Rendell said, while Orgill believes “there could be a rate cut as early as year end if inflation expectations become more well anchored".

What is behind the consensus is the average of several rate paths. Some of the analysts expect the base rate to be pruned back to 7.5-8.0% by the end of the year, while others see the current base rate at year-end as well. The latter group either expects the MPC to keep rates on hold from May onward or more rate hike(s) to follow and then rate cuts to be delivered in the autumn.

Irrespective of these, the rate course based on market expectations has been going higher and higher. While last summer the market thought the end-2008 base rate would be at around 6.0%, the consensus of forecasts is now at 8.25-8.50%."

Source: Portfolio Online Financial Journal