MNB Base Rate Significantly Negative in Real Terms

HUNGARY - Report 19 Feb 2017 by Istvan Racz

As CPI-inflation rose to 2.3% in January, the MNB base rate has turned significantly negative in real terms. And inflation is expected to rise further, even if at moderate speed, throughout 2017-2018. As a result, central bank policy in the forthcoming period will have to be determined mainly by how yield-hungry domestic investors will react to this situation. But the reaction is difficult to calculate, as real-terms negative central bank interest rates are essentially unprecedented on the local financial market.

In itself, the marked rise of inflation in recent months is unlikely to prompt early monetary tightening. This surge was largely in line with the MNB’s latest quarterly forecast, which attributed it mainly to rising energy prices, and expected inflation to level off well below the Bank’s medium-term target in H2 2017. In addition, the balance of payments remains rather strong, so that the MNB still needs to worry about the strong forint. Of course, the MNB, and private sector analysts for that matter, might easily underestimate the inflationary impact of rapidly increasing domestic wages.

Preliminary Q4 GDP reflected moderately decelerating growth, in line with the recent monthly output and demand data. According to the latter, the sources of this weakness included manufacturing, construction and consumer demand. We maintain that higher growth would require more fixed investment, less rapid wage growth and a weaker forint, and we are presenting new evidence on the adequacy of the existing stock of fixed assets, and on export prices. The growth impact of the massive wage hikes carried out in January remains to be seen, of course, but the odds remain that growth will likely undershoot official expectations, together with overshooting inflation, in 2017-2018.

The massive fiscal spending seen in December turned the annual cash budget back into deficit, yet it still left behind marked improvement compared to 2015 figures. Based on net financing requirement data, the ESA2010 balance may have also improved slightly. The government’s gross debt ratio fell again in 2016, and the Treasury’s cash reserves were run down much less in December than in the window-dressing operations seen in previous years. In January, the cash budget recorded the biggest ever first-month surplus, most probably supported by one-off revenue from land privatization. Despite the expected genuinely loose fiscal policy, the government is likely to remain cash-rich throughout this year, in view of big reimbursements due from the EU.

Whether or not the government will issue an FX bond on the international market this year remains an open question. In a staff paper published in early February, the MNB argued against such an issue, claiming that a new FX bond would be neither necessary nor favorable. However, Economy Minister Varga reacted by saying that establishing a new market benchmark following last year’s credit upgrades may be favorable, and it could be a mistake to exclude such an option right at the outset of the year.

Domestic politics remain unchanged, as regards the big picture, Fidesz firmly leading the polls, the radical right falling behind again after their temporary success last autumn, and leftist-liberal parties being spectacularly unable to forge a coalition for the 2018 elections. Some fresh air in this boring environment has been a recent initiative to hold a referendum in Budapest on the government’s existing bid for the 2024 Olympic Games, by a new political group of young intellectuals, who potentially could grow into an alternative force on the back of this initiative, refreshing the existing, somewhat worn-out domestic party structure.

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