Did the Hungarian central bank’s surprise decision to keep interest rates on hold yesterday suggest that President Viktor Orban is close to reaching agreement with the EU that would enable it to receive a new round of IMF assistance and prevent economic meltdown?
Most analysts think not.
Following two 50 basis point (bp) rate hikes in November and December, most analysts had expected the NBH to announce a further 50bp rate increase yesterday. Instead, the bank kept rates on hold at 7%, citing a strengthening in the value of the forint since the start of the month, as well as declining bond yields.
Recent currency strengthening reflects rising expectations among investors that Budapest may be inching closer to some form of compromise with the EU and IMF (see chart, courtesy of Barclays Capital).
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To recap, last week the EC launched legal proceeding against Budapest, torpedoing negotiations with the EC and IMF over a financial rescue package. Orban has subsequently issued a number of apparently conciliatory statements indicating that he may be willing to compromise by amending a number of the controversial new laws.
The severity of Hungary’s economic and banking crisis may eventually force Orban’s hand. Jackson estimates that the Budapest government only has funds to finance itself for another six months before going bust, and needs to roll-over some €19 billion of external debt this year, which will prove extremely difficult now that all three major ratings agencies have downgraded its sovereign rating to junk. But, given Orban's track record and the major differences between the EU and Hungary's positions, most analysts remain doubtful that a deal will be done in the near-term.
Consequently, most see yesterday’s rate decision as merely a temporary pause, with a continued impasse between Budapest and the EU/IMF likely to force the NBH to resume its hiking cycle in the coming months.
According to Daniel Hewitt of Barclays Capital:
| In our view, the government is not yet inclined to come to terms with the EC on these issues. Furthermore, the government does not yet appear to be ready to meet other EC and IMF requirements to start programme negotiations. Thus, there is a deadlock in place. In the past, deadlocks have led to market sell–offs, causing currency weakness and higher domestic interest rates. The market pressures have then spurred the government into action. At this point, we think this sequence will be repeated. Markets pressures are likely to increase before the government acts. The NBH has stated that it would raise rates in reaction to increased financial risks. Thus, the sequence of events is very likely to lead to further interest rate hikes. |
Capital Economics’ William Jackson:
| We continue to believe that there is a substantial gap between the terms on which governmentwould accept lending and the terms on which the IMF would provide it. In spite of the government’swarmer rhetoric over the past couple of weeks, we have seen few concrete details – rather it has simplystated that all issues are up for discussion. Only when negotiations start will we see how willing thegovernment is to concede ground. Given that the government has staked its reputation on maintaining economic “sovereignty”, we think negotiations will be tougher than most expect. Consequently, most see this week’s surprise decision as merely a temporary pause, with the prospect of further currency weakness, rising bond yields and more rate hikes to come. |
And Unicredit’s Gyula Toth:
| We think on the multi-week horizon the lack of rate hike might be a mistake and the bank could be forced to increase rates at a later stage. |
Of course, further rate rises will only add to the downward pressure on economic growth. This was underlined by the European Bank for Reconstruction and Development, which predicted yesterday that Hungary’s GDP would contract by 1.5% in 2012. According to the EBRD’s latest Regional Economic Prospects report:
| Given the large share of foreign investment in its domestic bond market, investor uncertainty has already translated into a rapid widening in yield spreads and forint weakness. Despite an agreement with the banking industry over the restructuring of households’ foreign exchange debt the country remains highly vulnerable to forint depreciation. Attempts by the national bank to defend the currency, which has already raised policy interest rates by 100 basis points at the end of 2011, would equally further depress growth. Given the uncertainty over the timing and nature of an EU/IMF programme, the projection foresees a contraction in GDP this year by 1.5 per cent. |
In other words, the situation in Hungary is liable to get a lot worse before it gets better.