National Bank of Hungary preview: Normalisation to continue unabated

We expect the National Bank of Hungary (NBH) to continue the normalisation of monetary policy despite recent market volatility, especially in the forint. We believe that global factors and repricing are the drivers of recent selloffs, while the local macro story remains supportive in our view. These episodes proved the need for cautiousness in policymaking and provided a good example as to why the central bank may prefer to err on the side of caution, signalling the importance of patience when it comes to the easing cycle.

At its June meeting, the central bank made a slight rebalancing in the order of factors that are affecting monetary policy. The updated forward guidance now puts the effects of international financial market developments on the domestic risk environment in first place, followed by incoming macroeconomic data and developments in the inflation outlook.

All things considered, we expect the central bank to replicate the decision it made last month and cut the quick deposit tender rate by another 100bp, bringing the effective rate to 15%. Similarly, we anticipate 100bp cuts to the one-day FX swap tender and the overnight repo rate (upper bound of the interest rate corridor).

Taking all the important drivers now shaping the monetary policy into consideration, we don't believe there's any need for a plan B. This is reflected in our call above, but let's take a look at a few details.

As far as international financial market developments are concerned, we believe that recent HUF weakening was widely driven by global factors. In early July, EUR/HUF briefly touched 388, crossing the 376-378 zone – the resistance level that stopped the forint from depreciating before the last three NBH meetings. While July's move was stronger than the previous three spikes, it still falls short of the rapid rise in March triggered by the collapse of Silicon Valley Bank. We therefore acknowledge the slight deterioration in FX stability, but still believe that it might not be enough to derail the ongoing normalisation of monetary policy. In this regard, market pricing is aligned with our view.

In terms of global monetary policy developments, we believe that we're rapidly approaching the end of hiking cycles for both the Federal Reserve and the European Central Bank (ECB) as the global disinflationary narrative shifts into a higher gear. As a result, the Hungarian interest rate advantage will not be eroded in two directions. In addition, while energy (especially gas) price risks have clearly not diminished, Dutch TTF gas prices are approaching the local lows seen in early June.

From a macroeconomic data perspective, the staggering EUR 1.1bn trade balance surplus in May is welcome news and shows a marked improvement in the country’s external balances, which also helps the current account. This is also accompanied by an improvement in the terms of trade.

Lastly, the June inflation figure, which fell from 21.5% in May to 20.1% year-on-year, is yet another positive development. However, given that the central bank separates the issues of price and market stability, we do not believe that this will have a material impact on the pace of the normalisation process. In this respect, recent comments by Deputy Governor Barnabás Virág reinforce our view that better-than-expected incoming data will not change the pace or magnitude of rate cuts. In the case that the disinflationary process occurs more quickly than expected, a positive interest rate environment may come sooner, which is necessary for disinflation to continue.

As the base rate is responsible for tackling fundamental price pressures, we expect it to remain unchanged at 13%. Obviously, the central bank will underscore the acceleration of disinflation as a significant factor, but we don't believe that the Monetary Council will want to make any substantive comments on a possible cut in the base rate any time soon. In contrast, recent volatility showed the need to emphasise the cautious and gradual approach to normalisation. We wouldn’t be surprised to hear these hawkish sounds again alongside the cut announcement.

The Hungarian forint is gradually normalising following the sell-off two weeks ago, which affected the whole region. We see global momentum and market overvaluation as the main reasons as local conditions improve. The market sell-off has likely lightened the heavy long positioning and we believe the massive carry will once again attract market interest. In addition, we think the market is pushing NBH to cut rates at a faster pace and the hawkish tone should be a boost going back to EUR/HUF 370.

In the rates space, we see that the very short end of the IRS curve has moved significantly lower in recent weeks due to the market wanting to see a more dovish central bank in the face of better macro numbers. However, our base case is that the NBH will not move away from the set course and these bets will be disappointed. In general, we see more steepening of the curve in the 2s10s spread, but a very short end. The FRA curve should see some repricing up this week, resulting in flattening in this segment.

Hungarian government bonds (HGBs) eased in July and the rest of the region caught up with the swift rally. We therefore see current valuations of HGBs as more justifiable, which could attract new buyers. Despite the fiscal slippage risk, YTD issuance has reached 60% by our calculations, which we see as more than sufficient. Moreover, recent government measures supporting HGBs and the fastest disinflation in the region should be enough to sustain demand.