National Bank of Hungary preview: Not there yet

The National Bank of Hungary (NBH) has made it clear on several occasions that the temporary and targeted measures (introduced in mid-October) will remain until there is a material and permanent improvement in the general risk sentiment. This general risk sentiment is defined by the combination of external risks (war, global monetary policy, energy, general investor sentiment) and internal risks (EU funds, current account imbalance).

There has been a lot of improvement in the general situation. When it comes to market sentiment, the market’s view is clearly positive about Hungary; EUR/HUF is now flirting with 380, in contrast with the 400 seen before the last rate-setting meeting.

The emerging market relief rally on dropping energy prices has fuelled an improvement in global sentiment as well. However, Hungary is still experiencing high energy prices at the back end, so there has been little relief, so far. And the improved global sentiment around energy prices has only just started to translate into hard evidence: the December trade balance showed a deficit of only €154m (vs €1.2bn in November). The fourth quarter (preliminary) current account deficit came in at €3.95bn, showing a €0.52bn improvement over a quarter. This is the impact of lower energy prices.

There is also anecdotal evidence that food prices have started to drop, alongside fuel prices, which makes us think that we’ve already seen the peak in inflation in January of 25.7% year-on-year. Because of this, we expect the National Bank of Hungary to keep its composure at its 28 February meeting and wait for more hard evidence before it starts to communicate about any upcoming pivot.

Even if the data suggest that the time is right for a change, there is a need to be patient due to the ongoing debate over the reforms needed to unfreeze access to EU funds. Though we see the government settling the dispute regarding the judiciary reform (a horizontal issue, which needs to be cleared before meeting other super milestones), there is just too much uncertainty still about the deal.

In such an environment, we see the central bank keeping its guard up, sending hawkish messages and patiently waiting for more proof of improvement regarding external, internal and political topics. In our view, the base rate remains unchanged at 13.00% with no change to the interest rate corridor as well. The targeted, temporary measures will continue as well, as any abrupt change to the structure or to rates could reverse the gains made by the forint, which would hinder the central bank’s task to reach the inflation target over the monetary policy horizon.

A trend-like change in external and internal risk sentiment could lead to a better situation by the time the March rate-setting meeting takes place. However, we think that the NBH will wait at least until April to deploy any changes to the targeted, temporary measures. Even if easing starts during the second quarter, the process will be gradual and slow with a pause after the rates merge at 13%. We see the central bank starting regular rate cuts during the fourth quarter, strictly taking care of the real interest rate to remain positive.

On the rates and bonds side, the global sell-off has hit the Hungarian market hard over the last few days, and the high CPI number and hawkish NBH pushed the whole interest rate swaps (IRS) and Hungarian bonds (HGBs) curve up, disrupting the normalisation process. The NBH appears to be serious about its hawkish tone, and in our view it will be a challenge for the market to start pricing in a central bank rate normalisation again. On the other hand, in the interim, core rates should ease their pressure on the long end of the curve. The question mark is whether we will see a steeper or flatter curve first. At the moment, we are leaning more toward the latter. In either case, however, the direction of the curve movement should be downward.

On the bond side, although the beginning of the year showed a surprising deficit in the state budget, we remain optimistic that the MinFin target will be met this year. On the funding side, we estimate that the Government Debt Management Agency AKK has issued about 14.2% of planned HGBs, a bit behind Central and Eastern European (CEE) peers. On the other hand, issuance is strong on the retail and FX bond side, so overall we see AKK in a comfortable position. After the global sell-off, the 10y HGB yield got as high as 8.85%, correcting down a bit later, but these levels should attract new buyers again. We still see a better story in the Czech Republic and Romania in the CEE space but remain constructive on HGBs and the positive normalisation story in Hungary.

The forint continues to maintain a number one position within the CEE region and in our view the reasons why the forint should outperform persist. Higher EUR/USD should improve the outlook for the region as a whole, gas prices are again testing new lows, plus the recent sell-off in the rates space has once again pushed the rate differential in Hungary back to levels from the beginning of the year and pushed FX implied yields back to record levels.

Overall, we continue to see a positive story supporting further gains in the forint. However, heavy long positioning remains an obstacle on the way down. In the short term, we expect the NBH meeting may only deliver a small boost to the forint given the clearly hawkish message in January. On the other hand, Moody's ratings review in early March may bring a reminder of the issues still on the table. Moreover, the EU story could again bring some headlines that may not be positive for FX at first glance. Overall, we expect the forint to peg toward the 380 EUR/HUF level in the coming weeks.