Rate Setters All Wanted Unchanged Rates In April - Here's The Why

The minutes show that the MPC supported unchanged rates so unanimously because they believed a cautious, wait-and-see monetary policy approach was required due to weak economic conditions, the risks to financial stability and the financing problems facing Hungary. If further improvement is seen on external markets and the forint firms markedly, the rate setting body may hint at a possible rate cut already at the next policy meeting on 25 May.

Monetary Council members agreed that “while there continued to be no inflationary pressure in the domestic economy because of weak economic conditions, the risks to financial stability and the financing problems facing Hungary required a cautious, wait-and-see monetary policy approach."

Still vulnerable

Members of the Council concurred that although sentiment towards Central and Eastern Europe had improved somewhat recently, Hungary was in a particularly vulnerable position in the current turbulent money and capital market environment.

Some members warned that the country's relative position had even deteriorated further compared with Poland and the Czech Republic. Several others noted that the deeper-than-expected economic downturn might lead to a sharper deterioration in the quality of domestic banks' portfolios than previously thought, despite the recent improvement in liquidity in financial markets.

Council members also agreed that, due to weak domestic economic activity, prices were likely to rise only moderately in Hungary and that inflation might be around 3% on the horizon relevant for monetary policy. In addition to the latest available inflation data, adjustment by firms through wages and employment also pointed to a reduction in upside risks to inflation. Some members thought that the subdued rise in tradable goods prices despite the exchange rate weakening was clear evidence of the downward effect on inflation of weak macroeconomic demand.

Uncertain global inflation outlook

However, members were divided over the potential inflationary effects of the programme announced by the new Government. Some members judged that the upward effects on inflation of the VAT increase would only be temporary in a recession environment, while others did not rule out potential spillover effects. On another argument, medium-term global inflation concerns were growing in the wake of the crisis management actions, and import prices were also likely to rise in Hungary.

Discussing the macroeconomic outlook, several members pointed to the worse prospects for activity than in earlier forecasts. It was also argued that Hungary's macroeconomic balance was improving, which was also reflected in the fall in the country's external financing requirement. Several members stressed that Parliamentary approval of the new Government's programme could serve to improve the external balance further.

Seamlessly operating FI market needed

Council members judged that restoring the health of the domestic financial markets was essential to promoting financial stability, which required the government securities market to function smoothly. Several members warned that this, in turn, required dealers to commit to quoting two-way prices in the secondary market and turnover to increase gradually.

It was also argued that the auctions to repurchase government paper might change the shape of the yield curve and, consequently, the fall in bond market yields did not necessarily reflect an improvement in expectations.

A lot depends on the cabinet's economic policy

Members of the Monetary Council judged that the change in the direction of the new Government's economic policy was the most important factor possibly influencing the room for manoeuvre in monetary policy.

For this reason, the Council should adopt a wait-and-see strategy approach pending Parliamentary approval of the Government's programme.

Some members argued that after successful implementation of the Government's programme the risk premium on forint assets was likely to fall, which, in turn, would leave scope to ease policy.

On another argument, in addition to restraining economic activity, the current high level of interest rates could be harmful over the long term, because the percentage share of higher risk debtors could increase within demand for credit, which might cause a further deterioration in banks' loan portfolio quality.

However, several members warned of the inadequate supply of market funds to finance the economy and, referring to financial stability considerations, they preferred a very cautious approach to policy looking forward.

After the discussion, the Chairman invited members to vote on the propositions put to the Council. The Council voted unanimously in favour of leaving the base rate unchanged.

The Council will hold its next policy meeting on 25 May. The minutes of that meeting will be published at 14:00 CET on 12 June."

Source: Portfolio Online Financial Journal