Analysts watching, waiting & divided

Analysts were divided almost equally into two camps, the former expecting a quarter per cent rate cut in May, and the other camp (to which Budapest Economics belongs) predicting that rates would be kept at the same level. As can be seen, those who expected the Monetary Council to continue the tactic of biding its time were right. At the same time, contrary to expectations, the central bank amended upwards the inflation expectations for 2008 (from 3.6% to 3.8% yr-on-yr), which indicated a worsening of short-term inflation prospects.

 

The following questions arise. Is the caution of the central bank in its judgement of inflation risks justified? Has the likelihood of a rate cut in the near future increased or decreased and when could the rate reduction be due at the earliest? How divided is the membership of the Monetary Council on the question of the short-term rate course?

The latest macroeconomic figures paint a rather mixed picture of the economy. Alongside the balance indicators (budget deficit, foreign trade balance) which reflect a gradual improvement – the growth rate of consumer prices slowed in April – the intensity of short-term inflationary pressure remains problematic. In the light of the wage figures available – based on which the growth rate of wages in the private sector is not slowing yet – the caution of the central bank is justified, even if some analysts and the Finance Ministry beg to differ. It is true that in certain sectors the frequently mentioned "whitening effect", i.e. reducing the size of the black economy, has played a significant part in the wage rises, however it is not clear from the figures whether the central bank is really facing the worsening of inflation expectations.

 

This dilemma and the central bank’s higher inflation expectations could result in the rate cut being postponed. However, in the current case we think there is a significant likelihood that the base rate will be lowered by a quarter of one percent this month. What is this expectation based on? The key moment of the press conference following the May rate decision was when MNB Governor András Simor said that seven members of the council had voted for the rate to remain unchanged, and six had voted in favour of a rate cut (with one member in favour of a half per cent cut). This represents a considerable shift from the earlier opinion of the Monetary Council (in March only one member voted in favour of a rate cut), which allows us to infer that if the macro economy and market environment do not worsen significantly by the next rate decision meeting, the members voting for a rate reduction could be in the majority this month.

 

In the event that inflation, in accordance with analyst expectations, continued to fall in May, but wage figures still do not give a clear picture of the development of inflationary expectations, the Monetary Council will find itself in a tricky situation again. The question, of course, is to what extent the council regards as necessary the cautious monetary policy of keeping the rate level unchanged, whilst in addition to the stable forint exchange rate, the yields of long-dated treasury bonds have significantly decreased (the risk premium expected by investors has dropped), and according to the central bank’s inflation report the medium-term inflation target can achieved at the end of 2008 or beginning of 2009. In our view, the central bank is currently not under market pressure in the direction of a rate cut, however a favourable May inflation figure and positive market mood would make it difficult to keep the base rate at the same level. In our opinion, despite all the above, the May decision has significantly strengthened the credibility of the central bank – demonstrating the MNB’s commitment to achieving the inflation target – which is particularly necessary at a time when investors are looking at the macroeconomic effects of the Gyurcsány Package with due confidence, but also with a critical eye.