BUDAPEST (Reuters) - Hungary’s new-look Monetary Council has kept its neutral stance on interest rates but signs are emerging that recent government appointees may push for cuts later in 2011 to support the ruling party’s unorthodox policies.
Prime Minister Viktor Orban’s centre-right Fidesz party picked four new members for the rate-setting Council in March, leaving central bank governor Andras Simor and his two deputies in a minority on the seven-strong committee.
Changes to the way in which such appointments are made were criticised by the European Central Bank as they stripped Simor — who has frequently been attacked by Fidesz — of the right to nominate two policymakers.
The new committee has so far voted unanimously over three meetings to keep interest rates on hold at 6 percent, despite fears the new members would push for rapid rate cuts to help the economy and meet government expectations.
But analysts said any indications that inflation risks are subsiding while domestic demand remains depressed could prompt arguments for a small rate cut, despite the risk of upsetting markets if such a reduction is viewed as premature.
“The new MPC members will be able to construct a decent ‘story’ to cut,” said Nomura analyst Peter Attard Montalto.
“The main trigger ... will be the turn-down in the bank’s exogenous rate forecast model as (domestic) inflation starts to fall and growth disappoints.”
According to latest data, Hungary’s retail sales dropped an annual 0.9 percent in March, while gross wages also fell. Many households are also struggling to repay foreign currency loans.
Inflation doves may also cite lower global commodity prices as a reason to lower rates later this year.
Hungary’s key interest rate has been held for four months after 75 basis points of hikes between November and January.
But a statement after the last rate meeting on May 16 dropped an earlier reference to rates remaining on hold for a sustained period.
“With that, the likelihood of keeping rates on hold has decreased and that of a change ... has increased,” said Zsolt Kondrat, analyst at MKB bank in Budapest.
“The (easing) bias is there and if they see room, an opportunity, they will cut rates.”
A recent interview with two new rate-setters by right-wing daily Magyar Nemzet indicated the new members on the Council may be preparing for policy shift later this year.
Gyorgy Kocziszky and Ferenc Gerhardt — who had earlier declined to speak publicly about monetary policy — said markets were showing growing confidence in Hungary’s economy, although they added that did not mean rate cuts should be rushed.
“If they are clever, before any cut they will prepare the ground with communication,” MKB’s Kondrat said.
A cut this year would surprise markets, as interest rate swaps and forward rate agreements and the median forecast in the last Reuters poll price in no change in rates in 2011, although some analysts said a cut may come before end-2011.
A key question is whether the Monetary Council will find justification in coming months to cut rates at a time when the ECB and other regional central banks are in tightening mode.
A drop in commodity and fuel prices since the last inflation report may be seized on by the Council’s doves, while the bank’s next report in June may also supply arguments for policy easing.
But a rate cut is more likely to come in the second half of the year, analysts said.
“I think we will see cautious, circumspect monetary easing,” said Concorde analyst Janos Samu.
The central bank’s main concern has been that a rise in commodity and energy prices could trigger second-round effects in Hungary where inflation has tended to overshoot targets.
Second-round effects have been stronger than expected, but annual core inflation at 2.7 percent in April was still below the bank’s 3 percent medium-term target for headline inflation. An expected drop later this year in the headline figure, from 4.7 percent in April, could support the case for easing.
Domestic demand has also been sluggish, and according to a central bank survey, Hungarian banks — hit by a big windfall tax — are unwilling to ease credit conditions.
Government fiscal cuts announced in March have helped cut the cost of insuring Hungary’s sovereign debt against default by about 140 basis points this year, to around 260 basis points.
Some analysts say a further drop in risk premiums and a firming of the forint would be conditions for any rate easing in Hungary — to compensate for still existing global inflation risks, and rate hikes by other central banks.
“There are no signs that the economy would be overheated. If the interest rate premium drops, that signals that interest rates could be cut,” said Gergely Szabo Forian of Pioneer Fund Management in Budapest.
Many analysts still think the risk of a new rise in energy and commodities prices or a drop in risk appetite could prevent a rate cut, and may even force Hungary’s central bank to hike.
The euro zone debt crisis could also deepen, although the forint has so far proved relatively resilient to bad news.
“If the NBH cuts rates without (inflation and market risks) decreasing, adverse market consequences can follow,” said Zoltan Arokszallasi of Erste Bank in Budapest.
“The forint could weaken and long bond yields could rise.” (Editing by Catherine Evans)