October 16, 2018 / 10:01 AM / a month ago

Steep Hungarian yield curve signals inflation, policy concerns

BUDAPEST (Reuters) - Hungary’s government debt yield curve is the steepest in at least 14 years as markets are pricing in fears that the National Bank of Hungary (NBH) may not give up its loose monetary stance in time to tackle rising inflation.

File photo: Hungarian forints and Euro notes are seen in this photo illustration. REUTERS/Bernadett Szabo

The central bank, which decides on interest rates later on Tuesday, is expected to keep Central Europe’s lowest rates on hold this year. Some analysts expect a hike next year.

As global sentiment soured, a jump in the U.S. 10-year Treasury yield has led to a surge in Hungary’s corresponding yield.

The spread between Hungary’s 3-month Treasury bill yield, which is at -0.01 percent, and its 10-year bond yield approached 4 percentage points last week.

“Any negative turn in the interest rate environment (in global markets) hits the long end as the NBH keeps short-term rates low,” one Budapest-based fixed income trader said.

“The curve has never been as steep as now,” the trader addded. “Market confidence that the NBH will react in time (to a rise in inflation) is lost.”

The NBH declined to comment.

It revamped its toolkit in September to prepare for starting a tightening of monetary conditions, but stopped short of saying when this could start.

(Graphic: reut.rs/2yKm3lx)

“After the 20bp increase of 10Y yields in Hungary experienced last week... one might wonder for how long this ultra-dovish monetary policy is sustainable,” Erste Group analysts said in a note.

The long-term yield rose above annual inflation, which ran at 3.6 percent in September, but short-term interest rates kept down by liquidity from the NBH’s fx swaps facilities, remain well below inflation.

That keeps local assets, mainly long-end bonds, more vulnerable than in other markets such as regional peer Poland where interest rates are higher, market participants said.

Headline annual inflation has approached the top of the bank’s 2-4 percent target range in the past months, but core inflation stayed at 2.4 percent in September.

Analysts said inflation does not yet worry the bank, which will discuss its next inflation report in December.

(Graphic: reut.rs/2COJQFN)

The latest Hungarian bond auctions, held on Thursday, drew robust demand due to the yield surge. Any further rise may make the papers attractive, Raiffeisen analyst Stephan Imre said in a note.

But any inflation surprise, including a possible surge in core inflation over 3 percent early next year, could hit local markets again, ING analyst Peter Virovacz said.

Surging energy and wage costs and a weakening of the forint against the euro this year may prompt companies to increase their prices, potentially surprising the NBH, he said.

“It is a real risk that there will be a big repricing in markets in January,” Virovacz said.

“The market seriously questions whether the NBH is right in its inflation forecasts... (Investors) do not believe that the bank keeps inflation under control,” he added.

Reporting by Sandor Peto; Editing by Andrew Heavens

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