A strange MNB base rate cut: monetary conditions have tightened substantially

HUNGARY - In Brief 25 Mar 2015 by Istvan Racz

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As reported on the screens, the MNB reduced its base rate by 15 bps to 1.95% yesterday, against the average market expectation of a 20bps rate cut (which we shared). In addition, they presented a new inflation report, which is markedly more optimistic than the previous one.The MNB now expects 0% average CPI-inflation for 2015 (0.9% previously) and 2.6% on an 18-month horizon (previously 2.9%), together with 3.2% GDP growth this year (as opposed to 2.3% predicted previously). Explaining their measure, they said the MNB would continue rate cuts until they feel that expected inflation is back in line with their 3% medium-term CPI-inflation target. (The extra complication that they introduced a +/-1% point tolerance range around the target can be safely disregarded as unimportant: this was always there, and anyway it does not matter a lot, as they are setting the rules for themselves and can change them rather flexibly, so it is difficult to see what extra flexibility this measure means for the MNB, especially as current inflation is miles away from the levels where it could become interesting.) What is much more important, however, is that regarding its immediate impact, the rate cut has proven to be a rather peculiar one, as it resulted in a marked tightening of monetary conditions. This is because the market has become so enthusiastic about the above-detailed news that it started a rally for Hungarian assets, leading to a 1.4% rise in the EURHUF fixing rate within a single day as a result. This means a substantial net tightening of monetary conditions of course. Please, note that the extra income pumped into the economy through a 15bps rate cut – assuming the whole of b...