MNI INTERVIEW: Varga Calms Cloudy Outlook - Ex-NBH's Kiraly

National Bank of Hungary monetary policy under new governor Mihaly Varga will prioritise stability over politics, former deputy governor Julia Kiraly told MNI, but the bank will have to target the exchange rate to prevent domestic inflation expectations running hot.

“There will be no big surprises,” said Kirali, a member of the Monetary Council from 2007-2013, and now a professor at Budapest’s International Business School. “I think it will be a very stable and accountable monetary policy, and I would not expect interest rates to change for the remainder of the year.”

Varga’s appointment of former debt office chief Zoltan Kurali as head of the monetary policy unit will further clarify the bank’s reaction function, a core component of its independence, she said in an interview. (See MNI EM POLICY: Kurali To Succeed Virag As NBH MonPol Lead)

“For the time being, it seems that the appointment of Mihaly Varga as governor was a very good decision,” said Kiraly, adding that outgoing governor Gyorgy Matolcsy, who had been openly critical of government economic policy, had complicated the NBH’s job. “I have the sense that Mr Varga wants to step out of the political arena, and this certainly gives more power to the central bank.”

Inflation, at 4.7% in March, was better than some expected, as slowing services prices and price freezes on certain food items made positive short-term contributions.

“It was always likely that some kind of moderation in service prices would come because of the so-called ‘voluntary’ cut to tariff and price rises made by the telecoms companies and the banks. But I do not believe that either will have a long-term and sustainable effect on inflation,” said Kiraly.

“Household expectations are connected to food inflation, and the recent outbreak of foot-and-mouth disease among cattle certainly has the potential to increase prices there - meat especially - and this will make stabilising expectations harder again.” (See MNI EM INTERVIEW: Hungary Price Caps To Boost Inflation- Ex-NBH)

CURRENCY WEAKNESS

Core inflation of 5.7%, as highlighted by the NBH in its end-March Inflation Report, suggests the overall measure will average around 5% this year, with the sector most sensitive to exchange rate developments - services -  key to whether the 3% medium-target is achievable, Kiraly said.

“If the currency returns to below 400, or if we see less market volatility, then the central bank should be able to get back to target over the medium term. But high volatility is the problem,” she said.

The forint weakened to 400 to the euro earlier in April and now trades at 406.

“What is even more important is the number of services which are related to the currency, because most domestic services are provided by small entrepreneurs, and small entrepreneurs adjust their prices according to the currency,” Kiraly said.

“If there is any kind of inflationary shock, and some inflationary shock occurs from time to time - for example, fuel shortages - the wage-price spiral immediately starts to work, and real wages increase at a faster speed than productivity. There is a permanent secondary effect, especially due to household and companies’ inflation expectations, which are still much higher than the target of the central bank."

FX TARGETING

With the forint the NBH’s main monetary policy channel, Kiraly was “convinced” that some form of exchange-rate targeting will be the MNB’s preferred course of action.

“We’ve seen something similar in Croatia, Bulgaria, in the past. Hungary will not introduce a currency board because of the high level of debt, but some kind of exchange-rate targeting is likely,” she said.

Hungary’s construction sector remains weak, while manufacturing suffers from lacklustre German demand and difficulties in bringing factories producing EV batteries online. 

Coupled with the uncertainty around the Trump trade war - “particularly bad for Hungary - a small, unstable country” - labour markets, already showing signs of loosening, are likely to experience growing problems in the months ahead, Kiraly said.

“Anecdotally, human resources companies are not only pointing to fewer and fewer companies looking for new workers, but are themselves firing people. So it’s clear there will be trouble ahead.”

Global uncertainty and market volatility mean the NBH is in a wait and see position. “That’s the best the central bank can do - provide some kind of stability," Kiraly said.