2021.10.27. Szerda 12:54 IT IS DIFFICULT TO SET THE PRICE OF THE INTEREST RATE PATH EXPECTED IN 3-6 MONTHS The monetary policy, which was quite relaxed in the last year, transformed radically, as after several years, the central bank turned to a restrictive mode and started to increase interest rates. The reasons are clear: inflation stagnates month by month or increases between 4.5-5.5 percent, and the trend became obvious for all economic operators. Macroeconomic analysts have been discussing for months whether inflation is temporary or not, and there is a wide range of opinions not only in Hungary but in most of the countries. Analysts, market operators and central bankers are also divided about what the surge of inflation is caused by and what can be done against it – at least in a short term – without causing significant turbulence on the markets. There is no doubt that the coronavirus created a completely new situation. First of all, the world’s economy was “switched off” in a few weeks, then the stepwise resumption revealed such interruptions of capacity and supply, whose effect, among others, appeared as the increase of inflation. We should not blame only the pandemic and the interruptions of supply after the pandemic. The relaxed monetary policy has been increasing the price of assets on an international basis for years (it is enough to think about the stock market or the real estate market), and these markets can only react to this permanent creation of money with the increase of prices. As a result of these effects, the central banks around the world have faced the same problem almost everywhere in recent months: inflation has risen far from the target band, putting more and more pressure on the central banks to respond. Consequently, the MNB (acting as the central bank of Hungary) has to face a really difficult situation: what could be the ideal interest rate path, what can the central bank do in the system of inflation targeting? Of course, it is launching a cycle of interest rate hikes, and MNB was the first in Europe to take this step quickly, announcing it in May with a message equivalent to verbal intervention and anticipating the steps of the coming months. Based on the expectations of the general analysts at the time, this should have paid off within two quarters – but what changed in the summer, which kept the situation sharp and returning the Hungarian forint to historic lows? On the one hand, almost all leading foreign central banks have faced the same inflation dilemma: the inflation data in both the USA and the leading European economies have deteriorated month by month, and inflation was above the target bands significantly (inflation was between 4-5 percent, which has not been seen for a long time). First, it has made the operators of the bond market uncertain, and on the other hand, it has forced the central banks to step in. It seems that this increasing pressure coming from the developed markets will be a serious headwind for MNB, which monetary policy will also have to deal with. Another significant international factor is that stock markets are also close to peak, while there is a high degree of uncertainty among the market operators, and potentially a general risk of “loss of appetite” is expected, which always comes hand in hand with the weakening currency of merging markets. It may be mentioned as the third factor that the abolition of QE (quantitative easing) may be started by the leading central banks at the same time. It also means the absorb of liquidity and raises the question of at what nominal levels and in what shape of yield curves the independent anchoring of yields of sovereign debt market without QE taking place. So the pace and rate are questionable everywhere, central bankers have to fine-tune meeting by meeting – they have to balance between the stability of the capital market, the finance of national debt, the breakdown of inflation, the cooperation with fiscal policy, the stability of retail mortgage/housing market, and almost all countries face the same – but at the same time, the consensus is that measures have to be taken. The fourth factor is the situation of the euro, which has not been at such a historic low against almost all major currencies for many years and has shown almost no strength in recent years (the Hungarian forint is primarily denominated against the euro and the Eurozone interest rate path is a determinant reference, so this is also a key factor). Thus, the weakness of the euro and Hungarian forint causes significant inflation together (logically, the former cannot be influenced by the central bank), and the internal structural tensions (e.g. on the labour market) causing inflationary pressure are also added. The fiscal side needs to be mentioned as the next factor. The expenditure side of the budget has expanded significantly compared to what was projected previously, and the economic recovery after Covid will continue with the use of budgetary resources. Finally – which could not be seen even this summer – new submarkets received an inflationary push through the commodity markets due to the shortage of balance of supply and demand. It is enough to mention the price of energy (oil and gas market). These factors arose almost simultaneously, but not unexpectedly. Although in September, MNB withdrew a significant amount of its initial momentum, and it already made the market operators appreciably uncertain. Hungarian forint returned to the weakening tendency, and the increase of yields on the sovereign debt market since January continued with further hikes. Why did the central bank make one step backwards? Perhaps the cycle started with too much enthusiasm and courage – the 30 basis points in June seemed like a big step back then, but by September, the 15 basis points were already low, the charm of novelty has disappeared. Retrospectively, perhaps a step between the two numbers would have better shown the market the expected interest rate path, helping them with pricing decisions. Perhaps the classic example of surgery may be guidance, saying that a fast and effective cut is much better than a prolonged and painful treatment of symptoms. Translated to the language of monetary policy, a message projecting a stronger increase in the next four to six months period, compromising between an interest rate path that is too fast or too slow, would be more effective. The procedures of the sovereign debt market should not be disregarded either: uncertainty also means that it is difficult for the operators to set the price of the interest rate path expected in three to six months, volatility has increased appreciably, and the operators are looking for the equilibrium price. The increase in the short-term interest rates and the restraint of QE have an effect simultaneously. Decreasing uncertainty is crucial from the point of view of stabilizing the sovereign debt market as well. If the message follows the theory of the “surgical cut”, the operators may evaluate how long they have to tolerate the bleeding positions. The participants need to get some messages or guidance. The flattening yield curve is highly expected, and the only question is where the end of the curve will stop, on which the communication of the central bank will have a significant impact in the future. The market volatility is much higher than needed, uncertainty has increased and surges are much more common this time, which might be a problem in financing the national debt. In conclusion, it may be seen that the direction is right, but the reduction of uncertainty is needed as far as possible. As several times in the past, our small national ship needs to navigate between the huge ocean liners. 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