INSTANT VIEW - Hungary announces new liquidity-providing tools (2)

Georgi Deyanov, Morgan Stanley, London

What has changed in the NBH's outlook? The NBH revised down its GDP growth forecast significantly but refrained from showing an annual GDP growth decline for 2020. The central bank now expects GDP to grow by around 2.5%Y versus 3.7%Y previously and sees growth recovering to around 4.4%Y in 2021. Although we share the view that growth is likely to bounce back in 2021, we think that the Hungarian economy is likely to contract by 5% year on year in 2020 due to the sharp decline of economic activity in Europe. The NBH also projects inflation to move back within the tolerance band as early as March and to move below the 3%Y target in the following months, thus averaging 2.7%Y in 2020. Core inflation excluding indirect tax effects is likely to be around 3.3%Y on average in 2020, before decreasing gradually to 3%Y in 2021, according to the NBH.

What has changed on the monetary policy front? As the government imposed a moratorium on interest and amortisation payments for all household and corporate loans until the end of 2020, Hungarian banks will likely need a significant amount of financing in order to face the decline in payments. Note that up until now the Hungarian banking system was characterised by a structural excess of liquidity which the NBH managed in a way to steer the interbank rates. The Covid-19-induced liquidity shock has put the Hungarian banking system in a situation where banks are likely to be seeking liquidity ahead and thus the NBH has introduced new tools to meet their demand at an unlimited amount.

Resuscitating short-term lending: The NBH will provide short-term liquidity to commercial banks through an overnight lending facility depending on the amount of eligible collateral submitted by the banks. Note that the central bank now accepts performing corporate loans as collateral, which brings the available collateral to over HUF 9.6 trillion. On top of the overnight lending facility, a one-week lending facility will be announced each Wednesday where the NBH will make a decision depending on market developments and demand by banks. Both short-term lending facilities will be accessible at the current base rate of 0.90%. The last time the central bank provided liquidity through the one-week facility was in 2017.

Unlimited long-term liquidity support at the base rate: The NBH decided to introduce a new fixed-rate collateralised loan instrument with maturities of three, six and 12 months as well as three and five years. Lending will be provided at a fixed interest rate by the NBH for an unlimited amount. The central bank will define the interest rate of the instrument at each tender but which will not be lower than the base rate at the time of the tender. While the central bank pledged that the programme will be available for an unlimited amount, it also reserved its right to set the amounts it accepts at specific tenders to manage liquidity effectively.

Auxiliary measures: Beyond the introduction of the long-term lending facilities, the NBH exempted banks from the reserve requirements by suspending the sanctions on reserve deficiency. This measure will likely release over HUF 250 billion immediately. This decision comes after the NBH also removed its 4% initial margin requirement for banks to use the FX swaps facility.

What does it all mean for monetary policy ahead? The NBH mentioned in its statement that it is considering relaunching its mortgage bond purchase programme, but most importantly we think that the switch from excess liquidity to liquidity shortage for the banking system is bringing back the NBH's monetary policy closer to a one where the policy rate becomes relevant again. Consequently, rate cuts become plausible as well in case the NBH wants to lower banks' funding costs further. There was no mention of the FX swaps facility's future in the statement but if we assume banks start getting enough HUF funding through the short-term and long-term collateralised lending facilities, the stock of FX swaps will likely shrink.

Orsolya Nyeste, Erste Bank, Budapest

The Monetary Council of the MNB left both the policy rate at the O/N deposit rate unchanged at 0.9% and -0.05%, respectively at its today’s rate-setting meeting. The O/N lending rate also remained flat at 0.9%. The decision was in line with the broad market consensus. The magnitude of the crowded-out liquidity also remained unchanged at a minimum of HUF 300-500bn for the next quarter. In its statement, the council strongly emphasized negative effects of the current Coronavirus crisis on economic developments.

Thus, in order to enhance the effectiveness of monetary policy, the MPC announced further liquidity-providing measures.

• A new fixed-rated collateralized loan instrument will be introduced with maturities of 3, 6, 12 months and 3, 5 years. The MNB will provide unlimited lending for banks at fixed rate.
• Banks will not fulfil their reserve requirements with immediate effect until a further decision is made.

Regarding the new economic forecasts, the MNB sees this year’s GDP growth in the range of 2-3%, annually. This relatively optimistic forecast suggests that following the current economic downturn, a V-shape recovery would come within a short period of time. Based on comments of Vice Governor Nagy, the already announced moratorium on corporate and household loan repayment could help maintain domestic consumption. In 2021, the economy will grow by 4-4.8% y/y, according to the MNB’s forecast.

We think however that the expected quick economic recovery could demand more explicit role of the fiscal policy to offset negative effects of the crisis. As for inflation projections, the MNB sees annual average inflation rate at 2.6-2.8% this year – mainly due to falling oil prices - and at 3.4-3.5% in 2021.

Liam Peach, Capital Economics, London

Hungary’s central bank announced a range of measures to increase liquidity in the banking system at today’s MPC meeting. But the economic effects of the coronavirus are likely to be much more damaging than policymakers currently think, suggesting that further monetary easing will come before long.

The decision by the National Bank of Hungary (MNB) to leave its overnight deposit rate unchanged at -0.05% was expected by the majority of analysts polled by Thomson Reuters, including ourselves. The focus of today’s meeting was always going to centre on the unconventional measures announced in the post-meeting communications. The central bank has previously quipped that it has a “million ways” to ease policy and today it showed us just a few of the tools at its disposal.

To mitigate the effects of the coronavirus and to ensure that there is ample liquidity in the financial system, the central bank announced that it will continue one-week liquidity-providing FX swap tenders on a daily basis until further notice. The central bank has been providing weekly FX swaps on a daily basis since 17th March, which it says has increased the stock of FX swaps by over 250bn forint to 2.2tn forint.

The MNB has been largely successful at controlling the short-end of the interest rate curve with FX swaps and this expected increase in the stock of outstanding swaps should help to keep short-term interbank rates low – 3m BUBOR around 0.5-0.6% – over the coming months.

The central bank confirmed that it will follow up the government’s announcement of a blanket moratorium on corporate and household loan repayments until the end of the year with a moratorium on its Funding for Growth Scheme. This will help to address the repayment difficulties facing debtors. The central bank also announced that it will assess the possibility of relaunching the mortgage bond program (which is tantamount to quantitative easing), a scheme that it retired at the end of 2018.

The centrepiece of the meeting was the announcement of a new, unlimited fixed-rate collateralised loan instrument that will be provided to banks with maturities ranging from three months to five years. The details of the interest rate applied to the instrument will depend on the tender by the MNB and the central bank estimates that the amount of uncommitted collateral that can be used against long-term lending is currently more than 7.0tn forint (or 15% of GDP).

In the post-meeting press conference, Deputy Governor Marton Nagy stated that the loan instrument will support liquidity in corporate and household loan markets and help to stabilise the government bond market – the 10-year government bond yield has fallen by 50bp today to 2.3%.

In terms of the impact of the coronavirus on the economy, the central bank mentioned that growth is likely to slow significantly in the first half of the year, reflecting the negative economic effects of the containment measures before picking up again as these effects subside and lost economic activity is regained.

However, the MPC still seems very sanguine on the economic effects of the virus. The central bank stressed that the updated forecasts in the March Inflation Report carry a certain level of uncertainty and the MNB expects GDP growth to be in a range of 2.0-3.0% this year and inflation to be between 2.6-2.8%. Only in the MNB’s assessment of a persistent impact of the coronavirus on the global economy does the central bank expect Hungary’s economy to enter recession and contract by 0-0.5%.

We expect the disruption from the coronavirus outbreak to hit activity, both in Hungary and in the euro-zone, harder than during the depths of the global financial crisis. Flash PMIs for the euro-zone released today showed that the composite PMI for March fell to a record low and car manufacturers across Europe are halting production. Our forecast is for Hungary’s economy to contract by 2% in 2020. (See here.)

As and when the impact of the virus on economic activity becomes clearer, we think that the central bank will step up monetary support by pushing short-term interbank rates towards zero and announcing the reintroduction of its mortgage bond program (and possibly sovereign bonds purchases). This is likely to be accompanied by a further fiscal response, where the room for easing is much larger.

José Cerveira, J.P. Morgan, London

(Research was published on 25 March)

Summary

• The NBH has eased monetary policy further, with two key measures: 1) a long-term collateralized lending facility offering (potentially) unlimited liquidity and, 2) a waiver on banks’ obligation to meet reserve requirements
• The new lending facility is a large backstop for banks and, indirectly, can also shore up the government bond market in a year of increased issuance
• If used in any meaningful size, it will also increase excess liquidity in the system and push market rates lower towards the bottom of the interest rate corridor (-0.05%)
• The waiver on reserve obligations will mainly support weaker banks struggling to meet reserve requirements
• The lending facility is potentially extremely powerful, as much as QE would be, but the lack of volume guidance weakens the announcement overall
• We expect that further easing via unconventional tools will be introduced in the next months

The NBH yesterday introduced new easing measures, including a (potentially) very powerful new long-term lending facility, but the announcement was weakened by the lack of volume guidance. Despite being reputed to be the most dovish central bank in the region, the NBH’s reaction to the COVID-19 shock so far has fallen significantly short of its CEE counterparts, so expectations for this week’s delivery were high. The interest rate corridor setup was left intact, and liquidity guidance was also unchanged at HUF300bn-500bn. The NBH announced new measures to ease monetary conditions which in normal times would be huge announcements on their own, but in the abnormal times we live in, disappointed somewhat for their lack of specifics. The two main measures announced yesterday are:

1. A long-term collateralized lending facility offering (potentially) unlimited liquidity at fixed rates (first tender today). The long-term facility is to be offered to banks at five maturities (3-month, 6-month, 12-month, 3-year and 5-year), at a fixed rate to be determined by the NBH at each tender, but which should not be ever below the base rate (0.9%). The amount allocated to the program is unlimited, but the central bank will determine the size of each individual tender. According to NBH calculations, there is over HUF9.6 trillion (around EUR27 billion, or close to 20% of 2019’s GDP) in eligible uncommitted assets to be used as collateral in operations with the NBH.
2. Exempting banks from complying with reserve requirements (with immediate effect). This exemption means any bank that fails to meet reserve requirement obligations will suffer no penalties; in effect, therefore, there are no compulsory reserve requirements. Reserves held at the NBH to meet reserve requirement criteria are around HUF250 billion (on monthly average terms), and banks can use this liquidity for other purposes (lending in interbank market, for example).

The new collateralized lending facility is not quite QE, but has many parallels with it, and can be as powerful. The potential amount at the disposal of this program (EUR27 billion, or close to 20% of 2019’s GDP) is firstly, a large backstop for the banking sector, especially in the context of the moratorium introduced by the government on private sector loans. The shorter-dated loans (less than a year) will ease any liquidity issues that may arise due to the lower cash flow from loan repayments. Secondly, and crucially, the longer-dated loans (3-year and 5-year) represent a massive incentive for banks to buy Government bonds (whose issuance is likely to increase this year), while locking in a profit for the mid-term (the spread between the tender fixed rate and the bond yield). This will help keep government borrowing costs lower at the long end. So, like QE, this tool should generate a new source of demand (which indirectly is the NBH) for government bonds and keep long-dated yields lower than otherwise. Unlike QE, though, the central bank relies on banks to buy government paper, and then pledge it to the NBH in exchange for fixed rate funding, rather than buying it directly in the secondary market. Though the incentive for banks is very strong, it is still a more indirect tool (than QE) to intervene in the government bond market.

It will also create new excess liquidity and should push market rates towards the bottom of the interest rate corridor. As the central banks begins to make collateralized long-term loans to banks, it will credit bank’s reserve accounts by the amount they pledge in collateral, and thus increase excess liquidity in the system, in very much the same way it would in a QE program. Market rates had trended higher in recent months (because of persistently high inflation, expectations of some policy tightening and government cash management operations), but the coming increase in liquidity, depending on how quickly loans get disbursed, is set to push market rates towards the bottom-end of the corridor (Figure 1).

The waiver on reserve requirement obligations may only add marginally to excess liquidity; we see it mostly as a support for weaker banks struggling to meet reserve requirements. Although there is now no penalty for banks missing their reserve obligations, reserve requirements still exist. Each bank, therefore, will still be remunerated at the base rate (0.9%) for the amount placed in their reserve account. This is obviously better than short-term market rates or the alternative deposit facility rate (-0.05%), so we anticipate that excess liquidity will not increase much due to this measure. It will help mainly those weak banks that may be struggling to meet reserve requirements.

The overall delivery is potentially very powerful, but lacks volume guidance and, in that sense, is somewhat disappointing (in the current macro context). All in all, there is no doubt that the NBH’s delivery eases monetary policy, improves liquidity conditions and shores up pressures in domestic lending markets. Yet against the current macro and market backdrop, and considering what central banks are doing globally and in the region, the package’s lack of specifics is somewhat underwhelming. Without room to cut rates in an impactful way like its CEE neighbors did, the focus was on the unconventional tools. The star of the announcement, the long-term collateralized lending facility, is an open ended tool that can end up being massive, but it can also be small. There is no level of commitment to how much this tool will be used. The range of possibilities spans from a cautious/reactive response to stresses in interbank or bond markets, to a massive deployment which could reshape the local market. Even some vague guidance on the volumes the NBH intends to bring on the tenders would have made the announcement much more powerful, in our view. In the press conference, Deputy Governor Marton Nagy argued that the NBH is still the central bank with the lowest policy rate in the region and defended the new long-term lending facility as more flexible than a standard QE tool.

The NBH is still operating with a rather benign macro outlook, so expect additional measures as that gets revised lower in the next few months. The NBH’s new projections point to 2020 GDP growth in the 2-3% range, which seems quite optimistic at this stage (we forecast -0.3%, with risks clearly skewed to the downside) so it seems likely that, as the data worsens further, the NBH would be ready to deploy further easing measures. At the press conference, Deputy Governor Nagy confirmed that there will be further steps from the central bank, but without going into detail.