Hungary Unexpectedly Cuts Key Rate as Inflation Eases

By Zoltan Simon

Nov. 24 (Bloomberg) -- The Hungarian central bank unexpectedly cut the European Union's highest benchmark interest rate as it starts to roll back last month's emergency increase, expecting inflation to slow ``rapidly.''

The Magyar Nemzeti Bank in Budapest cut the two-week deposit rate to 11 percent from 11.5 percent today. One of 25 economists in a Bloomberg survey expected a cut, while the rest forecast no change. The central bank also reduced the reserve rate to 2 percent from 5 percent, effective next month.

Emerging markets have been scorched by the global credit crisis as investors dumped riskier assets in a flight to safety, forcing a 3 percentage-point rate increase on Oct. 22 to defend the forint. The inflation rate fell to the lowest in more than two years and a forecast recession is set to ease price pressure, giving policy makers scope for a reduction.

``There is a great probability that inflation will significantly undershoot the 3 percent target,'' Andras Simor, the central bank's president, said at a press conference in Budapest following the rate decision. ``This gives us an opportunity to lower rates substantially and gradually.''

The forint traded at 260.84 per euro at 3:32 p.m. in Budapest, compared with 266.25 late on Nov. 21. It weakened 15 percent against the euro in the first three weeks of October, reaching a record 286.55 rate on Oct. 23.

Forint Rebounds

The currency has strengthened 6.3 percent since the emergency rate increase, which was the biggest in five years, and as the government secured loans from the International Monetary Fund, the European Union and the World Bank to avert a default.

``Today's monetary easing seems justified,'' Zsolt Papp, an economist at KBC Groep NV in London, wrote in a note to clients today. ``The reaction of the euro-forint suggests the Monetary Council managed to find the policy mix. Today's interest rate cut also suggests that the Monetary Council is prepared to consider another 50 basis-point cut in December.''

Policy makers voted with a ``significant majority'' to reduce the rate to 11 percent today, after discussing proposals to keep it unchanged or cut it to 10.5 percent, Simor said. Future reductions hinge on risks to the country's external financing ability abating, the bank said in a statement.

Rate Expectations

Forward-rate agreements show that investors are stepping up expectations for rate reductions. The six-month forward fell to 10.1 percent today, from as much as 12 percent on Oct. 27 and 10.6 percent a week ago.

``The IMF package and the rate increase stabilized the market,'' said Zoltan Torok, the Budapest-based Raiffeisen International Bank AG analyst who was the only one to correctly predict the rate cut. ``The global recession also improved the domestic inflation outlook.''

The forint avoiding a decline after the reduction would allow the central bank to continue lowering rates, Torok said.

The central bank today cut its forecast for this year's inflation to 6.2 percent from 6.3 percent, next year's forecast to between 3.1 percent and 3.4 percent from 4.1 percent and to between 1.5 percent and 1.9 percent from 3 percent for 2010.

Inflation slowed to 5.1 percent in October, the lowest rate since August 2006 and a looming recession will further ease price pressure, ``substantially'' increasing the room for possible rate cuts, central bank Vice President Ferenc Karvalits said on Nov. 13.

The central bank's 3 percent target will be met ``at the latest by 2010,'' Simor said on Nov. 14 in Frankfurt. The bank issued its latest updated inflation estimates today.

Premier Urges

Prime Minister Ferenc Gyurcsany has urged the central bank to cut rates as soon as the market situation allows to limit damage to the recession-bound economy. Gross domestic product will probably contract by 1 percent next year, according to government forecasts, as demand falters in the euro region, where the majority of Hungarian exports are shipped.

The economy contracted 0.1 percent in the third quarter from the previous three months, while the euro zone slumped into a recession for the first time since the introduction of the common currency 15 years ago.

The central bank expects economic growth between 1 percent and 1.1 percent this year, contraction of 0.2 percent to 1.7 percent next year and growth of 0.5 percent to 2 percent in 2010, according to the latest economic forecasts.

This year's budget deficit may be 2.9 percent of GDP, rather than the government's 3.4 percent plan, narrowing to between 2.2 percent and 2.7 percent next year, the bank said. In 2010, the shortfall may be between 2.3 percent and 3.1 percent, according to the latest forecasts.

To contact the reporter on this story: Zoltan Simon in Budapest at zsimon@bloomberg.net.