Hungary Cuts Interest Rates, Second Time in Two Weeks

By Zoltan Simon

Dec. 22 (Bloomberg) -- The Hungarian central bank cut its benchmark interest rate for a second time in two weeks and said it may reduce it further as inflation slows more quickly than expected and country risks subside.

The Magyar Nemzeti Bank in Budapest lowered the two-week deposit rate to 10 percent from 10.5 percent, in line with the forecast of 21 of 23 analysts in a Bloomberg survey. Two had expected a 1 percentage-point reduction. The move leaves Romania with the European Union’s highest interest rate at 10.25 percent.

Emerging markets have been battered by the global credit crisis as investors dump riskier assets in a flight to safety. Hungary raised interest rates by 3 percentage points on Oct. 22 to defend the forint and secured an international loan to avert a default. The bank has reduced rates three times in five weeks, by 0.5 percent each time, as the forint and bond markets stabilized.

“The base rate may be reduced in the coming months as long as capital flow is maintained and as the stability of the financial system allows,” the rate-setting Monetary Council said in a statement after the meeting.

The forint strengthened to 264.77 against the euro at 3:20 p.m., from 265.55 late on Dec. 19.

Slowdown’s Impact

An economic slowdown in Europe’s biggest economies, especially Germany, have slowed the flow of goods from eastern Europe and helped eased inflationary pressures. The Hungarian move comes after the Czech Republic and Slovakia also cut their key rates this month. Poland is expected to do the same when its Monetary Policy Council meeting ends tomorrow.

Hungarian policy makers also discussed cutting the interest rate by 0.75 percentage point and a full percentage point and “narrowly” decided to cut by a half-point, Governor Andras Simor told reporters today.

“Strong disinflation” and a slowing economy justify lower interest rates, while financial risks justify a “restrained” pace to rate cuts, he said.

Hungary’s ability to continue cutting rates hinges on the forint, which reflects country risk as perceived by investors, central bank President Andras Simor told Magyar Narancs weekly in an interview published on Dec. 18.

Other considerations for rate-setters include global risk indicators and Hungary’s relative position, as well as liquidity in the banking industry and government bond market and yields on local assets, Simor said.

IMF Bailout

“The only reason why the central bank has not been more aggressive in cutting rates seems to be the risk of a forint sell- off,” Bartosz Pawlowski, an economist at TD Securities Ltd. in London, said in a note to clients.

The forint fell to a record against the euro in October, forcing the central bank to raise the benchmark rate to 11.5 percent from 8.5 percent on Oct. 22, the biggest rate increase in five years. The country also secured 20 billion euros ($28 billion) in International Monetary Fund-led loans to shore up the economy, which is headed for its worst recession in 15 years.

The forint has replaced inflation as the top concern of policy makers as price pressures ease with a slowing economy, which contracted in the third quarter and may already be in a recession. The central bank expects the economy to shrink as much as 1.7 percent next year.

“The central bank doesn’t have to worry about inflation any more; the recession will do the job,” Budapest-based Intesa Sanpaolo SpA economists, led by Mariann Trippon, said in a Dec. 18 note to clients.

‘Steep’ Slowdown

Consumer-price growth slowed to an annual 4.2 percent in November, more than a two-year low, from 5.1 percent in the previous month, as crude oil prices, which fueled inflation last year, tumbled. Inflation peaked at 9 percent in March 2007. The bank targets an inflation of 3 percent.

“The inflation rate, based on recent trends, may continue to moderate and drop well below the 3 percent target in the relevant monetary policy horizon,” the Monetary Council said in its statement today.

The “steepness of the slowdown” in consumer-price growth is “surprising to everyone, even for us,” Simor said on Dec. 11. The bank expects the rate, which has exceeded policy makers’ target since August 2006, to fall to between 3.1 percent and 3.4 percent next year and to between 1.5 percent and 1.9 percent in 2010 from an estimated 6.2 percent this year.

Gradual Pace

The central bank voted 8-3 last month to unexpectedly cut the benchmark interest rate by a half-point, to 11 percent, starting to roll back October’s emergency increase in anticipation of slower inflation. Policy makers voted 8-2 to reduce the rate by another half-point at an extraordinary rate- decision meeting on Dec. 8, citing reduced country risk.

Even as slowing inflation opens the way for more rate cuts, the IMF has urged Hungary to use a “gradual and cautious” pace in reducing the key deposit rate.

“The reduction in the interest rate has been appropriate,” James Morsink, the head of the Washington-based lender’s delegation to Budapest, told reporters on Dec. 15. “Further rate cuts should be gradual and cautious.”

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