Hungary Unexpectedly Cuts Rate as Economy Enters Recession

Hungary’s central bank unexpectedly lowered the European Union’s highest benchmark interest rate for the first time in almost two and a half years after the economy slipped into a recession.

The Magyar Nemzeti Bank cut the two-week deposit rate by 25 basis points to 6.75 percent, the first decrease since April 2010. Seventeen economists in a Bloomberg poll said the bank would leave rates unchanged while one forecast the cut. The Monetary Council also considered leaving rates unchanged before a “tight” decision, central bank President Andras Simor said.

Monetary policy can only be eased to the extent that supply shocks to the economy and the upward impact on prices of government measures don’t lead to the build-up of second-round inflationary effects and perceptions about the Hungarian economy continue to improve,” the council said in a statement.

Policy makers have been divided on when to start easing borrowing costs with some arguing that the start of bailout talks opens the way to lower rates to spur growth after the economy sank into its second recession in four years. Others rejected the calls because of the inflation outlook and pending the bailout talks.

‘Further Easing’

“The National Bank of Hungary’s surprise decision to cut interest rates today suggests that further easing could be on the way,” William Jackson, economist at Capital Economics Ltd. in London wrote in an e-mail today. “Looking ahead, we suspect that with today’s vote, the external Monetary Council members are testing the waters; if there is no large sell-off in the local markets, they may well push for a further 25 basis point cut at the next meeting in September.”

The forint, which has gained 11.9 percent against the euro this year as investors speculated that Hungary will obtain an IMF bailout, weakened 1.4 percent to trade at 280.09 per euro after the rate decision in Budapest.

Forward-rate agreements used to wager on interest rates in one month fell 4 basis points to 6.84 percent, the lowest since November. The FRAs traded 28 basis points below the Budapest Interbank Offered Rate yesterday, the biggest spread in more than two years and signaling expectations for a quarter-point rate cut. A basis point is 0.01 percentage point.

The European Central Bank this month kept its main interest rate unchanged at a record-low 0.75 percent and the deposit rate at zero. Czech policy makers left their two-week repurchase at a record-low 0.5 percent on Aug. 2, while their Polish colleagues, who surprised the market with a quarter-point increase in May, also kept the benchmark rate at 4.75 percent on July 4.

‘Inflation Deteriorated’

“The inflation picture has deteriorated since our last inflation forecast, however the sustained weakness in the real economy acted in the opposite direction,” Simor said at a news conference in Budapest today. “The improvement in risk perception widened monetary policy’s room for maneuver, though it’s obviously a question to what extent that can remain the case in the future.”

Hungary’s economy contracted 0.2 percent in the second quarter from the previous three months and shrank 1.2 percent from the year-earlier period. The data show that the economy is “technically” in recession and the sharp slowdown in external demand hurts the growth outlook, according to the Monetary Council.

‘Weak GDP’

A rate cut may add momentum to the economy and would be accepted by investors, Ferenc Gerhardt, a monetary-policy maker said in an Aug. 10 interview. Meanwhile, Simor, speaking after last month’s rate decision, argued for a “cautious policy stance” until the outcome of bailout talks is known.

“Weak second-quarter GDP data further boost the chance of monetary easing, however, we only expect this at the end of September due to accelerating inflation and pending IMF-EU negotiations,” Istvan Horvath, director at the Budapest investment management unit of KBC Groep NV (KBC), said in a note yesterday. Hungary may lower borrowing costs in several steps until the end of the year, Horvath wrote.

Inflation, the fastest in the EU, accelerated to 5.8 percent in July from 5.6 percent in June, drifting further from the central bank’s 3 percent target. The pace of consumer-price increases may slow to the goal in 2014, Simor said last month.

Bailout Talks

Hungary is set to resume talks with international lenders on a credit line of about 15 billion euros ($18.8 billion) to protect the economy from euro-area contagion and to lower financing costs. International Monetary Fund and European Union officials are focusing on untangling policies that contributed to an economic contraction in the first two quarters and the downgrade of Hungary’s credit to junk.

Hungary faces a “big” debate with the IMF on whether it can finance payroll-tax cuts to protect jobs, Vas Nepe reported today, citing Prime Minister Viktor Orban.

Orban wants to win the “struggle” with the IMF and economists who questioned whether the budget will be able to provide enough funding for the jobs plan, he said, according to the Szombathely, Hungary-based newspaper.

Hungary will only cooperate with multinational companies that create local jobs and use Hungarian suppliers and raw materials, not with those that “raze the market and destroy small Hungarian companies,” Orban said in the interview.

The cost of insuring against default on Hungary’s debt for five years using credit-default swaps fell to 426 basis points from this year’s high of 735 basis points on Jan. 5.

“While we still see 50 basis points in rate cuts this year, we perceive some risks to the path priced in by the market,” analysts at OTP Bank Nyrt. wrote in a research report last week. Policy makers will “take a wait-and-see” stance until the next Report on Inflation is published in September, according to the note.

To contact the reporters on this story: Edith Balazs in Budapest at ebalazs1@bloomberg.net; Andras Gergely in Budapest at agergely@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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