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Hungary May Raise EU’s Highest Rate Again as Pressure Mounts

Hungary may need to raise the European Union’s highest benchmark interest rate next year as talks over a bailout stalled and the government and the central bank spar over monetary-policy independence.

The Magyar Nemzeti Bank increased the two-week deposit rate by a half-point for a second month to 7 percent yesterday and said it would raise borrowing costs further if country risk worsens. Policy makers also considered a quarter-point increase.

The European Commission and the International Monetary Fund suspended talks on a financial aid package to Hungary last week, citing objections to a draft law on the central bank that they say may undermine policy autonomy. The forint is the worst-performing currency in the world since June 30, data compiled by Bloomberg show.

“With the government at loggerheads with the central bank, talks with the IMF seemingly having broken down and fresh signs of strains in the bond market, we think it would be premature to rule out further, more aggressive, tightening over the coming months,” William Jackson, a London-based economist at Capital Economics Ltd., said yesterday in an e-mailed note.

The forint weakened 0.1 percent to 300.70 per euro at 9:45 a.m. in Budapest. It has weakened 12.5 percent in the second half of 2011, the worst performance among more than 170 currencies tracked by Bloomberg. The yield on Hungary’s benchmark 3-year government bonds was 8.43 percent, compared with 8.46 percent late yesterday.

Default Swaps

Credit-default swaps, which measure the cost of insuring government debt against non-payment, dropped to 578 basis points yesterday, compared with 583 basis points at the previous close, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers.

The Ceska Narodni Banka in Prague has left the two-week repurchase rate unchanged at a record-low 0.75 percent since May 2010, a quarter-point below the European Central Bank’s main refinancing rate after a 25 basis-point ECB cut this month. Russia’s central bank last month left the refinancing rate at 8.25 percent and Romanian policy makers resumed cutting on Nov. 2, bringing borrowing costs to a record-low 6 percent.

Hungarian policy makers raised the benchmark rate for the second consecutive month yesterday, boosting the benchmark rate by 1 percentage point during that period. Another increase may be needed if “risk perception and the outlook for inflation deteriorate further substantially,” they said in a statement.

50 Basis Points

“Clearly the hurdle has been set a little higher now with that statement,” Peter Attard Montalto, an economist at Nomura International Plc in London, said by e-mail. “We think our view of things ‘getting worse before they get better’ with regards to the IMF/EU and hence market moves and primary funding stress in the first half all mean that the conditions will be right for a 50 basis-point hike between January and February.”

The rate increase “impedes Hungary’s healthy economic growth and runs against EU trends,” the Economy Ministry in Budapest said in an e-mailed statement after the decision. The government estimates 0.5 percent growth in 2012, compared with a 0.1 percent growth forecast published today by the central bank. The inflation rate may average 5 percent in 2012, before falling to the central bank’s 3 percent target in first half of 2013.

The ministry’s statement is “unacceptable” and shows the government doesn’t understand the notion of central bank independence, something that’s also reflected in the draft law, the regulator’s President Andras Simor said yesterday.

‘Serious Doubts’

The IMF and the EU cited the draft legislation as they broke off talks with Hungary last week on an aid package, which the government requested last month after the forint fell to a record against the euro and before Moody’s Investors Service downgraded the country’s credit grade to junk.

“The commission has indeed serious doubts” about the central bank law and Commission President Jose Barroso conveyed his “strong concerns” in a letter to Orban, spokeswoman Pia Ahrenkilde Hansen told reporters in Brussels yesterday.

While the ruling party has made positive changes to the draft, they failed to address some of the ECB’s key concerns, including on the need to expand the rate-setting Monetary Council and on adding a vice president, Simor said yesterday, adding that the changes may be aimed at influencing decision.

“The freeze of informal talks with the IMF/EU due to disagreement on new central bank law confirms our view of a bumpy road ahead to a new IMF agreement, with renewed pressure on the currency in the coming 1-2 months,” Eszter Gargyan, an economist at Citigroup Inc. in Budapest, said by e-mail. “This is likely to necessitate one more rate hike in January.”

‘Very Negative Consequences’

Assuming the government agrees on an IMF program in the first quarter of next year, the central bank may forego further rate increases, Gyula Toth, a Vienna-based strategist at UniCredit SpA, said in an e-mail.

“The multiweek outlook of the Hungarian markets strongly depends on the outcome of the forthcoming IMF/EU negotiations and the rate hike in itself would not change the potential very negative consequences in case those talks fail,” Toth said. “From here our baseline assumes unchanged rates until the end of 2012, but this also incorporates an IMF/EU agreement reached in the first quarter.”

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