Orban’s IMF Reversal Helps Fend Off Hungarian Rate Increase

Hungarian Premier Viktor Orban pledging to yield in a row with the European Union helped the central bank leave the European Union’s highest main interest rate unchanged as the forint rebounded from a record low.

The Magyar Nemzeti Bank unexpectedly held the benchmark two-week deposit rate at 7 percent after a “close vote” yesterday, during which policy makers also considered a third consecutive half-point increase, central bank Governor Andras Simor told a news conference in Budapest. The forint and bonds rose, while stocks fell.

Orban was in Brussels yesterday, seeking to restart bailout talks that broke down last month over a central bank law that the International Monetary Fund and the EU said threatens monetary-policy independence. Speculation that the talks may collapse pushed the forint to a record low against the euro earlier this month. Orban’s pledge to change legislation to satisfy the 27-member EU helped local assets pare losses.

“The global environment and positive expectations regarding an IMF/EU deal are protecting the forint for the moment,” Gyula Toth, a strategist at UniCredit SpA, said in an e-mail. “In case any deterioration in risk appetite is met by delays in the IMF talks we expect the bank to be forced to hike rates again.”

Forint, Bonds, Stocks

The forint gained for a seventh day and traded at 298.66 per euro at 1:55 p.m. in Budapest, the strongest since Oct. 28, 2011. Orban’s conciliatory rhetoric sent the forint, the worst-performing currency in the world in the past six months, rallying against the euro after falling to a record low of 324.24 on Jan. 5.

The yield on 10-year government bonds fell 2 basis points to 8.86 percent from yesterday and dropped from 10.8 percent on Jan. 4. The cost of insuring state debt against default fell 4 basis points to 589 basis points after reaching a record 735 on Jan. 5. The benchmark BUX stock index fell for the second day, retreating 1 percent to 18,671.01.

“The majority of the council reckoned that the change in the government’s communication not only influenced risk premia in the short term, but may also have longer-term effects,” Simor said.

Orban-Barroso Meeting

Orban met European Commission President Jose Manuel Barroso yesterday to outline solutions to the EU executive’s concerns. The commission threatened on Jan. 17 to file a lawsuit against Hungary because of the central bank law, moves to force hundreds of judges into retirement by cutting their pension age and a plan to dismiss the data protection ombudsman after an overhaul of his office.

“The issues previously deemed most difficult are behind us,” Orban told private television station HirTV yesterday on his way back from Brussels. The start of aid negotiations may happen “any time,” he said, adding that there was no single question that the government regarded as a “taboo.”

“We had a comprehensive and constructive discussion,” Barroso said in a statement after the meeting. “The Prime Minister indicated Hungary’s readiness to address swiftly the issues raised by the commission.”

EU finance ministers at a meeting yesterday pushed Hungary to do more to rein in its budget deficit, holding out the threat of a suspension of subsidies if the government doesn’t meet fiscal targets.

‘Severe Deterioration’

Hungary’s budget sustainability underwent a “severe deterioration” last year, which was masked by one-time measures, the commission said in a report on Jan. 11. Hungary has failed to take “effective action” to rein in the budget deficit in a “sustainable nature,” it said. The ministers yesterday adopted the recommendation.

The outcome of yesterday’s vote is the result of “the divide between the four new members, who are closely aligned with the government, and the old guard, totaling three, who called for a 50 basis-point increase,” said Guillaume Salomon, London-based emerging-market strategist at Societe Generale SA. “We believe that the council is indeed completely divided.”

The four outside members of the rate-setting Monetary Council were appointed last year by a parliamentary committee dominated by lawmakers belonging to the ruling party.

‘Substantial and Sustained’

Hungary may need to raise the main rate further if the country’s risk assessment and inflation outlook “deteriorate significantly,” Simor said, adding that only a “substantial and sustained improvement” in risk premiums would warrant a rate cut.

Hungary’s recent rate increases contrast with the Romanian central bank, which has lowered borrowing costs twice in the past three months to 5.75 percent. The Ceska Narodni Banka in Prague has left its two-week repurchase rate unchanged at a record-low 0.75 percent since May 2010, while Poland kept its benchmark rate unchanged at 4.5 percent for a sixth meeting on Jan. 11.

Hungarian forward-rate agreements, used to bet on three-month interest costs in one month, fell 24 basis points to 7.56 percent, the lowest level on a closing basis since Dec 28. The Budapest Interbank Offered Rate, to which the FRAs settle, traded at 7.65 percent.

The government needs to reach an agreement with the two international institutions “as soon as possible” for financing costs to decline, the central bank said in a statement yesterday.

‘Period of Stability’

Delays in reaching a bailout agreement may force the central bank to raise borrowing costs again, Peter Attard Montalto, an economist at Nomura International Plc. in London, said in an e-mail.

“Expect a period of rates stability now, decisions will be increasingly led by market risk sentiment,” he said. As “market pricing must again get much worse to force the government to make real policy concessions, we also believe there will be more rate hikes -- say in” the second quarter.

Hungary is ready to change its central bank bill and other laws because starting talks on an IMF loan is more important for the government than engaging in a legal battle with the European Commission, Orban told reporters in Budapest Jan. 20.

Hungary, which became the first EU country to receive an IMF-led bailout in 2008, shunned fresh aid in 2010 when Orban became prime minister. He reversed his policy last year when the state started struggling to raise funds at debt auctions, the forint plummeted and the country’s sovereign-credit grade was cut to junk.

Test Case

Hungary’s public debt rose to 83 percent of gross domestic product at the end of the third quarter, the highest in the region. It compares with about half that ratio for neighboring Slovakia, which joined the euro in 2009.

Hungary has become a test case for democratic principles and economic-policy rules in the EU, forcing the commission to make good on a pledge to use all its powers to enforce the bloc’s norms. The country, which isn’t part of the 17-nation euro area, risks compounding the two-year-old European debt-crisis centered on the single currency.

The government may reach an agreement with the two international institutions in “a couple of months” after negotiations that will start “in the coming weeks,” Economy Minister Gyorgy Matolcsy told reporters in Brussels yesterday.

“We think that negotiations with the IMF can start officially over the next few weeks and we think that the odds of a package being reached by” the end of the first quarter or early in the second quarter “are good,” Pasquale Diana, an economist at Morgan Stanley in London, wrote in a note to clients yesterday. “Even a modest rally or a stabilization in risk metrics may be enough to persuade the” central bank “to remove some of the recent risk-motivated tightening.

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