Hungary’s IMF Talks Create July Rate-Cut Room: Officials

Hungary Keeps EU’s Highest Rate Unchanged on IMF Bailout Concern
The Magyar Nemzeti Bank kept the two-week deposit rate at 7 percent today for a seventh month, matching the forecast of 20 economists in a Bloomberg survey. Photographer: Akos Stiller/Bloomberg

Hungary held off on cutting the European Union’s highest benchmark rate, opting for caution amid concern about inflation and possible delays in loan talks with the International Monetary Fund and the European Union.

The Magyar Nemzeti Bank kept the two-week deposit rate at 7 percent today for a seventh month, matching the forecast of 20 economists in a Bloomberg survey. One expected a cut to 6.75 percent. The Monetary Council backed keeping rates on hold with a “substantial majority’ after considering a quarter-point cut in the benchmark rate, Governor Andras Simor said at a press conference in Budapest today.

The country’s risk perception and inflation outlook ‘‘warrant a cautious policy stance,” rate-setters said in a statement. A rate cut would require a “persistent” fall in the risk premium and an improvement in the inflation outlook, the policy makers said.

Central bankers have signaled divisions on when to start easing borrowing costs. While some have said the start of aid talks offers a chance to cut the main rate as early as this month to help growth as the economy sinks into its second recession in four years, others have warned that easing too early may erode the bank’s credibility.

‘Unchanged’ Policy

“We believe that monetary policy will be kept unchanged this month and that the outlook for monetary policy in Hungary strongly hinges on the ongoing negotiations between the Hungarian government and the EU and the IMF,” Benoit Anne, the London-based head of emerging-market strategy at Societe Generale SA, said in an e-mail before the rate decision. “Negotiations with the EU and the IMF will be very arduous.”

Investors pared their bets for rate cuts with forward-rate agreements used to bet on three-month interest rates in two months rising to 6.98 percent from 6.92 percent. The contracts traded 21 basis points below the three-month Budapest Interbank Offered Rate, indicating investors are no longer pricing in a full quarter-point drop in borrowing costs in September.

The forint, which gained 9 percent against the euro this year as investors speculated that Hungary will obtain an IMF bailout, trimmed its losses after today’s decision. The currency was down 0.2 percent at 288.15 per euro at 4:06 p.m. in Budapest.

“The start of bailout talks as such had no impact on today’s rate decision as we don’t know the final outcome of these negotiations,” Simor said, adding that the country needed an IMF deal “as soon as possible” to lower debt financing costs.

Inflation may slow to the central bank’s medium-term target of 3 percent in 2014, Simor said. That indicates a deterioration in the inflation outlook as Simor said last month the gauge may near the target by end-2013.

Growth Forecasts

Officials from the IMF and the EU disagreed with the government’s growth forecasts at the start of the talks, chief negotiator Mihaly Varga told Figyelo July 19. Suspending talks because of differences over economic forecasts is one possible outcome of the week-long visit from the international delegation that ends July 25, he said.

IMF and EU officials are focusing on untangling policies that contributed to an economic contraction in the first quarter and the downgrade of Hungary’s credit to junk. That includes the flat personal-income tax, which cut revenue without boosting consumption and prompted the Cabinet to plug budget holes through extraordinary industry taxes that reduced investments and pushed the economy toward a recession.

Hungary will probably miss its goal of obtaining a loan by the end of October as Premier Viktor Orban gears up for a re-election bid in 2014, according to a July 17 Bloomberg News survey of economists. Four of 12 economists expected an accord in October, six by the end of the year and two in 2013.

Aid Negotiations

Bailout talks are “extremely unlikely to bring any easy or fast results,” Zoltan Torok, a Budapest-based economist at Raiffeisen Bank Inetrnational AG, said in an e-mailed note.

The government wants a credit line of about 15 billion euros ($18.2 billion) to protect the economy from euro-area contagion and to lower financing costs. The yield on the 10-year government bond, which was 8.07 percent a month ago, rose for a third session to 7.41 percent today.

Talks with the IMF “give hope that things will improve and we want to put in place an interest-rate environment that gives incentives ahead of the start of a growth cycle,” central banker Ferenc Gerhardt said on July 11 in a joint interview with his colleague Gyorgy Kocziszky. “Naturally, there can be a rate cut this month, the possibility is there.”

Deepening Rift

The comments showed a rift between Simor and his two deputies on one side and at least three of the four non-executive rate-setters, who were appointed last year with ruling-party backing, on the other. The four united against the bank’s leadership in January when they outvoted a proposal to raise the benchmark rate by half-point to 7.5 percent to keep borrowing costs unchanged.

Since February, Gerhardt and Kocziszky, along with fellow non-executive rate-setter Andrea Bartfai-Mager, voted with Simor and his deputies to maintain interest rates against Janos Cinkotai, the fourth non-executive member, who backed rate cuts.

‘Barely Credible’

A rate cut today would have seemed “barely credible” for the central bank, which only last month cited the need for “persistently and substantially” falling country risk and an improvement to the inflation outlook for rate cuts, OTP Bank Nyrt., Hungary’s largest lender, said in a July 20 report.

Inflation, the fastest in the EU, accelerated to 5.6 percent in June from 5.3 percent in May, drifting further from the 3 percent target of policy makers. The central bank last month raised its forecast for the 2013 average inflation rate to 3.5 percent from 3 percent.

The cost of insuring against default on Hungary’s debt for five years using credit-default swaps rose to 506.6 basis points today, the highest in two weeks. The gauge was at 531 basis points on June 25.

The European Central Bank this month cut its main interest rates by 25 basis points, taking the benchmark to a record-low 0.75 percent and the deposit rate to zero. The Czechs cut their main two-week repurchase rate by a quarter-point to a record-low 0.5 percent on June 28. Polish policy makers, who surprised the market with a quarter-point increase in May, kept the benchmark rate at 4.75 percent on July 4.

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