Hungary Cuts Main Rate to Record Low to Fight Recession

Hungary’s central bank cut its main interest rate for a seventh month to a record low as policy makers vowed further monetary easing to fight a recession at President Andras Simor’s final meeting on borrowing costs.

The Magyar Nemzeti Bank reduced the two-week deposit rate by a quarter-point to 5.25 percent, matching the level from April to October 2010 and in line with the forecast of all 26 economists in a Bloomberg survey. The bank voted in a “tight” decision over a proposal for unchanged rates, said Simor, whose six-year term ends March 3.

Hungary slipped deeper into recession in the fourth quarter as the fading effect of higher taxes slowed price increases, boosting the case to continue cutting the European Union’s highest benchmark rate. Simor and his two deputies have opposed the easing, citing the need to fight inflation that’s faster than the central bank’s 3 percent target. Prime Minister Viktor Orban has said he’ll name Simor’s successor March 1.

“The impending change at the helm of Hungary’s central bank will lead to further cuts in interest rates over the coming months,” Neil Shearing and William Jackson, London-based economists at Capital Economics Inc., said in an e-mailed note today. “The scope for easing will be determined in large part by whether global risk appetite holds up.”

Currency Weakens

The forint dropped to a three-week low of 295.26 per euro at 4:55 p.m. in Budapest, down 0.6 percent from yesterday. The yield on the government bond maturing in 2023 rose four basis points to 6.26 percent. A basis point is 0.01 percentage point.

Eastern European central banks are easing policy to boost their economies, weakened by their biggest trading partner, the debt-stricken euro area.

Poland lowered its main rate by a quarter-point to 3.75 percent on Feb. 6, the fourth straight cut. The Ceska Narodni Banka has left the two-week repurchase rate at 0.05 percent since November, keeping it almost three-quarters of a percentage point below the euro-area benchmark. Hungary’s main rate matches Romania’s for the EU’s highest.

In Hungary, weak domestic demand is exerting “strong disinflationary” pressure, while a “favorable” global market environment may lead to a “sustained” drop in local asset prices, the Monetary Council said in a statement after the rate decision. The inflation rate fell to 3.7 percent in January, the lowest since September 2011.

‘Looser Conditions’

“The inflation target can be met even with looser monetary conditions,” the Monetary Council said. “The Council will consider a further reduction in the policy rate if the medium-term outlook for inflation remains consistent with the bank’s 3 percent target and the improvement in financial market sentiment is sustained.”

The market “appears to have priced in” that Economy Minister Gyorgy Matolcsy will take over as central bank president next week, K&H Alapkezelo, the Budapest-based fund management unit of KBC Groep NV, which manages $3.5 billion, said in an e-mail yesterday. That, coupled with further rate cuts, may keep the forint near 300 per euro in the first half of the year, K&H said.

Matolcsy will succeed Simor as MNB president, Nepszabadsag newspaper reported today, citing unidentified government sources. Orban yesterday told HirTV that he won’t shuffle his Cabinet, without saying whether that rules out Matolcsy for the central bank position.

‘Weaken Substantially’

Investors expect the main rate to fall to 4.25 percent, Zsolt Kondrat, a Budapest-based economist at Bayerische Landeskbank’s MKB unit, said an e-mail today, adding that “no tangible effect” may be exerted on lending and growth.

“Risks are that the easing cycle will continue until the exchange rate starts to weaken substantially,” Kondrat said.

Matolcsy spearheaded Hungary’s self-described unorthodox policies, such as the effective nationalization of privately managed pension-fund assets and the use of retroactive industry taxes, to keep the budget deficit within 3 percent of economic output and to lower government debt.

The measures contributed to a drop in lending and investment as Europe’s debt crisis curbed export demand. GDP shrank 2.7 percent in the fourth quarter, the deepest slump in three years, while the economy contracted 1.7 percent in 2012, the statistics office said Feb. 14.

Conflicting Forecasts

Hungary’s economy may contract 0.1 percent this year, the European Commission said last week. The government forecasts growth of 0.9 percent.

“There are excessive expectations on what central banks can achieve for the economy,” Simor said today. “The central bank has been cutting interest rates for more than six months and there is no trend-like change in lending.”

Matolcsy called in December for the “brave” use of unorthodox policies at the central bank to kickstart growth, before saying a month later that the Magyar Nemzeti Bank should follow a “conservative” policy course and avoid “surprises.”

The new central bank leadership may try to boost lending by offering funds at preferential rates to banks or limiting the amount commercial banks can hold in two-week deposits at the MNB, London-based Morgan Stanley economist Pasquale Diana said yesterday in a report after meeting officials in Budapest.

Lenders may also receive tax breaks from Europe’s highest bank levy to boost credit, Diana said. A weaker forint by itself is unlikely to stop rate cuts as policy makers are also considering credit-default swap levels and bond market developments in their risk metrics, he said.

The central bank may need to act as a “domestic buyer of last resort” in case of dislocations in the local bond market should Orban return to “unorthodox” policies before the run-up to 2014 elections, damaging investor confidence, Diana said.

(Updates with voting in second paragraph, Monetary Council statement in eighth and ninth, economist in 12th and 13th.)
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