Bloomberg News

Hungary Cuts Rate Again as Decision Polarizes Rate Body

September 26, 2012

Hungary’s second interest-rate cut in as many months shows Premier Viktor Orban’s allies have isolated central bank President Andras Simor and chosen economic growth over inflation, according to analysts from London to Budapest.

The Magyar Nemzeti Bank reduced the two-week deposit rate to 6.5 percent from 6.75 percent, with a “tight majority” over a proposal for no change, Simor told reporters in Budapest yesterday. A further lowering of rates may be considered, the bank said in a statement.

Simor is losing control over monetary policy after already opposing the first rate cut since April 2010 in August, when the four non-executive members of the Monetary Council, appointed by Orban’s allies in parliament, backed easing to help an economy mired in its second recession since 2009. Simor called it “pointless” with inflation at 6 percent in August, double the the bank’s target.

“It’s clear Simor is shunned and that the external members are in control,” Zoltan Arokszallasi, a Budapest-based economist at Erste Group Bank AG, said by phone. “The cuts have been risky and they have damaged the bank’s credibility.”

The nation’s benchmark rate is still the highest in the European Union, helping to prop up the forint as the government struggles to obtain a bailout from the International Monetary Fund and the bloc 10 months after requesting aid.

Forint Weakens

The forint, the world’s second-best performer this year against the euro, has weakened 1.4 percent since last month’s rate cut. It dropped 0.2 percent from yesterday to 285 per euro as of 11:25 a.m. in Budapest.

The cost to insure Hungarian debt for five years with credit default swaps fell to 385 basis points today, compared with 423 points before the first rate reduction and 630 basis points on June 5. The yield on the government bond due 2022 rose 4 basis points from yesterday to 7.3 percent.

“The recent improvement in market sentiment has given the four ‘external’ members of the MPC the upper hand in recent interest-rate decisions,” Neil Shearing and William Jackson, economists with Capital Economics Ltd. in London, said in an e- mailed note.

Leadership Challenged

Simor’s leadership is being contested from within the bank after two years of government onslaught that aimed to oust him at first and then to clip his powers. Parliament cut his salary, stripped him of his right to name rate setters and filled the majority of the Monetary Council with ruling-party appointees.

The Cabinet had urged a looser monetary policy and repeatedly called on the central bank to do more to help economic growth.

While the bank yesterday forecast in a staff report that interest rates would have to be raised from current levels to meet the price-growth goal, the majority of rate-setters said that “expected developments in inflation and financial markets as well as persistently weak demand warrant an easing of current monetary conditions.”

The Monetary Council said the inflation target is “likely to be met as the direct effects of cost shocks wear off,” in reference to rising food and fuel prices.

Faster Inflation

The bank yesterday raised its forecast for average inflation to 5 percent in 2013, up from a 3.5 percent projection in June. Price growth will average 5.8 percent this year, while the economy may shrink 1.4 percent and grow 0.7 percent in 2013, it said.

“The inflation-targeting anchor of the Hungarian monetary policy has been abandoned and the predictability of policy decisions damaged,” Zoltan Torok, a Budapest-based economist at Raiffeisen Bank International AG (RBI), said in an e-mailed note.

The debate over inflation risks isn’t unique to Hungary, with central banks around the world loosening monetary policy as the euro-area debt crisis threatens the global economy and financial stability.

The Bank of Japan (8301) expanded its asset-purchase fund on Sept. 19, a week after the U.S. Federal Reserve voted to extend its quantitative-easing program. The European Central Bank has agreed to buy the bonds of governments that accept austerity conditions to tame the euro turmoil.

‘Excessive Expansion’

Bundesbank President Jens Weidmann said Sept. 18 that “excessive expansion of the money supply” on the part of the ECB may boost inflation. Bank of England policy makers on Sept. 19 differed on the need for more stimulus in light of growing inflation risks.

“I would suggest most central banks are placing a greater emphasis on growth,” Christian Lawrence, a London-based strategist at Rabobank International, said by e-mail.

In Hungary’s case, rate cuts aren’t helping growth as the economy is primarily held back by subdued lending and investments that are a result of government policies, Simor said Sept. 13.

As demand for exports wanes in the 17-nation euro region, the Czech central bank may cut its main rate to 0.25 percent tomorrow from 0.5 percent, already a record low, while Romanian policy makers may keep the benchmark rate unchanged at 5.25 percent, median estimates of economists in two Bloomberg surveys show.

The need to ease Polish monetary policy is “obvious” and should come as a “cycle,” central bank Governor Marek Belka was quoted today as saying by the PAP newswire.

Further Reductions

Investors are pricing in more reductions in Hungary. Forward-rate agreements used to bet on three-month interest rates in three months were at 6.26 percent after the rate decision. The contracts traded 58 basis points below the three- month Budapest Interbank Offered Rate, indicating a year-end rate of 6 percent.

Yesterday’s rate cut was “confirmation of the Monetary Policy Council’s division and the external members’ shift from primary inflation targeting toward growth,” Eszter Gargyan, a Budapest-based economist at Citigroup Inc., said by e-mail.

The Orban government’s measures over the last two years, including a special tax on lenders and the nationalization of private-pension funds, contributed to a downgrade of Hungary’s debt rating to junk and a drop in investments.

Negotiations for a loan of about 15 billion euros ($19.4 billion) have been delayed several times because of Orban’s resistance to adhere to legal and economic conditions set by the IMF and the EU. An agreement may be reached by November, chief aid negotiator Mihaly Varga said in an interview published Sept. 22 in the Magyar Nemzet newspaper.

To contact the reporter on this story: Zoltan Simon in Budapest at zsimon@bloomberg.net

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


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