Hungary's main rate must rise further, MNB VP says

Analysis

Hungary's central bank, which raised borrowing costs at each of its last five meetings, must increase the benchmark interest rate further to contain inflation, said bank Vice President Henrik Auth.

Policy makers, who next meet on November 20, have raised the two-week deposit rate to 8% on concern Prime Minister Ferenc Gyurcsány’s efforts to cut the budget deficit will push inflation above the central bank's target. The government has cut spending and increased the value-added tax and regulated energy costs to slash the deficit from 10.1% of GDP forecast this year to 6.8% in 2007. Higher taxes and bigger utility bills sparked inflation and may force the country to delay adopting the euro beyond 2010. A rate increase „is of essential importance in maintaining the credibility of the inflation target,” Auth said in an interview in Budapest on October 31. „On the monetary policy's time horizon, we still haven't reached price stability. An unfolding of second-round effects and a shift in expectations could be very dangerous and we must do something.” Inflation is accelerating from a 34-year low in April after the government raised taxes and increased the price of natural gas, electricity, medicines and public transport. The central bank wants to keep the annual inflation rate, which rose to a two-year high of 5.9% in September, between 2% and 4% through 2009. It forecasts a 4.2% rate for the end of 2008, according to its August report.

Even after the forint rose 7% versus the euro and the price of crude oil declined 20% since the report, the inflation outlook may not have improved significantly, Auth said. „I don't see a marked shift right now,” Auth said. „The current downward risks and the simultaneous unquantifiable upward risks of expectations make the situation quite uncertain.” A pickup in core inflation, which strips out volatile food and energy prices, and faster-than-expected wage increases suggest continued inflationary pressure, Auth said. The measure rose to 4% in September rose to 4%, the highest in 21 months. August gross wages rose 10.7% from a year ago, the fastest rate since January 2005. The central bank's 13 policy makers remain divided over the interpretation of that data, the inflation outlook and the necessary monetary policy response, Auth said. Hungary needs to tackle spending on pension, health care and education to make the effects of deficit cutting last, he said. The tax increases threaten to slow economic growth, encourage tax evasion and lower employment, making it difficult for the government to maintain revenue growth, Auth said.

„By 2008, 2009, the deficit-cutting effect of the austerity measures will run out of steam,” he said. „Cutting current expenditures should have been a priority. The emphasis should have been on social transfers.” The chance that budget spending and the deficit will rise again is a continued risk for the economy and will make it difficult for the central bank to cut interest rates, Auth said. Hungarian bonds and the currency have benefited from resurgent risk appetite that have boosted emerging market assets across the board, he said. The central bank must now safeguard against a potential shift in the investment environment, which may lead to a sell-off in Hungarian assets unless the government can prove that it will be able to push through its measures. „The Hungarian economy remains very vulnerable,” Auth said. „When it becomes clear that the implementation risk is gone, when it becomes clear that fiscal policy is moving on the path that everyone thinks now, that's when the time will come to change the direction of monetary policy.” (Bloomberg)

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