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Central bank leaves base rate on hold, as expected

The Monetary Council of the National Bank of Hungary (NBH) decided at a meeting on Monday to leave the central bank's key rate on hold at 6.00%, in line with market expectations.

The decision could be an end to a tightening cycle started in November. Before that, the bank last raised rates in October 2008.

The decision was made against a backdrop of slowing year-on-year consumer price inflation in January, when CPI fell to 4.0% from 4.7% in the previous month.

Speaking at a press conference after the meeting, NBH governor Andras Simor said rate-setters voted on two proposals: one to keep the base rate on hold and the other to cut the rate by 25bp. The decision to keep the rate on hold was made with an "overwhelming majority", he added.

Simor called the drops in both headline CPI and core inflation in January a "pleasant surprise". The twelve-month rise in service sector prices -- a good indicator of domestic inflationary pressure -- was under 2%, but there continues to be growing external pressure from higher global prices for unprocessed food and for fuel, he added.

In a statement published after the meeting, the Council said it decided to keep the base rate on hold because the previous three rate rises will help to bring inflation down close to the target after the direct effect of cost shocks -- the recent fuel and unprocessed food price rises -- are over. In the coming months, the Council will decide if further rate rises are necessary based on an assessment of inflationary risk, the rate-setters added.

Simor noted at the press conference that rate-setters would have important new information at their next meeting, namely the NBH's fresh quarterly Inflation Report and details of anticipated government structural reforms.

The Council said it sees consistently higher-than-targeted inflation as the biggest risk to the mi-term outlook for inflation. Because inflation is over the "price stability" target, inflation expectations are not anchored, which could cause second-round inflationary effects, the Council explained.

Addressing economic growth, the Council said external demand could remain the engine for Hungary's GDP growth in 2011, but domestic demand is expected to catch up gradually. Changes to the personal income tax and a slow improvement in employment should support a pick-up in domestic demand, but a tighter lending environment and higher commodities prices will hold back the climb. Big one-off investments will lift fixed capital formation, although an uncertain business environment and banks' restrained lending activity will have the opposite effect, the Council said.

Rate-setters stressed the importance for decisions on prices and wages to be taken in light of the still considerable slack on the labor market. Wage rises that are not in line with improved performance not only put the inflation target at risk, but endanger the security of workplaces, they warned.

Although the risk premia on Hungarian financial assets have fallen in the past months, they are still high in regional comparison, the Council said. Structural reforms expected to be announced soon by the government could have a decisive effect on the country's risk assessment in the coming months, they added.

Answering a question about proposed amendments that would give Parliament the power to choose the Council's external members, Simor said, hypothetically, that if markets think the central bank's independence is endangered, this is a danger in and of itself.

The condensed minutes of the meeting on Monday will be published on March 18 at 2pm.