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Hungary should now start monetary easing, says City

Hungary should now “swiftly” embark on a gradual monetary easing as its real interest rates are among the highest in the world, London-based emerging markets analysts said on Monday as the Hungarian central bank kept its policy rate on hold at 9.5% for the fifth straight month.

Bank of America-Merrill Lynch said that with the economy likely to contract by 6.5% in 2009 as a whole, the negative output gap is set to reach 8%-9% of GDP.

Meanwhile, underlying disinflation continues, and “we see the underlying inflation (core CPI adjusted for indirect tax changes) declining to the 1.5%-2% range over the next 12 months.” For the current nominal policy rate of 9.5%, this implies a real interest rate of between 6.2pc, adjusted for the current core inflation, and 7.8% adjusted for BoA-ML's 12-months-ahead core inflation forecast. “This is one of the highest real interest rates in the world,” BoA-ML said.

It added that the “optimal”end-2009 interest rate for Hungary would be around 5%, assuming 6.5% GDP contraction, 3% core inflation, and unchanged EUR/HUF. Taking into account the risks, “our call remains to cut rates a bit less, to 7.50% by end-2009 and to 5.50% in 2010.”

Christine Li, London-based economist at Moody's Economy.com, said that the forint has strengthened 12% against the euro since March, although financial markets remain fragile and any bad news could destabilize the currency.

However, a weakening economic outlook calls for more monetary policy easing as recent economic data suggest Hungary's recession is accelerating. The IMF has allowed Hungary to run a larger budget deficit this year given the much worse than expected deterioration in the economy. This means additional spending cuts will not be necessary this year.

The central bank is expected to cut rates only gradually in order to prevent the forint from falling sharply. Overall, Moody's Economy.com expects interest rates to fall by 250 basis points by the end of 2009, taking the base rate to 7%, Christine Li said. (MTI – Econews)