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Interest rate poses dilemma for Hungary's central bank

Hungary needs to pare back its interest rate, but the country's central bank is facing too many obstacles standing in the way of a base rate cut, Reuters said in a blog feature.

With the euro zone in the doldrums, the Hungarian economy is taking a big hit: April-June growth coming in at a measly 1.5% on an annual basis, well below expectations; quarter-on-quarter growth was zero; data last week showed annual inflation at two-year lows last month, and, despite a cut to personal income tax rates this year, household consumption is stagnating, while employment is running at 11%.

Yet the central bank’s hands are tied. According to Reuters, a rate cut would weaken the forint currency and that would hurt the Hungarian families, municipalities and companies that are struggling with tens of billions of dollars in Swiss franc-denominated loans. The surging franc has already lopped half a percentage off Hungarian growth this year as families cut back on consumption to keep up loan repayments, Nomura analysts calculate. 

Another reason Hungary cannot really afford a weaker forint at this stage is its dependence on imports, which make up about 3/4 of GDP, according to Neil Shearing at Capital Economics.

Bond markets are betting on a rate cut — swaps are pricing in a half point cut over the next year.

According to ING Bank analysts, Hungary could need the protection of high interest rates in the event of a global market sell-off. Hence the bank can afford to cut rates only next year.

Shearing of Capital Economics agrees: “The central bank is in a bind. Provided the euro zone doesn't melt down, there could be room for one or two rate cuts next year but at the moment its hands are tied by the currency issue.”

Things could get worse, says Reuters, as the economic slowdown is blowing a hole in the state budget, which may prompt the deficit-cutting government to announce more austerity measures. All bets on a near-term growth uptick would seem to be off, Reuters concludes.