UPDATE - Hungary keeps key rate on hold at 6%

MNB

Hungary’s central bank MNB has kept the country’s key rate on hold at 6% at a rate-setting meeting on Tuesday and said it may be necessary to maintain interest rates at their current level over a sustained period.

The decision was in line with market expectations.

Rate-setters left the key rate unchanged for the sixth month in a row following a tightening cycle started last November and finished in January.

At the previous meeting held on June 20, Council members voted unanimously to keep the rate on hold and agreed that it might be necessary to keep the base rate on hold for a longer period to ensure the central bank's 3% "price stability" target is met by the end of 2012.

In the Council’s judgment, the Hungarian economy is likely to continue to pick up slowly over the next two years; however, the level of output will remain below its potential throughout the period. Domestic demand is expected to recover only gradually. Consequently, inflation may fall back to 3% by the end of 2012 even without policy tightening, despite the cost shocks hitting the economy, the MNB said on Wednesday in a press release explaining its rate decision.

The restraining effect on price and wage-setting of the persistent weakness in domestic demand and high unemployment, in addition to moderate movements in administered prices, is likely to be a key determinant of inflation as the effects of the cost shocks wear off. It may be necessary to maintain interest rates at their current level over a sustained period in order to meet the target for CPI inflation by the end of 2012, the Council statement said.

External demand is expected to remain the main driver of Hungarian economic growth in the short term, with domestic demand growth likely to recover only slowly. The pace of global economic activity is expected to ease slightly, but this effect on Hungarian exports may be offset by the implementation of large-scale investment projects, mainly in the car industry. The trade surplus is likely to remain high, reflecting strong export growth and weak imports due to subdued domestic demand.

The latest data on household consumption show little sign of a pick-up. Disbursements of real returns on private pension funds are likely to provide a temporary boost to consumption. However, the recent appreciation of the Swiss franc may lead to an increase in monthly installments on existing household debt. If the strength of the franc were to persist, it would take longer for households to adjust their balance sheets, which may act as a drag on consumption growth. This in turn may result in lower inflation, the Council calculated.

The generalized increase in risk aversion due to the escalation of the euro-area sovereign debt crisis also had an impact on countries of the CEE region, including Hungary. The deepening of the crisis could lead to persistently high risk aversion, which would be reflected in increased yields on government securities and interbank rates, as well as in a depreciation of the forint against the currencies of developed countries. In addition, a deepening of the crisis could cause a slowdown in euro-area activity, which would negatively affect the outlook for Hungarian economic growth through lower external demand.

The Monetary Council decided to leave interest rates unchanged in light of the above considerations. In terms of the Council’s future interest rate policy, a prolongation of the euro-area debt crisis represents the most important source of risk, the Monetary Council said, adding that the abridged minutes of its Tuesday meeting will be published on August 10.

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