UPDATE - National Bank of Hungary raises base rate 50bp after downgrade

The National Bank of Hungary’s Monetary Council decided to raise the central bank’s key rate by 50bp to 6.50% at a meeting on Tuesday.

The decision - the first rate change in ten months - came days after Moody’s downgraded Hungary’s sovereign rating to "junk" and was in line with market expectations.

Although many other options were discussed at the meeting, just one proposal was put to a formal vote and that vote was unanimous, central bank governor Andras Simor said at a press conference after the meeting.

"The Monetary Council decided to raise the base rate by 50 basis points in view of the upside risks to inflation and increased perceptions of the risks associated with the economy," the Council said in a statement. "If the outlook for inflation and risk perceptions remain persistently unfavourable, it may prove necessary to raise interest rates further in the coming months," it added.

The Council blamed the continued weakening of the forint and Hungary’s rising risk premia on the worsening outlook for global growth, the escalating debt crisis in the eurozone and "growing tensions" in the banking sector, including a government scheme allowing early repayment, in full, of foreign currency-denominated mortgages at discounted exchange rates.

The Council acknowledged the temporary improvement in market sentiment after the government said Hungary would seek financial assistance from the IMF as a precautionary measure, but noted confidence worsened after a downgrade by Moody’s of Hungary’s sovereign rating under "investment grade".

"In this situation, the Monetary Council considers it important that an agreement between the Government and the international organisations as well as between the Government and the Banking Association is reached as soon as possible," according to the statement.

The Council expects Hungary’s economic growth to "remain subdued" over the next two years, with an output gap present for the extent of the period. Increases in VAT and excise duties will probably raise consumer prices "significantly" in 2012, but the depreciation of the forint in recent months could lead to a build-up of inflationary pressure even in the medium term, it said.

The Council conceded that the degree to which companies pass on higher costs to consumers is "a source of uncertainty" and said it would "closely monitor" developments in tax-adjusted core inflation as well as CPI.

The Council deemed the outlook for economic growth in Hungary "unfavourable". The global downturn could cause export growth to slow and consumption is likely to "remain persistently low" because of balance sheet adjustments by households, uncertain income prospects, tax increases and the weaker forint. "Significant fiscal adjustment next year is also likely to act as a brake on domestic demand growth," it added.

The Council noted the early FX loan repayment scheme had caused the banking sector’s capital position to deteriorate further, which weakens banks’ lending capacity.

Asked about Hungary’s talks with the IMF, Mr Simor said the NBH would participate at the talks with the government, but he declined to make any further comment on the size or type of any agreement in order to avoid damaging the country’s negotiating position.

He said a country’s financing needs would have to be weighed against the funds that can be raised on the market in talks with the IMF. The credibility gained through a deal with the IMF is more important than the size of the deal, he added

Asked about reports of speculative attacks on the forint, Mr Simor said he had no proof that there were or were not speculative attacks on the currency, but added that speculation is a normal market activity. Speculative attacks are generally taken against countries with weak fundamentals, he said, adding that Hungary should learn lessons from the current situation.

The condensed minutes of the Council’s meeting on Tuesday will be published at 2pm on December 7, 2011.