Hungary cites spare capacity, easing inflation, drops base rate to 4¼%

By Toni Weeks

San Luis Obispo, Calif., June 25 - The Monetary Council of the Magyar Nemzeti Bank voted to reduce its central base rate by 25 basis points to 4¼% from 4½% at its meeting on Tuesday, according to a press release. The new rate is effective as of June 26. The bank last lowered the rate by 25 bps to 4½% from 4¾% at its meeting last month.

The council also lowered the two-week MNB bill rate to 4¼% from 4½%, the overnight central bank deposit rate to 3¼% from 3½%, the overnight collateralized loan rate to 5¼% from 5½%, the interest rate remunerated on required reserves to 4¼% from 4½% and the penalty interest rate applied in case of reserve deficit to 4¼% from 4½%.

The release said that the level of the base rate has been lowered in a series of small steps, correlating to a significant reduction in the rate since August 2012. The condition of the real economy, and particularly weak domestic demand, warranted the reduction over the entire period, the bank said. The outlook for inflation has shifted in the same direction, and incoming data confirmed that the council had room to continue its monetary policy easing cycle.

The council believes that inflation is likely to ease further in the short term, mainly driven by falls in administered prices and commodity prices. The inflation rate, adjusted for the direct price level increasing effects of indirect taxes, is expected to remain below 3% over the medium term.

Global economic activity picked up in the first quarter of 2013, but sentiment in international financial markets weakened, and indicators of real economic activity remained subdued. The major central banks either maintained or eased further monetary conditions during the last quarter, in line with the "fragile economic situation" and the low-inflation environment.

Domestic growth resumed in the first quarter of 2013 but at a slow rate, suggesting that the expansion of domestic GDP may continue in the coming quarters. Growth is likely to be driven by exports, and new capacity created in the automobile industry may stimulate Hungary's export market shares even though external demand remains subdued. Domestic demand is expected to stabilize this year following the decline in previous years.

In the council's view, global financial markets have become more fragile recently. Quantitative easing programs implemented by leading central banks will be key in sustaining the supportive financial market environment.

The council believes there remains a significant degree of spare capacity in the economy and inflationary pressures are likely to remain moderate in the medium term. Therefore the 3% target can be met with looser monetary conditions. As long as the outlook for inflation and the condition of the real economy justifies reducing interest rates further, it can be done, the council said. But increased caution is warranted in the volatile and rapidly changing global environment.

The abridged minutes of Tuesday's meeting will be published on July 10.

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