Hungary's central bank further reduces base rate by 10 bps to 2.6%

By Marisa Wong

Madison, Wis., March 25 - The Monetary Council of Hungary's Magyar Nemzeti Bank voted to reduce the central bank base rate by 10 basis points to 2.6% from 2.7%, according to a news release.

The council made the decision at its meeting on Tuesday, and the change becomes effective Wednesday.

Since August 2012, the council has reduced the central bank base rate significantly, the release noted. The council said it believes the significant reduction in the base rate implemented so far has helped the bank achieve the inflation target over the medium term and has contributed to the strengthening of domestic economic growth.

Looking ahead, inflation is likely to move in line with price stability, and disinflation is expected to slow gradually. The council anticipates that inflation will likely remain below the 3% target in 2014, before moving into line with the medium-term inflation target from 2015.

The inflation rate has been at historically low levels in recent months. Subdued inflation in external markets, the degree of unused capacity in the economy, the fall in inflation expectations and the reductions in regulated prices, implemented in a series of steps, have contributed to the development of a low inflation environment, the bank noted.

However, the weaker exchange rate of recent months has passed through gradually to the prices of core inflation items, which in turn points to higher underlying inflation.

The council said it believes the Hungarian economy returned to a growth path in 2013. Looking ahead, economic growth is likely to continue. Economic activity picked up gradually in the past quarters, with output rising across a wide range of sectors.

Hungary's external debt is expected to fall further, the bank said. The external financing capacity of the Hungarian economy continued to rise toward the end of 2013. With the external financing capacity remaining high, the external debt ratio is likely to fall further, which in turn will reduce the country's vulnerability, the council said.

The bank observed that the Hungarian risk premium did not change significantly in the past quarter, but volatility increased in financial markets. Due to the Fed's decision to further reduce the pace of its asset purchases, the increased focus on the vulnerability of some emerging economies and the escalation of the conflict between Ukraine and Russia, global investor sentiment has been volatile in the past quarter.

Nevertheless, Hungary's position is fundamentally strong compared to other emerging market economies, the bank said. The country's persistently high external financing capacity and the resulting decline in external debt are reducing its vulnerability. The council advises a cautious approach to policy given the uncertainty related to the global financial environment.

Overall, the bank feels that the macroeconomic outlook is surrounded by both upside and downside risks.

The council said there remains a degree of unused capacity in the economy and inflation is likely to move in line with the target in the medium term. The negative output gap is expected to close gradually at the monetary policy horizon, and, as a result, the disinflationary impact of the real economy is likely to decrease going forward.

Considering the substantial reduction in interest rates so far, changes in perceptions of the risks associated with the economy and based on currently available information, the central bank base rate has significantly approached a level that ensures the medium-term achievement of price stability and a corresponding degree of support for the economy.

In case of a significant deterioration in global financial market environment, the council said it sees no scope for continuing the easing cycle.

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