Hungarian Central Bank Unexpectedly Cuts Main Rate

Hungarian Central Bank Unexpectedly Cuts Main Rate

http://www.bloomberg.com/apps/news?pid=20601085&sid=aYG1x3PDvY9E&refer=europe

By Balazs Penz

June 25 (Bloomberg) -- Hungary's central bank unexpectedly cut its benchmark interest rate, the European Union's highest, for the first time since 2005 after core inflation slowed.

The bank's 13 policy makers, led by President Andras Simor, cut the two-week deposit rate to 7.75 percent after having left it unchanged since October. Fifteen of 22 economists polled by Bloomberg expected the rate to be held. The remainder predicted a quarter-point cut to 7.75 percent.

Hungary's annual inflation rate has quadrupled in the past year as the government raised taxes and utility bills, before declining in April for the first time in two years. The lessening effect of the measures led to a declining rate in the past two months.

``We didn't expect them to cut yet, but the decision means that the bank is quite optimistic regarding inflation and second-round effects,'' said Anders Svendsen, emerging markets analyst at Nordea Bank in Copenhagen. ``The decision should not have a major impact on the forint or bonds, because markets have already been pricing in rate cuts in Hungary.''

The Hungarian forint fell to 247.46 against the euro in a knee-jerk reaction to the central bank's comments, but rebounded to trade at 247.00 by 3:19 p.m. in Budapest. The yield on Hungary's 6 percent benchmark bond due October 20 2011 fell 9 basis points to 6.88 percent.

Forward rate agreements show that investors are betting that the benchmark rate will come down at least 25 basis points in the next five months.

Market Rates

The three-month money market rate is at 7.80 percent, or 20 basis points lower than the central bank rate, according to Bloomberg data. That difference compares with an average of 3.9 basis points this year, signaling investors and traders have stepped up rate-cut expectations.

The bank cited slowing core inflation, which strips out volatile food and energy prices, for cutting rates today, Simor said at a press conference. The rate shows that wages growing faster than expected don't translate to higher prices, he said.

He added that there's mounting evidence for the government's argument that rising wage figures are caused by a so-called ``whitening'' effect, or new tax rules forcing employers to declare previously hidden wages.

`Change Our Thinking'

``The events of the past few days showed us that we have to change our thinking,'' Simor said. ``The whitening effect is greater than expected. There is no sign that the faster-than expected wage growth in the services sector would be reflected in prices.''

Job cuts in the services sector proved that companies compensated for their higher wage expenditures by reducing their workforce rather than raising prices, he said.

Hungary's currency has gained 11.5 percent versus the euro over the past year, helping curb consumer prices by cutting the price of imported products.

The inflation rate fell for a second month in May, as the effect of the austerity measures wanes. It was 8.5 percent, compared with 8.8 percent in April and a six-year high of 9 percent in March.

The bank aims to cut the inflation rate to 3 percent within the next two years. It last month raised its average 2008 inflation forecast to 3.6 percent from 3.4 percent, citing higher energy prices and said it expects to meet its target in the first quarter of 2009.

`Moderating'

``The risk that inflation expectations would be fixed at a higher level seems to be moderating,'' the bank said in a statement today. ``The easing of uncertainties surrounding the inflation outlook make it possible for the central bank to cut the benchmark interest rate.''

The policy meeting was the last time deputy presidents Peter Adamecz and Henrik Auth will participate because their six-year terms are ending. Both voted to keep the rate unchanged last month. Julia Kiraly, who will join the board next month, said the key lending rate has peaked and policy makers need to decide when to start lowering it.

Today, the board voted 9-3 to cut the rate to 7.75 percent, with one policy maker backing a half-point reduction and two rate setters supporting no change.

Wage growth continued to exceed expectations in April, rising an annual 8.4 percent, exceeding a median forecast of 8 percent by economists. The central bank has warned that the pace of income growth may derail its efforts to subdue inflation.

``The development of nominal wages represents a significant upward risk,'' the central bank said on June 8 in its minutes from the policy meeting last month. Policy makers voting for an unchanged rate, including Simor, then outnumbered those backing a quarter-point rate cut by seven to six.