Hungary rate-setters disclose reasons for 50-bp rate hike in Nov (minutes)

The 50-bp monetary tightening was in line with expectations, i.e. analyts’ consensus. As the market was then pricing a larger rate hike (100-125 bps), the forint initially weakened, but - for a number of domestic and external reasons - it has appreciated since in several waves.

The NBH released the following statement today:

Weakening forint, inflationary consequences

Council members agreed that developments in inflation and the economy had been in line with the projection in the September Quarterly Report on Inflation. In terms of the outlook, however, the persistent weakness of the forint increased the upside risks to inflation and caused a sharp deterioration in the balance sheet position of households and the Government, with the resulting adjustment need weakening the outlook for Hungarian growth.

Members had differing views about how the depreciation of the forint would affect inflation. Some thought that the deterioration in market participants’ profit prospects would force these participants to pass on the cost increases from exchange rate changes and the uncompensated minimum wage increase to consumer prices even in the near term. In terms of the effect of the weak exchange rate on consumer prices, one member was of the view that it mainly influenced

US dollar-based crude oil imports, and therefore tax-adjusted core inflation, which has a greater significance in driving inflation expectations, was likely to rise only slightly. By contrast, other members argued that, given past experience, changes in the exchange rate of the forint against the euro had a measurable effect on developments in overall CPI inflation as well as in core inflation.

Worsening growth outlook

There was almost unanimous agreement among Council members that the outlook for growth had deteriorated significantly since the September projection. Some members were of the view that the depreciation of the forint exchange rate in recent months might offset the disinflationary impact of weak domestic demand, and therefore there was a threat to meeting the Bank’s 3% inflation target. That in turn made it necessary to tighten monetary conditions. Others, however, thought that this question could be only answered after seeing the December Report.

In terms of the assessment of the external risk environment, members were of the view that the euro-area debt crisis had deepened in the second half of November. They concluded that the worsening problems caused by the US fiscal deficit also contributed to the deterioration in the external risk environment, in addition to the euro-area debt crisis.

Inconsistent with fundamentals

Some members noted that the depreciation of the forint exchange rate and rises in Hungarian risk premia and yields in recent weeks mainly reflected the deterioration in global investor sentiment. They reiterated the Monetary Council’s earlier assessment that the recent depreciation of the forint was not consistent with the fundamentals of the Hungarian economy.

Others, however, emphasised that, over and above the extremely adverse external risk environment, developments in Hungarian economic fundamentals had also contributed to the sharp increase in perceptions of the risks associated with the economy in the past two weeks.

Those members thought that the increase in risks to the outlook for growth exacerbated the risks related to debt sustainability, in addition to leading to rises in yields and a depreciation of the exchange rate. All of this was reflected in a weakening of investor confidence in Hungary and the relative performance of forint-denominated assets.

Unexpected move, unanimous vote

Some members felt that the announcement by Moody’s that it had downgraded Hungary’s sovereign debt to sub-investment grade was an unexpected move, in light of the fact that it came after the Government had announced its intention to begin talks with the IMF. Several members welcomed the Government’s announcement and news that talks with the Banking Association had begun.

Assessing financial market developments over recent weeks, Council members agreed that the conditions for tightening monetary policy, as set out in the Monetary Council’s press release of 15 November 2011, still prevailed, given the further increase in risk aversion in European financial markets and in perceptions of the risks associated with the Hungarian economy. All members of the Monetary Council therefore agreed on the need to tighten monetary conditions.

Members also agreed that, if the outlook for inflation did not improve and risk perceptions did not decline, monetary conditions might be tightened further.

The next rate-setting meeting will be held on 20 December. The minutes of that meeting will be released on 11 January 2012 at 14:00 CET.

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• MNB,
• economy,
• interest rate