September 27, 2012 / 10:54 AM / 5 years ago

Hungary central bank's inflation report confirms deep split

BUDAPEST (Reuters) - Hungary’s rising inflation does not allow rate cuts according to the baseline forecast in the central bank’s inflation report published on Thursday, also confirming a deep split in the bank which cut its rates earlier this week.

The bank cut its base rate by 25 basis points to 6.5 percent on Tuesday, confounding many analysts as the second reduction in just four weeks came along with a revision of the bank’s 2013 inflation forecast to 5 percent from 3.5 percent.

“Although in our baseline scenario persistently weak demand and the improvement of the risk assessment point to the easing of monetary conditions, the considerable deterioration in inflation outlook does not allow for the easing of monetary policy conditions,” the bank’s inflation report said.

Many analysts said the rate reduction, which followed another cut last month, questioned the bank’s credibility as it targets 3 percent inflation for the medium term.

Andras Simor, the bank’s governor, said the rate decision was backed by a “slim majority” of the Monetary Council. That was the case in August when the four external members -- appointed by the government’s parliament majority last year -- outvoted Simor and his two deputies.

Two of the external members have said that the bank should put more focus on helping the economy which is in recession, while Simor has been more cautious over inflation and has said rate cuts could be little help as bank lending remains thin.

“The Council decided on a (rate) cut because it was thinking in an alternative scenario,” senior central bank economist Barnabas Virag told journalists on Thursday.

“There may be a way of thinking that inflation is driven mainly by cost-pushed shocks, and weak demand in the economy can eliminate second-round inflation impacts and that way the inflation goal can be met earlier (than H2 2014),” he added.

The bank said the economic crisis has damaged the Hungarian economy’s growth potential, while weak domestic demand could cut inflation quicker under a benign inflation scenario.

“The more favorable inflation path is consistent with lower interest rates, i.e. this scenario allows monetary policy to be looser than in the baseline scenario,” the report said.

Simor also said after Tuesday’s rate cut that under this positive scenario, the inflation goal could be met with looser monetary policy, but even this would not allow cutting rates in the next six months.

The four dovish rate setters have frontloaded the rate cuts, probably focusing on the benign scenario.

“The Monetary Council’s decision is based on the members’ own CPI risk scenarios. External members argue with a higher output gap, which would curb inflation over the medium term,” Eszter Gargyan at Citigroup said in a note.

The bank’s experts raised the inflation forecast for 2013 mainly due to an increase in food prices, which contributed about one percentage point to the rise.

Rising energy prices also maintain inflation pressure, while 0.2-0.3 percentage point in the rise was caused by a technical assumption that the government would cut next year’s budget deficit by 1.4 percentage point of economic output.

The measures -- half in state revenues and half in spending according to the assumption -- would bring the deficit to 2.4 percent of GDP next year, close to the 2.2 percent target.

Reporting by Sandor Peto; editing by Ron Askew

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