Hungary's inflation risk blocks rate cuts: official

BUDAPEST: Hungary's central bank cannot cut interest rates as long as it sees risks that increased raw material costs generate second-round inflation effects, a deputy governor of the bank said on Thursday.

The bank kept its base rates on hold at 6 percent on Monday, holding fire at its fifth monthly rate-setting meeting running, after discussing its quarterly inflation report.

After the meeting the bank cooled rate cut expectations by returning to an earlier reference that it would need to keep rates on hold for a sustained period to meet its 3 percent inflation goal by end-2012.

Ferenc Karvalits told InfoRadio in an interview aired on Thursday that inflation considerations and risks to the country's forint currency justified caution in monetary policy.

The rise of raw material prices has lifted Hungary's short-term inflation indicators more than the projections in the March inflation report, and prices have partly spilled over into Hungary's core inflation, he said.

"We expect that when these raw material price shocks run out -- a short-term raw material price change has impacts for about a year -- the inflation course returns to near the inflation target," he said.

"As long as inflationary impacts stemming from the raw material price shock, the danger of their second-round effects, remain, we need to keep monetary conditions relatively tight," he added.

Another risk is that an escalation of the debt crisis in the euro zone periphery could curb investors' appetite for assets in emerging markets including Hungary, even though the country's fiscal cut plans have been received positively, Karvalits said.

"That would affect inflation through import prices by weakening the (forint) exchange rate," he said.

"But that would be independent of domestic economic trends, an event to which the central bank must react only when it occurs; it is not possible to 'store' merasures in advance," he added.

FORINT NOT OVERVALUED

Karvalits said Hungary's export performance has been robust, while domestic demand was sluggish.

"All that indicates that the (forint) exchange rate is probably not overvalued (against the euro)," he said, adding that a weakening of the forint would not help economic recovery.

"That could provide the export sector some additional help, but a significant part of households have a foreign currency debt whose burden would increase further and that would destroy rather than help domestic consumption," he said.

A surge of the Swiss franc against the euro, Central Europe's reference currency, have weakened the forint to a record low against the franc at 227.37 on Thursday. Most of the foreign currency loans of Hungarians is in Swiss franc.

"When the crisis management of the problematic countries in the euro zone arrives to a solution, probably we will see a consolidation in merit in the euro/Swiss franc exchange rate," Karvalits said.

Copyright Reuters, 2011