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Monday, March 31, 2008

Hungary's Central Bank Raises Interest Rates

Hungary's central bank increased the benchmark interest rate for the first time in 17months this morning, opting for a larger-than-expected increase in an attempt to halt soaring government bond yields and stem inflation. The Magyar Nemzeti Bank's 12 policy makers, led by President Andras Simor, raised the two-week deposit rate at a meeting earlier this morning to 8 percent from 7.5 percent.

Hungary is the seventh country to raise rates this month after central banks from Poland to Iceland lifted borrowing costs to tame global inflation and reverse a trend of investors flocking to what are seen as less risky assets.

The yield on the benchmark three-year Hungarian government bonds rose to 9.78 percent on March 7, which was their highest level since October 2004, as the weakening in Hungary's economy, growing political uncertainty and problems in global credit markets prompted investors to favor less risky assets. The three-year yield was 9.32 percent on March 27, and the yield has risen 126 basis points since the last meeting of the Hungarian central bank monetary policy committe was held on February 25. At that point policy makers last voted 8-4 to keep interest rates on hold for a fifth month, opting instead to try to fight inflation by letting the forint trade freely for the first time ever and betting on the currency's strengthening. Events have subsequently turned this into a completely false hope, hence today's changed vote.

Hungary's inflation rate did fall back slightly to 6.9 percent in February from 7.1 percent in January, but it still remained at more than twice the bank's 3 percent target level, and really their credibility was also at stake if they continued to sit back and watch. The bank last month raised its inflation forecast to 5.2 percent this year and 3.6 percent for 2009, from 5 percent and 3 percent, respectively.

As Portfolio Hungary comments:

The larger-than-expected hike by the cenbank may signal its strong commitment to meeting its medium-term inflation goal (3%), and that the MPC wanted to “get over with" the rate hike pressure with a single big step.

It is not net clear as yet whether the MPC considered in its decision the medium-term impacts of the political tension between the governing coalition parties that took a drastic turn over the weekend and today.

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