Hungary's central bank, which earlier today cut its base rate by another 25 basis points to 5.50 percent, said it would only consider further rate cuts if the outlook for inflation remains in line with the bank's 3 percent target and the improved sentiment in financial markets is sustained.
The National Bank of Hungary, which began cutting rates last August, said the short-term outlook for inflation had recently improved and it expects inflation to return to around the target as the impact of last year's tax rises wanes and domestic demand remains weak.
However, the bank also warned that if companies pass on higher production costs in response to government measures that affected the prices of non-core items, "it may pose an upside risk to the medium-term outlook for inflation" and it would closely monitor underlying inflation.
Since August last year, the central bank has cut rates by 150 basis points to stimulate growth and this month's guidance is largely similar to last month when it also said it would only consider further rate cuts if good financial market sentiment continues and the inflation target is achievable.
Hungary's inflation rate eased further to 5.0 percent in December from November's 5.2 percent, with lower prices of durable goods, processed foods and fuels the major factor.
Hungary's inflation rate jumped last year due to higher indirect taxes, which triggered price hikes, a depreciation of the forint plus higher food prices from bad weather.
"Hungarian economic growth is likely to resume following last year's recession as the country's export markets recover," the central bank said, adding that output is significantly below its potential level and the labour market remains loose.
It added that global risk appetite had continued to improve in the past month but the "contrast between buoyant sentiment in international financial markets and the subdued outlook for growth continues to pose a risk."
Hungary's Gross Domestic Product fell by 0.2 percent in the third quarter from the second quarter, the third quarterly contraction in a row. Year-to-year, the economy shrank by 1.5 percent in the third quarter, up from second quarter decline of 1.3 percent and first quarter contraction of 1.2 percent.
In 2011 Hungary's economy expanded by 1.7 percent and the International Monetary Fund said in its annual review this month that the economy was projected to have shrunk by 1.5 percent this year, up from its October forecast of 1.0 percent.
This year the IMF expects Hungary's economy to stagnate with any rise in exports offset by weak domestic demand. Inflation in 2013 is projected to have eased to 3.5 percent from 5.6 percent in 2012, but the IMF said inflation expectations were still not well anchored.
The IMF said further rate cuts by Hungary's central bank should be "considered very cautiously" as rate cuts are unlikely to have a material impact on aggregate demand, given the difficult operational environment for banks, and the foreign currency exposure of private and public balance sheets remains significant so any sizable currency depreciation could be destabilizing.
The central bank said its policy tools allowed it enough room to maintain a policy stance that is consistent with its inflation outlook and any expansion of its range of "unconventional policy tools may provide effective support only during times of acute financial market stress."