Hungary's central bank cut its base rate for the 12th time in a row to help boost economic activity and inflation but added that it may change the "pace or extent of policy easing over the coming months" due to "the significant reductions in interest rates so far and the volatile conditions in financial markets."
The National Bank of Hungary, which has now cut rates by 175 basis points this year alone, said inflationary pressures are likely to remain moderate in the medium term due to the "significant degree of spare capacity in the Hungarian economy" and data confirm that weak demand has exerted a strong disinflationary impact as firms have limited ability to raise their prices.
A 25 basis point cut in the bank's base rate to 4.0 percent should help ensure that inflation rises toward's the central bank's 3.0 percent target, but the increased volatility in financial markets and the uncertain outlook for global growth pose a risk and this "calls for maintaining a cautious approach to policy," the bank said, adding:
"A sustained and marked shift in perceptions of the risks associated with the economy may influence the room for manoeuvre in monetary policy," the central bank said, signaling that it is getting closer to a more neutral policy stance and the aggressive pace of easing is drawing to a close.
Since August last year, the bank has cut its base rate by 300 basis points but it is now becoming more cautious about the effect that further rate cuts may have on capital flows and the forint currency.
In June the central bank also noted that its room for manoeuvre was affected by the shift in market's perception of risk but it added that it would cut rates as long as the outlook for inflation and the real economy justified such a move. The reference to further rate cuts was omitted in today's statement.
Like most other emerging market currencies, Hungary's forint weakened in May as major investors started to withdraw funds from riskier markets, with the forint falling 4 percent against the euro during the month. But by early June the forint bounced back and is down only 1.6 percent against the euro since the start of this year, quoted at 295.8 to the euro today versus 291 in early January.
The central bank said there had not been any significant sell-off in domestic assets during the past month and domestic indicators of risk had declined despite uncertain global financial markets.
Hungary's inflation rate has been pushed down due to weak demand and the central bank expects underlying inflation to remain subdued in the medium term and the risks are moderate.
Inflation in June was 1.9 percent, slightly up from 1.8 percent the previous month. The bank said the impact of regulatory price measures from 2002 to 2009 on consumer prices had halved after 2010, indicating a change in the approach of economic policy to inflation.
"Consequently, inflation in 2013 is expected to fall back to around 3 percent even excluding the effect of the reduction in utilities prices," the bank said.
Hungary's economy, which has been in a deep recession, is showing signs of improvement and the bank said growth is likely to resume this year though it will remain weak.
In the first quarter of this year, Hungary's Gross Domestic Product expanded by 0.7 percent from the previous quarter - the strongest quarterly growth rate in eight quarters. However, on an annual basis, the economy contracted by 0.9 percent, the firth quarter with a negative growth rate.