The guidance by the National Bank of Hungary (MNB) shows the central bank is getting closer to halting its easing campaign that was restarted in March with the base rate cut by a total of 60 basis points so far this year.
In recent months, including last month, the central bank said it would continue with "cautious easing" of the policy rate due to the outlook for inflation.
And while the MNB's monetary council repeated that monetary conditions should remain loose for "an extended period" to meet its inflation target and support the economy, it noted that sentiment by global investors has deteriorated since its previous inflation report in March due to the downgrade of Greek sovereign debt and weak U.S. data. This had lead to a rise in long-term yields on Hungary's forint-denominated bonds and a depreciation of the forint.
The MNB will still need to conduct a "cautious approach" approach to monetary policy and said it had considered three alternative scenarios in its June policy report.The first scenario was that higher yields in developed markets could lead to a higher risk premium on developing markets, which meant the inflation target could be reached with tighter policy than assumed. A second scenario involved mounting geopolitical tensions that led to a sudden sharp rise in risk premiums and therefore tighter monetary policy than assumed. A third scenario called for a persistent low cost environment that leads to lower inflation and stronger economic growth that then justifies even looser monetary conditions than the baseline projection.
The central bank still expects inflation to be below its target of 3.0 percent, plus/minus one percentage point, this year and next, and "significantly below the target in the short term" although it should remain in positive territory, illustrated by slightly higher inflation than previously projected.
Hungary's inflation rate rose to 0.5 percent in May from minus 0.3 percent in April, ending eight consecutive months of deflation.