Hungary central bank holds rates, flags possible cut

BUDAPEST (Reuters) - Hungary's central bank held interest rates unchanged on Tuesday but flagged a possible rate cut for the first time in a year to aid its sickly economy, as the government has moved closer towards starting talks on an international loan.

The bank's rate-setting Monetary Council has been split over policy, with several members seeking a window of opportunity to cut rates from Europe's highest at 7 percent, while others are more concerned over inflation and the impact of the euro zone crisis on the forint.

The bank said tax hikes can have inflationary impacts but it projected the economy would contract by 0.8 percent this year, sliding into recession again after the last downturn in 2009.

"The Council will consider a reduction in interest rates if Hungary's risk premium falls persistently and substantially and the outlook for inflation improves," it said, flagging a rate cut for the first time since mid-2011 in its official statement.

Hungary is Central Europe's most indebted country relative to economic output, with its debt around 80 percent of gross domestic product. The economy needed International Monetary Fund (IMF) bailout during the 2008-2009 global crisis and its debt rating was downgraded to "junk" by the three biggest rating agency at the end of last year and early this year.

In last week's Reuters poll analysts projected that a credit deal with the IMF and European Union, expected by the end of 2012, could help the bank cut its base rate to 6.5 percent by the end of the year.

Prime Minister Viktor Orban's conservative government, often at loggerheads with Brussels over policy, last week submitted new amendments to a disputed central bank law, which investors hope will open the way to starting talks with the International Monetary Fund and EU after months of delays.

"Junk"-rated Hungary also has lifted value-added taxes this year to stabilize its budget and plans new taxes on banks and telecoms firms, in new measures which could lift prices and weigh on the ailing economy further.

Analysts said the IMF talks likely will be difficult and the euro zone debt crisis poses risks to the forint, but chances for monetary easing were increasing.

"With a relatively stable exchange rate, there is an increasing chance of a rate cut. If the IMF talks set off and the international environment does not worsen, a 25 basis point cut is conceivable," said David Nemeth, analyst at ING Bank.

LITTLE HELP TO ECONOMY

In its quarterly inflation report the bank lifted its forecast for average inflation next year by half a percentage points to 3.5 percent, above its 3 percent inflation goal.

It repeated that Hungary needed the IMF deal as soon as possible to shield its economy from shock waves from the crisis-hit euro zone and caution was warranted in rate policy.

A rate cut would be the first reduction since four new rate setters were appointed last year by parliament in which the ruling Fidesz party has a two-thirds majority.

The three other members who were appointed by the previous, Socialist government, Governor Andras Simor and his two deputies, have been regarded as more hawkish.

Analysts said small rate cuts would not help the economy, but the majority of the Council seeks the window of opportunity to loosen policy after disappointing unemployment, consumption and investment figures.

"In the short term the interest rate channel will not work, as lending is so weak now and most loans are in Swiss francs," ING's Nemeth said.

"A 25-50 basis point cut will not boost the economy or lending. But the direction is important, so a trend will start which ... could contribute to the economy, lending finally picking up in 2014."

(Reporting by Gergely Szakacs/Marton Dunai, writing by Sandor Peto; Editing by Michael Roddy)