The monetary council surprised the markets today, by cutting the base rate by 50bp, to 11.00%. After the emergency 300bp rate hike (from 8.50% to 11.50%) carried out in October, when protecting the forint from further falls became the top priority for the central bank, the most important question was when the central bank would be able to “take back” from this. Although the fact, that the fundamental state of the county suggested the start of rate cuts sooner or later, we – in line with the market consensus - did not expect any rate change for today, given the uncertainties around the forint exchange rate and fast changes in global risk appetite. The statement of the monetary council says however that the agreement with the IMF and the upcoming budget adjustment measures have reduced the risks to the financing of the country's external debt, which has increased the maneuvering room of the monetary policy. Therefore, the council decided to cut the base rate.
At the press conference Governor Simor said that that they had tried to match two different factors: on the one hand, the base rate could be cut, because of the disinflation, on the other hand, whether the rate cut was possible from the point of view of the financial stability. There were three options discussed: a 50bp cut, keeping the base rate on hold and a 100bp cut. The decision of the 50bp rate reduction had a strong majority.
The statement also said that interest rates could be cut further if the risks around capital inflows and the stability of the financial intermediary system continued to diminish. This suggests that rate cuts should continue and another 50bp rate reduction could come even next month, but this will strongly depend on the general state of capital markets.
In the November Quarterly Report on Inflation, the forecast for the 2009 average inflation was cut to 3.1-3.4% y/y, from the 4.1% y/y, projected in August. What is more spectacular is that the prediction for the 2010 average inflation was cut to 1,5-1,9%, from 3% y/y. Thus, according to the new forecasts on the horizon relevant for monetary policy, the bank will undershoot the 3% inflation target, which was the main reason for today’s loosening.
As for the economic growth prospects, it’s not too favorable that the bank’s staff expects a GDP decline of 0.2-1.7% y/y for 2009. In the previous (August) report, the expectation for the 2009 GDP growth was 2.6% y/y. For 2010, they see the GDP growth rate in the range of 0.5%-2%, which does not suggest a strong recovery after the 2009 bad year. The downward correction in GDP was due to the deterioration of the external growth outlook, investors' lower willingness to take risks, declining liquidity and deterioration of domestic credit conditions.
Market reaction: the forint has reacted with appreciation to the rate decision, approaching the level of 260 against the EUR.
