ECB offers Hungary token warning on central bank independence

By bne IntelliNews December 10, 2012

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Under continued pressure from the Hungarian government, the country's central bank was the subject of a rare statement on December 7 from the head of the European Central Bank (ECB) calling for its independence to be respected. However, Mario Draghi won't be able to prevent Budapest putting its own man at the helm of Magyar Nemzeti Bank (MNB) come March.

"A key prerequisite for a credible monetary policy is the independence of the central bank," Draghi told a conference organized by MNB, according to Reuters. "The ultimate success of a central bank in maintaining price stability depends on its credibility."

The warning is hardly the first from Europe over the ongoing fight between Prime Minister Viktor Orban and MNB Governor Andras Simor. The animosity between the pair - clear from the time Orban took office in 2010 - and Budapest's attempts to bring the MNB under control became the main topics throughout the last year's worth of "negotiations" over a bailout from the EU and International Monetary Fund (IMF). The formal opinion of the ECB on Budapest's new central bank law was central to that process.

While that saw Orban forced to repeal constitutional changes made in January, it has not prevented him getting his way eventually. The four "external" members of the monetary policy council have just pushed the MNB's fourth consecutive monthly cut in interest rates, despite the clear opposition of Simor and his two "internal" colleagues on the council. Further cuts are expected, according to comments from council members.

However, Simor won't have to suffer such indignity for long, as his term ends in March. Given Orban's track record, and the fact that Hungary is now apparently happy to ditch any pretense that it wants a loan programme from international lenders, the PM is unlikely to worry too much what anyone thinks of the governor's replacement, or the strengths of his connections to the PM or the ruling Fidesz party. Many tip Gyorgy Matolcsy, the current economy minister and credited as the architect of Hungary's controversial economic policy, as the most likely to take up the reins. Such a move which would put the markets on edge, although riding the global wave of liquidity, investors have proved hard to rattle over the past few weeks.

Still, Draghi clearly feels he has to make the point at least. He was careful to note while speaking in Budapest that "independence" means the central bank must have the means and instruments needed to achieve its price stability objective without being influenced by outside forces. He also warned that lowering interest rates in an indebted economy may risk weakening its currency, which might in turn lead to higher inflation and offset the impact of economic stimulus.

"Credible inflation-targeting in small open economies also depends on central banks' recognition of the impact of their monetary policy decisions on the exchange rate," Draghi was quoted as saying. "For example, in the presence of heavily indebted private and public sectors with large open foreign exchange positions, central banks have little space for maneuver when faced with a flagging economy."

Simor has been desperately making similar statements for over a year, as he has resisted Orban's demands to lower what was the EU's highest benchmark rate of 7%. However, with the economy having sunk into recession in the second quarter of the year, he finally lost his footing as the external members of the MPC pushed through the first 25 basis point cut in the series. Orban will name his pick for new governor in February.

Mihaly Varga, a minister without portfolio who heads the (now practically defunct) talks with the IMF but has been careful to try to remove his own hat from the ring as the potential next MNB governor, told the local press ominously on December 7 that the forthcoming changes at the central bank will bring it in line with government policy.

"An opportunity will arise for the harmonization of monetary and fiscal policy," Varga told Napi Gazdasag in an interview. "Naturally, there will not be full harmony, as the two actors, government economic policy and the central bank, have partly opposing roles," the minister added.

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