Tim Gosling in Prague -

To the surprise of few, Hungary's economy officially entered its second recession in four years on August 14 as it reported a 0.2% GDP contraction quarter on quarter for April-June. The continued slowdown of the economy, revealed on the same day that July inflation came in at 5.8%, puts the central bank in a tricky position as it holds the EU's highest benchmark rates.

Hungary escaped sliding into technical recession in the first quarter of the year by the skin of its teeth when it recorded a GDP contraction of 1%, but revised figures for the fourth quarter of last year were lifted to flat. The writing was pretty much on the wall after Budapest revealed that industrial production plummeted in June, to leave second-quarter output 0.4% lower than in the first three months of the year.

The government placed the blame for the slowdown squarely on the Eurozone, which is responsible for much of the country's economic activity via export demand. "The figures aren't surprising," the Economy Ministry said in an emailed statement, according to Bloomberg, citing the slowdown in Hungary's export markets which caused a "temporary loss of momentum."

While growth in Germany, Europe's largest economy and Hungary's biggest export market, recovered in the second quarter to record an expansion of 0.3%, the single-currency region slowed by 0.6% quarter on quarter as the debt crisis continued to take a stranglehold. The warning sign from Hungary's poor industrial production and GDP figures is particularly acute given the fact that Daimler's Mercedes-Benz factory - heralded by many as having the potential to offer Hungarian macro indicators a healthy boost - started deliveries from the central city of Kecskemet in April.

"While the Daimler plant is expected to somewhat counterbalance the weakness on export partners' markets in [the second half of 2012], the effect of the plant seems to be able to support the economic growth to a lesser extent than assumed earlier," write analysts at Erste.

Statistician Peter Szabo told reporters following the release of the GDP figures that, "Production is stagnant or dropping basically across the economy," adding that a decline in agricultural output in the second quarter contrasted with a significant increase last year.

Erste says that with the breakdown not known yet, it can only guess on the underlying trends, "but it is very likely that only net exports could contribute to growth positively. Household consumption could have remained in the negative territory, while investments likely fell not just on a yearly, but also on a quarterly basis."

Today's data provided more grist to the mill for Erste's dimming view of Hungary's economy, and the bank has cut its growth forecast for 2012-13. "For this year, we now expect a 0.8% contraction, and for next year, we now only see the expansion of real GDP at 1%. Please note however that it is not today's figure that caused the downward revision of growth forecasts from our side."

At the same time, the accelerating contraction will put more pressure on the Magyar Nemzeti Bank, which is still holding out against government pressure to bring down the highest interest rates in Europe at 7%. While many expect a cut at some point this year on the back of the start of talks over a bailout with the IMF and EU, the unaffiliated members of the monetary policy council are resisting, citing currency weakness and persistent inflation as factors staying their hand.

Indeed, the same day that the GDP data came out, Budapest also released CPI numbers showing price increases at 5.8% in July. Although much of that inflation is the result of tax increases, it still puts the MNB in a tricky position. Erste, however, suggests it will hold out until the fourth quarter of the year at least.