European Central Bank President Mario Draghi said on Friday that Hungary's central bank needs to retain its independence to be credible, an indirect warning against undue influence by Hungarian politicians.
Hungary's central bank has been at loggerheads with Prime Minister Viktor Orban's government in the past two years over its independence, an issue that has also brought clashes between Orban's government and the rest of the European Union.
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In February, Orban will pick a new governor to replace Andras Simor, whose six-year mandate expires in March. Some analysts are concerned that Orban is likely to pick a loyalist. which could make the bank more politicised.
Rate setters already appointed by the ruling Fidesz party's parliament majority have outvoted Simor and his deputies in the past four months, cutting rates.
"A key prerequisite for a credible monetary policy is the independence of the central bank," Draghi told a conference organised by the Hungarian central bank.
He stressed the importance of aiming for price stability: "The ultimate success of a central bank in maintaining price stability depends on its credibility."
Draghi added that independence means that the central bank has to have the necessary means and instruments to achieve its price stability objective without being influenced by outside forces.
He also said that lowering interest rates in an indebted economy may risk foreign exchange rates falling, which in turn may 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 said.
"For example, in the presence of heavily indebted private and public sectors with large open foreign exchange positions, central banks have little space for manoeuvre when faced with a flagging economy."
Hungary's central bank has cut interest rates by a total of 100 basis points in the past four months to 6 percent, and more easing is expected in the next few months to aid the recession-hit economy, as the majority on the Monetary Council clearly prioritises growth now over inflation risks.
Simor, the outgoing governor, has been warning over the risks of inflation. He told the same conference on Friday that monetary policy can stimulate economic growth only as long as it does not jeopardise price stability.
He said letting inflation loose was not the way to produce lasting additional growth in the economy.
"In my opinion, when inflation expectations, i.e. the longer-term inflation outlook, become uncertain, the central bank should act much more firmly to keep price and wage-setting behaviour disciplined," Simor said in a speech.
He said fiscal consolidation in Hungary must be made credible and public debt must be put on a sustainable declining path. (Additional reporting by Sakari Suoninen. Editing by Jeremy Gaunt.)