"The decline in Hungary’s inflation will continue, albeit at a slower pace than previously envisaged, the central bank (NBH) has said in its quarterly Report on Inflation released on Wednesday. The upward revision to the bank’s CPI estimate was driven by higher oil price assumptions and a larger-than-expected rise in regulated prices.Subdued domestic demand continues to have a strong downward effect on prices, which may lead to an inflation rate that undershoots the medium-term target (3.0%) in 2011. Despite a more benign external environment, the sharp decline in domestic demand continues to impede recovery, the central bank added.
In its latest Inflation Report published on Wednesday, the NBH projects 4.4% annual average inflation for 2010 and 2.3% for 2011, up from 3.9% and 1.9%, respectively in its Nov Inflation Report. The c.bank published its key macro estimates on Monday, but the related detailed figures, analyses and assumptions have been made available only today.
As the NBH said on Monday, inflation will drop to below the 3.0% target only in early 2011, instead of the autumn of 2010 as expected earlier.
Why the upward CPI fcast revision?
The upward revisions in the central bank’s inflation forecast were mainly driven by factors outside the scope of monetary policy (see above), such as the higher oil price assumptions, the rise in regulated prices and the change of the weights in consumer basket. The NBH staff noted, though that subdued demand is likely to exert downward pressure on prices over the entire forecast period.
"Expected developments in trend inflation will be reflected in the annual price index only after the temporary price-increasing effect of the indirect tax increases has phased out. In the first half of this year CPI inflation may significantly overshoot the inflation target; however, base effects may drive the price index near to the 3% target from July," the NBH forecasted. Inflation may drop below the target from 2011.
"The increase in excise taxes and a number of measures affecting administered prices early this year may hold the annual inflation around 6% in the short term; however, trend inflation, which is closely related to changes in macroeconomic fundamentals, may continue to moderate in 2010."
Change in growth structure
Global recession has brought about a considerable decline in Hungary’s economic output. The more benign external environment is likely to help fuel the recovery in Hungary - via a better export outlook - but the decline in domestic demand can be sharper and more prolonged than earlier expected, which continues to be manifested in GDP decrease.
The change in the structure of GDP (better outlook on external markets, worse household consumption prospects) is shows in the table below that sums up the NBH’s baseline assumptions.
However, lending by domestic banks may remain extremely subdued throughout 2010, as a consequence of higher riska version and a drop in demand for loans due to recession, which woudl amplify the contractionary effects of inevitably pro-cyclical fiscal and monetary policy on aggregate demand, despite improving external conditions.
The recovery in Hungary is likely to lag behind that of the global economy, largely reflecting the decline in domestic demand. The projection for the economy remains one of appreciable GDP growth from 2011.
Favourable external financing position
The economic downturn, however, will lead to a dramatic decline in Hungary’s external financing requirement (see table below). "The heterogenous pattern of growth may lead to a further improvement in Hungary’s external balance. As was the case in 2009, this is likely to help the economy operate without the need to rely on substantial foreign funding in the coming years, following a period of rapid accumulation of external debt.
Although the significant improvement in Hungary’s external balance has reduced the vulnerability of the economy, weak indicators of activity and the high government debt to GDP ratio continue to pose downside risks.
Without further government measures, the deficit targets (3.8% of GDP for 2010 and 2.8% of GDP for 2011) are likely to be overshot, the NBH projects.
"In 2010 and 2011, the general government deficit as a percentage of GDP can only be reduced to below 4% if the government’s stability reserves and interest reserves for contingencies are cancelled. However, further measures will be required to meet the fiscal target. It is important to note, however, that trend developments in the fiscal balance, adjusted for the effects of the economic cycle, remain downwards in the baseline projection."
According to the latest analyst surveys, the market also expects a deficit target overshoot."
Source: Portfolio Online Financial Journal
25.02.2010