High inflation expectations also pose risks

01 December 2010 - The Magyar Nemzeti Bank has today published its latest Quarterly Report on Inflation. The Report finds that the main source of mounting inflationary pressure in the Hungarian economy has been the recent sharp increase in unprocessed food prices; and the pass-through effects of that increase are increasingly less constrained by rising domestic demand. The risk that without a tightening of policy this short-term price shock would lead to a sustained rise in inflation has increased significantly, due to high inflation expectations.

The Bank’s Quarterly Reports on Inflation, containing comprehensive analyses of the Hungarian economy, have been published since 1998 (translations available in english since 2000). The Reports have included projections for output and inflation since 2001. The Report projections are conditional, produced using a so-called rule-based approach, assuming unchanged monetary and fiscal policies and incorporating average exchange rates and commodity futures prices of the previous month.

The November Report projection is for the annual average rate of inflation to be 4.9% in 2010, 4.0% next year and 3.3% in 2012, implying that throughout the forecast period inflation exceeds the 3% inflation target. Price stability, i.e. bringing inflation back to target, is a precondition for sustained and rapid economic growth. Inflation developments in the coming quarters are likely to be determined by the food price shock and the partial passing on to customers of the sectoral windfall taxes. Prices and wages continue to be set on the basis of backward-looking inflation. With the recovery of economic growth, the risk of inflation expectations returning to pre-crisis levels has increased. The Bank’s most important task is to prevent this from happening.

The Hungarian economy had recovered from its two-year long recession by early 2010. The outlook for economic activity is determined primarily by the external environment and the Government’s fiscal measures. Taking account of these factors, the Bank expects economic growth to be 3.1% in 2011 and 4% in 2012. While the planned reduction in personal income tax rates and a couple of large-scale investment projects in the car industry are likely to contribute to growth, the investment environment may be adversely affected by the introduction of sectoral windfall taxes and changes to the private pension fund system, which in turn may weigh on investment activity.

Willingness of the unemployed to take jobs has increased as an effect of the measures taken over the past years and, consequently, the unemployment rate has not fallen despite rising employment. Given that the recovery of domestic demand remains fragile, it is important that the pick-up in growth is associated with a rise in employment. This may be facilitated by moderate increases in wages.

The Report can be accessed on the Bank’s website at www.mnb.hu under ‘Publications’.