A quarterly Inflation Report prepared by the staff of the National Bank of Hungary on Thursday highlights a continued a rift between external rate-setters and the central bank's executives and staff over the room excess capacity in Hungary's economy leaves for monetary loosening.
The staff said in the report that the negative output gap "in itself" would justify a looser monetary policy stance, but added that an increase in production costs worked against this effect. In spite of weak demand, the staff assumed companies would pass at least part of these higher costs on to consumers. Though conceding that the scale and pace of this pass-through was "surrounded by significant uncertainty", the staff said factors pointing in the direction of monetary tightening and easing "broadly cancel each other out" in the first half of the horizon in baseline forecasts and suggested rates should be cut only when cost push inflation dissipates.
The Council, whose four external members have outvoted its three internal members to cut rates for almost half of a year, argued in a statement included in the report that the excess capacity in the economy "offsets" the medium-term inflationary risks. Weak demand will force companies dealing with higher costs - lifted by government measures - to keep price increases "moderate", the Council said.
Even if monetary conditions are eased, the mid-term inflation target can be met, the Council said, though adding that a reduction in interest rates would be conditional on a continued improvement in financial market sentiment and data that confirm the inflation target can be achieved.
Consumer price inflation will fall to the 3% "price stability" target in the second half of 2014, according to baseline projections in the report. Although the full Inflation Report was published in full on Thursday, the main projections it contains were presented after the Council's rate-setting meeting on Tuesday.
The MNB lowered its forecast for average annual inflation in 2013 to 3.5% in the fresh report from 5.0% in the previous report. The reduction in the projection for 2013 followed government announcements early in December that household energy prices would be cut by 10% from January 1.
A reduction in household energy prices is expected to cut a full percentage point off CPI. Changes to the pace and the scale of excise tax increases will take another 0.4 percentage point off the index. The MNB projects CPI will fall to 3.2% in 2014.
The central bank put core inflation, which excludes volatile fuel and food prices, at 5.2% in 2013 and 3.7% in 2014. Excluding the effect of indirect tax effects, core inflation is set to reach 3.5% in 2013 and 3.4% in 2014.
The MNB's projection for average annual inflation this year edged down to 5.7% from 5.8%. The MNB knocked down its projection for GDP growth in 2013 to 0.5% from 0.7%. It forecasts GDP growth of 1.5% in 2014.
The central bank stood by its projection for an economic contraction of 1.4% in 2012. MNB chief analyst Barnabás Virág said the projections in the report were prepared assuming exchange rates in November and December, in line with accepted practice. The HUF/EUR rate was around 283-284 during the period.
The MNB projects the general government deficit will reach 3.0% of GDP in 2013 with the full cancellation of HUF 400 billion in budget reserves. Without the cancellation, the gap is seen reaching 4.4%.
The central bank put the deficit in 2014 at 3.8% of GDP with the cancellation of reserves and at 5.2% without. The MNB staff attributed the increase to a planned pay rise for teachers and the accounting of a loss by the central bank.
"In terms of longer-term developments in the deficit, it should be noted that by 2014 government investment may decline to an extremely low level, falling well behind the replacement needs of fixed assets," the staff said.