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MNB perceives inflation due to taxes

While economic output is likely to fall this year, with growth only expected to resume in 2013, CPI inflation in June was higher than previously expected, and inflation is to exceed the target over a sustained period, the MNB said in a statement on Tuesday, explaining the Monetary Council's decision to keep its base rate at 7% earlier in the day.

The level of output will be below its potential in the period ahead, however, the consumer price index is expected to remain above the inflation target over the policy horizon, reflecting the effects of tax changes and other administrative measures, MNB said.

Inflationary pressures from the real economy continue to be subdued due to weakening demand, but the tax increases in early 2012, the measures included in the Structural Reform Program and the latest announcement of an increase in excise duties are likely to cause inflation to exceed the target over a sustained period.

The consumer price index is expected to remain significantly above the medium-term target into 2013 as a result of a series of increases in indirect taxes affecting consumer prices. Although this is unlikely to fuel second-round effects due to persistently weak demand and slack in the labor market, meeting the inflation target is expected to be delayed, MNB explained.

Hungary's export growth is weighed down by the slowing in external demand, and there is significant uncertainty around the recovery in Hungary’s export markets expected from the second half of this year. However, the pick-up in production following the build-up of manufacturing capacities over the past quarters may offset the effects of the slowdown in external demand. Domestic demand is likely to fall further in the coming quarters.

Persistently high unemployment, falling real incomes and precautionary behavior by households suggest that consumption will decline over the period ahead. Investment is likely to remain subdued, reflecting the weak outlook for economic activity, the unpredictable business environment and tight credit conditions, the bank said. Perceptions of the risks associated with the Hungarian economy have improved recently, but financial markets remain fragile in Europe. Growing risks in some euro-area countries may negatively affect premia on Hungarian financial assets.

The Monetary Council welcomes the start of negotiations between the Government and the EU and IMF. Reaching an agreement in the current volatile environment could lead to a sustained improvement in risk perceptions. It is very important in terms of the future evolution of the risk premium that the Government remain committed to meeting the fiscal deficit target.

The volatile risk environment and above-target inflation for an extended period continue to warrant a cautious policy stance. The Council will consider a reduction in interest rates if Hungary’s risk premium falls persistently and substantially and the outlook for inflation improves, MNB said. The abridged minutes of Tuesday’s Council meeting will be published at 2 p.m. on August 8, 2012, it added.