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MNB raises 2009 inflation forecast to 3.7%

  The National Bank of Hungary (MNB) raised its 2009 inflation forecast to 3.7% in its fresh quarterly Inflation Report published on Wednesday from a 3.1-3.4% forecast in the previous report in November.

The MNB also increased its inflation forecast for 2010 to 2.8% from 1.5-1.9% in the previous report. The forecast is based on the assumption that any significant improvement in external demand and the bank sector’s lending activity is unlikely in the next few quarters, though some recovery is expected from 2010. A prolonged deterioration of business conditions and lending activity in Europe also cannot be ruled out.

The report forecast the economic contraction would continue in 2010 and put GDP down 0.5% after a projected 3.5% fall in 2009. In the November report, the bank projected a 1.7-2.0% contraction in 2009 and a 0.5-2.0% rise in 2010. The projections in the report take into account a package of tax changes announced by the prime minister a week earlier. The package would lower payroll tax and raise taxes on consumption while budget spending would be cut.

By reducing the corporate tax burden, the government measures are expected to increase labor demand and stimulate economic growth. However, higher indirect taxes and cuts in budget expenditure are likely to reduce disposable household income and consumption, thus contributing to a decline in GDP in the first two years after the changes are introduced. From 2011, supply side factors will begin to dominate again.

The inflation rate is set to slow further in the H1 of 2009 from 3.1% in January, but rise over 4% for a year from Q3. A planned increase in the main VAT rate (affecting 93% of the consumer basket) from 20% to 23% from July 1 will raise Q3 CPI by 1.8 percentage points over the current rate, according to the bank.

A rise in the excise tax at the same time will raise the rate 0.3 percentage point, and a cutback in government price subsidies will raise it another 0.5 percentage point. The bank assumes that further measures could be required to keep the ESA’95 general government deficit under 3% of GDP in 2010. The MNB puts the 2010 deficit at 3.3% of GDP without additional changes.

Businesses will adjust to the decline in sales by cutting staff and holding back wage growth, still their profitability is likely to continue falling until 2010. Households’ increasing uncertainty about their future income as well as the fear of layoffs are expected to result in a rise in the propensity to save.

In line with its previous practice, the forecast was calculated using the current central bank base rate (9.50%), a HUF/EUR exchange rate of 289.7 and an oil price of €38.1 per barrel. The HUF/EUR rate is 12% weaker than the 257.9 assumption in the November report. The oil price is well under the €60.4-per-barrel assumption in November. (MTI-Eco)