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Wednesday, March 12, 2008

Hungary Inflation February 2008

Hungary's inflation rate remained at more than double the central bank's target rate in February, reinforcing the general impression that policy makers will raise interest rates again, and probably as early as this month, even though this months annual rate was slightly down on the January one. Hungary's consumer prices rose in February by 1.1% month on month and by 6.9% year on year. There is still considerable debate among analysts about where end of the year inflation will be, although the consensus number seem to be somewhere in the region of 4.7%.

Seasonally adjusted core inflation was in fact up slightly at 5.3% year on year as compared with 5.2% in Jan 2008. The monthly rise in core inflation was 0.4% compared with 0.6% in January. Again this could be read as suggesting that pressure from "second round effects" stemming from the original increase in fuel, food and administered prices is still growing slightly.

Hungarian inflation has now consistently exceeded the central bank 3 percent target since August 2006, heading upward under pressure from global food and energy prices, and following "own goal" inflation pressures due to the increase in state administered prices as the Hungarian government lifted utility bills and social security contributions in an attempt to reduce a record budget deficit. Last months "bright idea" of attempting to fight inflation by trying to induce a stronger currency has foundered on the unwillingness of market participants to take the proposition seriously. In fact market players have been increasingly betting against the forint and trying to force higher interest payments, leaving policy makers with little alternative but to consider higher borrowing costs when they next meet on March 31.

Yields in the fixed income market continue to rise, and 3-month discount T-bills were sold at auction yesterday with the average yield set at 8.78%, up 33 basis points from Monday's benchmark fixing, and 69 bps higher than at the previous auction of the instrument a week ago. Meanwhile the forint continues to firm slightly, hovering close to the 260 level against the euro in morning trade today. This development is more a product of the cautiously optimistic global investor sentiment which followed the Fed's liquidity easing decision yesterday than a reflection of any underlying change in Hungarian fundamentals.

So the central bank continues to struggle, and its credibility is certainly under the microscope at this point. Last month they raised their inflation forecast to 3.6 percent from 3 percent for 2009 and to 5.2 percent from 5 percent for this year, and markets will be keen to observe how this situation evolves, both in terms of slippage on the forecast and in terms of attitudes inside the bank itself. Really the bank have set themselves a pretty high inflation target for this year (since most market analysts year end inflation comfortably below 5%, although the rate of deceleration is still unclear), so we could be more or less optimistic on the delivery count here, but we do need to note that core inflation (which strips out volatile food and energy prices, and is one of the central bank's most closely watched indicators) rose this month to an annual 5.3 percent from 5.2 percent in January.

The February price increases were still largely driven by food and energy costs. The price of natural gas rose 15.4 percent and power prices increased 9.8 percent in a month while the cost of cooking oil rose 4.2 percent.

February's annual consumer price index reading was thus influenced by a number of factors. It was evidently pushed higher by a rise in fuels prices, the delayed accounting of several regulatory price hikes, but we also saw the ending of the deflation process in consumer durables. This latter component could be attributed to some extent to the weakening in the forint, although - since consumer durable prices rose by 0.2% on the month after rising by 0.1% in January - an accelerating increase in this component so early in the year should certainly raise some eyebrows. Downward pressure was exerted on CPI by the base effects of the fact that several of last year's sharp price hikes - in e.g. medicines - fell out of the index.

Services prices rises decelerated, increasing by 0.7% on the month following a 1.7% increase in January, which seems to confirm the view that the bulk of the administrative price changes had already shown up in the index in the previous month.

All in all a most difficult picture for the central bank who are certainly ging to face some hard decisions in the coming months, as the needs of Hungarian internal demand would seem to indicate monetary loosening, while the inflation problem and the need to protect the forint make tightening an almost foregone conclusion.

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