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Thursday, December 11, 2008

As Hungarian Inflation Drops, Is There A Deflation Risk?

Consumer prices in Hungary dropped 0.2% month on month and were up by 4.2% year on year in November 2008, falling well short of the 4.5-4.6% year on year consensus forecast. Seasonally adjusted core inflation fell to 4.1% year on year from 4.6% in October, according to the latest data from the Central Statistics Office. Month on month seasonally adjusted core CPI was up 0.1% as compared with 0.2% in October.

“The pace of disinflation in Hungary is astonishing given the Forint sell-off in Q3. November inflation collapsed to 4.2% from 5.1% previously, substantially undershooting the consensus at 4.7%. Falling oil prices were responsible for 0.5pp of the decline but other categories are also confirming that inflation is likely to fall further in Hungary."
Bartosz Pawlowski, Toronto Dominion Bank, London

As Bartosz Pawlowski says the rate of disinflation is really quite astonishing at this point, and this is clearly about much more than just oil prices. What we need to think about is the impact of the wage cuts in the public sector which will begin to lock in this month, and the sharp reduction in both internal and external demand, and on all fronts, and for all sectors next year. Hungary is obviously facing a very nasty recession (contraction in 2009 in the 3% to 5% range), and this sharp drop in demand is bound to have a negative impact on prices, so the threat of deflation is real, I would say, at this point. The problem is to stop negative price movement expectations locking-in (ie people expecting prices to go down rather than up, and this setting in over a number of years, as has happened in Japan). The normal recipe for this is some combination of near zero interest rates and quantitative easing from the central bank, but Hungary is a long way away from having the necessary conditions to run such an unconventional policy (like the one Bernanke is tooling up in the US right now), so the economy is virtually defenceless at this point, but no wonder the NBH is in a hurry to try and bring rates down.

If we look at the seasonally adjusted core index, which was still up a fractional 0.1%, but the curve below will rapidly show you that price increases have been flattening out since the early summer, and we are soon about to head down, in my humble opinion.

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