Other contributors to the analysis and forecasts in this report include various staff members of the Department of Economics and the Department of Monetary Instruments and Markets, Department of Statistics. In this regard, the current extent of the fiscal demand effect will prompt much smaller shifts in the inflation projection.
Financial markets
Changes in the exchange rates of the currencies in the region against the euro. By comparison, it has been below 100 basis points for several months now in the case of the Polish, Czech and Slovak currencies.
Inflation and its determining factors
Economic activity
At first glance, external demand showed signs of recovery in the first quarter of 2005, with GDP growing by almost 1 percent in Germany and by 0.5 percent in the euro area, beating expectations. However, this surge appears to have been the result of a significant drop in imports (imports fell by 1.4 percent in Germany and 1.6 percent in the euro area compared to the fourth quarter of 2004), mainly due to an unexpected decrease in domestic absorption ( especially investments) by Hungary's foreign trade partners. Indices that relatively strongly reflect changes in the economic cycle (annual indices and trend time series) testify to the continued growth of total domestic gross investments in fixed assets.
However, such imports remained low in terms of levels, resulting in a significant improvement in the trade balance in the first half of 2005 compared to the previous year. With the exception of Poland, the growth rate of the new EU members from Central and Eastern Europe is decreasing. Over the past two years, Hungary's quarterly economic growth rate has been one of the lowest in the region.
However, in practice, especially in the case of quarterly frequencies, the estimate on the production side is even more uncertain than the one on the expenditure side.
Labour market
Together, these two phenomena can be attributed to the decrease in the participation rate and the simultaneous increase in the rate of activity. Private sector, adjusted for the change in the seasonal pattern of bonus payments. seasonally adjusted, annualized quarter-to-quarter growth rates). Despite the decline in wage inflation, the rate of growth in nominal unit labor costs in the private sector – one of the most dominant cost-side factors of inflationary pressure – accelerated slightly in 2005 Q1.
According to the data available for April and May, however, it appears that the increase in nominal unit labor costs in the private sector has been rather short-lived. In the first quarter, real unit labor costs in the private sector (ie the index of nominal unit labor costs deflated by output prices) also rose. Nominal unit labor cost, productivity and wages in the private sector. annual quarterly growth rates).
Despite the developments described above, the ULC-based real effective exchange rate index appreciated only slightly in Q1 due to the stagnation in the appreciation of the nominal effective exchange rate.
Inflation developments
In the second quarter of 2005, the decline of the annual core inflation index, which began in mid-2004, continued, as confirmed by alternative indicators of core inflation. Disinflation was eased by the fact that tradable goods inflation reached a historically low level in the EU as well. In the second quarter of 2005, the rise in oil and raw food prices led to an increase in the CPI despite the overall disinflationary environment.
A closer look at the region shows that the recent price increase was characteristic only of Hungary, while in neighboring countries unprocessed food prices remained the same or price increases were much more modest. Inflation in regulated prices grew significantly in the past quarter, by almost 1.5 percent. Disinflation has in the recent past been accompanied by a decline in perceived and expected inflation among economic participants.
It should also be noted that the level of Hungarian prices of unprocessed food is one of the most volatile in the European Union.
Inflation outlook
Our forecast takes into account the impact of the future measures recently announced by the government (tax reduction program, expansion of the family assistance scheme, increase in the minimum wage; see details in Chapter 4). The increase in Hungarian exports in the first half of the year far exceeded growth in external markets. This is considered a partly temporary phenomenon and export growth is expected to return to trend levels in the second half of the year.
However, in contrast to the usual cyclical nature of the process, broadly defined public investment is expected to increase only minimally in 2006 and then decline in 2007. As a direct result of the VAT reduction, the consumer price index is expected to fall by 1.4 percentage points in 2006. When assessing the long-term effects of the VAT reduction, other risk factors also emerge.
The most notable is the uncertainty surrounding the impact of the VAT reduction.
Special topics
Background information on the projections
- Impact of an alternative interest rate and exchange rate
- A comparison of our projections with those of other
The macroeconomic information released since the release of the May report has materially influenced our projection for consumer price inflation over the entire forecast period. Additional household income will also be generated in 2006 through the announced changes to the family assistance scheme. Under this accounting method, the purchase of fighter aircraft in 2006 and 2007 will have a significant one-off impact on developments in certain components of GDP and on the current account deficit.
In general, accrual accounting for the aircraft does not lead to any change in our GDP projection. Our projection allows for the adverse impact of the acquisition of Gripen aircraft on the current account and its contribution to an increase in public consumption and imports. Our forecast for 2006 consumer price inflation was mainly moderated by the technical effects of the VAT cut.
Our projection takes into account the approximately 0.5 percent GDP proportional negative effect on the current account resulting from the Gripen acquisition.
Developments in general government deficit indicators
For the purposes of our central projection, the balance of interest is taken into account on the basis of the forward yield curve published on 8 August 2005. With one exception, the effects of measures reported to the European Commission are included in the central projection . However, in the meantime, the carryover funds, which jeopardize the achievement of the deficit target in the coming years, have grown extremely rapidly.
To quantify the effects of the announced tax cuts, we have based ourselves on the measures described in the information document. Changes to the family benefit scheme have been announced under the 100-step program and no independent estimate of their impact has been made. Our analysis above indicates the expected scale of measures the government is expected to take to reduce the deficit, as planned in the Convergence Programme.
Due to currently known determinants, the ESR deficit in 2007 would be higher by 0.2 percent of GDP compared to the ESR deficit in the previous year.
Developments in the external balance
According to our projections, the consolidated government's borrowing requirement to GDP could be 1 percentage point higher in 2005 than in 2004, to above 9 percent. The sharp increase in the current account deficit expected in 2006 can therefore be attributed to two factors. The uncertainty in trade statistics (see Box 4-5) could imply a higher current account balance of almost 1 percent of GDP.
In 2006, mainly as a result of the one-time effect of the Grpien lease agreement that adds to the current account deficit. In our opinion, one of the reasons for the low detected import could be the difference in the statistical measurement. However, the experience from the increase in VAT rates in 2004 provides only modest help in assessing the expected impact of the current measures.
The figure thus calculated is called the technical impact of the VAT rate reductions on the consumer price level.
The macroeconomic impact of the 2006 VAT reduction
We estimated the profit impact at two-thirds, so only one-third of the VAT rate cuts are reflected. We estimate that four-fifths of the VAT rate cuts are immediately reflected in consumer prices, so the profit impact is an estimated one-fifth. In this case, however, the proportion of goods affected by VAT rate reductions is relatively low.
Impact on profit: the share of the reduction in the VAT rate that is not reflected in (gross) living costs. Transfer: the proportion of the reduction in the VAT rate that is reflected in the (gross) prices of consumer goods. Impact of the reduction in the VAT rate: impact on the price level of the relevant group in 2006 (in percentage points).
Our calculations do not show significant cost factors of inflation, which would be reflected in the indirect effects of the VAT rate reduction.
Assessment of the effects of the envisaged minimum wage increase
This means that the total household income will not increase solely because of the increase in the statutory minimum wage. For this reason, 85 per cent are expected. of the effect of the VAT reduction to be beneficial for con-. Below is a brief overview of the mechanism by which the minimum wage affects macroeconomic factors.
In the central scenario described in this report, case (A) is taken as the basis and the effects of other versions are included among the risks. A) The labor market is free of imperfections, but the labor supply does not change as a result of the minimum wage shock (main scenario). As a result of the wage shock, labor costs rise and thus inflation. The labor market is free of imperfections, but the labor supply is increasing as a result of the minimum wage shock.
The effects of economic cycles on the public financial balance 73 The impact of world crude oil market prices on the Hungarian economy 75.
