Hungary inflation sharply down at 4.2% yr/yr in Nov from 5.1% in Oct, 4.5-4.6% market call (2)

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Hungary's consumer prices dropped 0.2% month on month and rose 4.2% year on year in November 2008, undershooting the 4.5-4.6% yr/yr consensus in a Portfolio.hu poll.

For the end of the year the analysts now project CPI to be at 4.2%, down from 4.9% in the previous monthly poll.

CPI in January-November came in at 6.3%, down from 6.5% in Jan-Oct, the Central Statistics Office (KSH) has reported on Thursday.

The sharp drop in yr/yr inflation to 4.2% in Nov from 5.1% in Nov may be traced back to two factors. Fuel prices are falling as the world market price of crude is ebbing away and last year's dramatic supply shock at food products is now history. What is dominant presently is the favourable impacts of this year's good crops. These two factors contributed so strongly to disinflation that it did not even matter much that the KSH has put the gas price hike into the Nov index and the price decrease at industrial goods has not continued due to forint's weakening.

Observing the processes from a distance we will realise that there is no major surprise in the stunning decline in inflation. The latest (Nov) m/m indices were all negative all over Europe, which means Hungary's -0.2% fits nicely into this picture.

Apart from the aforementioned, there was another highly pleasing reason behind the falling CPI, namely a spectacular disinflationary process taking shape in the area of services over the past months and continuing in November, as well. Given that one of the key factors that determine prices in this product category are expectations, which are stable and of great importance regarding the long-term outlook, the data indicates that inflation may stay low persistently.

Interest rate outlook - CPI not on stage

In view of the above, it is no surprise that the seasonally adjusted core inflation decelerated to 4.1% yr/yr from 4.6% in Oct, while it filters out the direct impact of both fuels and raw food.

In monthly terms, core CPI has risen 0.1%, which compares with +0.2% in the previous month.

It is also stunning that based on the past three months' core CPI data, the yr/yr price increase (the so-called quarterly annualised core inflation, which is watched very closely by the central bank) would be only 0.8% (!).

We should draw no far-reaching conclusions from today's lower-than-expected inflation figure with regard to possible rate decisions. When it comes to lowering the unrealistically high base rate the NBH currently focuses on financial stability above all. Governor András Simor noted a number of times that Hungary's inflation would clearly allow lower rates.

There is one other interesting feature of the 4.2% 12-m CPI index, namely that the December figure could easily start with the digit 3. This means the NBH will have fulfilled its 3.0% +/-1ppt medium-term inflation objective by the end of 2008.

On the road to deflation?

Regarding the inflation outlook, we need to delve deep into other data, as well. The latest GDP numbers published this week (revised for Q3) leave no doubt about the fact that Hungary's economy is virtually in recession and the situation is most likely to get worse before it improves in the near future.

The government's adjustment measures to be implemented next year could not have possibly exerted an impact on disinflation and household consumption has not yet been dented by hardships to obtain loans from banks. These will have their effect felt only in 2009.

In light of this, we can rest assured that the NBH will undershoot its inflation target. Considering this we may say that monetary easing is pressing, but then there are stability risks to be observed.

Another aspect of the swiftly moderating inflation is how it will affect Hungary's budget position. In theory, lower inflation means smaller revenues for the state coffers, but thanks to the high ratio of expenditures indexed to inflation the impact may be muted.

While low CPI may worsen the balance only a bit, considering that the economy could contract by more than 1% (the official gov't fcast), this could in fact carry risks to meeting the budget deficit target.

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