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QUARTERLY REPORT ON INFLATION MAY 2006

QUARTERLY REPORT ON INFLATION MAY 2006

MAGYAR NEMZETI BANKTable

MAGYAR NEMZETI BANKTable 2-2Estimated effect of the VAT rate cut in individual items of the consumer price indexWeight (%) Previous estimate for… Evaluation of the previousestimate...pass through ...effect of VAT rate cutProcessed food 11.8 90 -0.5 AcceptableIndustrial products 28.2 80 -2.7 Overestimated, the true effect maybe between -1 and -1.5 percentMarket services 19.0 33 -0.7 AcceptableVehicle fuels 4.7 100 -4.0 AcceptableRegulated prices 20.3 94 -1.5 Overestimated, the true effect mayaround -1.2 percentConsumer price index 100.0 74 -1.4 Overestimated, the true effect mayaround -1.0 percentCore inflation 67.7 66 -1.4 Overestimated, the true effect mayaround -0.8 percentStill low trend inflation, with changing internalstructureWe believe that trend inflation, as during the whole lastyear, stood at a very low level in Q1 as well, and did notshow signs of a turn in the direction of inflation. March andApril trend inflation developments – which already weremost probably not influenced by the VAT rate cut inJanuary – continue to indicate trend inflation of around 2per cent. Even lower trend inflation is likely on the basis ofthe core inflation excluding the effect of the changes inindirect taxes; the constant tax rate core inflation stood ata level of around one per cent in Q1. 15At the same time, a shift in the internal structure of coreinflation can clearly be observed, which was alsodescribed in detail in the February update of the Report.The inflation differential of tradable products and marketservices, which was very high for a long time even in internationalcomparison and did not show any signs of declinein Q4 either, took a quick turn early this year. Deflation intradable products (excluding the effect of the VAT rate cut)decreased, while there was a substantial decline in servicesinflation.Chart 2-24Indicators of trend inflation*(annualised quarter-on-quarter growth rates)14121086420Per cent00 Q100 Q200 Q300 Q401 Q101 Q201 Q301 Q402 Q102 Q202 Q302 Q403 Q103 Q203 Q303 Q404 Q104 Q204 Q304 Q405 Q105 Q205 Q305 Q406 Q1Constant tax rate core inflationLow tradables inflation, with some signsof accelerationPer cent14121086420Core inflation* In case of the time series of core inflation the latest data point is the averageof the price changes in March and April. We believe that data from Marchalready reflect trend inflation developments quite well, because the VAT ratecut only had a slight effect by then. Core inflation excluding the tax effect isthe MNB’s own estimate, based on our estimate for the effect of the VAT ratecut in January 2006 on core inflation.Disregarding the inflation reducing effect of the VAT ratecut, inflation of tradable products remained low. On the15Core inflation not containing the indirect tax change is an MNB estimate, which also adjusts core inflation taking account of the price reducing effect ofthe latest VAT rate cut estimated by the MNB. Therefore, there is a difference in conception between this indicator and the constant tax rate index publishedby the CSO, which is adjusted by the technical effect of the tax rate change. As, contrary to the aforementioned indicator, the constant tax rateindex does not take into account that sellers of consumer goods do not completely reflect the VAT rate changes in their prices; in case of the VAT ratecut the constant tax rate index overestimates trend inflation.32QUARTERLY REPORT ON INFLATIONMAY 2006

INFLATION AND ITS DETERMINING FACTORSother hand, in the latest months, there appear to be somesigns of an abatement or a turn in the deflationary trendseen last year.The possible end of deflation in tradables is also supportedby the fact that, approaching the end of last year, industrialproduct inflation of the euro area also began to accelerate,which, in general, may have reflected a weakeningof the earlier global disinflationary pressure. In parallel withthis, it was likely that sooner or later the price reducingeffect of the growing competition in the domestic productmarket perceptible after the EU accession would decline;retailers cannot go on increasing the ratio of cheaperimported products in their supply, and mark-ups of domesticproducers and distributors may have shrunk to a relativelylow level.Chart 2-25Industrial goods inflation and its main determinants*(annualised quarter-on-quarter growth rates, the exchange rate in level)Per cent6.55.54.53.52.51.50.5-0.5-1.500 Q100 Q200 Q300 Q401 Q101 Q201 Q301 Q402 Q102 Q202 Q302 Q403 Q103 Q203 Q303 Q404 Q104 Q204 Q304 Q405 Q105 Q205 Q305 Q406 Q1Euro area tradables inflationEUR/HUF exchange rate (right-hand scale)Domestic tradables inflationIt is important, however, to emphasise that the significantdepreciation of the forint vis-à-vis the euro in the lastmonths is not yet reflected in the latest developments oftradables inflation. The inflationary effect of exchange ratedepreciation is expected to materialize only later, on thetop of current inflation developments.Services inflation started to declineEUR/HUF270265260255250245240235230225* For the ‘domestic industrial goods inflation’ time series the latest data pointis the average of price changes in March and April. We believe that data fromMarch already reflect trend inflation developments quite well, because theVAT rate cut only had a slight effect by then.At the same time, disinflation of market services clearlytook place: the annual price increase fell from the earlier6–7 per cent below 5 per cent by March-April. The declinein inflation is not only the result of the VAT rate cut, as theinflation of services not affected by the VAT rate cut, whichconstitute more than half of all services, also declined. Thisresulted in a decline in the upside inflation risk, which wehad seen earlier in services inflation stabilising at a highlevel, despite the low inflation environment.Chart 2-26Market services inflation*(annualised quarter-on-quarter growth rates)Per cent1412108642003 Q103 Q203 Q303 Q404 Q104 Q204 Q3The long-awaited start of the expected adjustment of servicesinflation to the low inflation environment was probablyfacilitated by several factors. On the one hand, the gradualdecline in labour costs of the sector during 2005 may havecontributed to disinflation. On the other hand, from thedemand side, disinflationary pressure may have followedfrom the fact that the earlier strong shift in relative prices ofservices and tradables probably drove consumptiondemand from services to tradable products in 2005 H2. 16Lastly, the sudden fall in inflation at the beginning of theyear is in conformity with the observation also valid for theeuro area, that in a low inflation environment services’ priceadjustments take place typically once a year, at thebeginning of the year.Declining trend in inflation expectationsAccording to the surveys conducted by Medián and GKIas well, economic agents’ inflation expectations also seemto be adjusting to the low inflation environment. As a resultof the VAT rate cut in January, there was a notable declinein both Q1 perceptions and expectations of householdsand business companies, which may also have reflectedrespondents’ optimism regarding the VAT rate cut.Although this decline was partly corrected according toMedián’s survey for Q2 (prepared in April), perceptions04 Q405 Q105 Q205 Q3Per cent14Services sector ULCNontradables inflationNontradables inflation (not affected by VAT rate cut)* For the ‘market services inflation’ time series the latest data point is the averageof price changes in March and April. We believe that data from Marchalready reflect trend inflation developments quite well, because the VAT ratecut only had a slight effect by then.05 Q406 Q112108642016See further details on our hypothesis with regard to the shift in consumption towards tradables in the February 2006 update of the Report.QUARTERLY REPORT ON INFLATIONMAY 2006 33

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