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QUARTERLY REPORT ON INFLATION MAY 2006

QUARTERLY REPORT ON INFLATION MAY 2006

OverviewEquilibrium

OverviewEquilibrium risks render the stableinflation environment fragileAccording to our main scenario, which – consistent with earlier practice – isconditional on the assumption of an unchanged short-term interest rate andexchange rate, inflation is expected to stabilise around 3 per cent and economicgrowth to decelerate in the longer run. At the same time, the persistentlyhigh general government and current account deficits continue to callinto question the sustainability of the macroeconomic path.The main underlying reason for the persistently high external imbalance isthe high general government deficit, developments in the latter constitute akey issue in terms of the sustainability of the macroeconomic path. As by theend of the preparation of the Report we do not have official information withrespect to changes in fiscal policy, we prepare our projection according toour ‘usual’ conditional path. In 2006, based on the Budget Act and thisyear’s developments, a stimulating effect almost one per cent of GDP isexpected, while for 2007–2008, we assume a fiscal contraction on the orderof one half of a per cent, which corresponds roughly with the average valuerecorded in the previous two budget cycles. Considering that without anyfurther measures, the currently adopted measures and determinationswould foreshadow a 1–1.5 per cent deterioration of the deficit by 2008, theslight fiscal tightening assumed in the projection would also require theadoption of measures exceeding two per cent of GDP by 2008.Our macroeconomic projection depends heavily on the structure of a possiblefiscal adjustment. It is based on the assumption of adjustment implementedin an average structure, with government consumption and investmentplaying a dominant role. However, we have not specified such anadjustment in full detail in the government balance sheet.A weaker exchange rate and higher oilprices than earlier are expectedTrend inflation in Q1 is estimated to havebeen between 1 and 2 per centOur forecast – according to out rules- is based on the average April monetaryconditions and futures oil prices. This renders assumptions of anexchange rate of EUR/HUF 265, a short-term interest rate of 6 per cent, andoil prices persistently around USD 70. These assumptions point to significantlyhigher-than-earlier inflation projection, however their effect is partlyoffset by the current very low trend inflation, and the actual data on inflationhave shown no signs of a turnaround as of yet.Evaluation of inflation figures for the beginning of the year is renderedextremely difficult by the January VAT rate cut, which was estimated tohave reduced consumer prices by nearly 1 per cent. In the last quarter,trend inflation may have been between 1 and 2 per cent, which showsthat the character of the economic environment remained broadly disinflationary.The significant gap between the total consumer price index and core inflationcontinued to widen, due to substantial increases in prices ofunprocessed food and petrol. The sustainability of the low inflation environmentwas ensured by the fact that there was no significant inflationary pressurefrom the labour market and households’ consumption demandremained subdued. At the same time, the increase in European importedQUARTERLY REPORT ON INFLATIONMAY 2006 7

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