Monetary conditions have changed little in the period since the publication of the previous report. The impact of the April consumer goods inflation on the central projection is therefore discussed separately in chapter 1.2.3.
The NBH’s projection and latest inflation developments
Assessment of first-quarter data
Monitoring price developments in the eurozone is extremely important in relation to domestic price changes. Although Eurostat's April eurozone HICP figure is 2.4%, the latest data shows no clear sign of a significant decline in the HICP, which has remained above 2%.
The previous inflation projection versus the actual rate
Among these factors, the effects of the increase in the price of tobacco products in January, as a result of the increase in excise duty in some countries of the eurozone, can be considered as temporary. The difference between actual prices and the assumption suggests that market participants were equally surprised by the high oil prices in the first quarter.
Reasons for the difference between projections and actual data
Among the domestic developments related to inflation, the evolution of wages and therefore household consumption is the most important, in addition to the exchange rate. Since the value of most of the variables that influenced the projection of the market services price index over the near term developed in a direction implying stronger than projected inflation, the aforementioned error must have occurred due to the fact that the Bank's model mainly medium-term catch developments.
Projecting the consumer price index
Assumptions of the central projection
The current central projection is based on a constant oil price assumption, assuming that the Brent oil price remains unchanged from the average April level for 2002-2003. In the short term, changes in the price of oil directly affect the price of vehicle fuel and market-priced energy. There has been a significant change in the assumption of inflation in the prices of imported tradables, reflecting an inflationary shift, primarily with respect to domestic tradables and, indirectly and in the longer term, the prices of market services.
In contrast, monthly growth in the current assumption is higher in the first half of the forecast period (up to December 2002) and gradually declines. The assumption had to be changed because data for the first quarter of 2002 signaled accelerating inflation across the euro area and in Germany, Hungary's main trading partner. The bank's assumption of the forint/euro exchange rate reflects a somewhat stronger currency than in the February report.
Details of the central projection
10 The wage effect is even greater, as minimum wages are expected to have a significant impact in the services sector in 2002. 11 The difference between the inflation rate of market services and tradable goods has fluctuated between 5 and 5.5 percent in recent years. Another factor implying an upward revision to expected inflation in tradable goods prices is the significantly higher wage projection for 2002, which reflects cost pressures on domestic prices.
This is partly because certain regulated prices early in the year (such as domestic postage, gambling fees) rose more sharply than expected in light of the government's intentions, in line with inflation expectations. The Bank nevertheless wishes to emphasize that, in accordance with transparency requirements, the projection for inflation in regulated prices is based on the rate of increases as laid down in the prevailing Budget Act. According to the decision of the Monetary Board, any deviation from the assumed path of regulated prices and future changes in fiscal policy measures is reflected in the uncertainty spread and not in the central projection.
Uncertainty in the central projection
According to the Monetary Council, uncertainty about changes in imported inflation is symmetrically distributed. As regards the degree of exchange rate pass-through, the Monetary Council maintains the February assumption of a 37.5% pass-through to the level of tradable goods prices over a year. According to the central projection, prices in this category of goods will increase by an average of 5% in 2003.
Inflation projections were also prepared for the two scenarios of the real economy presented in the above Summary. In addition, the real economy scenarios also differ in the wage projection for the competitive sector and the projected path for imported inflation, which changes. Finally, the rate of increase in prices of alcoholic beverages and tobacco remained high due to the lagged effects of the January increase in excise duties on tobacco and the prolonged depletion of stocks.
Demand
- External demand
- Fiscal stance
- Household consumption, savings and fixed investment
- Corporate investment
- External trade
- External balance
Partly due to the lower base and partly due to developments in the year in question, the expansionary effect was corrected from the previous 0.7% to 1.3% of GDP. The bank's assumption of a 0.3% improvement in the ESA17 primary balance as a percentage of GDP is derived from a hypothetical path. Wage growth in the public sector is likely to be higher than in the private sector.
In contrast to the fall between 0-5% in the bank's previous forecast, corporate investments in fixed assets are currently expected to increase slightly, by 0-3%. As a result, the average annual growth rate of exports is likely to be 1 percentage point higher than projected in the previous report. Hungary's current account deficit in 2002 is now forecast to be EUR 1.9-2.4 billion, as predicted in the February report.
Output
General government borrowing demand is expected to be higher as a percentage of GDP compared to last year, due to the base effect and stronger fiscal expansion, described in the fiscal policy chapter. As a result of the March data, manufacturing output growth in the first quarter was higher than our expectations. There are two reasons for this: 1) the change in the forecast of external demand; and 2) the dramatic low fourth quarter data.
In the bank's analysis, growth in manufacturing value added is determined by variations in external demand in the longer term. In the current forecast, value added in industry in 2002-2003 thus follows the long-term trend determined by the development of external demand. The forecast for value added in the service sector has been revised significantly compared to that published in the previous report.
Employment
In the projection, slower than expected nominal adjustment leads to higher wages and lower numbers in employment. These two factors account for a largely equal share of the shift from the previous projection. Taking into account the uncertainty of the labor market processes, the forecasts for the private sector as a whole are for wage inflation between 10.4% and 12%, and those for employment growth are between -0.6% and 0% in 2002.
Forecasts for wage inflation are between 6.2% and 8.8% and for employment growth are between 0.3% and 1.3% in 2003, and the central path is 7.5% and 0.8% for wage inflation and employment growth respectively . However, if the wage adjustment proceeds more slowly than described in the previous report, this may cause the number of employed people to fall further. Taking all these factors into account, overall private sector employment growth is expected to be between -0.6% and 0%.
Labour reserves and tightness
Chart 3–2 Average weekly hours worked by manual workers in manufacturing and number of vacancies in the private sector*. This may imply that firms will still be more inclined to adjust the number of employed people than to accept nominal adjustment. By contrast, an increase in external activity and an acceleration in nominal adjustment from the latter half of 2002 could lead to a gradual increase in the number of people employed in the manufacturing sector.
The services sector continues to enjoy buoyant activity thanks to strong household demand (see section on consumption). As the current projection activity is more buoyant than previously anticipated, employment in the services sector expands at a steady pace in both years. This is the combined result of a projected 2% decline in manufacturing employment in 2002, followed by a flat period in 2003, and an increase of about 1.5% in service sector employment in both years.
Wage inflation
On the other hand, a stronger than estimated impact of the increase in minimum wages may represent a negative risk for employment growth. The hypotheses that explain the absence of nominal adjustment are crucial from the point of view of the real economic costs of disinflation. Econometric studies support the bank's earlier assumption that the minimum wage increase in 2001 had no real effect on the aggregate level of wages in manufacturing, but instead caused an almost 2% excess increase in wages in the service sector.
Providing a more accurate estimate of the effect of the minimum wage has meant an upward revision of service sector wage indices. In contrast, due to the inclusion of the minimum wage effect, no significant nominal adjustment related to market services is likely sooner than 2003. Growth is accounted for in equal percentages by the slower than expected nominal adjustment. and considering the effect of the minimum wage.
Productivity and competitiveness
Forecasting real exchange rate price indicators is strongly related to inflation forecasting, as exchange rate forecasting and exchange rate pass-through analyzes implicitly contain the concept of real exchange rate. Furthermore, by using the concept of the equilibrium relationship between the prices of non-tradable and tradable goods, the projection of market services implicitly contains another concept of real exchange rates.35 Thus, the projection of exchange prices is strongly related to the real exchange rate based on production prices, while the projection of non-tradable goods is strongly linked to the real exchange rate of non-tradable goods. The price forecast is partly formed on the basis of the real exchange rate of consumer prices. In 2001, real exchange rates for consumer goods and production prices appreciated by 7.5% and 8.8%, respectively.
From the figure below, it is clear that manufacturing prices responded more to the widening of the exchange rate band than consumer prices. 35 The forecast for the real economy is based on a third concept, the unit labor cost-based real exchange rate. 36 As the bank does not make quantitative projections of manufacturing prices, only the consumer price-based real exchange rate is analyzed for the projection.
International economic environment and risk perception
The EMBI sovereign risk premium, which reflects changes in the propensity to take risks, has also risen strongly over the past three quarters. All this is a good indication of an increase in investors' willingness to take risk. The absence of a stronger fall in the spread was not contrary to the Bank's expectations.
While the upward adjustment of Hungary's current account deficit for 2001 and the parliamentary elections may have caused some temporary uncertainty in the first quarter of 2002, the main explanation for the sovereign bond spread remaining broadly static must have been that these the differences are already low by international comparison. . During the period of EMBI spread decline, the average spread of Hungarian foreign currency bonds fell to a historical low. Thus, for example, the current spread of Hungarian bonds is lower than that of Greek bonds in the period immediately before Greece's EMU membership,38 and is close to bond spreads of eurozone member states, which are now between 10 – 40 base point.
Interest rate and exchange rate developments
Capital flows
Long-term yields
