Headline inflation in CE hides potential for rate cuts

By bne IntelliNews February 17, 2012

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January inflation figures from across Central Europe released on February 16 spat out headline figures in excess of expectations, but analysts note that tax increases and continued commodity price rises drove CPI almost exclusively, and that demand played little if any role. That makes sense as the spectre of recession looms, and with core inflation actually below target, it raises the prospect that central banks in the region could soon consider easing monetary policy in a bid to stimulate growth.

VAT rate hikes in both the Czech Republic and Hungary helped boost January CPI to 3.5% and 5.5% respectively. The Czech figure was the highest since December 2008, with a rise of the country's lower VAT rate (on food, pharmaceuticals and public transport) from 10% to 14%. Hungary also introduced a VAT hike - from 25% to 27%, the highest in Europe - at the start of the year.

However, as Capital Economics points out, "inflation fell in Poland and Slovakia as VAT hikes in January 2011 have now dropped out of the annual comparison. Headline inflation hit a 6-month low of 4.1% in Poland in January (down from 4.6% in the previous month) while in Slovakia inflation came in at 3.9%, down from 4.4%." The analysts suggest that headline inflation for the pair is set to fall sharply again in the second quarter "as last year's VAT hike and the commodity price shock unwind."

Analysts at Komercni banka also conclude that tax hikes and commodities are pretty much solely to blame for Czech price rises, pointing out that although "inflation is at its highest level since December 2008 ... on the other hand ... the Czech economy was in a state of recession in the second half of 2011. This should offset the impact of a higher-than-estimated rise in consumer prices."

Stripping out the VAT rises and impact of the commodities spike then, "in the Czech Republic, Hungary and Poland, constant tax core inflation is below their respective central banks' inflation targets," Capital Economics claims. Over at KB they claim that "adjusted inflation is virtually zero, signalling that there are no demand-driven inflation pressures in the economy."

Notwithstanding the headline figures then, the data suggest that central bankers could actually have the freedom to move to try to stimulate growth in some CE countries. Hungary, given the weakness of the forint and high level of foreign-currency debt, Hungary, may have less room for manoevure.

Capital Economics pushes this scenario hard, saying: "In particular, in the Czech Republic and Poland, we think that above-target headline inflation is no barrier to looser monetary policy to tackle the challenging growth outlook ... In Poland, this measure tells a rather different story to the recent hawkish comments made by several rate-setters - namely that high inflation could prompt interest rates hikes later this year. [Lower headline inflation in the second quarter should open] the way for interest rate cuts in the second half of the year (we have pencilled in 50bps of cuts)."

However, KB is more wary. "Czech National Bank board member Eva Zamrazilova had previously stated that should January's CPI reading exceed both market and CNB's expectations, she would vote for a hike at the board meeting in March. However, the stance of other board members remains unknown ... Inflation jumped over the 3% level and should stay above the CNB's inflation target throughout the whole year in 2012."

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