CPI-disinflation accelerated in May
The outlook on energy prices remains positive, despite a substantial upward correction in recent weeks. Save for the case of a major disruption of the supply flow, energy import costs are still bound to fall by a lot this year. Recent data on gas reserves and energy conservation is impressive. Operational risk around the continuity of service through the Turk Stream and Druzhba pipelines has increased with the escalation of the military conflict in Ukraine. However, these facilities are located further away from the war zone, and both Russia and Ukraine appear to be interested in maintaining the transit of gas and oil to Europe.
Figures for April have made the BOP picture significantly better looking than in Q1, but the deficit of the basic balance was still higher in the first four months than one year earlier. The trade account exhibited major improvement, on cheaper energy but also an improving non-energy balance, caused mainly by weak domestic demand. However, almost everything else, including investment income, transfers from the EU and errors and omissions, has deteriorated.
Q1 GDP details have revealed some odd features, including the key role of agriculture in minimizing the recession, despite that this took place in the winter period, when farming activity is normally quite low. More importantly, the speed of nominal GDP growth fell back sharply in Q1, a negative event from fiscal revenues’ point of view. Monthly data for April indicates that recession is likely to continue in Q2, and it may be easily worse than in Q1.
The headline rate of CPI-inflation dropped spectacularly in May, surprising the market and pushing disinflation back to the path predicted by the MNB’s Q1 inflation report. Falling fuel prices, weak consumer demand and the slowdown of food price inflation all made a contribution. The likely continuation of the weak economy and the existence of exceptionally big base effects between now and January 2024 is making further rapid disinflation an increasingly realistic scenario. Administrative restrictions on energy and food prices will remain in place this year, although price capping on basic food items will be materially eased from August.
The central government’s cumulative cash deficit ratio fell markedly in May, and the gross and net debt ratios also decreased in January-April. However, the annual deficit target, on which the government continues to insist, still appears to be a long shot. Reaching it will be made difficult by rapidly increasing net interest payments, decelerating nominal GDP growth and continued heavy spending on energy subsidies. We expect improvement on this latter item, but not on the first two, over the rest of this year. The budget plan for 2024 is in parliament; it is aiming at further tightening of policy in principle, but it is missing any reserve for a likely sizable recapitalization need of the MNB, and it relies significantly on new development transfers from the EU, access to which has not been secured yet.
Unsurprisingly after the latest inflation data, the MNB reduced the O/N deposit rate by another 100bps, to 16%, at its late-June Monetary Council meeting. The MNB hinted at the possible unification of the sterilization rate with the base rate by September. Analysts also expect regular further cuts in the sterilization rate, to significantly below the current level of the base rate by year-end. However, the restoration of a positive real interest rate by that time is also expected, in line with the MNB’s stated objective. The Bank is likely to reduce the sterilization rate gradually, remaining watchful of the development of inflation, reactions by the forint, and of geopolitical as well as global market events.
There were no new developments on Hungary’s access to EU funds in the past month, which is unsurprising given the timetable outlined by the EU Commission a few weeks ago. This issue is unlikely to reach a decision phase again before September. The government is keeping a low profile in the EU ahead of that decision: it has cast a supporting vote for the EU’s 11th sanction package against Russia, in spite of its usual combative voice heard in domestic communication. The EU Parliament continues putting pressure on the government, reporting that the rule-of-law situation has not improved at all lately, and asking the EU Council to do something to remove Hungary’s 6-month term EU presidency, scheduled for H2 2024. The US Senate’s Foreign Relations Committee is blocking a major arms purchase by Hungary until the latter approves Sweden’s accession to NATO.
In domestic communication, the government is focusing heavily on the war in Ukraine to explain current economic difficulties and to keep the public under psychological pressure with its much-stressed "pro-peace" political stance. Meanwhile, it is making efforts to increase its controlling power, this time by having purchased a major publishing company and pushing through a new parliamentary act on the status of teachers in public education. Meanwhile, activity by the largest opposition force has fallen back lately, whereas the second most important opposition party has apparently come alive after a long period of calm.
Fitch Ratings is to present its conclusion on Hungary’s credit rating shortly after the cut-off time for this report. This is to be watched closely, as the agency changed its BBB rating outlook to negative in January, and it said it still saw a downgrading risk for the country a few weeks ago.
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