Higher growth, more employment means higher non-fuel inflation
GDP growth is still likely to decelerate from its recent cyclical peak between now and end-2020, but we see now higher growth rates for the next two years than we did three months ago, something similar to the current forecast from the MNB. This revision is based on the rather strong and probably enduring thrust of both consumer and fixed investment demand, whereas a slowdown of the European economy is likely to act as a limiting factor.
However, our more optimistic outlook on GDP implies that employment will have to grow further significantly throughout the whole of the next two-and-a-quarter years. Rising employment will be increasingly in conflict with the shrinking domestic labor force, while improvements in the labor market activity ratio are no longer available in any great measure. In principle, Hungary could import guest workers, but heavy competition for labor in the CEE region runs counter to this, and the government is seen opposing the idea of importing labor from more distant parts of the world.
Amidst such circumstances, wage inflation is bound to remain strong in the foreseeable future. This is likely to be supported by government policy, as statutory minimum wages will be probably raised further by a similarly large amount in 2019 as in this year. Assuming this measure takes place eventually, we expect non-fuel CPI-inflation to rise straight to the upper end of the MNB’s tolerance range by end-2019, the headline inflation rate remaining slightly lower only if fuel prices do not move higher after September 2018.
The balance of payments is moving gradually closer to balance, but the external income balance will likely remain positive, and a small net financing surplus is also likely to be preserved for the next two years. Based on the BOP outlook, no significant correction of the forint vis-a-vis the euro, similar to the one earlier this year, will be necessary, and the MNB is unlikely to aim for one, given the prospective elevated level of domestic inflation.
Fiscal policy is currently being tightened, following a very relaxed stance during the campaign that preceded the parliamentary election held in April. The government is becoming much more conservative about spending money on development, and a significant amount of reimbursements from the EU is also likely to come in before end-December. Even so, the cash deficit target will be admittedly overshot this year, whereas the main policy target on the ESA-2010 deficit will be most likely met. The constitutional requirement to reduce the debt ratio each year will be formally met in 2018 as well, but the amount of the annual reduction will likely be nothing to be particularly proud of.
The budget approved for 2019 aims at moderate tightening of policy. Importantly, the expected statutory minimum wage hike will be significantly budget-positive, especially as the annual reduction of the social contribution tax, a compensatory measure to contain pressure on employers’ costs, will be smaller than in 2018 and it will come only from July. This should imply further upward pressure on producer prices and reduce competitiveness, mainly in the SME sector. The MNB’s new cheap loan facility should be an important relief to SMEs, though its significance must not be overestimated at a time when interest rates are relatively low anyway.
MNB policy is likely to be stuck between rising non-fuel inflation and global interest rates on one hand, and fiscal consolidation and decelerating GDP growth on the other hand. For now, the Bank is obstinately holding on to its long-standing loose policy stance, claiming that inflationary pressures will settle down by the middle of next year. However, it is preparing backstage for the time when a more efficient conduct of monetary policy might be required. Evidence includes the ongoing clean-up in the Bank’s policy toolkit, and the accelerated removal of slack liquidity from the banking system in recent months. We still expect the MNB to start moderate increases in interest rates only in H2 2019.
The political situation remains tough, allowing little reason for optimism in medium term. The EU has started its Article 7 procedure against Hungary, but it is unlikely to go much beyond continuous political pressure. Similarly, the European People’ Party is not very keen on taking early action against Fidesz. However, the sharp cutback of access to EU financial transfers between 2021-2027 is likely to go through, roughly as proposed by the European Commission in May. This means that Hungary will have to go through a major macroeconomic adjustment over the next few years. Fidesz’ strategy seems to be to delay this adjustment and distribute its impact for several years. In the meantime, they will likely continue efforts to concentrate power in domestic politics. For quite a while, they are likely to be successful in this latter regard, as they essentially hold all the important cards in their hands, and as their voting base is unlikely to withdraw support until economic matters change significantly more for the worse than currently.
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