Inflation forecast moved sharply higher
Compared with our previous forecast, released in April, the most important change is a massive upward revision of the inflation outlook for this year and 2023. At this moment, we expect CPI-inflation to peak in the high teens around end-2022 and decelerate from that point onwards, back to a high single-digit level at the end of next year. This forecast assumes the continuation of existing administrative price controls, except the most recently announced limitation of fixed pipeline gas and electricity prices to the average consumption of households.
Factors driving inflation up so much this year include the war’s impact on oil and gas prices, the combined impact of global food price inflation and a heavy domestic drought, a stronger-than-expected economy and a weaker-than-expected forint. On the other side, inflation should fall in 2023 due to progressive substitution of Russian energy, and the weakening global and domestic economies, the latter affected by tightening fiscal and monetary policies. Our forecast appears to be roughly in line with the MNB’s regarding this cycle’s peak level of inflation, but it is less optimistic regarding the timing of that peak and the speed of the subsequent deceleration.
We were apparently wrong about expecting a sharp slowdown of GDP growth in 2022 three months ago. The current prospect is that average growth for the year will remain quite high, even though H2 will most likely see rapid deceleration because of fiscal tightening. This will be partly due to the fact that fiscal adjustment is coming later than expected, and that it may not be quite as big as initially thought, because of a tricky, though wholly regular, accounting of this year’s extraordinary income tax refunds.
However, we do not expect any real GDP growth for next year, given the remaining sizable fiscal adjustment need in that period. The latter should stem from 1) the likely lack of access to a big part of development grants from the EU; and 2) the very high costs of maintaining the lowly fixed gas prices for households, even in the recently announced reduced form of the scheme. These are likely to make a big hole in the budget plan set for 2023. For sure, some of these extra expenses will likely be offset by the positive revenue impact of faster-than-expected inflation, the usual great supporter of Fidesz budgets.
The MNB scaled back its counter-inflationary talk and action somewhat from mid-April, which contributed to faster-than-desirable forint weakening, amidst undoubtedly difficult global conditions. Reacting to the weak currency, the Bank returned to more energetic tightening in late June, and it has been following that path since then. However, we still have the impression that the MNB is planning to maintain rather than markedly increase real interest rates, and is only aiming at limiting the forint’s nominal depreciation against the euro to a reasonably moderate pace. Behaving consequently this way, the MNB appears to be expecting a substantial contribution to its stabilization efforts from the tightening of fiscal policy and from administrative price controls.
We have been arguing recently that the government and the MNB need to maintain some nominal forint depreciation through time, to generate fiscal revenue and to avoid the need for a recapitalization of the loss-making central bank. However, the forint weakening that took place between end-March and mid-June was clearly excessive compared to these requirements. Consequently, we expect that the MNB will try to keep the EURHUF exchange rate around the 400 level for a few months, reducing yoy HUF depreciation to a more normal level before allowing further nominal weakening of a moderate pace later on.
During the next one-and-a-half years, central bank policy will have to remain watchful about the balance of payments. The country’s net external financing requirement will likely continue to grow this year before more or less stabilizing at a relatively high level in 2023. The latter stabilization should be due to the impact of the cooling economy on the trade balance, even partly compensating for the likely negative impact of a decreasing inflow of EU transfers.
The government is apparently softening its position regarding the conditions of accessing EU transfers, as the end-2022 deadline of getting RRF plans approved approaches. However, this appears more like an organized step-by-step retreat rather than a breaking change of view that could speed up negotiations markedly. As the Commission is under strong pressure from Parliament in the EU to stay tough on Hungary, we currently assume that about half of the funds expected by the government from the EU are likely to be lost next year. This would come on top of no RRF money or funds from the new EU budget this year, of course.
Within NATO, Hungary is cooperating in an orderly fashion by raising defense expenditure even in the face of tightening fiscal policy. Lately, its position on Ukraine has also strengthened, due to its clear support of the latter’s EU accession, and its apparent cooperation with Ukraine on agricultural exports. However, a newly generated conflict within the EU has been a recent Hungarian veto of the global minimum corporate tax. It seems that PM Orbán may act as a consequent nonconformist in foreign policy to create a bargaining position for his talks on access to EU funds. However, he will have to find a compromise with the US government as well, which has announced the termination of its bilateral tax treaty with Hungary, as a retaliation for the latter’s negative vote on the global minimum tax.
Growing public dissatisfaction with the latest fiscal adjustment measures is likely to lead to an erosion of Fidesz’ popularity, but it is difficult to follow, as currently no one prepares opinion polls on party preferences. But even if its popular support falls, all the key positions relevant for fiscal decisions remain in Fidesz hands. Eventually, the harsh reality of fiscal restrictions will probably bring the leftist-liberal-green opposition back to the race, despite the latter’s continued disorganized state and fundamental inaction. This is a risk for Fidesz for the medium term, with only rather limited short-term consequences.
New data shows that Covid is coming back in Hungary as well, although it remains at a moderate level for the time being. Information globally available on the new Omicron variants is greatly controversial, and the domestic authorities have remained spectacularly silent on the issue so far. We expect the local presence of Covid to grow substantially more serious than currently, but we see no reason to treat it as a potentially major disruptive factor for this year and 2023.
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