Reopening is underway, the MNB is starting to tighten
The third wave of Covid, by far the most severe of all so far, has clearly been overcome. Given the relatively soft lockdown rules in force until most recently, aggressive domestic vaccination must have played a key role in this success.
However, the epidemic is still far from finally being over. Factors of remaining uncertainty include the unavoidable slowdown of vaccination from here onward, the yet unknown effectiveness of some of the locally used vaccines, and the similarly unknown effects of the most recent reopening measures.
Beating expectations, Q1 GDP growth was materially positive, although still negative on a yoy basis. Areas of strength included industry, the financial sector and IT/communications, whereas weaknesses remained in Covid-hit services, mainly in the hospitality sector and transportation, and in low consumer confidence.
The rest of 2021 must be markedly better from the growth point of view, given the improvement on Covid and reopening prospects. However, the normalization of domestic and international travel can be only partial by the summer high season, and semiconductor supply problems in the car industry are likely to be persistent. The recovery of consumption will likely be helped by the improving labor market, although probably contained by accelerating inflation.
The debt moratorium in force since March 2020 has been extended until June 2022, with a slight change in its conditions after end-August this year. This is seemingly a politically motivated decision, by which the government intends to postpone any potential debt service problems until after next year’s parliamentary election.
The usual quarterly tax collection, especially of the VAT, resulted in a seasonal monthly central budget surplus in April, making the cumulative four-month fiscal balance appear largely in line with the revised deficit target for this year. Meanwhile, the annual update of the convergence program and the draft budget for 2022 have made clear that the government is aiming only at another moderate reduction of the deficit and debt ratios for next year, as well.
The BOP continues to be nearly balanced in terms of net external financing, as merchandise exports, mainly industrial, are doing well, whereas imports are contained by sluggish domestic demand.
CPI-inflation indeed reached its predicted yoy high in April, mainly due to a large base effect associated with fuel prices. However, the headline rate rose more than expected, and non-fuel inflation also rose significantly. Meanwhile, the KSH revised its core inflation data, with reference to a change of methodology, and this inadvertently caused the MNB’s adjusted core inflation measure to look more favorable.
In response to the upswing of inflation to far above the tolerance range, the MNB’s vice governor made a pretty aggressive statement recently, essentially announcing the start of a new tightening cycle. According to this, the Bank may raise the base rate, and also the 1-week deposit rate if necessary, at its late-June rate-setting meeting. In the longer term, the MNB expects to contain and eventually cancel the quantitative easing policies introduced last year. But for now, asset-purchasing programs will be continued, in order to keep bond yields relatively low.
We believe that the MNB is talking tough now with a view to lessening the required size of its actions later. Its latest statement was made on the back of the relatively strong Q1 GDP data. However, the forint’s recent appreciation against the euro may make any material interest rate hike unnecessary. Aggressive tightening could easily make the forint too strong against the euro in the rest of 2021, defeating the current official hopes for a rapid economic recovery.
The government is counting on a record high amount of development transfers from the EU under the outgoing medium-term budget this year. However, prospects for the new recovery fund are not quite as rosy, as the EU Commission is reportedly unprepared to finance the government’s newly established foundations in university education. In view of possible complications, government has decided to go only for grants, and not for loans, out of the recovery package.
Currently, there is no further news on the activation of the fiscal rule-of-law mechanism. However, the issue is likely to come back to the forefront of diplomacy later this year, and the EU Commission has recently urged the government again to join the European Public Prosecutor’s Office.
Fidesz gained somewhat in the polls, which may reflect success with mass vaccination. The united opposition still has a moderate lead in most surveys, but that would be probably insufficient to win the election. Meanwhile, Fidesz continues its precautionary measures in case of a poor election outcome, as suggested by its most recent initiative to make the national atomic energy authority, the institution supervising the Paks 2 project, markedly more independent than so far.
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