The forint is to stay weak on a sustained basis
The temporarily but substantially depreciating trend of the forint, which started in May, collapsed spontaneously in early July, without the MNB doing anything material to stabilize the currency, except for stopping its usual market interventions against the HUF for several weeks. The key takeaway from the story for longer term is that the MNB is prepared to take a rather high amount of risk to its inflation targeting policy, apparently in an effort to support the government’s ambitious growth target. This should mean a weaker forint on a sustained basis than previously thought.
Even though the weaker forint should be seen as favorable for growth, we are not raising our GDP forecast, but continue to expect growth to slowly decelerate from its current relatively high speed. This is in part because the European economy is already losing steam, significantly earlier than we thought previously, and in part because the inflation / labor market situation and the existing need to tighten fiscal policy will likely pose major barriers to growth in medium term.
Fiscal policy became very loose before the April election, which was to a great extent hidden by the strong growth cycle and by EU development transfers. A great deal of consolidation is due already this year, with more to follow in 2019. The fiscal impulse will likely weaken further in 2020, when cash distributions under EU programs have ceased to be available. We expect the government will indeed carry out the consolidation required to keep the debt ratio on a slowly decreasing trend, with a view to earning credit much more from rating agencies than from the EU Commission.
Further down the road, we regard it pretty much as a done deal that Hungary’s subsidization by the EU will fall sharply under Brussels’ next medium-term budget, largely in line with the EU Commission’s proposal. However, this should have no effect on the economy before 2022-2023, when the development funds granted by the new EU budget indeed start to become available.
The external trade balance and the country’s net financing surplus are likely to remain robust and even improve between now and end-2020, as the trade balance and net factor income are supported by the cooling of the economy, and the implementation of EU-backed development projects generates increasing reimbursement claims on the EU. Hence any medium-term forint weakness is much more likely to come from capital movements, subject to the MNB's remaining unprepared to tighten policy in response to financial market shocks or to similar moves by major central banks.
Inflation is quite likely to stay at or moderately above the MNB’s medium-term target in the coming 12-month period, and to move close to the upper end of the Bank’s tolerance range by end-2019. This should not be in conflict with growth prospects, as the expected cooling of the economy will likely leave consumer demand growth strong and the unemployment rate on its existing decreasing trend. A great deal of temporary uncertainty will be introduced from late 2019 by the government’s recent decision to markedly raise the VAT on newly built apartments from January 2020.
The MNB has recently conceded that tightening will be required on a two-year horizon, but still insists it will take place only after mid-2019. At this point, it appears to be in the position to stick to that in the next 12 months, as long as it does not mind that CPI-inflation holds out in the upper half of its tolerance range for a longer while. Even in the case of a need for earlier tightening, the MNB could resort to the reversal of non-conventional policies before raising interest rates. We expect interest rates hikes only from H2 2019, and only on a moderate scale. However, money market rates and government bond yields may change quite significantly in response to market forces, just as they have so far in 2018.
The Fidesz government has continued its drive towards more domestic power concentration with great vigor in recent weeks, making use of the extra power it acquired in the April election. The government passed a constitutional amendment and the contentious "Stop Soros" package, and appears to have a rich variety of additional ideas in this regard. However, it is unlikely to suffer any serious repercussions in the foreseeable future, given the ever-increasing weakness of the domestic opposition and the existing complicated political situation within the EU.
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