The need for further monetary tightening has become more evident lately

HUNGARY - Report 22 Sep 2021 by Istvan Racz

The 4th wave of Covid is now definitely underway, as expected. Despite similarities to last September’s developments, it has become more difficult to measure the true size and dynamics of the epidemic, as widespread vaccination made the identification of infected people more difficult than it used to be. Further uncertainty at this stage is the lack of knowledge about the potential impact of the Delta variant, the durability of vaccine protection, and the likely consequences of an almost complete lack of safety measures. Anyway, the authorities are definitely not planning the reintroduction of any Covid restrictions, insisting on the claim that mass vaccination should just solve the whole problem.

Economic recovery decelerated in July. Yoy growth rates remained impressively high in industry, construction and the hotel business, although unsurprisingly fell from the skyrocketing levels of Q2. However, minor setbacks were recorded from June, especially in industry, where car manufacturing continued to face a major supply problem. Retail sales growth appeared modest, but judging by the rapid recovery of services in the Q2 national accounts data, total private consumption is likely to have done better. Hotels enjoyed a decent recovery from very low levels this summer, even though foreign tourists were still largely missing due to restrictions on cross-border travel. The labor market continued its slow recovery in July and is now almost as tight as it was immediately before Covid’s appearance.

The government budget is still operating with a deficit deeply below target, and its prospective position is made even stronger by the strengthening of taxable income and sales turnover. The government is set to pay something extra to old-age pensioners over the rest of this year, but the impact of that item is likely to be quite small. Yet everyone expects the government to fill the gap between the deficit suggested by the existing trend and its annual target at some point in late 2021, with large extra spending items that are yet to be determined, just as happened last year.

Following a reduction of the government debt ratio in January-July, the Treasury issued three big FX-denominated bonds in September. This was in addition to the annual financing plan, but the deficit target was left unaffected. The main motive behind this step may have been the intention to hoard cash reserves before the likely sharpening of the rule-of-law debate with the EU later this year. The choice to do this through EUR and USD bonds appears logical, for the forint bond market has come under some pressure due to the MNB’s tightening course, whereas the new FX-denominated bonds were met by ample demand, enabling the issuer to launch low-cost benchmark issues.

The government cabinet decided to start the phasing out of the moratorium on bank debts, which households and domestic companies have had the right to enjoy since late March 2020. From November, only the most vulnerable clients will be allowed to stay, and the scheme will also expire for them in June 2022. This was a compromise between a growing financial stability concern and Fidesz’ desire to export the worst part of the problem to the period after next year’s election.

CPI-inflation returned to the immediate neighborhood of 5% in August and is likely to move even higher over the rest of 2021. Recently, Q2 national accounts data, producer and external trade prices, wage growth and inflationary expectations have produced ample evidence of growing inflationary pressures in the domestic economy.

The MNB raised the base rate further in September and said it would continue to do so with a monthly frequency until inflation has stabilized around the 3% target in a sustainable way. It has also cut back liquidity generation through quantitative policies and is seeking to proceed on this course further. These steps appear to be aimed primarily at strengthening the forint rather than at containing bank lending growth. The forint is just entering a period of yoy appreciation, assuming EURHUF is kept around its current level, and that would contain inflationary pressures if sustained for a sufficiently long time. The MNB’s tightening course will have to compensate for the impact of rapid economic growth and a loose fiscal policy between now and the election next April.

The conflict over Hungary’s access to the EU’s RRF funds has not been sorted out yet, and there is a realistic chance that access to those transfers will not be granted to the country any time soon. The EU Commission is getting tough indeed, as shown by its reluctance to approve Hungary’s RRF plan and its proposal to fine Poland on a rule-of-law issue. On the other side, the payment of transfers out of the outgoing EU budget has continued, and the EU Court’s decision on the fiscal rule-of-law mechanism is now expected to come only in winter. Finally, the current odds for the upcoming German election represent no good news for Hungary’s government.

Domestically, the opposition primaries have just started, providing participants with a great deal of good publicity. Campaign talk is becoming even more aggressive than so far, with the opposition talking about a mass theft of public assets and of prospective prosecution if it wins, and Fidesz speaking of a nightmare if its most-feared political opponent returns. Meanwhile, the government has revealed an impressive list of fiscal give-aways for early 2022, which it hopes will support its case in the election next April.

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