A bit of a problem with inflation
Those analysts who believed a few weeks ago that Fidesz was unlikely to use its two-thirds parliamentary majority to carry out further constitutional reforms appear to have been clearly wrong. In fact, a draft act to further restrict the operation of non-government organizations, and a constitutional amendment to restrict the right of assembly and to set up a parallel court system are just waiting for parliamentary approval. In addition, PM Orbán has just announced a constitutional review to start in late 2018. All these legal changes are likely to lead to increasing concentration of power in Fidesz’ hands and a further erosion of democracy.
Mr. Orbán’s constitutional reform plans are still unlikely to trigger any serious protestation in domestic politics. People at large are calmed down by rapid wage growth and low unemployment, opposition parties are in ruins, and Fidesz controls an ever-increasing part of the domestic press. Jobbik and LMP, two of the bigger opposition parties, appear to be internally divided, whereas Együtt, one of the smaller opposition parties, was disbanded outright recently. Meanwhile, the number and the reach of independent media products are seen shrinking further rapidly.
However, its existing trend of domestic policies is causing serious trouble to Fidesz in its international relations. Most lately, the Netherlands' Christian democrat CDA party called the European People’s Party to oust any member force that crosses a certain "red line", with specific reference made to Fidesz. Simultaneously, the German CDU, the EPP’s leading force, was reported to have set conditions for Fidesz to avoid expulsion from the party family. Membership in the EPP is important for Fidesz, for it served as a protective umbrella for the party in recent years, against much sharp criticism and hostility from elsewhere in European politics.
The weakening of Fidesz’ positions in Europe appears to be highly detrimental for Hungary’s government relations as well. A key area where this has become evident is the EU’s 2021-2027 medium-term budget. Providing details on its budget proposal, the EU Commission specifically proposed a 24% reduction of Hungary’s transfer quotas at comparable prices, which would cut the ratio of incoming net EU transfers to GDP to 1.7% in 2021-2027 from 3.2% in the current 7-year budget. It is true that other CEE members would also suffer similar cutbacks, but the political problems with Hungary (and Poland) must have influenced the Commission’s proposal negatively, and are unlikely to improve the country’s positions in the forthcoming political debate on the EU budget.
GDP growth remained high, at 4.7% yoy, in Q1 2018, but some deceleration from the previous quarter’s cyclical peak was already evident, especially on an ex-agricultural basis. Industry, construction and exports showed signs of a slowdown, whereas consumption and services reflected further acceleration. The same trends were present in April’s PMI, industrial output, construction and retail sales data. An acceleration of bank lending and the extremely generous government handouts of transfers under EU-backed development programs are fuelling GDP growth currently.
CPI inflation suddenly rose to 2.8% yoy in May, explained predominantly by fuel prices and driven by the most recent weak HUF / strong USD combination on currency markets. Core inflation did not follow this rise, yet we do not expect any reversal of the headline rate’s jump, in view of relatively high producer price inflation, strong consumption, the increasingly tight labor market and continued rapid wage growth. Indeed, the y-o-y headline rate may get stuck around the MNB’s 3% target level and even exceed that moderately in the rest of 2018.
Curiously, the large Q1 cash deficit of the central government was combined with a fully balanced general government budget on an accrual basis, as regards net financing data. The only way this could be possible was through a big local government surplus and the acceleration of project completions under EU-backed development programs, the latter making sizeable write-ups of claims on the EU possible. In cash terms, some consolidation already took place in May, but substantially more will be required in the rest of 2018. The draft 2019 budget has been delivered to parliament recently with a decreasing deficit target, and approval is expected to take place before the end of July.
Despite its significant inflationary impact, the authorities have been quite relaxed about the weak forint so far. Finance Minister Varga indicated at EURHUF 319-320 that the government regarded the existing exchange rate as normal, but it had no exchange rate target whatsoever, essentially setting no expectations for MNB policy. The MNB spoke in a similarly relaxed way on two occasions recently, and is likely to refrain from any obvious tightening in the near future unless its 2-4% tolerance range has come under threat, which is unlikely for the time being. Yet the MNB’s next inflation report, to be discussed by the Monetary Council on June 19, will be of great interest, given the need to revisit the Bank’s inflation outlook, and also its GDP forecast, the latter in view of the government’s optimistic convergence report.
In terms of actual central bank activity, the MNB has proven tighter than its talk recently. The Bank injected some HUF400bn of liquidity into the banking sector through FX swaps in May and the first half of June. But this was only a partial compensation for the amount of liquidity lost by the banking sector in that month, due to capital outflows driven by emerging markets’ global weakness. At the same time, the total stock of monetary sterilization rose considerably, whereas the stock of free liquidity fell. This also means in practice that the MNB is paying a higher average interest rate to banks now than it did at the end of April. As a consequence, BUBOR rates rose moderately as well.
Now read on...
Register to sample a report