Correction of fuel prices amid rising core inflation creates policy uncertainty
Q3 GDP growth was revised higher in the second estimate, pushing the seasonally adjusted year-on-year rate slightly above 5%. Growth is increasingly propelled by domestic demand rather than the export-driven industrial sector, which suggests that the trade balance must significantly deteriorate. This can be indeed spotted in the September merchandise trade accounts, but the total impact on the balance of payments is mitigated by strengthening EU transfers and some improvement in net errors and omissions. At any rate, net external financing remains firmly in surplus.
Growth in the industrial sector is still held back by the weakness of European industry, including car industry problems with new and tighter environmental regulations. However, the trend of Hungarian industry appears relatively strong compared to its European counterpart. This signifies, most probably, the continued relocation of activity within the European continent in pursuit of lower production costs. Industrial subsectors outside car manufacturing have shown significant strength recently.
Robust output growth puts increasing pressure on the labor market. Labor productivity is set to grow faster this year than at any time since 2008, but still at a rate that requires similarly rapid employment growth. As a result, the broadly defined unemployment rate, including the participants of social employment programs, continues to shrink on a regular basis.
The headline rate of CPI-inflation fell sharply in November, due to a sizeable correction by fuel prices. However, core inflation continued to rise by most existing measures, especially those that are calculated and used by the MNB for policy purposes. Going forward, we see the continuation of the fuel price correction into December, as a result of which the headline rate may fall temporarily below the 3% inflation target, and most likely to or slightly below core inflation. However, the sudden drop in the headline rate should be regarded as a one-time event only. Both non-fuel inflation and the headline CPI-inflation rate are likely to rise to 4% yoy by end-2019.
The central government’s cash budget exhibited a further bit of improvement in November. This was due, among other things, to reduced spending under EU-backed development programs and to decreasing net interest expenditure. In addition, the cash payments of development grants by the EU has sped up lately, just as expected. As a result, the central government’s debt ratio stood exactly at its end-2017 level in October, whereas its cash reserves grew markedly.
Despite the urgent proximity of the end of this year, the government’s decision on the statutory wage minimum to be enforced in 2019 is still missing. The official explanation is that employers and trade unions have not been able to reach agreement, but eventually it must be the government‘s decision, as it is a key element of macroeconomic policy. We suspect that the recent drop in the headline CPI-inflation rate will likely make the government more confident about setting a higher wage floor increase than otherwise, with a view to maintaining robust consumption growth and to bringing the labor market closer to equilibrium.
The conclusion regarding central bank policy seems somewhat more complicated. Typically, the MNB is eagerly looking for reasons to delay the start of policy tightening, and the correction of the headline inflation rate appears to be a possible reason to justify such a delay. However, the Monetary Council stressed the rising level of adjusted core inflation measures after its December rate-setting meeting, and dropped from its statement the conclusion that inflation is unlikely to reach the target on a sustainable basis before mid-2019. Of course, it remains to be seen what this means in terms of actual policy. We maintain the view that the MNB should start its tightening cycle rather sooner than later.
Following uneventful months, the Fidesz government ran into a bit of trouble in domestic politics around mid-December. They continued the implementation of their power-concentrating legislative program, by setting up, by a parliamentary act, a parallel court system under the supervision of the minister of justice, and they also amended the labor code, trimming employee rights further. These amendments provoked first a noisy attempt of parliamentary obstruction by opposition parties, and then a week-long series of street demonstrations in Budapest, although so far with relatively limited number of attendees and falling short of Paris-style aggressiveness. These developments do not necessarily sound as if they will have immediate severe implications for Fidesz, but this may not be the end of the story.
The government’s new legislative steps have prompted further international criticism, some of which may serve as points of reference on related subjects later on. The latter mainly refers to the proposed rule of law mechanism, to be attached to the 2021-2027 EU budget, which has just been approved by the European Parliament’s committees responsible for the matter. Another piece of bad news for Hungary is that the political decision on the EU budget has just been postponed until the European Council’s October 2019 meeting. One practical consequence may be a delay of the disbursement of development funds out of that budget, possibly until late 2022 or 2023.
Now read on...
Register to sample a report