Hungary ranks first in the EU’s league table on growth
According to Eurostat, Hungary recorded the highest GDP growth within the EU in Q2 this year, following a second place taken in this important league table in the previous quarter. Apparently, good growth performance in the face of a weak all-European cycle is a regional phenomenon, as the new EU member states from the CEE region have been doing quite well against the continental average lately.
Detailed Q2 national accounts data reflects the continuation of the same 5% annual GDP growth as has been present for more than two years now. Key explanatory factors have also remained unchanged. Most recent figures show that the same growth trend has continued so far in Q3 as well. Despite all private sector forecasts and warnings from various authorities, we have not been able to spot any serious signs of deceleration so far.
Despite the poor outlook for long-term equilibrium, the domestic labor market situation eased a bit in July. The net excess labor force increased somewhat, and our broad unemployment measure also failed to show any further decrease in that month. We believe that the progressive release of people from social employment programs, labor imports and technology investments should jointly explain this phenomenon.
The August data on CPI-inflation was quite positive again, further substantiating the relaxed view taken by the MNB. Consequently, the September inflation report is likely to reflect a good deal of optimism. We still believe that the headline rate will reach and perhaps exceed the 4% policy threshold temporarily for three months starting from December, but we do not see the same risk for adjusted core inflation, the MNB’s policy indicator.
A word of warning here is that the overall inflation picture is still much less friendly than suggested by consumer prices only. The deflators of GDP and domestic demand were once again much higher than CPI-inflation in Q2. This is unimportant from the point of view of central bank policy in the short term, as the relatively stable prices of exports and imports are moderating price pressures, and also as the MNB continues to focus on the consumer market only.
The price paid for all the good macro news is a marked deterioration of the BOP, by 4% of GDP in the year to H1 2019. This number reflects the financing balance, against which all other indicators can only give a partial picture. The negative change is due to the fact that GDP supply growth is driven by markedly more rapid expansion on the demand side. Now that the net financing balance is a deficit, the current model of GDP growth appears unsustainable.
Recent government finance data still reflects tight fiscal policy. The general government recorded a small financing surplus in H1 2019, and the central government’s cash deficit dropped substantially in January-August. The government is disbursing less in EU funds while receiving more reimbursements from Brussels than before, but the cash balance also showed improvement on other revenue and spending items. Less than one month before the local government elections, the governing party’s campaign still appears rather cheap from the fiscal policy point of view.
The government sold further large amounts of MÁP+ retail bonds in July and August, although demand fell from the level seen immediately after their introduction. Monetary consequences also moderated, as no further drawdowns from household deposits or drops in bank holdings of government debt occurred. However, the massive sales of MÁP+ have markedly contributed to the reduction of government bond yields and longer-dated BUBOR since early June.
In recent weeks, the MNB massively raised their FX swap stock, to replenish banking sector excess liquidity from historic lows reached in July. We have no full picture of what caused the underlying liquidity squeeze, but we suspect that a growing fundamental deficit of the BOP and MÁP+ sales must have been key factors. The MNB’s reaction has led to lower short-end BUBOR levels after several upticks in recent months, and to a weaker forint against the euro.
Going forward, we expect the MNB to be content with the current levels of BUBOR and EURHUF between 325-330 for Q4 2019. On September 24, when the Monetary Council is due to set the framework of MNB policy for the rest of 2019, we expect some further quantitative tightening on the banking sector’s excess liquidity, but only to a moderate extent, possibly by HUF50-100bn as a quarterly average from Q3. However, no further interest rate measures are likely.
An interesting episode, which may have helped the forint sink to a new record low at EURHUF 333.5 on September 11, was the outbreak of a conflict between MNB Governor Matolcsy and Finance Minister Varga on exchange rate policy. We believe that the case was more of a communication error than a serious difference of views. However, should the forint remain prone to break out to above EURHUF 330, the MNB could be forced to show signs of concern about the looseness of monetary conditions if they do not want inflationary pressures to be refueled by the weak currency.
There will be two important elections held on October 13: local government elections in Hungary and a parliamentary election in Poland. The former should serve as an indicator of the Fidesz government’s longer-term stability and it can modify the domestic power structure ahead of the next parliamentary elections. The Polish vote, however, is important for PM Orbán as the incumbent Polish government serves as a crucially important back-up for him within the EU. At present, Mr. Orbán seems to be doing well regarding the prospects for both votes, although the domestic local elections are not at all free of the risk of partial failure.
The most recent developments of EU diplomacy have been expectedly negative for the government. In the European Parliament, Fidesz was forced to withdraw two of its candidates for leading committee positions, and the Finnish presidency is also actively pushing its critical political agenda against Hungary. Mr. Orbán’s support of the new EU Commission head is seen starting to pay back, in terms of the nomination of his candidate for the desired Commissioner position, but the required endorsement by Parliament remains difficult to achieve. However, rumors say that Fidesz is unlikely to be expelled from the European People’s Party at the latter’s next conference in November.
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