Inflation Keeps Rising Despite MNB Optimism
The second estimate of Q2 GDP brought no surprises. Compared to the first release, the y-o-y growth rate was marginally reduced, to 3.5%. This is the same as our new forecast for full-year 2017, as we expect a moderate deceleration in H2. The main factor driving growth was a spectacular rebound of fixed investment on the demand side and of construction output on the supply side, in addition to a marked expansion of industrial output, the latter based mainly, but not entirely, on the recovery of manufacturing in the Euro Area. However, growth was pulled down by a cyclical weakness in agriculture, and the expansion of household consumption was much less than generally expected. The latter suggests, among other trends, that overall income growth in the household sector may have fallen significantly behind the double-digit rate at which real wages have been expanding in recent months.
Following strong results in H1, industrial output fell markedly in July, bringing the y-o-y growth rate down to a marginally positive level only, the weakness coming mainly from car manufacturing, but also from a broad range of other sectors. As PMI data remain expressly robust, some analysts suspect that the July setback was a temporary phenomenon, reflecting the impact of the usual summer production breaks in big industry, which may have come forward a bit, as compared to the same period of 2016. However, we remain cautious with this hypothesis, as evidence suggests that the pace of the industrial recovery has started to weaken already.
The central government’s cumulative cash deficit was still materially up on last year in January-August. But adjusted for EU transfers and adding in local government surpluses, this result points to a full-year general government deficit substantially below the 2.4% of GDP target set for this year. However, no one expects the government to really undershoot the deficit target by any big amount. More likely is the use of some technique towards the end of this year to bring forward spending from next year, aiming at a moderately below-target annual deficit number, just as happened in December 2016. Any additional flexibility generated in the 2018 budget in this way would be used most likely to loosen fiscal policy further. Most recently, one idea rumored as having come up in the government has been further cuts in wage taxes, partially offset by a bigger hike in statutory minimum wages than planned so far.
In late August, S&P improved the outlook on its BBB- sovereign rating for the long-term debt of Hungary from Stable to Positive somewhat unexpectedly. The primary reason behind this was the recent improvement of the banking sector’s situation, whereas economic growth and improving fiscal stability made it only to second and third places. An important dataset supporting S&P’s decision was the H1 2017 financial results of banks, which was released by the MNB just shortly before the rating announcement. According to this, the – otherwise impressive – average profitability of domestic banks did not really improve this year, but the NPL ratio fell considerably, due to successful asset sales and work-outs, and rising collateral values as macroeconomic conditions and the property market have strengthened. We still do not expect an upgrade from Hungary’s lowest investment grade sovereign rating to take place any time soon. However, Moody’s and/or Fitch Ratings could easily decide to follow S&P, raising the outlook on their Baa3/BBB- ratings at their next revision dates for Hungary on October 20 and November 10, respectively.
Inflation continued its systematic march towards higher levels in August, just the same way as the labor market tightened further in July, according to most recent data. It is not only that the headline CPI-inflation rate picked up sharply, to 2.6% yoy, but also that core inflation, as estimated by the KSH, rose further as well, to 2.8% yoy. In an article published one day ahead of the August CPI data, the MNB claimed that KSH’s core inflation indicator does not represent the underlying trend correctly, and that even the headline inflation rate is likely to subside towards 2% again over the rest of 2017. However, even the MNB’s own adjusted core inflation indicators have shown material increases recently, and the MNB’s analysis appears to be downplaying the importance of tight labor market conditions. On that basis, we continue to expect moderately increasing inflation in late 2017.
Central bank policy has appeared to be focused on the EURHUF exchange rate since mid-August. Following no action against the forint’s moderate appreciation in July, the MNB verbally intervened in late August, indirectly signaling that it would not welcome the forint's rise stronger than EURHUF 305. This was logical from the point of view of competitiveness, based on the development of industrial sales prices. The market apparently took the message, with the forint hovering around the MNB’s perceived new preference level ever since the MNB spoke. Continued de-sterilization and the generation of extra liquidity through FX swaps also supported verbal intervention. In September, a bigger de-sterilization step will likely follow, with a view to achieving the end-Q3 ceiling set for the 3-month deposit facility. In addition, the MNB is likely to announce a further cut in bank access to the 3-month deposit, possibly so that the facility can finally cease to exist by the end of Q1 2018.
European diplomacy over the past month was quite eventful from Hungary’s point of view. Events included French President Macron’s trip to the CEE region, PM Orbán’s call to the EU to pay half of the cost of Hungary’s border fence and EU Commission President Juncker’s blunt refusal of that request, followed shortly by the European Court’s decision defending the EU’s refugee distribution quotas, and German Chancellor Merkel’s initiative to discuss Hungary’s negative response to the Court’s decision by the European Council in October. Migration policy has also become a major issue in the German parliamentary election, as Ms. Merkel is preparing to initiate a permanent refugee redistribution scheme, and threatened to withdraw financial support from any member state which rejects that. In general, the strategic line of major Western European decision-makers increasingly appears to be a series of actions to isolate PM Orbán’s government - and the government of Poland – with a view to either convincing Fidesz (and the Polish PiS) to cooperate more or leaving these two countries behind in the intended upcoming wave of further integration, and – most likely – reducing their access to EU funds in the next 7-year budget period.
In domestic politics, rising employment and wages still seem to do the job, as suggested by the opposition’s inability to make any gains in opinion polls. Moreover, an aggregation of various polls and estimates of parliamentary mandates based on them shows that Fidesz managed to increase its share of determined voters, and it is once again on the brink of having electoral support sufficient to obtain a constitutional majority at a parliamentary election. Even this would only hold if leftist-liberal parties formed an efficient alliance to optimize their election results next April, but the outlines of such a coalition are still missing. In a rare agreement on any policy matter, nine opposition parties reached broad consensus on the need to change the election law. However, essentially all the big conflicts remain on the opposition side, providing Fidesz with better-than-equal chances to win a constitutional majority next April.
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