It is high time to change the course of MNB policy
The uptrend of consumer inflation continued at an accelerated pace in February. CPI-inflation now exceeds the MNB’s medium-term target by all existing measures, including core inflation adjusted for indirect tax changes, the central bank’s favorite index. Importantly, inflation rose in the face of a moderately strengthening currency in early 2019. In short-term, the only potential factors that could contain the upward trend of inflation are a serious external disinflationary impulse, or if that is not available, then higher domestic interest rates and/or an even stronger forint.
Following one case of verbal intervention to support the forint in mid-January, the MNB did spectacularly nothing in the past month. However, the risk of a further build-up of inflationary expectations is currently so high an evident that we do not expect the Monetary Council to conclude their next rate-setting meeting on March 26 without a material step to tighten policy. Elimination of the negative O/N deposit rate will likely not be enough at this point, but a quarter-of-a-percent hike, combined with a promise of more rate increase shortly if needed, and potentially with a mildly restrictive target on FX swaps could possibly do the job.
Detailed national accounts data for Q4 2018 explains a lot about the background of the problems with domestic price stability. This reflects an economy that has been growing at an annual 5% rate throughout the last two years, domestic adsorption growing by around 7% over the same period. On an ex-agriculture (= core growth) basis, only a very small deceleration took place in Q4, followed by a similar trend early this year. Growth appears pretty much broad-based both on the supply and the demand sides, and it seems to be resistant to the ongoing cyclical downturn in the Euro Area.
This year’s labor market trends are not entirely clear yet, but the January increase in minimum wages and the existing strong upward wage pressures in the manufacturing sector will most likely keep annual wage growth at the upper end of the single-digit range. This would represent only a minor deceleration from last year and generate no disinflationary impact at all. In principle, fiscal policy could also help price stabilization, but in fact, it was already tightened very substantially in H2 2018, and no further tightening in this area appears realistic.
Indeed, prospective fiscal loosening could be regarded as more likely in the medium-term if one gives credit to the colorful but somewhat chaotic structural reform talk, which has been heard from official sources recently. However, the release of the government’s own five-year reform program in late February clarified that the upper hand is still held by the Finance Ministry, meaning that fiscal discipline, with a view to further reduction of the government debt ratio, remains an overriding priority. We regard this reform program as limited but comfortingly reasonable.
As part of the recent reform brainstorm, the MNB governor came forward with a plan to put all government debt in domestic hands in no more than six years from now. We recommend investors to perceive this as a direction of policy rather than a specific project. Basic macroeconomic information suggests that the plan would be way too ambitious in this form. The latter might explain why the prime minister and the finance minister appear to be much more cautious on the subject, even though both of them have emitted signals to support further progress towards a model in which the financing of the government would rely mainly on HUF-denominated debt and domestic retail investors. Most recently, the finance minister proposed to make interest earned from household bonds to become free of the income tax.
Just one week after a similar move by S&P, another unsurprising credit upgrade was granted to the government by Fitch Ratings, to BBB/Stable. The next review date for a major rating agency will be that of Moody’s on May 3. On that occasion, a similar upgrade from Baa3/Stable would be less likely, as Moody’s has exhibited much less enthusiasm for Hungary’s achievements than the other two agencies recently.
In recent weeks, PM Orbán continued his trend of generating increasingly sharp conflicts in European diplomacy. This time around, the European People’s Party found one of his provocative campaign posters as running against its values and interests, prompting a proposal by a number of member parties to exclude Fidesz from the EPP. A vote on this is scheduled for March 20. The current odds are that Fidesz will likely be voted to stay, but it is not absolutely clear-cut, as having Fidesz in the party family may cause more harm to the EPP than vice versa. From Fidesz’ point of view, exclusion from the EPP would remove the party from the governing political faction in the EU, deprive it of the protective shield the EPP has provided against heavy criticism from the European mainstream, and most likely lead to a poor result for Hungary in the EU budget debate, which is scheduled to take place later this year.
Curiously, the potential exclusion from the EPP would not necessarily prove harmful for Fidesz on the domestic political scene in short-term, provided they can convince their support base that it was due to the government’s fierce resistance to an alleged secret master plan on the part of the EU to promote mass immigration from the third world to Europe. Indeed, Fidesz is apparently putting lots of energy in preparing the public for the exclusion, claiming that the EPP has shifted towards the left, abandoning the true conservative values which Fidesz continues to represent. In turn, the domestic opposition is putting pressure on the EPP to expel Fidesz, in a quest to get European assurance about PM Orbán’s alleged wrongdoings, and to show to people that the prime minister can be eventually defeated.
Apart from the EPP issue, Fidesz continues to keep domestic politics under tight control. Its predominant position in opinion polls remains unchanged, and in all the conflicts we listed in our previous monthly report, its opponents (parties, trade unions, the representatives of judges, scientists, physicians, etc.) proved to be too weak to reach any tangible results. In fact, the government has just won a fight with the Hungarian Academy of Sciences, taking away the latter’s so far independently managed research institutes and placing them under partial government control. In addition, the terms of employment for those having a job with central government public administration units were changed by a parliamentary act from March, so that the regular working hours were substantially extended without any compensation. There is a good chance that Fidesz can get away with this measure without any significant political consequences. If so, it will properly demonstrate the strength Fidesz currently enjoys in domestic politics.
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