Slower growth unlikely to imply more rate cuts
We thought a few times in the past that relations between PM Orbán and the EU mainstream could hardly be worse than they actually were. But the most recent events suggest we were wrong on all of these occasions. One problem is that Hungary’s six-month rotating presidency within the EU seems to have gone fatally off-track, and there are now clashes between the government and the EU on various policy issues almost on a daily basis. But the really big issue is that hostilities with the EU mainstream and now with Ukraine have reached the area of energy supplies, in the form of Ukraine’s banning Russian oil transit from Lukoil on the Druzhba 2 pipeline to Hungary and Slovakia in July, and the EU initially showing hesitation to help resolve the case. At this moment, the problem seems to have been scaled back by Ukraine's essentially revoking its ban, after a series of pugnacious statements from all sides. But this has not been fully arranged as yet, and the case does not seem to be finally and reassuringly settled.
Drawing conclusions from this, as regards its implications for monetary policy, appears to be very difficult at this moment. One reason is the genuine "fog of war" environment that surrounds the Lukoil case. Apparently, all participants prefer to be highly non-transparent, so that even establishing the basic facts has proven to be a difficult task so far, not to mention the likely consequences on the future prices of imported oil and domestically used fuels, and most importantly on inflation. Under such conditions, the MNB had better, and is also likely to, be extremely cautious.
An even more recent event, with a similarly negative potential, was Ukraine’s incursion into Russia in early August, which has caused European gas prices to rise since then. This is because of Ukraine’s reported capture of a gas terminal that forms part of a key transit route to Europe, which raised the risk of a potential disruption of the continent’s gas supply. Fortunately, most of Hungary’s imports of Russian gas is transported through a different route, but if prices rose further due to this problem, that would also have an impact on Hungary, first on the government budget, and then potentially on inflation, as well.
For sure, there would be some justification for a further loosening of MNB policy, given the weak showing of GDP in Q2 2024. This year’s official growth forecast was cut back markedly several months ago, but the economy seems to be performing even weaker than that downwardly revised projection. It is true that weak external demand for Hungary’s industrial output, as well as the government’s cutbacks in development spending, cannot be cured by lower interest rates and a weaker currency, but the latter could offer some compensation through the generation of demand in other sectors. We understand the MNB’s latest moderate rate cut indications for H2 2024 as serving this purpose, and we expect monetary easing realized at the upper end of its indication range over this period. But even further rate cuts are much less likely, given the continued rapid wage growth, the official expectation of strengthening economic recovery, and the short-term prospect of rising inflation, which is in conflict with the MNB’s ambitious disinflation plan for 2025.
The weak economy is not good news for fiscal policy, of course, but the extra pressure on this year’s budget is not substantial, as the government scaled back both its GDP growth forecast and short-term fiscal adjustment ambitions at the outset of this year. Moving forward within the year, the central government’s cash deficit is decreasing as a ratio to GDP, due to the continued extreme tightness in development spending and the easing of the interest payment burden after its peak seen in Q1. PM Orbán seems to have started his campaign for the 2026 elections early by promising to double income tax deductions for families in recent weeks. The good news is that this measure will not affect 2024, it will not be fully introduced in 2025, and it will be much smaller than the massive fiscal give-away before the previous parliamentary election in 2022.
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