The end of interest rate cuts is near
Our new quarterly forecast changes moderately from the previous one, issued in January. We still expect considerable economic recovery in 2024, but we scaled back our GDP forecast given the weakness of European industry, especially car manufacturing, and the longer-than-expected time required for the upturn of consumer demand. The government and the MNB have recently reduced their growth expectations by a larger amount, and there is now broad consensus on a narrow range in which GDP growth is expected. We currently stand at the lower end of that forecast range.
The disinflation process, which started roughly one year ago and has brought about spectacular results, is largely over. Domestic inflation has reached its cyclical low point: it can only rise, and most likely it will do so, from where it is today. Reasons for this include changing base effects, energy and food, the labor market, and the return to nominal forint depreciation this year, following the trend of appreciation seen last year. But on the positive side, the relative weakness of domestic demand, including both private and government, consumption and fixed investment will most likely hold inflation back from any major pickup in 2024.
Last year’s fiscal deficit ratio landed at an unexpectedly high level, rising a bit from 2022. This may be traced back to a sharply rising interest burden, temporarily high energy subsidies, weak VAT results, and the failure to grab development grants from the EU, among other factors. Debt costs are expected to fall eventually, but only from 2026. This year’s budget will be hit by weaker-than-expected nominal GDP growth in 2022-2024, whereas it will be helped by a decreasing need for energy subsidization and somewhat strengthening revenue from the VAT. Unfortunately, the availability of the budgeted amount of EU funds remains uncertain.
The government has just announced cutbacks in fixed investment spending, but more adjustment would be required. We believe that even the upwardly revised deficit target for 2024 is too ambitious, and we expect only a small deficit reduction, together with a moderate increase in the debt ratio, this year.
The balance of payments ended 2023 with a marginally better-than-expected outturn, nearly balanced as regards the fundamental part, a spectacular improvement from the previous year. From here, it is likely to deteriorate slowly, supported by the lack of a rapid economic recovery.
A much-needed reconciliation between Economy Minister Nagy and Governor Matolcsy has taken place recently, removing a key factor that depressed the forint, and raising the efficiency of MNB policy. But even so, only little room has been left for further interest rate cuts by now. We expect that the MNB will continue rate cuts at a reduced monthly pace in Q2, but at that point, the loosening cycle will be over, so that no further rate cuts will be implemented until end-2025. The base rate will remain positive in real terms, but to a decreasing extent, as inflation rises.
2025 should not be very different from this year. Investors are likely to see a slightly stronger economy, with slightly higher inflation and a slightly worse BOP. The need for fiscal adjustment will remain just as serious as today, but the political appetite for it is likely to decrease progressively as the 2026 parliamentary election approaches. MNB policy after March 2025, when Governor Matolcsy’s term ends, is a big question: a more government-friendly replacement will likely be appointed, representing significant policy risk going forward. Other major risk factors mainly include energy prices, given the uncertainties inherent in the military conflicts in Ukraine and the Middle East.
Foreign relations are likely to remain business as usual. PM Orbán has great expectations about the upcoming European election, but he is unlikely to "occupy Brussels", which he is aiming at. His recent partial concessions in the EU and the most recent events in US domestic politics have taken some heat off the Fidesz government as a permanent dissident regarding Russia/Ukraine, China and other issues. But the government will still have to watch its steps permanently, as the EU Commission and its successor after the election will likely keep a close eye on the Hungarian rule-of-law situation, and even partial access to EU funds appears to be much less than guaranteed.
Finally, one area that we clearly got wrong three months ago is domestic politics. We found it a boring sequence of non-events, expecting the June European and local government elections to be largely a done deal. But it turned out somewhat differently, because of the unexpected appearance of Péter Magyar, a former member of Fidesz’s inner circle, who quickly rose into the role of a popular new opposition leader in the aftermath of the ugly child abuse scandal that rocked the Orbán regime a few weeks ago. His future potential is hardly calculable. We expect his appearance will contribute to Fidesz’s long-term erosion, provided he proves to be reasonably successful in the upcoming elections. However, these elections will be most probably still won by Fidesz, especially as Mr. Magyar is dividing the already fragmented opposition even further.
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