'Tightening' has made monetary conditions looser
On March 26, the MNB carried out a small policy tightening, for the first time since December 2011. However, what was done fell short of the market’s expectations, and so it led to a moderately weaker forint and, consequently, to somewhat looser monetary conditions. This was because the MNB combined a marginal increase in the O/N deposit rate and the announcement of regular small reductions of its FX swaps with raising its medium-term core inflation forecast to above target levels and took a rather relaxed stance in its verbal intervention.
Going forward, the MNB is likely to continue the upward adjustment of its O/N deposit rate in small quarterly steps during the rest of 2019, combined with small weekly downward adjustments of the FX swaps stock, the latter also counting as pro-forint market intervention, of course. Meanwhile, it will most probably refrain from touching the base rate. However, we expect moderate increases in the base rate and the MNB’s credit interest rates as well in 2020-2021. At the same time, investors should expect the MNB to be very cautious about the withdrawal of FX swaps, with a view to keeping the forint on a trend of slow nominal depreciation vis-à-vis the euro.
Tightening of central bank policy will remain a necessity in medium term, given the existence of heavy inflationary pressures. We expect both headline and adjusted core CPI-inflation to exceed 4% at end-2019, on the continuation of GDP growth above potential growth, the resulting massive wage pressures and robust consumer demand. However, inflation is likely to be capped at that level by the cooling economy and higher interest rates in the subsequent two years.
Underlying our inflation and monetary policy forecast is a macroeconomic base scenario, which includes only moderate slowdown of GDP growth in 2019 and a bit more in 2020, before a moderate acceleration again in 2021. However, growth should remain relatively buoyant throughout the next three years, at no point dipping below 3%. This takes into account the EU Commission’s existing forecast on the European economy, which does not reckon with a no-deal Brexit. Factors to slow down growth in 2019-2020 are likely to be the weakening of the Eurozone, the peaking of construction activity, the moderating impact of inflation on real wages, and the prospect of a poor agricultural season this year.
In turn, we expect the renewed acceleration of GDP growth in 2021 on the basis of the domestic political calendar. Specifically, the next parliamentary election is due in H1 2022, and fiscal policy is likely to become materially looser in the previous year. Until then, however, fiscal policy is most likely to remain rather tight, with a decreasing general government deficit this year and in 2020. In this latter period, the government’s cash deficit is likely to be much smaller than in recent years, perhaps even falling to zero or close to zero, as less EU-related disbursement of development funds will be probably combined with more cash reimbursements arriving from Brussels.
Lower cash deficits imply lower issuance of government debt, of course. Actually, issuance to the market is likely to fall back by even more than justified by the prospective improvement of the government’s cash balance. This is because the government has an ambitious plan to rapidly increase the share of household bonds within its overall debt stock. However, the feasibility of this plan is doubtful, as households require substantially higher yields than institutional investors, and so the potential to issue more household bonds may be contained by increasing debt costs.
The labor market situation is unlikely to turn for the better in medium-term, as the domestic labor force is set to shrink further, and labor productivity growth remains short of actual economic growth. However, the situation is likely to be eased somewhat by the increasing arrivals of foreign guest workers. The latter is already present, despite the existing political narrative that is hostile to immigration, but it is unlikely to be the real solution to the problem, because of the big size of existing and prospective labor shortages.
In politics, we expect PM Orbán to continue his path towards political isolation within the EU’s political center, and his ongoing shift towards the camp of extreme right parties. Most importantly, he is likely to come out of the upcoming EU budget debate poorly, which would markedly reduce Hungary’s fiscal resources most likely from 2023. However, the Fidesz government is likely to maintain relatively good working relations with the US, and its current massive predominance in domestic politics is unlikely to come under any serious threat over the next three years. Indeed, we expect some erosion of Fidesz’ current excellent standing in the polls over time, in view of some existing domestic conflicts, but this is likely to be an issue for the 2022 parliamentary election the soonest.
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