Hungary - Economic update April 2019

No signs of slowdown yet

Contrary to the growth slowdown in the Czech and Slovak economy, the Hungarian economy appears to have had a strong start to the year based on retail sales and industrial production figures. The former was expected as real wage growth reached about 6% yoy and consumer confidence remains strong. These figures suggest that domestic consumption may continue to boost growth in 2019 too. Even so, the magnitude of the jump in retail sales (8.4% yoy) was a surprise, and continued growth around that level in the following months would suggest that the Hungarian economy is overheating. It is mainly non-food products sales that are booming, in particular sales of clothing, furniture, and electronic devices etc., which were up more than 10% yoy in February.

An even bigger surprise comes from industrial production. Despite the deteriorating European and global economic environment in the previous months, the Hungarian industry keeps on accelerating. While industrial production increased by only 2.2% yoy in September 2018, growth accelerated to 5.9% yoy in February. It seems the newly entering capacities were able not only a counterweight to the less favourable international economic environment so far, but even helped accelerate industrial production. In particular, the production of vehicles, computers and electronic device is growing.

Looking ahead, we are confident that consumption growth will continue. Driven by the tight labour market, we expect wages to grow by 10% yoy, supporting retail sales. We expect retail sales to grow by more than 6% yoy in 2019. By contrast, the outlook for industrial production is much harder to predict. For now, we expect industrial production to increase between 4-5% yoy in 2019. However, continued weakness in the external environment might ultimately harm Hungarian industry too, albeit clearly later than elsewhere in Central Europe. The strong domestic economic performance might deteriorate the external balance further, causing the current account surplus to disappear. All of this clearly points to an overheating Hungarian economy.

Price pressures building

While the Hungarian economy has been doing well, price pressures are building. Recall that the Hungarian consumer price index jumped in March to 3.7% yoy, up from 3.1% yoy in February and 2.7% yoy in January (figure HU). Moreover, core inflation and all inflation figures, which are monitored by the Hungarian National Bank (NBH), like core inflation filtered from indirect tax changes or demand sensitive inflation, have accelerated since last August from around 2.3% yoy to around or even above 3.5% yoy in March.

Figure HU - Price pressures are building up (consumer price index, national definition, % change year-on-year)

Source: KBC Economics based on HCSO (2019)

The latest figures confirm our view that the strong domestic consumption and the fast wage increases are creating inflationary pressures in the economy. Similar to other countries in the region, we expect headline inflation to moderate slightly in the coming months, driven by base effects in oil prices. We expect headline inflation to be around 3% yoy by July, while core inflation may even accelerate further and might go above 4% yoy temporarily. Additionally, we see headline inflation reaching the 3.7% yoy level again in December, so the drop of the inflation is likely to be temporary.

June NBH rate hike a done deal

The macroeconomic situation increases the risk that the NBH was not aggressive enough to stop the upward inflation trend. If we look at inflation expectations, they have been moving up since 2016. Households already see inflation moving above 4% yoy.

Despite the higher inflation, we don’t expect any substantial change in monetary policy for the coming two months, as the NBH may want to see how the European slowdown and potential recovery will develop, and how long the ECB and other central banks may keep their loose monetary conditions. We expect that the stock of foreign currency swaps may moderate further in the coming weeks. The NBH would like to see the 3-month Bubor around 25 basis points versus the current level of 16 basis points, as it expected that the monetary policy changes delivered in March to have pushed up the short end of the curve by 10 basis points, which hasn’t happened so far. We also expect that the NBH may increase the overnight deposit rate by 10 basis points in June again, and the 3-month Bubor might be around 40-50 basis points at the end of the year.

Hence in our view, it is quite unlikely that the NBH will start an aggressive tightening cycle in the near future, except in the case the Hungarian forint is suddenly pushed into much weaker levels (which is not our base case scenario). We have to highlight again that, from an economic perspective, we see more and more signs of an overheating domestic economy, which has to be monitored closely in the following months. An overheating economy increases the risk of an exchange rate weakening in the medium term if the NBH doesn’t tighten its monetary policy, or if the international environment doesn’t trigger a cool-down of the Hungarian economy.

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