Although Hungary is still facing a trifecta of challenges, the technical recession during late-2022 and early-2023 will provide a tailwind to tackle the issues. We expect inflation to gradually descend from its early-2023 peak, reaching single-digit territory by the end of the year if price caps are extended. At the same time, negative net real wage growth and tighter monetary and fiscal policies will keep domestic demand muted. The latter will be driven by postponed public investment spending and windfall taxes. Retreating consumption and lower investment activity reduces the country’s import need, which is also supported by a spreading awareness of energy usage. Improving external balance and diminishing net external financing need will boost the relative attractiveness of Hungarian assets, especially the forint. We are bullish in every aspect
After the post-Covid led rebound in 2021, this year started on a strong footing. GDP growth came in at 7.3% YoY during the first half of 2022. Despite all the challenges presented by the war and resultant energy crisis, Hungarian economic activity was boosted by rising domestic demand. A key source of this was the government’s pre-election spending spree during the first quarter. As this positive momentum of re-opening and fiscal easing starts to fade and the challenge of rising energy bills and extreme inflation starts to bite, the economy’s quarterly based performance is beginning to slump. The two biggest difficulties Hungary is facing – higher energy bills and increasing unemployment – didn't fully impact the economy in the third quarter. Nonetheless, the 0.4% quarter-on-quarter drop in real GDP means that we’ve already seen the first leg of the expected technical recession in Hungary. We expect the drop to continue in the fourth quarter mainly due to falling consumption and shrinking investment activity. Real wage growth reached negative territory in September, while lending activity also dropped. In the corporate sector, we see companies going out of business or reducing working hours due to skyrocketing energy costs. Big data also suggests the economy has been on a downtrend. But despite the weak second half, the strong first half will save the year: we see 2022 GDP growth at around 4.8%. When it comes to the 2023 outlook, the negative carry-over effect, the ongoing fiscal and monetary tightening and the shrinking purchasing power of households will take their toll. We expect 0.1% GDP growth on average in 2023, followed by a marked rebound in 2024 as Hungary will have access to EU funds, boosting investment activity. Headline inflation moved to 21.1% YoY in October, the highest reading since 1996. 58% of the price pressure is from the food, alcoholic beverages, and tobacco sectors. This is due to a combination of a weather-related supply-side shock in agriculture, the high costsensitivity to energy in the food industry and the transmitted tax changes affecting food products and retailers. In the short run, we expect further increases in CPI, though the peak might be near. Negative real wage growth, thus decreasing aggregate demand, is reducing the pricing power of corporates. Price expectations of retailers have also started to drift lower, pointing to an impending turnaround in inflation. The peak could be around 23% (if price caps are extended), followed by a gradual slowdown during the first half of 2023 and a more rapid normalisation in the second half of next year. However, the full-year average in 2023 could be higher – around 16.7% - than the average in 2022, which we forecast to come in at 14.4%.
During the first half of 2022, there was a major fiscal spending spree, not necessarily unrelated to the April general election. As the energy crisis deepened, the government introduced significant fiscal tightening during the second half of this year. Against this backdrop, we don’t see an issue with the 6.1% of GDP deficit target. Indeed, it might be even better due to the higher nominal GDP. Fiscal consolidation will continue in 2023 via limited investment spending and temporary windfall tax revenues. Shrinking nominal financing need and strong nominal GDP growth will help reach the Maastricht deficit criteria by 2024. Expected EU funds inflow will significantly help the budget, especially the sum of €5bn related to the 2014-2020 Cohesion Fund, which is due by mid-2024
The recent monetary policy setup lies on three pillars. The 13% base rate will remain unchanged for a long period, ensuring structural price stability. In the meantime, monetary tightening will continue with liquidity measures. Roughly half (c.HUF5bn) of the excess liquidity is tied up in long-term facilities like the 2-month deposit and the required reserve. The other half sits in the one-day quick deposit facility at 18% and one-day FX swap facility at 17%, as parts of the third pillar. These are to stabilise financial markets. We see the gradual convergence of the effective (18%) rate to the base rate in parallel with a permanent improvement in both external and internal risks. Timing wise, this means a reversal of the “whatever it takes” hawkish stance might start only in the first quarter of 2023.
The unemployment rate has started to rise as companies are operating under severe stress. However, the move from a nearrecord low 3.2% to 3.6% in 3Q22 is nowhere near to a collapse. A high level of orders keeps manufacturers optimistic and in need of labour. By contrast, in the services sector, where energy and labour account for a greater part of costs, companies have reduced working hours, laid off employees or gone out of business. Due to this duality, we expect the unemployment rate to peak at only around 4.5% during mid-2023. With an above 20% inflation, we see tough negotiations between employers and employees about next year’s salaries. In our view, real wage growth – reaching practically zero in 3Q – will turn negative and remain so until the end of next year
Due to the energy crisis, Hungary’s trade balance of goods has been on a downtrend. But we see light at the end of the tunnel. With the changes in the utility bill support scheme, households have started to be more aware of their energy usage. Companies have spent more on energy efficiency lately. Hungary has already secured its gas supply throughout the winter. This means less pressure on the external balance from an energy import view going forwards. With falling consumption and a reduction in investment activity by households and the public sector, import needs will retreat as well in the coming quarters. However, this improvement comes too late, so we see an 8.4% of GDP deficit in 2022 with a slight improvement in the balance to –6.8% of GDP next year.
When it comes to the Hungarian forint, we believe it is more likely to be moved by non-monetary events and shocks in the short run. The government's conflict with the EU over the rule of law has entirely dominated the market and will remain a major issue at least until the end of this year, in our view. We expect a positive outcome on the rule of law issue and an unlocking of the potential of the forint, which has lost by far the most in the CEE region this year. As some form of positive outcome of this story seems to be priced in already, and also market positioning seems to have flipped to a slightly longer view in recent weeks, in our view, the EU story has become asymmetric for the HUF. So instead of a jump in forint strength, we expect a gradual drift lower below 400 EUR/HUF next year. However, our strong conviction regarding a positive outcome for Hungary makes the forint our currency of choice in the CEE4 space. Moreover, in our view, Poland will take the baton of major market attention from Hungary next year with its ongoing conflict with the EU, looming elections, expansionary fiscal policy and a central bank trying in vain to end the hiking cycle. On the other hand, we believe that the period of emergency NBH meetings is over, that the EU story is coming to an end, fiscal policy is pointing to tangible consolidation and that the current account deficit should come under control.
If the forint remains under control, we see more room for normalisation of the short end of the IRS curve. On the other hand, the long end should decline to a lesser extent also due to the support of core rates, resulting in bull steepening. However, the timing of NBH policy normalisation remains a risk and low liquidity of the market may be painful. On the HGBs side, we see favourable supply conditions and ASW levels have finally returned to normal territories. The AKK's focus on the long end of the curve and basically zero issuance in the shortend maturity bucket supports our steepening bias. However, we see that the EU story is more about FX trades and the FI market is still struggling. Therefore, we see better value in other countries in the region for now but believe HGB's time will come soon, and we remain constructive in our views. On the back of a tough year for Hungary’s external bonds, we see current valuations as attractive given optimism of some improvement in the key areas of EU funds, fiscal policy, energy issues and the external balance. We think spread levels on the nation’s euro-denominated bonds in particular have room to compress versus regional and rating peers. This preference should be supported by expectations that near-term external issuance is likely to be in dollars rather than euros.
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