Hungary set to slip into recession

Skyrocketing consumer prices, the looming energy crisis and the aggressive tightening of monetary conditions point in the direction of Hungary entering recession, according to economists. The country’s GDP growth will remain feeble next year as well.

Hungary’s economy faces multiple risks of which some are triggered by international developments while others relate to domestic issues. Decades-high inflation, a looming European energy crisis induced by the war in Ukraine and aggressive rate hikes by the central bank to tame inflation are all factors that work against economic growth.

Technical recession on the horizon
Incoming data for second-quarter economic activity point to a good performance considering the circumstances. However, shifts in monetary policy from gradual to aggressive tightening, austerity measures on the fiscal side (tax hikes, expenditure cuts, revised utility bill support scheme), and the looming escalation of the energy crisis has prompted economists at ING Bank in Budapest to lower their GDP outlook for the second half of the year and 2023. “Our base case predicts a shallow technical recession in the coming couple of quarters, yet full-year GDP growth could be around 5.0% year-on-year. In 2023, we see only 2% YoY growth with downside risks,” Péter Virovácz, chief economist at ING wrote in a research note.
Raiffeisen Bank Hungary economist Zoltán Török is less optimistic about the short-term economic outlook. According to him, it’s impossible to predict the severity of the energy crisis, and Hungary needs to prepare for bad and worse as there will be energy shortages. With regards to economic performance, Török sees the growth rate slipping deeply into negative territory by the end of the year due to a slowdown in external demand and very high inflation, which will rise even further. The labor shortage will also have a hampering effect on growth, as skilled labor will be missing in several sectors of the economy. To make matters worse, investments are being hit by poor investor appetite and very high-interest rates, factors that will take a toll on next year’s economic performance as well, according to Zoltán Török.
Virovácz pointed oud that the output of car and electronics manufacturing sectors, the drivers of the nation’s economy, over the next few months will be crucial for GDP growth. “The still elevated manufacturing PMI (57 in June) and the packed order books (total stock of orders up by 30% YoY in May) are providing a glimmer of hope, which could be totally dashed by a full-blown energy crisis,” according to the economist.

Inflation readings keep on rising
In June, the headline inflation caused less of a surprise with its 11.7% year-on-year figure. What has caused more of a shock is the core inflation reading, which jumped to 13.8% YoY. Price changes in food (especially in processed food) and fast-moving consumer goods were the main contributors to the high figure. These alone would have been enough to prompt analysts to revise their forecast upwards, but there is more. Changes in the utility bill support scheme and in the small business taxpayers’ tax will boost inflation further. ING Bank sees Hungarian inflation peaking at 16-17% in September-October, raising the 2022 and 2023 averages to 12.4% and 9.3%, respectively. Raiffeisen expects inflation to peak at 14% later this year.
In the face of rapidly rising consumer prices and record forint weakness, the central bank delivered the expected 100-basis point rate hike at its July rate-setting meeting. The bank raised interest rates by a total of 485 basis points over the past three rate decisions. Markets expect policy makers to continue the decisive tightening with another 100bp hike in August, after which the bank may lower the extent of individual rate hikes to be in line with major central banks. Interest rates may peak at 14% in December 2022.

Forint remains in the grip of politics and geopolitics
The Hungarian central bank’s aggressive tightening cycle and the rising rate differential should protect the forint from another significant move above the 400 level, but this will not be enough to help push the currency below this level, Virovácz said. The forint’s future path will be strongly driven by developments in the USD, the energy crisis and Hungary’s standoff with the European Commission. “For now, we expect a stalling around the 400 EUR/HUF level,” he said.
According to Török, as long as risk appetite remains low and current problems persist (war, price hikes, energy crisis), risks to the Hungarian economy would remain elevated. The analyst believes that the interest rate premium offered by the central bank is appropriate. However, the cycle of rate hikes could come to a halt before the end of the year, if inflation indeed peaks at 13-14%.