Economy 6 June 2017, 9:45am

ANALYST VIEW - City economists turn more upbeat on Hungarian growth

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Morgan Stanley’s economist have raised their GDP forecast for Hungary to 3.8% from 2.9% previously for 2017. They have also upped their 2018 estimate to 3.3% from 2.8%, according to the investment bank’s latest research note. This is one of the sharpest upward revisions as regards GDP estimates for the Central and Eastern European region, but the new figures are still way below the Hungarian government’s official forecasts (4.1% and 4.3%, respectively). At Morgan Stanley, they still do not believe Hungary’s marked economic growth this year will accelerate further in 2018. Other London-based investment banks have also turned more upbeat about Hungary’s growth outlook.

Morgan Stanley published its mid-year outlook for the CEEMEA region late on Sunday. The revised GDP prognoses (see chart below) show that the investment bank has turned significantly more upbeat on several economies. The key reason is that for the first time since 2010 growth picked up both in developed and emerging economies, not to mention that growth was recorded also at importers and exporters of raw materials. This reflects a wide-spread upturn hence the upward revisions.

GDP growth revision was among the sharpest for Hungary. MS has upped its growth estimate for the country by 0.9 percentage points to 3.8% for this year and by 0.5ppt to 3.3% for next. These would be among the most dynamic output increases in CEEMEA, but Poland and Romania are expected to do even better this year and next and Serbia to show larger economic growth in 2018.

It is noteworthy that MS lowered its previous GDP estimates both for this year and next for Ukraine, yet the country is still expected to record moderate growth of 1.9% in 2017 and 2.7% in 2018. Economists at Morgan Stanley do not believe Russia’s economic train will be thundering down the tracks at breakneck speed, whereas Croatia is seen reaching a fairly nice growth at around 3.0%.

Several other London-based investment banks have revised their GDP estimates for Hungary lately. J.P. Morgan, for instance, now expects 4.0% economic growth this year vs. 3.6% previously, but it has left its 3.5% forecast unchanged for 2018.

"We think the NBH’s dovish stance at least in part reflects its view of weak transmission from the output gap, to inflation and also moderate pass-through from stronger wage growth to prices," commented Nóra Szentiványi, a London-based analyst at J.P. Morgan after the Hungarian central bank (MNB) left its base rate on hold at 0.9% last month.

"In our assessment, Hungary’s output gap is already positive and the Phillips curve is far from flat. However, the NBH’s CPI target (2-4%) is sufficiently high to accommodate a further meaningful rise in core inflation without necessitating a monetary policy response. We also forecast GDP growth to slow to 3.5% next year after the spring parliamentary elections and also due to slower Euro area growth. Yet, this would still be above our estimate of Hungary’s potential growth (2.7%) and implies a widening positive output gap to 1% by end-2017 and 1.5% at end-2018," she added.

Anlysts at Capital Economics believe that one important consequence of the recent period of strong growth in Central and Eastern Europe (CEE) is that “economies are now running at close to full employment." They expect growth to remain robust over the next 12 months but, as output gaps close, underlying inflation pressures will begin to build.

The most common way of measuring how much economic slack is left in the region is to estimate the so-called “output gap" - that is the difference between the levels of actual and potential GDP.

“According to our estimates, output gaps in the CEE economies have narrowed from between -2% and -5% of potential GDP in 2013 to virtually nothing now. In other words, economic slack has now largely been exhausted," Liam Carson at Capital Economics said in a research note last month.

According to CE’s own estimates, Hungary’s output gap is +1.8% of potential GDP.

“However, continued strong growth will result in the further build-up of capacity constraints. This, in turn, will cause underlying inflation pressures to mount."

The analysts anticipate a sharp rise in core and headline inflation throughout CEE over the coming quarters. As a result, they expect most central banks in CEE to begin tightening monetary policy over the next 12- 18 months. And by 2018/19, as the economic cycle matures, growth in the region will slow.

At a country level, the risk of a sharp build-up of underlying price pressures is greatest in Hungary, and to a lesser extent, Romania.

One implication of this is that tightening cycles in Hungary and Romania are likely to be more aggressive than in the rest of the region.