Hungary c.banker promises lengthy tightening, as war impacts everything

Strong supply shocks to come

As everywhere else in the world, the Russian-Ukrainian war and sanctions on Russia are shaping the macroeconomic situation. The risks are therefore even greater than usual,

strong negative supply shocks will determine inflation and GDP in the coming quarters,

said Barnabas Virág.

Growth could be 2.5 to 4.5% this year, while inflation could be in a range between 7.5% and 9.8%, according to the central bank.

The consumer price index could return to the central bank's tolerance band (3% +/- 1ppt) in the second half of 2023 and reach the 3% target in the first half of 2024, added Virág.

Interest rates could stay high for longer

What we see is that in the short term, the war and sanctions will determine inflation and GDP,

in the medium term, inflation is clearly the bigger risk.

This should be the focus of medium-term decisions. This will require a consistent, tightening, anti-inflationary policy, and a continuation of the cycle of interest rate hikes in larger steps.

The central bank's expectation remains that the base rate will gradually catch up with the benchmark rate in the coming months.

A longer period of tighter monetary conditions is warranted to ensure price stability,

said Virág.

Currency swaps remain in place

As of the beginning of March, the central bank continues to use its previous foreign exchange swap instrument, with the next tender taking place tomorrow, said Virág. This is to ensure that the tightening implemented by the central bank is reflected in all areas.

"The Bank places even greater emphasis than previously on ensuring that short-term rates in every sub-market, particularly in the swap market, and at all times develop consistently with the level of short-term rates deemed optimal by the Monetary Council. To that end, the MNB has been actively using its swap instrument providing foreign currency liquidity from the beginning of March," the MPC said in a statement.

GDP growth could have been 6% this year

The carry-over effect of last year's robust economic output increase was around 2.5 percentage points in economic growth. This means that even if GDP stagnates, economic growth could still be 2.5%. Until the outbreak of the war, the Hungarian economy was still on a recovery path, with a 6% growth being absolutely on the cards for 2022, said Barnabás Virág. In other words, the growth fundamentals of the Hungarian economy were strong.

Inflation is not specific to Hungary

The rise in inflation is an international trend, Hungarian inflation is not outstanding in Europe. In the first months of the year we saw severe repricing, and the trend in January continued in February, with repricing around three times the average of the last ten years.

Cost effects across the economy are being passed on to consumer prices very quickly,

said the Deputy Governor.

What did the war change?

We have moved from a linear world to a non-linear world in a great many areas of life,

Virág summed up the impact of Russia attacking Ukraine. Prices rose substantially over a very short period of time, and these negative supply shocks will dominate the world in the coming period, especially in Europe.

In the money markets, the closer a country is to war, the bigger the movements have been, and the Hungarian market has been no exception. There was a very rapid change in positioning,

about 700 billion forints of short positions were set up in the forint market, which led to a rapid depreciation of the exchange rate in the short term, followed by a rebound last week.

The war will leave a mark in all sectors of the economy

The structure of growth may shift towards household consumption this year, but at a lower pace, stressed Virág. The impact of the war will be felt in almost all elements of GDP, with growth slowing in all aspects. However, if this situation is resolved, the Hungarian economy could be capable of a rapid recovery again,

some of the growth momentum lost this year is expected to be regained in 2023.

Even to keep on climbing

Since the beginning of 2021, inflation has been subject to increasingly severe cost shocks worldwide, which are gradually accumulating in magnitude and over time, underlined Virág. Weaker economic growth and government measures are dampening inflationary pressures, but very strong supply shocks are emerging and pushing up the pace of price increases.

Inflation is expected to rise further in the coming months, with our calculations suggesting that the March figure will be higher again, currently looking between 8.5% and 9%. This trend will continue, with a turnaround in the second half of the year,

said Virág.

Risks

According to the central bank's risk scenarios, there are clear upside risks to inflation, while there are slightly downside risks to economic growth, said Virág.

Interest rates will converge in the end, but it's unclear where

The base rate will gradually catch up with the benchmark policy rate (1w depo), but the next period will determine when and under what conditions this can happen. What is certain is that the two interest rates will converge, but saying more than that would be very risky, said Virág in response to an analyst's question.