Hungarian gov't takes unexpected step amidst fight against inflation

Inflation finally starts to ebb when things take an unexpected turn

In recent months, we have finally seen a meaningful decline in the inflation rate after a long period of time, with the rate of inflation first starting to fall only symbolically from the peak of 25.7% in January, before going down more palpably in April and May. Thus, the latest data now show an inflation rate of 21.5%, still very high and probably the highest in Europe, but already well below the peak.

In autumn 2022, the government had already set a target of single-digit inflation by the end of this year, and one of the big steps towards this goal was the May CPI figure, which was lower than expected (21.5% vs. 22.2% market consensus). Experts say that everything is now in place to have inflation in single-digit territory by year-end.

Given the fight against inflation, it was surprising to see the 2024 tax bills this week, which include a marked increase in excise duty on fuel. This could raise the price of a litre of petrol and diesel by up to 40 forints, nearly 10%, which will inevitably be reflected in inflation from January.

On the one hand, there will be direct effects, as vehicle fuels account for roughly 8% of the inflation basket. In addition, there are likely to be second-round effects, as some sectors (transport, taxis, etc.) will certainly incorporate the higher costs in their prices.

How dramatic could be the impact then?

For the time being, analysts are also only trying to estimate the inflationary impact of the tax increase, as an accurate calculation would require knowledge of world oil prices and domestic fuel prices at the end of December. Another key variable is the weight of fuel in next year's consumer basket. That is why, when asked, they assumed that prices would remain around current levels and tried to make an estimate from there.

"Without the increase in excise duty, we expected inflation to be below 7% in January, with fuel adding 0.6-0.7 percentage points," Mariann Trippon said. This could bring annual inflation close to 6% in 2024, according to the analyst at CIB Bank. And this calculation does not include indirect effects, the spillover of rising fuel prices to other areas.

The big question remains whether this year's disinflation can continue next year or whether we will be stuck in a high inflation regime,

Trippon summed up the outlook, saying the probability of the latter scenario is not negligible.

According to ING Bank's forecast, the world oil price may range between USD 75 and USD 95 next year, which immediately implies that the tax rate effective north of USD 50 per barrel will remain in place throughout 2024, said Péter Virovácz.

He said that while the forint may still strengthen against the dollar this year, the global price of Brent oil could rise significantly, even approaching $100. This could lead to a 15-20% increase in fuel prices this year already, which would be topped by a further 6% increase in excise duty from January.

Virovácz estimates that the excise tax reform could raise inflation by around 0.5 percentage points in the first round next year.

However, we can also expect some second-round effects, as this will raise the cost levels of many companies, which could easily be passed on to consumers again, especially when real wage growth returns and the economy starts to perform better and consumption picks up.

Virovácz points out that in next year's budget the government expects an average inflation rate of 6%, which has so far exceeded market consensus. With the tax laws submitted, this could easily reflect the impact of the tax hike, as we could already be close to 6% on average.

The [excise tax] change will also mean that the central bank's inflation target of 3% is unlikely to be met in 2024,

the ING Bank analyst highlighted.

Péter Kiss, Investment Director at Amundi, also estimates that the tax increase could add 0.5-0.6 percentage points to inflation in 2024. It is worth adding that a similar but opposite impact on year-on-year inflation in January 2024 will be the base effect of the fuel price increase due to the abolition of the fuel cap in December 2022, which will be carried over to January (as it will drop out of the base, it will mean a decline of around 0.7 percentage points), so the two factors will roughly offset each other, he says.

Kiss says a half-percentage-point rise in inflation expectations for 2024 could therefore be justified, but it would not be of such a magnitude and nature as to affect the central bank's current cycle of interest rate normalisation and then, according to expectations, the rate cut cycle that will start in the fourth quarter of this year.

Cover photo: Getty Images