May Inflation Data Offers Positive Surprise

Analysis

The beginning of the summer brought good news and bad. While sky-rocketing inflation finally seems to be slowing down visibly, industrial production broke a three-year negative record. The weak performance may increase the risk of an ongoing recession.

Far below expectations, inflation decreased to 21.5% in May from 24% in April, with almost all factors, bar service provider prices, contributing. Food prices rose less than expected, and fuel prices fell, while household energy prices decreased further due to lower consumption.

Durable consumer goods prices fell due to the strengthening of the forint and the reduction in the costs of manufactured goods, while the prices of alcoholic beverages rose less than expected. However, the growth in the price of services continued to exceed expectations.

In the case of food prices, the increase in the cost of seasonal foods was offset by increasingly widespread price reductions, which may continue in the coming months due to the decrease in raw material prices and production costs.

The easing of inflationary pressure is reflected by the fact that core inflation also decreased to 22.8% from 24.8% in the previous month, MBH Bank head analyst Gergely Suppan says in commenting on the new data released by the Central Statistical Office (KSH) on June 8.

“In the coming months, due to base effects and price reductions announced for some food products, we expect inflation to gradually decrease and then to fall sharply from the middle of the year,” he writes in a note.

The base effects may be strengthened by the fact that international raw material, product and energy prices and transport costs have all fallen significantly, often to 2021 levels, in recent months, so the analyst does not expect any new external price shocks.

Lower Inflation Faster?

In fact, it may even lower inflation faster than expected, and the strengthening of the forint could also accelerate the reduction of inflation, something that can already be observed in the case of consumer durables, Suppan notes.

“Due to the increasingly favorable trends and the growing downside risks, we can substantially reduce our average inflation expectation this year to below 17.5% from the previous 18.5%, while next year’s inflation will be 3.7% despite the fuel excise tax increase at the beginning of next year,” he reckons.

“Inflation processes will also strengthen our interest rate expectations at the end of the year; accordingly, the base interest rate may drop to 10.5% by the end of the year, after it is expected that the one-day deposit rate will be tied to the base interest rate in September,” he added.

While inflation caused a positive surprise, industry suffered a bad start to the second quarter. In April, the production volume was 2.5% below the previous month’s level and declined by 8.3% on a year-on-year comparison. Based on working-day-adjusted data, production fell by 5.8%.

The sector’s weak performance increases the probability that the Hungarian economy may shrink for the fourth consecutive quarter. The decline means industrial output has fallen below the production peak before the coronavirus crisis.

Detailed data shows that out of the 13 sub-sectors of manufacturing industry, only electrical equipment manufacturing (which includes petroleum processing, electronics, and battery production) was able to increase compared to the previous month. Most sectors are characterized by a downward trend even in the longer term.

Gradual Revival

“After the expected temporary fluctuations caused by the energy crisis, we expect a gradual revival in industrial production from the middle of the year, which is due to the gradual recovery of internal demand, as well as the expected commissioning of new capacities, mainly related to battery production and the automotive industry, as well as the food industry, the chemical industry, and the defense industry,” Suppan comments.

In the medium term, the domestic economy could benefit significantly from the large-scale investments of Catl, SK Innovation, Samsung SDI, BMW, and Mercedes, as well as from the development of defense industry capacities, as a significant increase in military spending is expected in the coming years, he says.

For this year, Suppan expects a very modest growth of around 0.5% in industrial production but believes industrial production may significantly increase from 2024 as a result of the rising new capacities.

Another piece of bad news is the latest construction industry data: in April, according to the raw data, the volume of construction output lagged behind the previous year’s level by 3.2%. Based on seasonally and working day adjusted indices, construction output was below the March level by 2.6%.

The coronavirus crisis broke the pace of growth of the construction industry. Although it was slowly recovering from this shock, the energy crisis and the massive cuts in the state budget after the elections hindered development. The performance of the sector is constantly below its peak in 2019; in the last four years, only a few months have brought a good performance for a short time.

As this is the third quarter that the Hungarian economy has shrunk, based on the data available thus far for Q2 2023, it cannot be ruled out that the recession will extend to four quarters. Retail trade, industry and construction all fell in April compared to the previous (also not very strong) month. All of the above are increasing the risk of the ongoing recession.

This article was first published in the Budapest Business Journal print issue of June 16, 2023.

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