Hungarian Economy may Stagnate, With Double-digit Inflation for Most of 2023

“The domestic economy is likely to be characterized by growth of around zero percent in 2023, moderating inflationary pressures from mid-year onwards, a slightly deteriorating labor market situation, and a slowly and gradually improving external imbalance,” Mariann Trippon, senior analyst at CIB Bank, said at a press event at the end of 2022.

The baseline scenario for 2023 assumed that the government and the European Union would reach an agreement on rule of law issues “and that EU funds will be available again from next year.”

The domestic economy was still growing at a dynamic pace in the first half of 2022, but Q3 saw a significant slowdown. Although data from the Central Statistical Office (KSH) showed GDP expanding at a rate of more than 4% year-on-year, it was down 0.4% on a quarterly basis. The slowdown will become more pronounced in the coming quarters. Nevertheless, GDP growth is expected to have remained around 4.5% for 2022 as a whole, Trippon said.

However, CIB Bank’s forecast for 2023 has deteriorated since May, with the baseline scenario suggesting stagnation or possibly minimal growth next year. In previous years, the main driver of expansion has been domestic consumption, but this is now slowing. The combined effect of weaker external demand and expected high energy prices is that net exports cannot compensate for the slowdown in domestic consumption.

“Household consumption is forecast to fall in 2023. Although we expect only a moderate deterioration in the labor market, rising unemployment, more uncertain employment prospects, falling real income due to high inflation, a higher interest rate environment, and generally deteriorating consumer confidence will dampen household consumption,” she explained.

Low Growth

CIB experts expect meager growth in investment, close to 0%. Fiscal adjustment pressures and the slippage of EU funds will lead to a clear slowdown in fiscal investment next year. At the same time, corporate sector investment will be held back by a weakening demand environment, cost-side shocks, rising financing costs, and an uncertain outlook.

The unemployment rate, which has been slowly rising in recent months, stood at 3.8% in November. Negative trends could continue in the coming months as companies adjust their workforce to the deteriorating demand environment and cost shocks. In line with the economic slowdown, the unemployment rate could reach 4% and is expected to rise further in the first part of 2023. Thereafter, a correction in employment could start in the second half of the year, in line with the expected recovery.

Thus, the acute labor shortages that have characterized the economy for several years will remain. In theory, easing labor market tensions could also ease wage pressures. In the first part of 2022, the significant acceleration in wage outflows was due to the increase in the minimum wage and the guaranteed minimum wage for higher-skilled workers, scheduled wage increases in the public sector, and one-off payments.

But the new data may reflect the corporate response to runaway inflation: in a labor-scarce environment, employers are forced tomake mid-year wage adjustments orpay one-off benefits.

“With inflation set to remain at very high levels next year, even in a deteriorating labor market, we do not rule out wage dynamics remaining in the double-digit range. But real earnings will still fall on average in 2023,” Trippon warned.

The domestic economy was characterized by intense inflationary pressures in 2022, which became more widespread and robust as the year progressed. In addition to supply-side factors, strong demand also drove up the rate of monetary depreciation, and price caps have not prevented the acceleration. As a result, CIB Bank forecasts that the annual CPI could exceed 23% in December.

High Inflation Remains

Inflation is expected to remain above 20% throughout the first half of 2023. Although a sharper deceleration could start from the third quarter, average annual inflation could be around 17%, with the rate of money depreciation only returning to single digits at the end of 2023.

The disinflationary impact of a substantial slowdown in growth and falling demand will slowly and gradually feed through to consumer prices, but the very high starting level, the inadequate anchoring of inflation expectations, risks related to supply-side tensions, and the uncertain exchange rate outlook could make disinflation challenging.

According to CIB, the National Bank of Hungary (MNB) may start cautiously cutting interest rates early in 2023. If the expected disinflation materializes, country vulnerabilities ease, and risks diminish, the possibility of gradually closing the gap between the overnight deposit rate and the base rate and even a reduction in the base rate in the latter part of the year could open up. In the baseline scenario, by the end of 2023, the base rate of the MNB could fall from the current level of 13% to close to or slightly below 10%.

The MNB’s aggressive 500-basis point interest rate hike stabilized theforint rate in October-November, with the euro-forint exchange rate correcting from a historical high of 430. However, the Hungarian currency massively underperformed its regional peers in 2022: the Czech koruna actually strengthened by around 2%, and the Polish zloty lost only 2%.

The extraordinary widening of the interest rate differential was, therefore, insufficient to trigger a significant appreciation of the domestic currency. For the interest rate differential to have a beneficial effect, a substantial reduction in the vulnerabilities of the domestic economy and markets is essential, Trippon said.

“If uncertainties surrounding the rule of law process are removed, inflation prospects improve, and a tangible positive turnaround in the country’s balance sheet position is outlined, theforint could strengthen against theeuro, and the cross rate could stabilize below 400 again in the course of 2023,” CIB analysts concluded.

This article was first published in the Budapest Business Journal print issue of January 13, 2023.