Euro Membership "Extremely Unlikely" Before 2015

 Analyst Nigel Rendell believes the Hungarian economy “faces its most severe recession since the early 1990s."

RBC now expects Hungary's gross domestic product to contract by at least 2% yr/yr in 2009. The cabinet's latest forecast is for -1%, but some analysts have much more ominous forecasts (-5% from Danske for instance).

“Domestic demand will decline, hurt by a combination of IMF constraints, further fiscal tightening, high interest rates and a contraction in bank lending," Rendell said in a strategy update.

He believes consumer spending will suffer a particularly large fall as disposable income is squeezed and unemployment rises.

At the same time, he noted that government spending would continue to be scaled back as the IMF forces further fiscal discipline.

With exporters hit as major trading partners in Western Europe face recessionary conditions and cut back demand, Rendell expects no more than a weak recovery in 2010.

Rendell pointed out that Hungary is one of the most open economies in the region, with exports accounting for 81% of GDP (and 78% of these going to the EU).

“Weakening European demand is already seeing Hungarian export growth slow to +5.5% y/y in Q3 2008 from +15-20% throughout 2007," the analyst projects.

But he warns that “conditions will get much tougher as the German economy, which takes almost a third of Hungary's exports, falls into recession."

“Manufacturing output is down 2.8% yr/yr in the latest three months, while business confidence continues to decline," Rendell said. He forecast that domestic activity will remain depressed. (Consumer confidence is also at historically low levels and retail sales have contracted in yr/yr terms for every month since Q1 last year.)

Inflation homes in on target

Helped by lower commodity prices, tighter monetary policy and weakening demand, CPI inflation is trending lower, the analyst said.

Rendell sees inflation back within the central bank's (NBH) 2-4% target range by the second quarter of 2009, “and is forecast to finish 2009 at 2.6% -the lowest rate since early 2006".

Base rate to be cut further

“Given the depressed economic outlook, the NBH wants to reduce rates further, but the speed and magnitude of future declines will depend on the stability of the financial markets," the analyst noted.

He believes “monetary easing will be opportunistic -with the NBH taking advantage of periods of relative calm -but cautious in nature."

Rendell expects the key repo rate to be edge down to 9.50% by Q2 009 and to 8.00% by December next year from the current 11.00%.

HUF concerns remain

The gap between the EUR/HUF and CDS that existed in 2008-H1 has been closed (see chart below). While Rendell sees EUR/HUF “reasonably valued", he stressed it was “vulnerable to a renewed spike in regional or global risk aversion."

Rendell expects some modest HUF weakness in 2009, to 280 by June and 290 by year-end.

Euro convergence - no longer in sight

“The anchor of EU membership provided Hungary with USD 8.1 bn of FX financing but the prospect of Euro membership is no closer," Rendell said.

He sees Hungary as “the euro laggard" within Central Europe, trailing behind Poland and the Czech Republic. At present Hungary only meets one of the Maastricht convergence criteria.

The analyst believes government debt levels will continue to rise and may not start to decline until after the 2010 election.

“The lack of progress and heightened global risk aversion is driving bond spreads higher, with Hungary trading at twice the level of Poland," he said, adding that euro zone membership before 2015 “remains extremely unlikely".

Source: Portfolio Online Financial Journal