MNI INTERVIEW: Hungary Price Caps To Boost Inflation- Ex-NBH

Capping food prices and cutting income tax for mothers may not guarantee ruling party Fidesz victory in next year’s general election, but risk propelling inflation into double figures, former National Bank of Hungary researcher Adam Reiff told MNI.

A lifelong exemption from income tax for mothers with at least two children and a cap on price margins for some basic food items announced earlier this month are likely only the forerunners of multiple measures aimed at swaying voters in the run-up to 2026 polls, when Prime Minister Viktor Orban faces a strong challenge from Peter Magyar’s Respect and Freedom (Tisza) Party, said Reiff.

Handouts before elections three years ago cost around 15% of GDP and were a major contributor to the following year’s surge in food prices, in addition to higher energy prices linked to the war in Ukraine, noted the researcher, whose work at Budapest’s Institute of Economics - after 15 years at the NBH until 2021 - has focussed on the effect of the 2022 giveaways on voter behaviour.

“It’s the essence of Fidesz strategies that they are doing multiple things at the same time. If each of them has one marginal effect then the end result might be significant,” he said. “My prediction is that the government is going to implement even more subsidies this time,  especially because they are lagging behind the main opposition party in the opinion polls. Hungarian inflation is already the highest in the EU at 5.6% in February, and I can imagine that it will be raised into the double digits.”

While central bank estimates point to the margin cap on food products shaving around 0.8 percentage points off inflation in April and May, Reiff was less optimistic. Previous central bank studies found that other food prices actually increased as wholesalers and retailers sought to recover lost profits by compensating elsewhere, he said.

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“It’s in the best interests of the retailers to let the wholesalers increase the prices, because the margin that they can put on that product - butter, for example - is going to increase,” Reiff said. “It's also good for them if the nominal price is higher, because then they are going to sell fewer items, so the associated losses are smaller. I'm pretty sure that the prices of substitute goods will also move up, and I'm not even sure that in the long- run the price of those affected goods is going to be lower again.”

After signalling that upside risks to the inflation outlook remain -- effectively ruling out further cuts this year, Reiff said --  the NBH under new governor Mihaly Varga will do whatever it can to keep inflation under control and condition market expectations of future rates policy. (See MNI EM NBH WATCH: Rates Held, Inflation Risks Tilt Upwards)

“In that respect, the central bank is going to be as transparent as before. Maybe when the decision between a rate hike and a hold is borderline they will be tilted towards a hold because of technical considerations, but eventually they will have to hike,” he said.

“If the forint starts depreciating - to around 420 or 430 to the euro - then the central bank will be under pressure to increase the rate.”

Should raising rates and capping price margins be insufficient to tame inflation, the government would be likely to reintroduce nominal price caps more broadly - albeit only temporarily, Reiff said.

“I don't think that they can do it for a substantial amount of time, because that will ultimately lead to supply shortages. This is something we already experienced with the gasoline price cap, which led to long queues at the pump in December 2021 and eventually the government was forced to lift the price cap.”