Domestic demand is holding up well
The macroeconomic consequences of the war in Ukraine are not yet reflected in growth figures in Q1 2022. Economic activity continued to grow, by 2.1% q/q after 2.2% and 1.1% respectively in the previous quarters.
It was primarily driven by strong domestic demand, currently at 7% above its pre-Covid level. The strong performance in terms of consumption (retail sales up by 9.2% compared to January 2020) can be explained by new supportive measures implemented by the government, ahead of the legislative elections last April. These included bonuses, income tax cuts, or the payment of an additional month's pension.
Other government measures aimed at supporting households’ purchasing power included a temporary freeze on 1) prices of energy and certain food items and 2) mortgage rates. Similarly, the moratorium on loan repayments has been extended until December 2022. Furthermore, the average salary increase over the past few months has been higher than inflation, thus has contributed to support the purchasing power of household incomes against a background of rising inflation (10.8% year-on-year in May). Contrary to expectations, investment remained strong in the first quarter with an increase of 4.4% in Q1 2022 following 0.2% q/q and 2.1% q/q respectively in Q4 2021 and Q3 2021. Net exports, on the other hand, were a drag on activity.
Economic indicators suggest a slowdown in activity over the next few quarters. Retail sales excluding vehicles appear to have peaked in March. Industrial production has also weakened since March, probably due to supply disruptions and rising costs for intermediate goods and raw materials. In May, the drop in new orders and the increase of delivery times, reflected by the underlying manufacturing PMI indices, suggest that the decline in industrial activity could continue over the short term. As a result, investment could suffer in coming quarters. The uncertainties related to the war in Ukraine are weighing on business confidence and will undoubtedly lead to the postponement of projects. Similarly, the recent introduction of a tax on windfall corporate profits in certain sectors could have a negative impact on investment decisions.
In terms of foreign trade, exports have increased at a slower pace in recent months while imports have remained high. Hungary’s direct exposure to Russia in terms of exports is very low, at 2.1% of GDP, but the indirect effect through trade relationship with EU is significant. In contrast, Hungary is heavily dependent on Russia for its energy supply
(50% of energy imports). At the present time, the EU embargo on Russian oil imports does not apply to Hungary, Slovakia and the Czech Republic.
The expected slowdown in activity over the next few months will nonetheless have a limited impact on growth in 2022 due to the significant carry-over effects in the first quarter, currently at 5%. Real GDP growth is likely to remain very strong at 6% this year. In contrast, it is expected to slow significantly to 2.9% in 2023 due to inflation remaining at high levels and slowing activity in the advanced countries.
Monetary tightening to combat inflation
