Economy 3 July 2023, 4:45pm

When could Hungary's forint ease above 400 versus the euro?

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For the time being, positive real interest rate outlooks may still support Hungary's forint, but with gradual interest rate cuts, the euro could rise back to 400 in the foreseeable future, economists at UniCredit Bank projected in a recent analysis. The analysts expect little economic growth this year and that the budget deficit will overshoot the target both in 2023 and 2024.

Drámai jóslat érkezett a gyenge forintról - Megszólaltak az elemzők a történelmi mélypont után

Economic growth seen stalled

The Hungarian economy will dodge the recession bullet this year, but its output could increase by a mere 0.2% in annual terms, UniCredit projected in its latest quarterly outlook on Central and Eastern Europe. This is considerably below the government's 1.5% GDP growth estimate, but it is bang in line with the updated forecast of ING Bank published last week.

"We expect the Hungarian economy to avoid a recession this year, despite public consumption and investment falling amid tighter fiscal policy, and destocking offsetting part of the rebound in exports," they said, forecasting GDP growth to pick up to 3.7% in 2024.

They expect household consumption to expand by merely 0.6% this year, mainly due to extremely high inflation.

"While wage growth is likely to outpace inflation from 3Q23 onwards, consumers could remain bearish as house prices continue their moderate decline, financial conditions remain tight and government transfers fall in an effort to contain the budget deficit," they said. In the medium term, the delay in the construction of the Paks 2 nuclear power plant due to the involvement of Rosatom could hurt growth prospects through investment.

UniCredit's economists forecast inflation to fall around 8.0% by the end of the year but to show only a moderate growth from there onward and still be above 6.0% at end-2024, with annual averages expected at 17.4% and 6.5%, respectively.

They also pointed to the latest government measure affecting consumption, namely a compulsory discount scheme applied until October to prices of the most important food items. Retailers will have to discount the price of each item on the list for at least a week and by at least 10% in June-July and 15% starting in August, while making sure that sales are higher than in the corresponding period of 2022.

The scheme could lead to more price volatility, which might be inflationary as inflation expectations remain unanchored.

The analysts also warned that government suggestions that the inflation target could be lifted from 3% (already the highest in the EU) further undermining central-bank efforts to bring inflation down.

With disinflationary base effects at play, UniCredit expects annual inflation to fall below 20% by July and into single digits by November, probably ending the year at around 8%. "Thereafter, disinflation may be cumbersome," the analysts say.

No EU funds on the horizon

The analysts do not expect a swift unblocking of Recovery and Resilience Facility (RRF) and cohesion funds because the proposed reforms fall short of the EC’s requirements and implemented reforms are not appropriately monitored.

Shrinking infrastructure projects might not be enough to squeeze the budget deficit to 3.9% of GDP, as planned.

They expect the public shortfall at 4.4% of GDP in 2023, despite 1.1% of GDP in extra profit taxes on banks and retail, and cuts in line ministry spending of 0.8% of GDP. The budget deficit will fall below 3% of GDP in 2024 only if retail energy and gas prices increase by at least 30%, besides additional cuts to line ministry spending of 0.6% of GDP and revenues from the additional taxes of 1.2% of GDP.

Forint to edge towards weakening again

In an environment of high inflation expectations and loose fiscal policy, the central bank (MNB) is carefully normalizing interest rates in line with market expectations, UniCredit's analysts said.

They expect the one-day deposit rate (benchmark) and the monetary-policy rate to be unified at 12% by the end of this year, with additional cuts to 6% in 2024.

"Monetary transmission to new lending costs has brought new borrowing to a halt, apart from the government’s HUF 2.5tn in loans, mostly for working capital meant to prevent blockages in the economy. We do not expect the credit impulse to turn positive before 2024, with mortgage lending at risk of lagging behind even longer if house prices do not stabilize," they aded.

By offering a tax holiday from the extra-profit tax on banks for bonds that mature beyond 2027, the government is trying to incentivize banks to shift up to HUF 1.3 trillion of the liquidity kept at the central bank into government bonds. In addition, investment funds might have to buy HUF 0.5tn in bonds.

"The measure aims to improve net issuance, raise the share of local currency in total public debt, and increase the average maturity of HGBs. Limited issuance amid healthy demand, especially in 1Q23, helped cap bond spreads to the rest of Central Europe, despite markedly higher funding costs, but it also shortened the average maturity of new debt," the analysts said.

The HUF remains too strong, in our view, but carry trades are supported by the only positive real interest rates in EU-CEE,

the analysts said, expecting EUR-HUF to move higher in autumn amid rate cuts.

They see EUR-HUF closing at 390 at the end of this year and at 400 at end-2024.

The forint has been among the best performing currencies in the world this year, with only the Mexican peso strengthening more in six months. If the fresh forecast comes true in the second half of the year and the euro rises to 390, the Hungarian currency would make up for a significant part of this year's soaring.