Hungary forint sinks to 1-year low, as feud of economic policymakers unnerve investors
Volatility on the forint market is increasing
- The MNB has created quite a stir in EUR/HUF
- The fundamentals of the Hungarian economy are weak
- How low can Hungary's interest rate premium melt?
- Should we expect a stronger or weaker forint in the longer term?
- Is EUR/HUF north of 400 around the corner?
In recent days, we have seen significant volatility in the forint market, which increased after the Hungarian central bank (MNB) decided to shift gears and cut the base rate by 100 basis points, following four consecutive 75bp reductions. It has not helped the forint either that tensions between economic policy makers, i.e. the government and the central bank, are increasing, exacerbated by negative news on the economy and the budget deficit. So it may well be that the central bank's acceleration was indeed only temporary.
"Concorde forecasts that the MNB will slow down the pace of interest rate cuts in the second quarter, as the central bank's communication following the 100 basis point rate cut stressed that the 6-7% rate level expected by the market by the end of the first half of the year could be realistic," Sándor Jobbágy, senior macroeconomic analyst at Concorde, told Portfolio.
"Of course, our interest rate advantage will gradually decline in the first half of the year, but we expect it to be smaller than what the market is currently pricing in," he added.
"The weakening of the forint over the past few weeks was definitely an unexpected development. While it was likely that the exchange rate would weaken in the longer term, but not that it will this rapidly," Gábor Regős, Chief Economist at Gránit Fund Management, wrote in an analysis e-mailed to Portfolio.
"I could not attribute the weakening to a single factor, there are several factors to take into account - and they are not necessarily all economic," he added.
Gábor Regős listed the following factors that could have played a role in the easing of the forint:
- Ahead of the February policy meeting, the MNB left open the question of whether the easing would be 75 or 100 basis points, but ultimately opted for the larger cut. This led to only a slight HUF depreciation initially, but may have played a role in the subsequent weakening (if not necessarily in itself, it may have amplified the effect of other factors).
- The weakening has been influenced by the latest stage in the tussle between the central bank and the government - this has no impact on the real economy and should not be news to the market, but it has still affected the exchange rate.
- December's unfavourable external trade data may also have had an impact, with export volumes falling by 8.4%. However, a significant part of this may be due to the calendar effect, without which the decline would have been only 1.6%. So it's possible that the market has overreacted to a piece of data that may not be as important as it may appear at first glance, although the trend in external demand certainly warrants caution.
- Also contributing to the weakening was the significant improvement in Poland's sovereign risk: the new government's agreement with the European Commission could lead to improved relations and the release of frozen funds, with investors seeking Polish assets rather than Hungarian ones, Regős said.
According to Mariann Trippon, Chief Economist at CIB Bank, the melting interest rate advantage could also be a problem for the forint. "The supportive interest rate advantage we have enjoyed so far continues to erode as regional central banks have been rather cautious about cutting rates, while expectations of the first easing date are being pushed back by developed central banks," she said in her analysis.
Zoltán Árokszállási, Chief Economist at Equilor, also drew attention to the expectations of interest rate cuts by the major central banks, the US Federal Reserve and the European Central Bank (ECB). In his analysis published on Portfolio, he underlined that markets are currently pricing in a first cut of 25 basis points by both central banks for June, so the current level (5.25-5.50% for the Fed and 4.5% for the ECB) could remain until then.
He argues that, the MNB's interest rate cuts will be limited by the fact that Hungary will have to hold a substantial premium to this at the end of June.
Mariann Trippon shares a similar view. "The persistent strained relationship with the EU, the tight fiscal situation and the tension between economic policy makers are worsening our risk perception, resulting in higher desired premiums," the CIB economist pointed out.
Zoltán Török, Chief Economist at Raiffeisen Bank, also draws attention to this tension. "In recent years we have seen that the Hungarian government is not afraid to take on conflicts," he wrote in an analysis published on Portfolio.
"We have little doubt that this will be the case for the rest of 2024. So the forint could take a further and further beating in the future. However, for these to be temporary effects, macroeconomic developments need to improve and a safe level of interest rate spreads needs to be ensured. Otherwise, we'll be headed for an EUR/HUF range above 400," he added.
Analysts agree that the MNB can no longer really lower interest rates in the second half of the year because of the interest rate spread considerations.
"With inflation slowly rising again from the second and third quarters and the central bank's real interest rate target, there will be no room for any meaningful interest rate cuts in the second half of the year, even if the ECB and the Fed start a new cycle of rate reductions in line with global expectations in the summer," Sándor Jobbágy told Portfolio.
Overall, based on our expectations for inflation, the central bank interest rate and balance of payments developments, we expect a gradually and slowly weakening forint exchange rate trend in 2024,
said Jobbágy. He added that there could of course be fluctuations, and the movements in the last few days of February seem to be like that at the moment.
According to the consensus estimate of analysts polled by Portfolio, the coming months will bring higher price indices than January's 3.8%. Inflation could average 4.4% this year, rising to 5.3% year on year in December. Analysts say the reason why the MNB should not cut interest rates further after the summer months is that it could say goodbye to a positive ex-post real interest rate.
"It is not only the EUR/HUF exchange rate level per se that matters, but also the speed of depreciation and the evolution of volatility," said Jobbágy. It is noteworthy, for example, that even in the midst of the weakening wave that started on 28 February, the forward (option) volatility of the forint remained below the levels immediately preceding the outbreak of the Russian-Ukrainian war in February 2022.
If we continue on a slow, gradual depreciation path and reach sustained levels above EUR/HUF 400 by the last quarter of 2024, this should not cause any problems in itself, he added.
According to Gábor Regős, the fundamentals certainly do not yet support the weakening of the forint seen in recent days. In fact, the current account balance has improved a lot compared to 2022 (rebalancing) and real interest rates are strongly positive. We should note, however, that sooner or later monetary policy easing will not be determined by the real interest rate, but by the interest rate differential between the monetary conditions of the major and regional central banks. On this basis, a small, positive correction in the exchange rate cannot be ruled out in the coming period, he said.
Looking ahead, the MNB's actions will be decisive: a verbal intervention before the next interest rate decision is not inconceivable, but it is also clear that at the current exchange rate the pace of the easing will have to be moderated, Regős said. How much it slows down and what it communicates will influence further rate developments.
"In an unfavourable scenario, an exchange rate above 400 forints is not out of the question, but I hope that this will not happen this year, or at least it will not be persistent," Regős wrote, adding that a slow weakening may be likely in the longer term. Stable exchange rate levels are possible in a very, very best case scenario, he said.
Feud between gov't and cenbank weighs on HUF
There's an ongoing dispute, including public name-calling and volleys over rate cuts, between the government and the central bank. The former is headed by Prime Minister Viktor Orbán, who has been pushing the MNB for larger rate cuts for months to help the economy emerge from recession. The latter is headed by György Matolcsy, whom Orbán used to call his "right-hand man" when Matolcsy was still his Economy Minister.
People familiar with the dispute, who talked with Bloomberg on condition of anonymity, said distrust between the two sides is so intense that all meaningful communication between them has ceased. This new level of dysfunctionality of economic policy is unnerving investors, the news agency said.
“A hit to central bank credibility may be an acceptable cost at present to achieve Orbán’s goals,” Malin Rosengren, a portfolio manager at Bluebay Asset Management, told Bloomberg.
However, such a loss to credibility destabilizes the currency for years to come.
The forint is already one of the worst-performing emerging market currencies this year.
The feud reached boiling point last week, when the government unveiled plans to step up supervision over the central bank, ostensibly to hone in on what it sees as lax financial management, particularly tied to a controversial network of foundations. Matolcsy called it a “significant attack” against the monetary-policy institution.
Finance Minister Mihaly Varga told Bloomberg in an interview that the government may yet reconsider the contested legislation when the cabinet is slated to discuss it next week. The government’s decision will assess “not just whether it conforms to legal requirements, but also the economic and business environment in which the decision is made,” Varga said in an interview in Budapest Wednesday.
Cover photo: Getty Images
