The strength of the forint may be short-lived - Equilibrium Institute
The gradual moderation in inflation allows the central bank to progressively lower the policy rate, but the vulnerability of the forint allows only cautious interest rate cuts, according to a recent analysis by the Egyensúly ["Equilibrium"] Institute. Falling inflation and a high base rate have pushed real interest rates into positive territory for the first time since 2015, in the second quarter of 2023. The National Bank of Hungary (MNB) has repeatedly stressed in recent months that positive real interest rates could persist, supporting the forint.
However, in a study published in July 2023, the MNB stated that in the changed economic environment, the weakening of the forint has no stimulative effect on the economy, while it has a stronger impact on inflation than before.
This could be interpreted as a sharp change in direction, as it suggests that the MNB will pay more attention to maintaining exchange rate stability in the future.
Against this background, the Equilibrium Institute expects the pace of the interest rate reduction cycle to slow down, with interest rates falling to 11.5% by the end of this year, 8% by the end of 2024, and 6% by the end of 2025.
The depreciation of the forint is likely to continue, but will be more moderate than in recent years, they add.
After bottoming out at the end of 2022, the exchange rate of the forint against the euro stabilised in the range of HUF 380-390 following a dynamic appreciation, while the parallel increase in the price level led to a significant real appreciation.
The Equilibrium Institute predicts that the forint is currently overvalued: the real exchange rate is above the equilibrium level, which is hurting exporters and consumers, cooling the economy, and helping disinflation.
Looking ahead, the forint is expected to remain on a weakening path, in line with the higher risk premium demanded by international investors, correcting its current overvaluation. The main reasons for this are the gradual disappearance of the attractive interest rate differential and the persisting uncertainties around EU funding. However, the depreciation will remain moderate as the reported large inflows of FDI and the resulting recovery in exports will ensure sufficient foreign exchange inflows.
The average exchange rate of the euro is expected to be in the range of HUF 393-403 in 2024 and HUF 406-419 in 2025, according to the institute.
Cover photo: Getty Images
