Forint in free fall may force Hungary to hike rates, join euro waiting room

The continued plunge in Hungary’s national currency is forcing the country’s decision makers to revisit earlier policy measures as the weakening forint wreaks havoc in the economy. The central bank may be forced to resume its tightening cycle while the government has indicated it could bring forward the nation’s erm-2 accession, the waiting room of the euro.

The Hungarian forint is among the world’s worst performing currencies, on par with the Turkish lira and the Argentinian peso. The National Bank of Hungary’s aggressive interest rate hikes have failed to put a floor under the sliding currency as Hungary's enormous energy costs, widening current account deficit, and a stand-off with Brussels that led to a freeze in EU funds makes the forint an easy target in international financial markets.
After raising its base rate to 13%, by far the largest in the European Union, Hungary’s central bank said it would stop hiking interest rates and would tighten monetary conditions by draining liquidity. The sliding forint now puts this policy announcement at risk.

Surging inflation
Following the central bank’s surprise announcement that it would end its rate-hike cycle, Hungarian consumer prices spiked to a 26-year high of 20% in September. Analysts believe that the forint is poised for further weakening in the light of rising inflation and the negative global environment. Against this backdrop, the central bank’s declaration of ending the rate hiking cycle at 13% may prove premature.
Analysts at JP Morgan argued that policy rates need to rise to at least 16-17% to stabilize the currency. Meanwhile, Péter Virovácz, economist at ING Bank in Budapest said that a positive message signaling an end to the standoff with Brussels and granting Hungary access to EU funds could end risk aversion and help the forint.

Euro waiting room
The sinking currency may also force the hand of the government and bring forward the issue of euro accession. Previously, members of the government said euro accession was not on the agenda and repeatedly said that the days of the single European currency may be numbered. In a sharp change of tune, Finance Minister Mihály Varga said this week that Hungary may seek to join the euro’s ERM-2 waiting room this year or next. The ERM-2 is an exchange-rate mechanism that keeps a country’s currency in a fixed range against the euro before adopting the single currency. The government may consider joining the mechanism if and when it manages to reach a potential year-end deal to unblock European Union funding, according to Varga. The minister added that Hungary wouldn’t necessarily adopt the euro any time soon. “ERM-2 is something any sane person thinking about fiscal or monetary policy must consider,” Varga told journalists, adding that Hungary would benefit from the ERM-2 by becoming more competitive. The government was examining the conditions Croatia undertook to join ERM-2 before its planned euro adoption next year, Varga said.
Euro area finance ministers, the European Central Bank and the ministers and central banks of the non-euro states that are participating in the ERM-2 must all give a green light for any country that wishes to join the exchange rate mechanism.