Record weak forint puts Hungarian central bank in tight spotThe Hungarian forint weakened to a record level against the euro this week and Hungarian government bond yields jumped amid a souring of international market sentiment and a surge in COVID-19 cases. The central bank raised the interest rate on its one-week deposit facility in an attempt to stem the slide of the currency.
The forint weakened to its worst level against the euro in history, passing the 370 mark, the USD/HUF was trading at its weakest level on record and Hungary's bond yields rose more than 20 basis points. Traders said the market rout was due to a worsening of the international market sentiment, significantly rising infection levels in Hungary and expectations that the central bank will raise interest rates to protect the forint.
Central bank in action
Last week, the National Bank of Hungary (MNB) raised the benchmark interest rate by 30 basis points to 2.1% in a bid to curb inflation, which hit a 9-year high in October, and hiked the rate on the one-week deposit facility by 40 basis points to stem the rise in short-term bond yields. The moves proved insufficient to shelter the forint from the selling pressure.
The strengthening US dollar and the worsening of the COVID-19 situation in central Europe weakened the region's currencies in the past days. Nevertheless, the forint underperformed its regional peers and weakened to record levels against the euro and the dollar. Economists stressed that Hungary’s loose fiscal policy ahead of general elections next year is a risk to inflation.
In a response to the sustained forint weakening, the central bank moved this week to raise the one-week deposit rate once again. This time it delivered a hike of 40 basis points to 2.9%, the second increase in the depo rate in a week. The bank pledged to continue its monetary tightening as long as necessary and flagged a "more extensive and longer lasting" tightening to curb rising inflation risks and anchor inflationary expectations. "The one-week depo rate will exceed the level of the base rate as long as the commodity and financial market risks relevant to the inflation outlook prevail," a bank statement said, adding there was no time limit for this decision.
The central bank reacts to sustained inflation risks by changing its key base rate, while the one-week deposit rate is used to tackle short-term shocks in risk premia.
Hungary’s central bank became the most actively tightening monetary authority in the world after it raised interest rates by 30 basis points in June, which was followed by two 15 basis point hikes in the next two months. Central banks in Poland and the Czech Republic rae also following suit, having delivered interest rate hikes of 75 basis points and 125 basis points in the past weeks.
The Hungarian currency lost 20% of its value in 2019 and 2020 versus the euro as a result of the Covid crisis, but stabilized in 2021. The forint traded in a tight range against the euro between May and September, moving between 350 and 355. The currency began to slide following the September Monetary Council meeting when policymakers slowed the pace of rate hikes from 30 basis points to 15 basis points. Markets expected the central bank to deliver more aggressive rate hikes after the tightening cycle began in June and were disappointed that policy makers slowed the pace of tightening. Stubbornly rising consumer prices also called for more decisive action on the part of the MNB.
The central bank’s strategy of tightening monetary conditions through using the benchmark interest rate and the one-week deposit rate may be confusing for the markets, according to ING Bank analyst Péter Virovácz.
At the same time, the MNB is indeed in a tight spot as it seeks to temper inflation with tighter policy at a time when the government is pursuing a loose fiscal policy. The government of Prime Minister Viktor Orbán announced generous tax breaks and hefty plans involving state spending ahead of general elections scheduled for spring 2022. Central bank Governor György Matolcsy repeatedly criticized the government’s economic policy and warned that spending plans unveiled by the Cabinet are set to fuel inflation and boost the budget deficit as well as the current account.
The central bank’s December policy meeting will be decisive for long-term monetary policy as the MNB will publish its revised growth and inflation projections for 2021 and 2022. Continued global woes, however, may force Hungarian policy makers to alter their strategy if the pressure on the forint remains in place.
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