Is the weak forint weak? – Portfolio.hu

In the first three quarters of 2020, the forint weakened 9 percent against the euro and in September approached the lows seen when the Covid-19 pandemic broke out. During the same period, the national currency also depreciated against the zloty, the Czech koruna and the Romanian leu (3%, 3% and 8%, respectively).

It is customary to speak of a weak florin, but often it is not so clear who wants to say what.

Have you devalued too much over a period of time? Was it better devalued against the euro than its regional counterparts? Has the “usual” devaluation trend accelerated? Was the devaluation stronger than national economic fundamentals or world market sentiment would justify? These and other considerations can be criteria for the “weakness” of a currency.

Starting from internal economic fundamentals, the issue of inflation has emerged immediately in the recent period. From about the fall of 2019, and then after some interruption, accelerating the epidemic situation, a cycle seemed to form. The weaker exchange rate led to an increase in the prices of highly imported goods and services, and then the real increase in inflation reflected the exchange rate (partly due to the reduction in prospective real interest rates) and induced another weakening of the forint. apostrophizing the exchange rate effect as a minimal factor, it continued to apply the most lax monetary policy possible.

From the point of view of monetary policy, the concept of a weak (too weak) exchange rate can also be defined as the exchange rate in a given period that no longer helps (or explicitly prevents) the preservation of the purchase value of one currency, keeping inflation in the target range.

If such a situation not only develops, but also appears permanent, market participants expect the central bank to react, and if not, they might turn away from the currency, accelerate the devaluation, and inadvertently increase pressure on the central bank to step in.

Many market participants (such as real traders with a EUR / HUF exchange rate of around 340 for 2020 and various portfolio investors) have perceived this type of currency market situation when the EUR / HUF exchange rate returned to exceed 360 in the second half of September this year. The situation was no longer unknown: in spring, the MNB wanted to point out that the exchange rate above 360 ​​(or the devaluation rate) already hid important risks. However, the answer was more indicative: the broadening of the interest rate corridor by raising the central bank’s lending rate, which cannot be considered the reference interest rate in the prevailing interbank liquidity.

As “exchange rate risk” seemed to disappear more permanently, the two summer base rate cuts also indicated that monetary stance had not changed substantially: the objective was to make the most of the room for maneuver that a policy allowed loose monetary. So when the strengthening of the fall wave of Covid-19 and core inflation rates that rose above 4 percent again weakened above the 360 ​​EUR / HUF levels, new but still followed. more secondary interventions (raising and breaking the one-week deposit rate from the base rate, verbal intervention highlighting the risk of inflation by the forint).

Of course, it is understandable that the central bank is not trying to adjust in a recessionary or global crisis economy. The fact that it does not do so despite the growing inflationary risks despite the recession is emphasized as the main reason for the temporary increase in inflation. At the moment, market opinions are divided on this, although for the most part they expect lower inflation by 2021 than this year. According to central bank forecasts, the growth / demand dilemma that requires tightening against inflation that requires easing can be resolved by 2021. Furthermore, the movement of the forint does not appear to endanger the stability of the system financial, government debt financing is operational at current interest rates (although stronger central bank involvement modifies market conditions at the long end of the yield curve) and the debt ratio is low in all markets. sectors. Furthermore, the weaker forint may even be favorable for exporters in the short term (although the latter can be considered a very limited effect).

The question is, is the weak florin still weak in this situation? Or, based on the above, is it enough for the exchange rate to fluctuate around the 360 ​​level?

Although the EUR / HUF close to 360 at the beginning of October means weak forint levels (7% weaker in nominal terms than at the beginning of the year, it did not regain its regional position, there is a lot of uncertainty in inflation expectations due to the strengthening of the transmission of the exchange rate), which is even fair and sustainable in light of the above criteria of inflation, financial stability and debt financing? Or is it just a temporary situation, in addition to a situation that allows base rate cuts in summer (?), Or the appreciation of the temporary forint that was seen in the first days of October?

According to my calculations, based on a fundamental model based on interest rate, inflation and labor productivity differences, the EUR / HUF exchange rate could move even in the 320-330 range, but eliminating epidemic risks and a substantial improvement in the prospects for GDP growth would be a basic condition for such a recovery. and strengthen investor confidence in emerging markets. But we do not expect a significant and lasting strengthening (similar to a trend) of the forint not only due to the effects of the epidemic or the crisis.

Of course, the viral situation continues to have a strong impact on the forint and inflation (the CPI indicators in summer and September differed significantly from the usual seasonal pattern) and on the outlook for GDP. However, there are also a number of other warning signs that the forint’s long-term weakening trend is likely to continue:

• Central bank interventions have so far only been sufficient for a moderate correction of the forint,
• So far, there are no definitive signs that the basic strategy of monetary policy has changed (and the last 15 years have shown a weakening trend for the forint),
• Household inflation expectations have barely improved and are highly volatile (although the impact of a double-average dynamic on food prices can be strong here),
• On the economic fundamentals side, new support from the equilibrium side (budget, foreign trade, balance of payments) is unlikely even after an expected growth correction
• the private sector’s foreign currency deposit portfolio is showing rapid growth.

Of course, there may be several factors behind the increase in foreign currency deposits, but in any case it is revealing that while in 2019 the exchange-adjusted increase in combined foreign currency deposits of households and the business sector was barely 5%, in 2020 it reached 12% at the end of August. Double digit growth over the last decade was only seen in 2016, while there were also 4 years in which the stock showed a decline.

Furthermore, even if we take into account significant inflationary effects outside the scope of the central bank (for example, on the supply side, the evolution of food prices or the Covid effect, which can be inflationary through the exchange rate and partly directly), it is clear that at present neither exchange rate risks nor inflation risks are negligible.

Could the current inflation and forint problems be resolved by a prolonged or intensified contraction in demand due to the crisis situation (linked to the appearance of the expected deflationary effect in the euro area)? Perhaps more administrative steps like overhead cuts that pushed inflation into the -0.5-1 percent range for several years?

Clarifying these issues can also affect the long-term trend of the forint exchange rate. Meanwhile, the strengthening and implied volatility of the forint, which has been dislodged from international market sentiment since mid-year, continues to suggest rapid changes in the short term.

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