Forint s-t Gains May Be Even Bigger Than Previously Thought

While some correction may take place after this big move, Goldman Sachs trimmed its 3-month EUR/HUF forecast to 230 from 238, saying HUF-supporting factors still exist. GS left its 6- and 12-month forecasts at EUR/HUF 230 and EUR/HUF 225, respectively.

István Zsoldos, analyst at Goldman Sachs in London, said he has been favouring the HUF for three main reasons:

Inflation is a problem, and the exchange rate is the NBH's only effective tool to combat it;

The HUF has lagged the general appreciation trend in the region by a wide margin (see the chart below) and was (and still is) cheap compared with its regional peers;

We have seen a substantial fundamental improvement on the fiscal and current account side, which means that FDI is now broadly financing the CA deficit.

The elimination of the HUF trading band in March allowed these forces to play out. In the following you can see how they have changed in the light of the recent appreciation.

Central bank cannot afford to be relaxed about CPI outlook

The appreciation of the forint does affect the central bank's (NBH) inflation forecast, Zsoldos said.

“The HUF strength so far has been almost exactly offset by the higher oil price, so the NBH's forecast is unlikely to change much," he said, estimating the coefficient on the HUF pass-through at about 0.2, so EUR/HUF at 235 would bring the forecast down by about 1.5ppt, other things equal (the NBH's May inflation forecast assumed EUR/HUF 253.8 by end-2009, which is some 7.5% weaker than the current level).

“However, other things are not equal: the oil price assumption was around USD 106/bbl in the May Report, so an oil price of around USD 140/bbl would increase the forecast by almost the same amount. In other words, the NBH can still not afford to be relaxed about the inflation outlook even after the recent HUF appreciation," the analyst said.

The NBH failed to deliver the widely expected 25-bp rate hike this Monday, which raised doubts about its commitment to low inflation and, implicitly, about the HUF strength, but Zsoldos thinks the commitment is still there.

“Our impression was that the speed of appreciation was one reason why the NBH did not hike rates (although this topic was not mentioned in the commentary afterwards). However, we still believe the NBH wants to manage a broad nominal appreciation path of the currency, to channel real appreciation through to nominal appreciation, and that, if necessary, it will hike interest rates in the future," the analyst said.

He continues to forecast 50 bps in additional hikes in the next three months, although he noted that the HUF move has increased the downside risk to this view.

HUF still behind regional trends

The forint has still not caught up with regional trends and for that to happen Zsoldos said it would need to appreciate to around EUR/HUF 220, below his long-term forecast of EUR/HUF 225.

“GDP growth has been weaker in Hungary than in other countries in the region, so there should probably be some discount compared with its regional peers," Zsoldos said. He emphasized, though, that even with today's exchange rates, manufacturing wages in Hungary are about 8% lower than in Poland and 15% lower than in the Czech Republic, while marginal productivity is unlikely to be very different.

“The pick-up in growth this year and the slowdown elsewhere in the region should reduce the growth discount, and productivity growth for the economy as a whole is already similar to that in Poland."

The analyst thinks that the improvement on the external side is solid, and “should not be threatened by even further appreciation."

The experience of other countries in the region points to robust exports in the face of large appreciations. Hungary's own past experience tells a similar story. Importantly, productivity increases have offset the recent appreciation so far: the unit labour cost measure in manufacturing in EUR terms has been flat in the past 12 months in Hungary, using the latest exchange rates.

Politics and global risk appetite are the main risks

Zsoldos said Socialist Prime Minister Ferenc Gyurcsány “may resign or be forced out before the next election, and this could be a short-term negative for asset prices."

He believes the risk of early elections would increase significantly if the Socialists (MSZP) and their former coalition partner, the Free Democrats (SZDSZ), failed to agree on a budget proposal that should have the support of both parties.

Given the traditionally slow summer season in politics, he does not expect any of these issues to come to a head before late August at the earliest.

“More importantly, neither would we expect an early election or the replacement of the PM to have much of a negative impact on fundamentals. We do not expect a massive increase in the budget deficit, despite the forthcoming elections (although some eventual overshoot of the 3.2% budget deficit plan for next year is possible)," Zsoldos added.

He sees the other major source of risk in a major downturn in global risk appetite, “as the country is still seen as the most risky in the region, despite the improvements in fundamentals."

“This risk is hard to pin down, but we think it is more significant for the rates side (the NBH would compensate by tightening) than for the FX side. Overall, some of these risk scenarios may even provide favourable entry opportunities." 

Source: Portfolio Online Financial Journal