"As the global market environment has become less friendly in the past few days, the forint's firming momentum against the euro seems to have faded, while Poland's zloty and the Czech koruna, which are supported by base rates much lower than the Hungarian benchmark rate, conquered new all-time highs versus the single European currency.Is it only a transitional dithering of forint or the end of its months-long and intense appreciation series? If it is the latter, what implications can it have for the interest rate policy of the National Bank of Hungary (NBH)? Is the forint still undervalued in regional comparison? Portfolio.hu has asked these and other questions from a local fund manager and a macroeconomist to see what lies ahead of the HUF. The two economists do not see further HUF strengthening in the short term, but they do not believe it either the national currency will become weaker versus the euro permanently.
“The forint strengthening that kicked in below 250 to the euro initially came about as a consequence of different option deals, but it is hard to grasp why the appreciation has continued over the past weeks, given that we have not seen major foreign capital influx (the churning in of hot money)," Péter Duronelly, investment director of Budapest Fund Management, told Portfolio.hu on Wednesday.
He emphasized that the HUF appreciation took place amidst natural capital flow processes (greatly improving external financing status and the conversion impact of continued foreign currency lending).
Due to the aforementioned, Duronelly expects the forint “to remain hold its strength in the remaining of the year." In the short term he projects EUR/HUF 230-240, while in the medium term he sees 230-250 more likely. “If the exchange rate swings out of these ranges, it will have consequences on interest rates (the base rate of the central bank)," Duronelly added. In his view, the central bank (NBH) could refrain from monetary tightening in the months to come.
Duronelly's projection of the likely EUR/HUF range also leads to the conclusion that the forint's nominal appreciation will not continue and so there will be no improvement in the HUF's considerable lagging behind in the regional firming trend.
Duronelly said the fact that the forint lagged the general appreciation trend in the region “does not create an appreciation pressure in itself", since this is not the case in the unit labor costs (ULC)-based real effective exchange rate.
Should there be a transitional improvement in sentiment in the pessimistic global money and capital market environment (bear market rally), there may be further forint gains ahead for some time.
“At the moment I don't see any major HUF-supporting factor from government securities, since non-residents “are currently not very keen on buying HGBs", Duronelly added. On a 1-2 year horizon, he is most pessimistic about long developed market bonds (expecting yield rises), while he finds it possible that long yields will drop in Hungary in the short term. He noted, however, that it is “extremely difficult to estimate" what consequences of the likely contraction of the Hungarian yield premium could have.
Due to the domestic political risks that stem from the existence of a minority government and risks of a spending spree in the run-up to elections in 2010, no positions are being built on the market, Duronelly said. “Everybody knows that the cabinet will open the money satchel wide before the elections, as the MSZP (Socialist Party) is fighting for survival and wants to prevent Fidesz from obtaining a two-thirds majority (in Parliament)," he added.
The HUF was simply overbought
“The forint has become overbought during the past weeks" and 230, a nice round figure, came in handy in stopping the firming momentum, János Samu, analyst at Concorde Securities, told Portfolio.hu, underlining the psychological factors behind the sizzling out of the HUF's appreciation versus the euro.
Chiming together with Duronelly, Samu also believes the forint is not behind its regional peers in terms of the appreciation of the real effective exchange rate. Consequently, he finds it “hard to imagine" that the forint's strengthening to the euro, which was so intense in the past weeks, will continue. In the short term “chances for a correction are higher", he added.
“I cannot see the major breakthrough" in investors' assessment of the Hungarian economy, but we are beginning to shift into their focus due to the high real rate of return, Samu gave an argument for the strength of the HUF. Meanwhile, the inflation dampening impact of the strong domestic currency and the rate cuts that are likely to follow provide a counterargument. Because of this, “the forint will probably be volatile but without any marked firming “in the months to come, Samu projected.
The analyst sees the forint remaining strong in the medium run, which will improve the outlook on inflation and so it is to exert a favourable impact on government securities yields, as well. In Samu's view, this impact is to be supported if the government does not loosen the fiscal belt in the following two years. Based on the current developments, the analyst is upbeat on the budget.
Samu said he does not feel wage inflation risk overly grave in Hungary, while he believes the deterioration in the European business cycle could drive inflation lower via dampening growth of the Hungarian economy. This is one of the reasons why Samu expects the next policy move of the central bank to be a rate cut.
He believes this could happen already in August, when the NBH will publish its updated Inflation Report. By the end of 2008, Samu sees 100-bp monetary easing that would take the base rate down to 7.50%."
Source: Portfolio Online Financial Journal
17.07.2008