The Hungarian forint gained more than 1% against the euro on July 3, drifting below its all-time low of 330.7 earlier in the day. The central bank hopes to sit out the storm without giving in to the market's expectations to end its dovish policies, but bond yields have continued to creep up higher.

The Hungarian currency was quoted at 327 versus the euro on Tuesday afternoon and one dollar bought 280 forints, a gain of 1.5%. The forint strengthened more than its regional peers on Tuesday on expectations that the Magyar Nemzeti Bank (MNB) will possibly shift its tone and review its stance on its ultra-loose policies.

The markets have begun to price in higher rates, based on future contracts of the Bubor, the Budapest Interbank Offered Rate, business website Portfolio reported.

At present, the three-month Bubor rates are quoted at 0.28%, but forward rate agreements show significantly higher rates, at 1.12% from six months on, which is 22bps above the 0.9% base rate.

Bond yields up steadily

Bond yields on both the short and long ends continued to creep up. State debt manager AKK sold HUF36.5bn of discount three-month T-bills at Tuesday’s auction, below its initial HUF40bn offer. This is the first time since mid-December that the debt manager has sold T-bills below its offer.

The average yield rose to 0.26%, its highest level since March, 13bps over the secondary market benchmark and a 3bps increase from last week. The auction reflected the market sentiment that the MNB should be starting to tighten rates.

Yields of the three-year bond rose to a two and half year high of 2.09%, the five-year bond to a one-year high of 2.49%, and the 10-year bond to 3.76%, its highest level in three years, with 17bps, 14bps, and 10bps increases respectively.

The MNB's Monetary Council held a non-rate setting meeting on Tuesday, where they discussed economic and financial trends, and according to the statement the exchange rate was not on the agenda.

MNB on the sidelines

The MNB has been trying to sit out the current wave of forint depreciation and is sending out the message that there is nothing spectacular going on, trying to fend off any suggestions seen by some market players that there is a tension between the ultra-loose monetary conditions and economic fundamentals, business portal Portfolio observed.

The MNB's communication strategy has been clear. It confirmed on Friday that it does not wish to react to exchange rate movements and its primary goal and legal mandate is to achieve and maintain price stability. It also shrugged off any suggestions that speculation may be behind the forint, a comment made by government spokesperson Zoltan Kovacs.

This idle and wait-and-see position of the MNB shows that it is not worried about the impact of the weak forint on inflation, according to analysts. The central bank has shown resilience in not giving in to market pressure on previous occasions when the forint has moved to the lower end of its band.

For a long time, its strategy paid off: the forint has appreciated back to stronger levels each time. The massive trade and current account surpluses have helped to reduce the country's external vulnerability, and the steady inflows of EU funds also lent support to the exchange rate.

For more than two years, the EUR/HUF exchange rate moved in a tight range of 303-315. It slipped to a two-year low of 317 in May during the Italian mini-crisis. Since then it has weakened more than 4%.

The April foreign trade data has shown that the massive surplus is beginning to narrow as rising consumption and investment activity will likely lift imports, while exports remain vulnerable to negative economic news coming from Hungary's main export markets.

Raiffeisen Bank has adjusted its forecast higher to a level of 325 at the end of September 2018 and to 320 at the end of the year. It expects the 320 level as the new equilibrium exchange rate.

Finance minister sees no inflation risk

Finance Minister Mihaly Varga acknowledged that the budget factors in a stronger HUF/EUR exchange rate than seen in recent weeks, but said the weakening of the forint did not pose a risk to the budget balance.

Inflation continues to remain below 3% and the oil price is not critical either, so the government does not plan on intervening, Varga said, adding that the central bank was closely monitoring the exchange rate and could count on the government's help should it need to step in.

He did repeat that the 2019 budget, which parliament could approve next week, would ensure steady economic growth and reserves should increase by 50% to more than HUF300bn.

When the government released the first details on the budget draft and its plans to boost reserves last month, it lent support to the exchange rate.