Hungary’s central bank scrambled to prop up the forint on July 7 as the currency became a target of speculators amid worsening emerging market sentiment and concerns over the country’s macro-economic vulnerabilities.
The Hungarian National Bank (MNB) hiked its one-week deposit rate by 200 bps to 9.75%, and strongly hinted it would raise the base rate at its next meeting on July 12.
“It is considered necessary that the rise in the one-week deposit rate should be built into the base-rate tightening cycle as early as possible. The fast closing of the gap between the base rate and the one-week deposit rate will be discussed at the Monetary Council’s next meeting on 12 July,” the MNB said in a statement. Last week policymakers had raised the base rate by 185bp and the one-week deposit rate by 50bp, bringing both rates to 7.75%, already the highest rate in Central Europe.
The bank added that it will start using swap tenders providing foreign currency liquidity within quarters. The first tender will be held on 8 July.
The moves steadied the forint, which was trading at 402 to the dollar on July 8, down from 384 at the start of the week, but up from almost 410 on July 6.
In addition, Prime Minister Viktor Orban’s radical rightwing government indicated on July 7 it would take further measures to cut the budget deficit, which has ballooned because of pre-election budget giveaways at the start of the year, now accentuated by further handouts to lessen the impact of higher energy and food prices.
The central bank remains focussed on the threat of inflation, which has been worsened by the falling forint. Inflation has soared because of imported energy and food price rises, which the government has merely tried to cover up by temporary price ceilings. Hungary’s CPI growth came in at 10.7% y/y in May.
Growth remains strong, giving the central bank some leeway to raise rates without fear of sparking a recession. The MNB raised its GDP growth forecast in a recent report to 4.5-5.5% in 2022, driven by growth in consumption.
The economic crisis is putting further pressure on the Hungarian strongman to cut a deal with Brussels over Hungarian breaches of the European Union’s rule of law, which has led to the freezing of EU Reconstruction Funds, which could account for 0.6% of GDP in 2022 and 2023.
Concerns over Hungary’s deteriorating budget and current account deficits have led to Hungary being picked out as the most vulnerable country in Central Europe to financial market concerns over rising inflation and deteriorating growth, sparked by Russia’s invasion of Ukraine and the West’s imposition of sanctions.
Hungary had a trade deficit for the tenth month in a row in April and the current account deficit is on track to reach nearly 7% of GDP. This compares with 2.2% of GDP in the Czech Republic and a deficit of 1.5% of GDP in Poland, Reuters reported.
In May Orban’s government announced windfall taxes aimed at collecting HUF800bn from companies in eight sectors, including in energy, retail and airlines, but these kind of temporary fixes have not impressed investors.
Hungary also remains one of the most indebted countries in Central Europe, with a public debt level of around 77% - far higher than 42% of GDP in the Czech economy and about 56% in Poland, according to Reuters. S&P has pointed out that Hungary needs to repay or refinance 11.5% of GDP annually. Rising financing costs could increase by 1.6% of GDP by 2025, an extra burden of HUF800bn (€2bn).
Moves by the European Central Bank and the US Federal Reserve have deepened the investor flight from emerging markets, pushing up bond yields and putting pressure on currencies across the region. Emerging markets saw $4bn of outflows in June as fears of a coming global recession grew stronger, the Institute of International Finance said in an update on July 6.
However, the forint has become decoupled from its peers in Central Europe – with the forint depreciating about 9% this year, while the Polish zloty has eased just 4%, Reuters reported. Hungarian bond yields have also jumped this week, with the 10-year yield at around 8.80%
The MNB was the first central bank in the EU to begin the current tightening cycle but it has now been overtaken by others. However, in Hungary the monetary policy has also been undermined by the government’s continuing loose fiscal policy.
Real interest rates are negative throughout the region and analysts predict further rises.
The National Bank of Poland (NBP) increased its reference rate by 50bp to 6.5% on July 7, below market expectations for a hike of 75bp at least. Analysts said the NBP had wound down the pace of monetary tightening – after a series of five increases ranging from 75bp to 100 bp – because of worries that another big rate rise could hurt already flagging Polish growth.
On July 7 Serbia's central bank raised the reference interest rate further, by 0.25 of a percentage point, to 2.75% as part of its tightening policy.
On July 6 The National Bank of Romania (BNR) surprised the market with a 1pp rate hike that brings the refinancing rate to 4.75% and the Lombard rate to 5.75% — which is still far behind the inflation rate (14.5% y/y in May.
The Czech central bank remains the most hawkish in the region after the MNB. The CNB hiked its base rate by 1.25pp to 7% last month to contain inflation, though incoming Governor Ales Michl has indicated that he will try to restrict further rate increases. Czech inflation reached 16% y/y in May, above the CNB’s forecast of 14.9%.