If this continues, trust in the HUF may be irretrievable

A HUF after the collapse of its exchange rate in 2022, hopes were revived last year and again this year that the weakening trend that started in 2018 has ended and that the period of stability of the forint may come again, which may last until the introduction of the euro.

With the approach of the 400 exchange rate level, the confidence of many was shaken again, but now, after the level has fallen substantially, hope is really beginning to run out of reason.

Since the end of 2022, as can be seen in the graph, the stability of the forint was guaranteed by the fact that the exchange rate of the euro did not exceed the level of 400, for a day at most, but even then it quickly returned below.

In recent months, it was already worrying that the exchange rate was getting closer and closer to the level, started sticking to it, and then closed above it on a weekly basis at the beginning of October. After that, it still looked like it could go back below that level, but after the uncertainty of the last few weeks the current ugly weekend doesn’t promise anything good technically.

Mid-week turnaround

The question is why all this happened when the balance of payments still shows a strong surplus, and the central bank previously emphasized the importance of exchange rate stability. If we look at when the last strong weakening phase started, it could be that the MNB’s interest rate decision on Tuesday and its explanation could be a decisive factor after the decline started the following day.

In itself, the fact that there was no interest rate cut did not cause any surprise, as this was also what the market expected. However, the central bank communicated that the current level of 6.5 percent, which is high compared to both inflation and the base interest rate of the Eurozone, could be maintained for a long time, and this may have alarmed the market.

There can only be one substantial reason for the stalling of the interest rate reduction cycle, and that is precisely the weakening of the forint. The effects causing the weakening, i.e. the money market situation, are worse than what the central bank had previously expected, which is clearly shown by the exchange rate itself.

Conversion of savings

With a permanently surplus balance of payments, the currency only weakens if, for some reason, the demand for the euro/forint is so strong that it exceeds the effect of the balance surplus. In practice, this can happen in two cases: if domestic trips or purchases abroad increase to an extremely large extent, or if, due to a lack of trust, savings are converted en masse into euros. The first case is not very likely, since the tourism coming to the country is also very strong, but the mistrust is even more so.

Level 400 can have a serious psychological effect: many people might have thought that if they saw this again, they would stop taking risks and switch to the stable euro, especially since the risk-free forint interest rates and returns have already fallen compared to last year’s levels.

The effect can be strengthened by the increasingly uncertain macroeconomic situation: the budget deficit is mitigated only by EU funds that are still trickling in.

Uncertainty factors

The data on economic growth and the decline in industrial production do not inspire confidence, and in such circumstances, the 3-6 percent economic growth vision proposed by the government for next year may also indicate that, in order to stimulate the economy, fiscal discipline, low inflation, or they can even sacrifice the stable HUF exchange rate.

The effect of all this can be strengthened by the expected election spending next year, as well as the fact that there will be a new central bank governor from March. thus, monetary policy can also changethe stability of the forint exchange rate, as a priority, may also take a back seat in the case of the central bank.

Outburst

The fears are thus given, the flight to the euro is an understandable process, and now the signal on the graph also confirms these processes.

The longer the exchange rate of the euro is above HUF 400, the less they expect it to return below it stably and permanently, so in a technical sense, the breakout from the almost 2-year base, in which the 400 level was the strong resistance, is becoming more and more realized.