Currency Forecast - HUF: Monetary Easing Weighing On Short-Term Outlook - JUNE 2017

BMI Hungary Currency Forecast
Spot 2017f 2018f
Source: Bloomberg, MNB, BMI. Last Updated: 31 March 2017
HUF/EUR 308.58 308.79 306.00
HUF/USD 288.78 299.80 300.98
Policy Rate, eop 0.90 0.90 2.00

BMI View: The Hungarian forin t will remain broadly stable against the euro in the short term, as declining rate expectations in Hungary weigh on the unit . Longer term, a persistent nominal and real rat e differential between Hungary and the eurozone will underpin gradual HUF appreciation, as will higher real GDP growth rates in the former.

Short-Term Outlook (three-to-six-months)

We expect the Hungarian forint (HUF) to remain broadly stable against the euro in the short term, as interest rate expectations in Hungary have been pared back somewhat in light of the persistently dovish position of the Hungarian Central Bank (MNB). Significant downside pressure on the forint stemming from lower rate expectations is likely to be largely avoided however, as the recent decline in developed market rate expectations - largely due to a re-pricing on account of fading optimism surrounding growth and reflation prospects in the US - support the relative attractiveness of HUF-denominated assets. Following a false break of resistance at HUF307.00/EUR in September 2016, which saw the currency appreciate to a 17-month high of HUF305.28/EUR, the forint has since been on a mildly depreciatory trend. Looking ahead, the next three-to-six months is likely to see the forint trade within a range of HUF307-312/EUR.

Stable In The Short Term
Hungary - Exchange Rate, HUF/EUR (Daily)
Source: Bloomberg, BMI

Long-Term Outlook (six-to-24 months)

In terms of valuation, Hungary's CPI-adjusted Real Effective Exchange Rate (REER) is currently running around 6.0% below its 10-year average, which in the context of Hungary's sizeable current account surpluses (estimated 4.4% of GDP in 2016) suggests to us that the forint is trading at undervalued levels. However, when adjusted for unit labour costs (ULC) the picture is somewhat different as the REER has already risen by 5.0% since 2015. In part a corollary of growing labour shortages, rising costs are placing pressure on the country's ULC-adjusted REER and limiting the unit's external competitiveness, adding weight to our forecast for only modest HUF appreciation over the longer term.

Rising ULCs Hampering External Competitiveness
Hungary - CPI (LHS) & ULC (RHS) adjusted REER, 2005=100
Source: Eurostat, BMI

From a fundamental perspective, a persistent nominal and real interest rate differential between Hungary and the eurozone will continue to favour HUF. Although markets are beginning to price in a less accommodative European Central Bank (ECB) over a multi-year horizon, including the possibility that the ECB hikes the negative deposit rate in 2018, systemic and fiscal risks in the eurozone will limit its ability to tighten policy, and our core view remains that its overall policy stance will remain quite loose through 2020, keeping real yields depressed. While markets have recently pared back interest rate expectation in Hungary, we expect accelerating core inflation to necessitate a reversal of the MNB's current dovish stance, with the central bank commencing monetary tightening in 2018. Given our outlook for real rates across the eurozone to remain low in the years ahead, gradual rate hikes in Hungary will widen real rate differentials, lending support to the forint.

Long Term Trend Intact
Hungary - Exchange Rate, HUF/EUR (Monthly)
Source: Bloomberg, BMI

Higher inflation and more positive growth dynamics in Hungary relative to the eurozone will also be supportive of the forint. Reflecting this, we expect real GDP growth in Hungary to accelerate to 2.6% and 2.8% in 2017 and 2018 respectively, from 2.0% in 2016, compared to an average growth rate of 1.6% for the eurozone. This largely informs our above-consensus forecast for nominal rates in Hungary over the coming years, meaning elevated inflation is unlikely to undermine real rates significantly. An improving debt profile will also be supportive of the forint, as will obtaining an investment grade rating from all three major credit rating agencies in 2016.

Persistent Real Rate Differential Supporting Forint
Real Yields & Spread Hungary Over Germany, pp (10-Year Local Debt Yield Over Core CPI)
Source: Bloomberg, BMI

Reflecting this, we expect the lira to reach HUF308.00/EUR and HUF306.00/EUR by end-2017 and end-2018 respectively, after averaging HUF308.79/EUR during 2017. While this suggests a modest pace of appreciation in spot terms, we are more bullish relative to what FX forward markets are currently pricing in. In line with this, the latter is pricing in the forint ending 2017 and 2018 at HUF310/EUR and HUF312/EUR respectively. Therefore, given our above consensus forecast for nominal rates, in total returns terms we see the unit performing well in the long term.

Risks To Outlook

While we forecast the MNB to begin tightening monetary policy in 2018, it is plausible that the central bank could delay hiking if growth disappoints, undermining the forint. This would be exacerbated by the widening fiscal deficit, as the government shifts to an expansionary fiscal policy. Further damaging the HUF in this scenario, a faster-than-expected rise in global inflation and interest rate expectations - in the US or the eurozone - would be fundamentally bearish for the forint and emerging market assets more broadly. A sharp further rise in global yields could precipitate a noticeable sell-off in the forint in the context of a prolonged dovish bias in Hungary.