To the gloom which is growing here we could add the prediction from 4Cast this morning that energy and forex pressures will force the Central Bank Monetary Council to hike rates by 25 basis points in February.
“Though the call is finely balanced, the fact that market prices an absolutely zero chance for a hike offers a good opportunity to open bearish positions that could be closed with minimal losses if we happen to be wrong," said Gábor Ambrus, analyst at 4Cast is quoted as saying.
Ambrus stressed that forecasting Hungarian rates has been “one of the most challenging tasks lately", with rate calls over the past year undergoing serious revisions even the week ahead of meetings. I think one of the important points to notice here is the mention of "forex pressures". In my opinion it will be the need - at least as long as they are able to - of the central bank to try and protect Hungarian households and corporates from "translation risk" arising from a falling forint that will increasingly drive short term monetary policy. This of course puts internal demand in a real straightjacket. It also builds up future risk, since - as indicated yesterday - the differential between forint mortgage loan interest rates and Swiss franc ones will only encourage further borrowing in the Swiss franc, borrowing which at some stage will undoubtedly unwind, since with the forint where it is it is hard to see substantial export growth. Basically a very, very difficult situation. To which must be added the looming political instability.
This issue is rapidly being brought home on the sovereign debt front, with Fitch following colse behind the warning from Standard & Poor's last week about risks of pre-election fiscal laxity in Hungary. Fitch Ratings added its voice to this growing chorus yesterday (Moody's were also busying themselves warning on Bulgaria, and Fitch itself recently lowered the broad credit rating outlook across a wide range of Eastern European countries citing specifically the deteriorating global conditions and the dependence these countries' have on external financing to keep the boat afloat). This time it was Ed Parker, Head of Fitch's Emerging Europe Sovereign Group in London who fired off the warning shot, indicating that Fitch are unlikely to be moving the Hungary sovereign rating upwards any time soon, point out that the ratio of direct capital inflows was likely to drop in 2008 from the 54% level achieved in 2007.
Unsurprisingly Parker mentioned the general elections which are set to take place in 2010, saying the run-up to elections creates uncertainties about the results of the consolidation, which may be exacerbated by risks attached to growth and inflation. But of course he could well have added that this uncertaintly will only be heightened if the planned referendum in March goes forward.
Fitch was the last revised its credit outlook on Hungary on 5 November 2007. At that point it affirmed Hungary's Long-term Foreign Currency Issuer Default Rating (IDR) of 'BBB+', its Short-term Foreign Currency IDR of 'F2', its Long-term local currency IDR of 'A-'(A minus) and its Country Ceiling of 'A+'. The Outlook on Hungary's Long-term IDRs was revised to Stable from Negative.
Hungary is looking at a possible downgrade to the outlook on its debt if the Socialists-led government decides to remedy its unpopularity by opening the money sack in the run-up to elections, Kai Stukenbrock, S&P's primary ratings analyst for Hungary, said last week.
Fitch was the last credit rating agency last year to revise the outlook on Hungary. On 5 November it affirmed Hungary's Long-term Foreign Currency Issuer Default Rating (IDR) of 'BBB+', its Short-term Foreign Currency IDR of 'F2', its Long-term local currency IDR of 'A-'(A minus) and its Country Ceiling of 'A+'. The Outlooks on Hungary's Long-term IDRs have been revised to Stable from Negative.
Update Wednesday afternoon:
And of course it never rains but it pours. Lucy Bethell, a currency strategist at Royal Bank of Scotland in London has argued today that Hungary's forint may fall to an all- time low against the euro in 2008 as appetite for emerging- market assets wanes and the country's economic outlook worsens. Earlier today she suggested that the currency may trade as low as 290 during 2008, and the forint declined by 0.2 percent to 260.15 per euro as of 12:11 p.m. in Budapest. Bethell's end-of-year forecast is 280 per euro.
``Having seen the leu and then the rand weaken in reaction to global risk-aversion, the forint looks next in the firing line,'' Bethell wrote in a report yesterday, and Hungary's ``external financing needs are comparatively heavy'' at about 12.5 billion euros ($18.3 billion. ``The stock of international investment in local debt has already increased this year, leaving investors vulnerable to a gradual deterioration in risk appetite,'' Bethell wrote. ``With tight fiscal policy already priced in, it won't take much to dent the market's confidence.''
The forint is the worst performer against the euro this month among 26 emerging-market currencies, falling by 1.2 percent. A decline in the forint to 290 per euro would exceed the previous record low of 285.15 in June 2006, when Standard and Poor's cut Hungary's credit rating one step to BBB+ and the government announced measures to cut the budget deficit.
Clearly everyone has the jitters at the moment. Speculation following a rumour which went the rounds of financial the markets that Finance Minister János Veres and Prime Minister Ferenc Gyurcsány were about to announce their resignation lead thre forint to continue down to above 263 to the euro - a low that has has not been seen for more than 18 months now.
Responding to a question from a journalist, government spokesman Dávid Daróczi said speculation about such resignations was “absurd". Nonetheless it is difficult to see where the government can go, if the March referendum goes forward, and if the vote is to suspend the health and other charges, since this would be tantamount to a vote of no confidence in the whole fiscal adjustment process. With Hungarian monetary policy caught in a vice of having to try and protect the value of the forint due to the translation risk threat, and fiscal policy in real difficulty as internal demand slides downwards with no ability to ease, and indeed reduced revenue possibly coming onstream at some point if unemployment continues to rise, even while export opportunities decline in a more complicated external environment, policy has few real options at this moment, and the government must know that.
Second Update Friday Afternoon
The anti keeps going up and up. Gábor Orbán, portfolio manager at Aegon and a former member of the central bank's (NBH) staff in its Economics Department, has upped his inflation forecasts, saying higher CPI numbers make a rate hike inevitable. Portfolio Hungary cite him extensively:
“We have raised our forecast on annual average inflation to above 6% and 4% for 2008 and 2009, respectively. Since the inflation course is well above the 3% goal even on the horizon relevant for monetary policy, we give a greater chance for a rate hike than unchanged rates from now on," Orbán said.
“As the market, especially foreign punters, are just marinating these news, we should breace ourselves for serious negative reactions on the bond market," he added.
Orbán said he upped his CPI projections mainly over the impacts of the electricity market's liberalization. The restricted nature of the market liberalization may lead to a 30-40% hike rise for industrial users this year, which through production costs will exert an impact on consumer prices, as well, he noted.
If this increase affected every company (and they managed to fully pass it on to consumers) core inflation would go up by 1.0-1.5 percentage points, so the consumer price index would come in 0.8 ppt higher (at end-2009).
“In its February inflation prognosis, the NBH cannot escape but to take into consideration the aforementioned inflationary impacts. We believe the (February) rate decision will be basically determined by the end-2009 inflation, which could be around 3.5%, but most definitely, and in its trend, too above the 3% objective. [...] After the debate of the February Inflation Report, chances for a rate hike decision at the policy meeting have grown considerably," Orbán said.
The reaction of the market will be a “hump" in the yield curve, as rate hike expectations are getting priced in, which would hit the medium segment the hardest, he added.
If monetary tightening failed to materialise, it would lead to substantial forint depreciation through the consequent credibility problems and the revaluation of the central bank's inflation preferences, Orbán said. Such a step would also lead to a significant and lasting increase in the yields of longer bonds.
Altogether, we should not expect the long end of the curve to “get away with it", so yields in that segment look set to increase - if only transitionally - anyhow. Orbán projects that the forint's easing to the euro - a consequence of monetary tightening, political, growth and balance woes - and a deteriorating CPI outlook will push the fundamental value of the 10-year bond to above 7.4% transitionally and that of 2-yr and 3-yr instruments to above 7.5%. In the general negative sentiment market quotations could remain well above these levels, he added.