Right now, all eyes are on the Greek debt crises and its resolution. However, while all financial eyes are on Athens and Brussels another EU problem is brewing in Hungary. The Hungarian banking crises began during the housing bubble. At the time, the Swiss Franc was pegged to the Euro and it was less expensive for Hungarian banks to fund mortgages with Swiss Francs. After the bubble burst and the Eurozone recovery failed to take hold, the ECB set out to weaken the Euro. The Euro plunged to record lows against major currencies.
In the last quarter of 2014, foreign currency mortgage payments had become increasingly expensive as a result of the MNB’s weakening of the Forint[i]. The populist administration of recently re-elected Prime Minister Orban[ii] ordered banks to refund over £2.66 billion for unfair lending practices. The Hungarian Parliament approved legislation making the refund law[iii]. During this time, the Hungarian National Bank decided to maintain its benchmark at 2.1% set in July of 2014. This was the last of a two year easing cycle. However, the sequential easing weakened the Forint causing foreign currency mortgage payments to edge even higher.
Hence, the Hungarian private sector banking system was already extremely stressed months before the Swiss decoupling from the Euro. It should be noted that the private banking sector is 60% privately owned, (a good portion of that foreign), and 40% owned by the state. So by the end of 2014 as the MNB, the Hungarian government, courts and banks struggled to stabilize the financial sector, unbeknownst to anyone, Hungary was on a head-on collision course with the Swiss ‘Black Swan’ event.
Meanwhile, in a determined last effort, the ECB President Draghi had promised a bond buying program beyond all expectations. Sovereign yields across the Eurozone crashed through the zero bound. This did not go unnoticed by the Swiss National Bank. The SNB vigorously defended its Euro pegged export economy, swapping Euros for Francs until it was no longer viable. On 15 January, the SNB bailed on the Euro altogether. Not only did the Euro plunge vs the Franc, but so did the non-Eurozone currencies of EU members, such as Hungary. The loans financed in Swiss France became unaffordable, overnight[iv].
Remarkably, the Forint continued to strengthen vs the Euro, from the 15 January 52 week high of 327.67 to the Euro, toward its April low of 295.583 to the Euro; a 9.79% gain. MNB managing director Marton Nagy saw no need for the MNB to respond to Swiss Franc strengthening[v]. It needs to be noted that the MNB ‘base rate’ had last adjusted down to 2.10% in July of 2014. On 23 January the ECB announced its €1 trillion (£719.4 billion) bond purchase program. EUR/HUF dropped from its 52 week high of 327.67 per Euro to support at 309.54, a 5% decline in a week. The yield on the Hungarian 10 Year +BB sovereign bond fell to 2.86% from 3.04%. On 27 January, MNB signaled that although it was maintaining the 2.1% two week deposit rate, that more liquidity would eventually be needed[vi]. A few weeks later, the MNB doubled its bank bailout program to £1.234 billion to stimulate GDP growth. The MNB would resume its easing program 24 March, lowering the two week deposit rate to 1.95%
EUR/HUF finally found support at its 52 week low of 295.583 Forints to the Euro on 15 April and reversed from there. The MNB cut rates again to a new record low, 1.80% on 21 April. It was around that time that the ECB was alerted to possible banking irregularities, announcing that the MNB would be monitored closely for any funding of the government by the MNB; a prohibition under EU regulations. It was stated: “…Given the multitude of programs, their scope and their size, these programs could be perceived as potentially in conflict with the monetary financing prohibition, to the extent that they could be viewed as the [central bank] taking over state tasks or otherwise conferring financial benefits on the state…[vii]”
With increasing GDP and inflation expectations, reality finally reached currency markets and the Forint steadily weakened. More rate cuts followed on 26 May to 1.65% and on 24 June to 1.50%. These cuts were made in spite of increasing inflation expectations. Also, MNB switched its main policy tool 2-week deposit rate to the 3 month deposit rate, effective September 2015.
What are the possible outcomes? No matter how the Greek debt resolution goes it will cost the EU in some way. Most likely the Euro will experience further weakness against other majors. Hungary, on the other hand still has a serious dilemma of its own. It’s now under the watchful eye of the ECB, has a major stake in a troubled banking system whose major stakeholder are foreign. All the while, inflation seems to be accelerating. Further, monetary policy seems increasingly influenced by government policy. The existing plan to swap foreign currency loans for Forint loans, although remarkably successful, is bound to be inflationary at some point. Although, the MNB has given no indication it will reduce the two week deposit rate further, it will have a higher rate to work with when it switches its main policy tool to the 3 month deposit rate[viii].
The question becomes whether the MNB can get ahead of inflation quickly enough, if it should accelerate suddenly. If the Greek-EU standoff is resolved, it will strengthen the Euro at least for a while. If not, a ‘flight to quality’ might make the higher, but risker Hungarian deposit rates a ‘temporary haven’ rather than near zero or negative Eurozone deposit rates.
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[i] Forbes 29-7-2014
[ii] Bloomberg 12-9-2014
[iii] Reuters 8-6-2014
[iv] BBC 20-1-2015
[v] Hungary Today 22-1-2015
[vi] Bloomberg 27-1-2015
[vii] NASDAQ 20-4-2015
[viii] Bloomberg 2-6-2015