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Hungarian central bank scraps forint trading band

Hungary's central bank on Monday ended the forint's 30% trading band against the euro which has been in place since 2001, surprising markets with the move after the government gave its last minute agreement.

Governor András Simor told a news conference the move, agreed prior to Monday's decision to leave rates unchanged at 7.5%, would enable the bank to target inflation alone.

The news of the end of the band initially prompted a surge in the value of the forint against the euro to as strong as 257.50, but by 1833 GMT it was trading at 262.45 to the euro, around 0.8% stronger from the opening.

“If I'm trying to meet two goals (inflation and exchange rate) with one tool, then markets will start to wonder whether I'm really taking inflation targeting seriously,” Simor said.

“We think that markets will consider the bank's monetary policy more credible if there is no band,” he said.

Simor stressed that abandoning the band would also ease Hungary's path to joining the European Exchange Rate Mechanism 2, seen no earlier than 2012 by analysts in a Reuters poll.

“In terms of ERM-2, I've always said it's not necessarily good to go from one band to the other as the parity of the two may not be the same,” he said.

A government source told Reuters that the deal had been agreed only late on Sunday and that the cabinet noted the currency had moved away from the strong end of the band at 240.01 to the euro and believed there was a risk of more weakness.

“There had always been fears of excessive firming if the band was abandoned but recent market trends have reduced this risk and allowed fears to ease,” the source, speaking on condition of anonymity, said.

A Reuters poll conducted after the float showed analyst forecasts for the forint unchanged at 255 by the year end compared with 256 in a poll last week.

In the meantime, while the central bank left its key policy rate unchanged, it also warned of the risk of higher inflation as it raised its 2009 consumer price inflation forecast - its key policy horizon - to 3.6% from 3.0%.

The latest headline inflation figure was 7.1% year-on-year in January, caused by rising taxes and prices, especially commodities.

Simor said the bank “cannot and will not tolerate second round inflationary impacts.”

Analysts said however that the bank may still need to hike and credit rating agency Fitch welcomed the move as showing greater transparency, but said it would not alter its ratings outlook which is “BBB-plus” with a stable outlook.

“The upside shift in the inflation forecast suggests to us that the MNB needs to see a significantly stronger forint to meet the inflation target, and with the abandonment of the band significant forint appreciation is now possible, supporting disinflation,” said Eszter Gargyan at Citibank.

“Therefore, we believe that MNB will still need to raise rates in the coming months, but less aggressive moves may be sufficient to support the currency due to the strengthening of monetary policy credibility,” she said. (Reuters)