- • The National Bank of Hungary (NBH) and the government decided to scrap the forint’s trading band and adopt a free-float exchange rate regime in order to focus solely on meeting the medium-term inflation target of 3%
- • The inflation outlook contains significant upside risks to the 2009 inflation target and the central bank may have to hike rates to counterbalance these risks, but the forint and bonds may perform well if this strategy becomes credible
The Hungarian government agreed with the central bank to abandon the fluctuation band of the forint on 26 February 2008. The timing of the decision was a surprise for markets as the government didn’t support the idea before. The decisive factor could have been the risk/need of rate hike(s) as inflation has become a major concern for economic policy and as the credibility of the 3% inflation target was at stake.
The conflicting dual inflation and exchange rate targets have been mentioned by many observers as a possible source of instability. The IMF, economic think tanks and many economists argued in recent years that Hungary would be able to achieve low inflation easier without the band.
The band was introduced as part of the Bokros Austerity package in 1995 and was widened to +/-15% in 2001, when the central bank adopted the inflation targeting framework.
Low credibility of the inflation target
Inflation has accelerated to above 7% since last autumn, in line with the trend of other CE4 countries. However, there have been signs that inflation has not just risen on one-off shocks, like food, fuel or regulated prices, but that also services and tradable goods showed some acceleration in recent months. The underperformance of the forint and of the long end of the local government bond curve were a signal that markets feared the inflation shock was not just temporary, but that part of that could become a permanent development.
