The economic situation of two countries / currency areas When one country's economy grows faster than the other, demand for its currency usually increases as more investment and trade are attracted. This leads to an appreciation of one currency against the other. Conversely, a weaker economy leads to less demand and a depreciation of the currency. The monetary policy of the respective central banks When comparing central banks of two currency areas, they influence the exchange rate through their monetary policy decisions, such as setting the policy rate, conducting bond purchases or providing liquidity. These actions have an impact on inflation, economic growth, and market confidence in both currencies. Expansionary monetary policy, which aims to stimulate the economy, typically results in lower inflation and interest rates, which reduces the attractiveness of the currency and leads to depreciation. Tight monetary policy aimed at fighting inflation usually leads to higher inflation and a higher interest rate level, which increases the currency's attractiveness and leads to appreciation. Supply and demand in the foreign exchange market The foreign exchange market is where different currencies are traded. The supply and demand for a particular currency depends on various factors, such as the trade balance, capital flows, market participants' expectations and political events. When the supply of a currency is higher than the demand, its price falls and it depreciates. When the demand for a currency is higher than the supply, its price rises and it appreciates. If one goes into a bit more detail, 9 factors influencing the attractiveness of a currency can be found: Inflation Lower inflation of one currency compared to another is more attractive. That is, if inflation rises, the value of the currency falls. At the same time, it usually leads to rising interest rates. Interest rates If the interest rates of a currency rise, the currency becomes more attractive to lenders due to higher yields. This attracts foreign capital, which causes the currency to appreciate. Recession As a rule, interest rates fall in countries with rising recessions in order to support the domestic economy. However, this also makes the country less attractive to foreign capital, which causes the currency to depreciate. The exchange rate falls. Current account balance The current account records all expenditures and receipts of an economy from cross-border trade flows (goods and services) as well as income flows (earned income, property income, debt). The current account balance determines whether an economy produces more than it consumes or vice versa. A surplus in the current account balance means that a country's economy exports more than it imports, which leads to an appreciation of its own currency. A current account deficit means that an economy imports more than it exports and incurs foreign debt. Speculation If the market expects the value of the country's currency to increase, investors buy more of that currency to profit from rising rates of the currency. This further increases the demand for the currency and appreciates its value. Fiscal and trade policy The more sound a country's financial and trade policies are, the more confidence investors have in the country because the risks of abrupt changes are lower. This increases the currency's attractiveness. Political stability Markets hate instability and turbulence. The more stable an overall political situation is in one currency zone compared to another, the more predictable investments are, which attracts foreign capital. This increases the value of the currency. Import exchange ratio This is a ratio from economics that shows the ratio of export prices to import prices in a country. If export prices rise more than import prices, demand for the national currency increases, which increases the value of the currency. Government Debt If the market expects a further increase in government debt, the risk for capital providers also increases. Existing government bonds are sold on the market. As a result, the currency loses value. As can be easily seen, the influencing factors are complex interrelationships that often do not allow linear causality to be precisely demonstrated, since several factors act simultaneously. However, every now and then there are events that have a stronger effect and can explain the development in retrospect. What does that mean for the exchange rate development of EUR/ HUF? For more than 10 years, the euro has been on an uptrend against the forint, with temporary fluctuations and a major outlier in 2022. Source: ECB, own illustration In tabular form, the average EUR/HUF exchange rates over the last 10 years are as follows:
Positive influences:
As a result, the EUR / HUF exchange rate was stable on an annual basis in 2016 with close to 0% change due to the many mutually offsetting factors. Example 2020 Source: ECB The existing structure comparing the economic situation of the Eurozone and Hungary has changed due to the COVID-19 pandemic in 2020. Thus, Hungary's economy was hit harder than the Eurozone's, resulting in a year-on-year decline in gross domestic product (GDP) growth of 10.7 percentage points, while GDP growth in the Eurozone 'only' declined by 8.1%. These changes in the economic situation of the two currency areas had a negative impact on the forint against the euro. This devalued the Hungarian Forint against the Euro, as can be seen in the increase of the EUR/HUF from 330.53 HUF on January 1, 2020 to 356.92 HUF on March 18, 2020. Both the Eurozone and Hungary adopted monetary policy measures in the same year to stimulate the economy. For example, the ECB measures in 2020 included lowering the deposit rate to -0.5%, which made the euro rather less attractive. At the same time, there was an increase in the Pandemic Emergency Purchase Program (PEPP) to €1.85 trillion and an extension of the Targeted Longer-Term Refinancing Operations (TLTRO) III. The increase in the PEPP and the extension of TLTRO III in 2020 had a mixed effect on the euro exchange rate. On the one hand, these measures have improved financing conditions for the real economy in the euro area and supported inflation expectations, which has contributed to an appreciation of the euro. On the other hand, these measures have also eased monetary policy in the eurozone and reduced the interest rate differential between the euro and other currencies, which has led to a depreciation of the euro. According to an analysis by the European Central Bank (ECB), the monetary policy measures taken in 2020, including the PEPP and TLTRO III, have contributed to an improvement in financing conditions for the real economy in the eurozone. These measures have meant that financing conditions for companies and households have been more favorable than they would have been in the absence of these measures. This in turn has had a positive impact on economic growth and inflation in the euro area, making the euro more attractive. However, monetary policy measures have also led to an easing of monetary policy in the eurozone, which has devalued the euro relative to other currencies. For example, in April 2020, the ECB lowered the interest rate on the TLTRO III from -0.5% to -1% , which means that banks that increase their lending can benefit from a negative interest rate. This has contributed to the ECB's key interest rate remaining at 0%, while during the same period in 2020, the National Bank of Hungary (MNB) reduced the key interest rate from 0.9% to 0.6% in several steps to stimulate the economy, making the forint less attractive against the euro. The net effect of these factors on the euro exchange rate depends on the relative strength of these factors, which may depend on various market conditions. For example, the effect of improving financing conditions for the real economy may be stronger if the economic recovery in the euro area is faster than in other regions or if inflation expectations in the euro area are rising. Conversely, the effect of easing monetary policy may be stronger if the economic recovery in the euro area is slower than in other regions or if inflation expectations in the euro area are falling. One way to measure the net effect is to look at the actual exchange rate trend of the euro in 2020. The euro appreciated by 9.8% over the course of 2020. This suggests that the effect of improving financing conditions for the real economy was stronger than the effect of monetary policy easing. However, this increase may have been influenced by other factors, such as the course of the COVID-19 pandemic, geopolitical tensions, or trade relations. One can see from the 2020 example alone how very different factors can influence the exchange rate to varying degrees. It is almost impossible to bring such complex factors into calculable cause-and-effect relationships. Example 2022 Let's look at more current developments in 2022. Source: ECB The exchange rate between the euro and the Hungarian forint rose sharply in 2022 and then fell again. This is due to various factors that have influenced both the demand and supply of the two currencies. Some of these factors are:
Obviously, the economic development was not so strong that it outweightet the other factors. These factors have led to an overall increase in the exchange rate between the euro and the forint in 2022 from 367.71 HUF/EUR on January 4, with an intermediate high of over 430 HUF/EUR in October 2022, to 400.87 HUF/EUR on December 30. This represents an 8.58 percent appreciation of the euro against the forint in 2022. Forecast The current forecast for the exchange rate between the euro and the Hungarian forint is not clear, as there are many uncertainties and fluctuations that can affect the rate. According to finanzen.net, the current rate of the EUR/HUF is 381.97 HUF (as of:22.08.2023). In the overall view, the EUR/HUF rate currently continues to follow a medium-term upward trend. The very high key interest rates of the Hungarian central bank are currently strengthening the value of the forint. However, as shown, the forecast for the exchange rate depends on many factors that determine both the demand and the supply of the two currencies. Some of these factors include the economic situation of both countries, monetary policies of central banks, trade balance, capital flows, expectations of market participants, and political events. Several of these factors may change due to unpredictable external shocks. It is therefore difficult to make an accurate forecast. One way to make a forecast is to look at different scenarios based on various assumptions about these factors. For example, one could assume that the eurozone economy grows faster than Hungary's, that the ECB continues its expansionary monetary policy and that there are no major political crises. In this case, one could expect the euro to appreciate against the Hungarian forint. One might also expect that once inflation in Hungary is somewhat contained, the very high key interest rate will be lowered again, which will cause the forint to depreciate against the euro again. Conversely, one could assume that Hungary's economy grows faster than that of the euro zone, that the MNB continues its restrictive monetary policy, and that there are major political crises in the EU. In this case, one might expect the euro to depreciate against the Hungarian forint. And this is where the personal question of faith and assessment begins. Depending on who thinks which scenario is more likely, bet on the euro or the forint. There is no reliable prediction. Author: Dr. Peik Langerwisch After studying business administration with a degree in business administration and a magna cum laude doctorate in management theory, the author worked in global management consultancies and banks for twenty years and has now used his expertise as a real estate agent for real estate in Hungary for several years. Career and Expertise Sources: boerse.de bpb.de Eurostat exchange-rates.org EZB finanzen.net investing.com statista.com Wikipedia Wirtschaftslexikon Gabler