Cruising the Danube – keep an eye on the spread

Having just returned from Budapest, one would not easily notice the country is in the middle of a tough anti-immigration stance under fire by the European parliament. What I did notice however, was a deeper pocket in my jeans upon my return, for what I thought was a cheaper European destination, this was not exactly the case.

Although we stayed in the city centre, getting used to the local Forints took a while to accustom to. For an economy whose inflation is flat, close to 0%, and whose GDP growth year on year is 2.6%, Hungary’s status as an emerging European country should not be linked to a cheap destination.

Whether or not we got ripped off is a story for Trip advisor. What is noticeable from my experience there is the convergence Hungary, with a vast political history, seems to be having to European strongholds.

Hungary adopts an inflation targeting framework, which differs to the free floating exchange rate regime adopted by the western European countries. An inflation targeting framework is a floating exchange rate regime, whereby the country’s central bank imposes monetary policy measures, in the form of interest rate cuts or hikes in order to achieve a pre-determined inflation target.

To date Hungary’s inflation rate target is 3% and the current 0% inflation is far off, allowing for the central bank to further intervene going forward.

A factor, yet again not in my favour on my trip, was the conversion spread on the currency. Conversion spreads differ across different exchange institutions and it is important to note that the actual price one would see on yahoo finance for example would be exclusive of broker/dealer spreads. In my case I did the mistake of converting locally as it would have been much cheaper to do so on arrival.

Spreads are dealer/broker commissions exchange institutions make for currency transactions. Spreads will differ according to different bid/ask prices issued by currency dealers. A bid price is almost always lower to the ask price and would be the price at which the currency agent purchases your local currency in exchange for the foreign currency. The same applies vice versa with the ask price. The price difference between the bid and the ask is the spread.

Spreads usually differ across asset classes and in general the wider the spread, the lower the liquidity of the underlying assets. Currencies in fact tend to have lower spreads to other asset class alternatives, but can be wider between themselves. In fact the EUR/HUF exchange rate spread is greater compared to the EUR/USD given the latter is more widely traded and liquid on currency exchanges.

I will return to Hungary one day, though by then, given the country’s convergence and growth expectations path, a Goulash soup might put me back a few more euros than today. To somewhat mitigate that risk I’ll ensure I seek the lowest spread possible to get the most Forints for my euros.