Inflation surge prompted sharp monetary policy tightening

Consumer prices accelerated rapidly in the CEE region in the course of 2021 (figure CEE1). By the end of last year, headline inflation reached 10-year highs across regional economies, and there remains large uncertainty around the timing of a decisive easing of these strong inflationary pressures. We expect a further upward shift in the regional inflation readings in early 2022, as rising costs are passed through to prices with some delay (and not always in a symmetric manner).

In general, the reasons behind elevated inflation in the CEE region are similar to those seen in many other countries: strong aggregate demand, supported by initially loose monetary and fiscal policy, is clashing with the pandemic-crippled supply side of the economy. That said, surging energy prices, supply chain disruptions (the lack of some key materials and logistical constraints) and tight labour markets have all contributed to rapidly rising prices across CEE economies.

The inflation spike has prompted central banks in CEE to start an unusually aggressive tightening cycle. The Czech National Bank (CNB), which has long been the most hawkish central bank in the region, has so far hiked its key rate to 3.75%, delivering a sizable 3.5 ppts of tightening between May and December 2021. In addition, the CNB’s hawkish forward guidance signals more interest rate hikes to come early this year to make sure that inflation expectations remain well anchored. We forecast the CNB will deliver another 75-bps hike at its February policy meeting, bringing the key rate to a peak of 4.5% during this cycle. Other measures taken by the CNB to anchor inflation expectations include tightening the rules for mortgage lending and increasing the countercyclical capital buffer.

Meanwhile, Poland’s NBP progressed further in the hiking cycle in January, pushing its key interest rate to 2.25%. Still, the NBP remains behind its regional peers in terms of the size of policy tightening, which is even more striking if we take into account deeply negative (ex-post) real interest rates in Poland. This is due to headline inflation surging to 8.6% yoy in December, significantly above the NBP inflation target of 2.5%. As a result, we expect the NBP will continue, albeit reluctantly, its monetary tightening cycle until the first signs of inflation stabilisation emerge, likely not before Q2 2022.

Finally, the Hungarian central bank (MNB) raised its key interest rate from 2.1% to 2.4% in December. At first glance, it might seem that monetary policy setting in Hungary is more akin to that in Poland than in Czechia, but the opposite is true. In fact, the MNB is primarily using its one-week deposit rate to influence the short end of the yield curve. The one-week deposit rate has been hiked to 4% as of January 2022, after being as low as 1.75% in mid-November. Such a sharp increase in interest rates was implemented in response to an increasing risk of higher and more persistent inflation. Unlike in Czechia and Poland, the rate hikes in Hungary have been reinforced by ending the central bank’s bond purchase programme. Overall, we expect that at the current stage of monetary tightening, the one-week deposit rate will peak at 4.50% at the end of Q1 2022, bringing the 3-month BUBOR to 5%.

Although price pressures are expected to strengthen further in the CEE region at the beginning of 2022, the combination of a sharp monetary policy tightening, and our expectations for a stabilisation in energy prices and some easing in global supply bottlenecks should bring inflation back towards the targets levels, in particular in the latter part of this year. At the same time, there are notable upside risks to our inflation outlook, related not only to the persistence of global supply bottlenecks but also to tight labour markets in many of the regional economies.