The hot inflation summer for CEE central banks
Inflationary pressures have intensified notably across Europe in the recent months. Headline inflation reached a three-year high in the euro area and a more than eight-year high both in Hungary and Poland (figure CEE1). There are several driving forces at play, largely related to the reopening of the economies after the 2020/2021 lockdowns. The sharp recovery of oil prices from historical lows has materially increased energy inflation, while the ‘reopening effect’ has led to further price pressure across economies. Furthermore, intensifying supply-side bottlenecks, such as a global shortage of semiconductors, have pushed up prices of cars and other products. Similarly, some services have seen sharply rising prices due to limited supply.
While the ECB clearly sees the current inflation spike as transitory in the euro area, the situation in the Central and Eastern European (CEE) economies is less clear-cut. Indeed, some of the current inflation drivers are temporary, including a semiconductor shortage and higher energy prices, but different underlying economic conditions from those in the euro area suggest it might be necessary for the CEE central banks to act to prevent the inflation spike from feeding into inflation expectations.
The major difference between the CEE region and the euro area is much tighter labour markets. That said, the unemployment rate has remained relatively stable since the outbreak of pandemic, now ranging from 3.1% in Poland to 7.3% in Slovakia (figure CEE2). This contrasts with a considerably higher unemployment rate of 8.0% in the euro area. Moreover, regional surveys indicate that the lack of skilled labour force remains a source of concern for many companies. In the Czech Republic, this is a major headwind limiting production according to more than a third of the construction companies and a quarter of all industrial companies.
At the same time, we expect a faster pick-up in domestic demand across the CEE region, precisely due to the low unemployment rates fuelling private consumption. We also see higher investment on the back of industrial companies’ incentives to invest in automation, digitalization and the green transition, in particular in the automotive sector. In addition, the regional economies are set to significantly benefit from the NGEU funds, on top of the ‘traditional’ EU structural funds. Finally, fiscal policy is expected to be slightly more accommodative in 2021 and 2022 compared to the euro area, particularly Germany.
Overall, both tight labour markets and strong domestic demand are notable pro-inflationary factors. That is why we believe that there is a higher risk of inflation feeding through to wage negotiations in the CEE region compared to major euro area economies, despite the fact that labour unions are, in general, weaker in the former. That said, core inflation pressures are, in our view, set to remain somewhat stronger in the CEE economies in the quarters to come.
As a result, the CEE central banks are expected to act much earlier than the ECB. In Hungary, we expect a first rate hike as early as in June. The Polish central bank will likely be somewhat more reluctant to act in the same manner, but we expect its policy guidance to gradually change in favour of a less dovish bias. Meanwhile, the Czech National Bank (CNB) is also expected to deliver its first 25 bps rate hike already in June. Looking forward, we believe that the traditionally more conservative CNB is set to pursue a faster monetary tightening than its regional neighbours. This is also one of the reasons why we believe that the Czech koruna is set to outperform the zloty and the forint in the years ahead.
Box CEE1 - Czech inflation outlook
Headline inflation in the Czech Republic slowed from 3.1% yoy in April
to 2.9% yoy in May, thus moving just below the upper boundary of the
tolerance band (1.0-3.0%) targeted by the Czech National Bank. Transportation
prices, in particular fuel and car prices, remain the major driver of headline
inflation. A pick-up in transportation prices alone accounts for about a third
of the May inflation print, while higher alcohol and cigarette prices make up a
similar contribution. Headline inflation in the Czech Republic is set to remain
close to 3.0% over the summer before moderating towards the CNB inflation
target of 2.0% towards the end of 2021 and in 2022. Nonetheless, there are
significant upside risks, largely related to the ‘reopening effect’ of contact-intensive sectors following the easing of containment measures.
Box CEE2 - Hungarian inflation outlook
Hungarian headline inflation remained at 5.1% yoy in May, while core inflation increased from 3.1% yoy in April to 3.4% yoy in May. The main driver of rising core inflation was market services, which rose on the back of the reopening of the Hungarian economy. Looking forward, additional upward inflation pressures are expected to come from the end-May termination of free parking (adding appx. 0.2 pp. to the June inflation print) and higher food prices – in particular for seasonal fruits and vegetables – due to the somewhat disappointing harvest. Moreover, the exchange rate effect will push inflation higher too, as suggested by a surge in the tradable goods price index, reflecting the increased pass-through of previous depreciation of the forint. All in all, we assume that headline inflation peaked in May and should start to moderate to 4.9% yoy already in June before temporarily bottoming out at around 4.0% yoy in July and August. Afterwards, we expect to see a second wave of upward price pressures, pushing headline inflation to 4.5% yoy by the end of the year. Overall, we project annual inflation in Hungary to remain slightly above 4.0% in 2021.