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.