Inflation and interest rates on the rise

The waning of the pandemic and the gradual easing of containment measures in 2021 Q2 has boosted consumer and business confidence across economic sectors and lifted internal demand. However, it becomes increasingly clear that the recovery will not be as rapid as businesses had hoped. Consumer preferences may have changed, and fears of contagion and infection still persist in some (under-vaccinated) CEE economies (e.g. Bulgaria). Moreover, on the supply side, growth seems to be increasingly hampered by global supply chain disruptions, shortages in the raw materials of specialized components, and bottlenecks in international transport. A recent survey by the European Commission suggests that such supply bottlenecks are affecting a large part of the producers in Europe, including the CEE economies. Longer-lasting supply chain disruptions may continue to weigh on growth and delay an early recovery. 

Against this background of fragile recovery, Central European economies face strong increases in inflationary pressures. Headline inflation is well above 4% in the Czech Republic (4.9%), and well above 5% in Hungary (5.5%) and Poland (5.8%), respectively and seems clearly above the central banks’ tolerance thresholds. Increasing core inflation measures in the CEE economies moreover indicate that the observed inflationary pressures point at underlying structural inflation and do not only derive from energy price inflation. Looking forward, we do expect that inflationary pressures will persist this year – also on the back of the recent surge in gas, oil and coal prices – before eventually moderating. 

These strong inflationary pressures – both in headline and core inflation – raise concerns over a potential entrenchment of higher inflation. Central banks in Hungary, the Czech Republic and, recently, Poland have acted in response to these pro-inflationary pressures. Both the Czech National Bank (CNB) and the National Bank of Poland (NBP) hiked aggressively during their last policy meetings. The CNB raised the policy rate by 75bps to 1.5% while the NBP fundamentally changed course with a surprise hike of 40bps to 0.5%. In both cases, central banks noted that a pro-active tightening was required to pre-empt or prevent negative feedback loops caused by second-round effects and keep inflation expectations well-anchored.

However, despite these similarities in the actual central bank decisions, the signals to the market differ markedly. The aggressive CNB rate hike constitutes primarily a frontloading of already planned rates hikes as the CNB already initiated its rate hike cycle in early summer. The upward July and August inflation surprises induced a more proactive CNB stance. In this context, the November forecasts will shed some light on the further rate cycle. With the November forecast in hand, we expect the CNB to deliver an additional 50bps rate hike by the end of this year (either in one or two steps) and then another 25bps hike up to 2.25% in February 2022. After that, we believe the CNB will opt for a “wait and see” period to assess the impact of relatively fast monetary tightening on the real economy and inflation. It should reach the 2.50% peak of the hiking cycle by the end of 2022. This scenario is already more than fully priced-in in the market rates.

The future course of Poland’s monetary policy is, however, more difficult to read. The current 40 bps rate hike implies a 180-degree turn in the central bank’s policy. Only a few months earlier, Governor Glapinski endorsed the view that the high inflation spike was transitory and supply driven – the latter implying a look-through stance of the National Bank of Poland. The Governor justified the radical change in policy by referring to the need to anticipate monetary policy normalisation in a pro-active move to pre-empt any second-round effects (given the current 5.8% headline inflation rate). However, he remained reluctant to confirm that this rate increase presented the start of a hiking cycle. While we expect Polish policy to remain reactive rather than proactive, additional rate hikes are likely in view of the strong inflationary pressures also expected in the coming quarter.

Differences in the policy stances are also likely to be reflected in the different exchange rate dynamics. While positive carry may well support the level of the czech koruna, markets seem less convinced of zloty strength. Already now, we see an underperformance of the Polish zloty amidst increasing political tensions following the ruling of the Polish Constitutional Court. In addition, the lack of clear communication on the direction of monetary policy may add to this weakness and trigger additional peaks in interest rates going forward. We expect uncertainty to remain high in the coming months.