The ongoing war in Ukraine continues to keep commodity markets on edge. Threatened supply shortages of Russian oil, petroleum products and natural gas, as well as the prospect of a threatened harvest in the “breadbasket of Europe”, are adding fuel to the cauldron of long-unprecedented price increases and filling European producers and consumers with concern.

As in many other countries, inflation in the CEE region has repeatedly outperformed preliminary estimates and threatens to loosen anchored inflation expectations. Fears of an upward shift in these expectations and a consequent spiral of inflation are among the main reasons for the rise in key interest rates in those countries in the region whose central banks conduct independent monetary policy.

Of course, it is also true in the region that rising interest rates dampen inflation by weakening aggregate demand and thus economic growth. At some point, then, central bankers may find themselves at a crossroads where they must decide whether to continue raising rates even at the cost of triggering an economic recession and a painful rise in unemployment. In practice, the alternative method of fighting inflation - central bank appreciation of the domestic currency - faces a number of constraints that prevent its widespread and systematic application: first and foremost, the need to hold a supernormal amount of foreign exchange reserves to carry out market interventions. In the CEE region, only the CNB may hold a relatively high volume of reserves.

Recently published data on GDP growth in 2022Q1 indicate which countries in the CEE region have the economic performance that should help them withstand the ongoing anti-inflationary fight without falling into recession (see figure CEE1). Poland and Hungary emerge as growth champions from the comparison, with average quarter-on-quarter real GDP growth of 2.2% and 2.0% respectively over the past year. At the other end of the growth spectrum are Slovakia and Bulgaria with average growth of only 0.8% and 1.0% respectively. There are several reasons for the relatively higher growth performance of Hungary and Poland, but the above-average ability to use EU funds efficiently is definitely one of the top reasons. 

In the light of the comparison of the growth performance of the CEE economies, it is interesting to note that in the case of May consumer inflation, Poland and Hungary are not ranked at the top of any of the rankings, but only fourth and sixth in the regional rankings respectively (see figure CEE2). 

This can be explained, on the one hand, by the fact that both the Polish and Hungarian governments are more active than their regional counterparts in trying to slow domestic price growth through fiscal and administrative measures, respectively, and, on the other, by the fact that the central banks of both countries are among those that are not lagging behind in raising interest rates - and not just on the regional scale - (see figure CEE3).

While in the case of both the Polish and the Hungarian central banks, the manner of responding to the persistently strong inflationary pressures is unlikely to change in the foreseeable future, there is a certain degree of uncertainty in the case of the Czech National Bank. Following the appointment of Ales Michl as the new CNB Governor (as of 1 July) and the later announcement of the names of the three other members of the Bank Board who will replace their predecessors with expiring mandates on the same day, the new Board can be expected to be significantly more cautious than its predecessor when considering the possibility of further interest rate increases. However, the fact that two of the three newcomers to the Board have already served on it in the past, have proven themselves and are well-known and respected experts means that the renewal of the CNB Board as a whole now looks considerably less revolutionary than what the nomination of the Governor alone signaled.

In any case, the recent changes in the CNB’s leadership can also serve as a litmus test for the degree of sensitivity with which financial markets still perceive economic and political risks in the “new” EU member states, almost two decades after their accession. Figure CEE4 shows two significant depreciations of the Czech koruna this year: the first after the Russian invasion of Ukraine, the second after the announcement of the name of the new CNB governor.

Notwithstanding the two aforementioned falls in the koruna´s exchange rate this year, figure CEE4 shows that since the “sharp” start of the Covid-19 pandemic in autumn 2020, the Czech currency has performed better than its regional competitors. By mid-June this year, it had managed to appreciate by almost 6%, while the Polish zloty had weakened by roughly the same extent. The Hungarian forint has followed the most remarkable trajectory: it was still close to its starting point until mid-February 2022, but then began to lose ground rapidly and by mid-June had already fallen by around 12%. The forint’s turnaround would undoubtedly be helped, on the one hand, by financial markets’ increased confidence in the Hungarian central bank’s anti-inflationary stance and, on the other, by an improvement in the country’s tarnished relations with the EC and the associated easing of fears that the country’s ability to draw down EU funds would be blocked. Inspiration for how to proceed on the latter point can be drawn from the case of Poland, which in June, following a negotiated compromise with the EC on judicial reform, finally opened the way for the disbursement of funds related to its National Recovery Plan.