The turn of the wave in CEE: easing cycles underway

CEE central banks were among the first to begin with an aggressive tightening cycle in the face of an inflation surge seen in 2021. This did not come as a surprise since regional economies were burdened by some of the highest inflation rates in the European Union. However, as tight monetary policy started to restrict economic activity and supply shocks (i.e., elevated energy prices and disrupted global supply chains) began to abate, the CEE central banks have finished their tightening cycle, and some even already started to reduce policy rates.

The National Bank of Hungary (NBH) was the first of the regional central banks to start easing its monetary policy in April. The NBH has gradually cut its overnight deposit rate from 18.0% to 14.0%, and we maintain our view that a further reduction to 13% is likely in September. As headline and core inflation are expected to moderate further in the coming months (our baseline for headline inflation is a further easing to around 7% by end-2023), the NBH is expected to deliver additional cuts to bring the year-end base rate to 11%. However, some concerns remain about a continued disinflation path through 2024. We believe that there is still a high risk that inflation may become entrenched at around 5-6% year-on-year next year due to the wage increase, excise duty hikes, and the expected rebound in domestic demand. 

Meanwhile, the National Bank of Poland (NBP) shocked the CEE markets with an unexpected aggressive start of the easing cycle. Although headline inflation remained at an elevated 10.1% year-on-year in August, the NBP cut its key rate by 75 bps to 6.25%. At a press conference, NBP President Glapinski, in a politically oriented speech, defended the sharp rate cut by citing a faster-than-expected fall in inflation and a very favourable (inflation) outlook. At the same time, the NBP president repeatedly stressed that the price level has remained virtually unchanged for five months, implying a decline in annual inflation to the 6-7% range at the end of this year. Looking forward, NBP monetary policy actions remain difficult to read (partly because of the parliamentary elections held on October 15th) but there is a clear dovish bias that is likely to bring more rate cuts in the coming months.

In contrast, the Czech National Bank (CNB) has kept its key interest rate stable at 7.0% since mid-2022. However, as pronounced disinflation has taken place since early this year (headline inflation fell further to 8.5% year-on-year in August), the CNB’s bank board has gradually changed the tone and is set to begin the discussion about rate cuts at its September policy meeting. We expect the CNB will remain very cautious in the coming months as Q4 2023 headline inflation will move higher again (to around 9.0% year-on-year) due to the low base effect from last year’s energy savings tariff. Also, wage growth has been closely monitored by the central bank with respect to the potential wage-price spiral. Overall, we assume the CNB will begin its easing cycle with a 50 basis points rate cut at the December policy meeting and will deliver more forceful rate cuts through 2024 as inflation is projected to fall to 2-3% already in the first quarter of next year. 

Koruna under the new regime: weaker and more vulnerable

At its August policy meeting, the CNB decided to exit from the intervention regime (in place since May 2022) to support the koruna. We assumed this action would have two major implications – a weaker and more vulnerable koruna exchange rate. The first wave of koruna weakening occurred immediately after the formal end of the FX regime, pushing the Czech currency to around 24.20 EUR/CZK. More recently, the unexpectedly sharp interest rate cut in Poland confirmed our view that the koruna has become more vulnerable to external shocks, resulting in a drop above 24.50 EUR/CZK.

An aggressive start of the easing cycle by the NBP has led to a materially weaker zloty but the negative spillover effects have affected the whole CEE region, most visibly in the koruna exchange rate. The reason was that the CEE economies are traditionally perceived as one homogeneous region by major global investors. As a result, some investors assume that the CNB might act in a similar manner as the NBP with an aggressive cutting cycle, which is, however, extremely unlikely in our view.

The deteriorating market sentiment related to the NBP’s actions might nonetheless remain in place for some time. With the NBP’s dovish bias and parliamentary elections scheduled in October, the risks are tilted towards a weaker zloty and by extension a weaker koruna. Importantly, we expect the koruna to come under pressure also from a narrowing of the positive interest rate differential, an effect that is set to accelerate in the first half of 2024. All in all, we expect a weaker and more volatile koruna, which is now more vulnerable to shifts in sentiment not only in the Czech Republic but also in other CEE markets.