MITTELEUROPEAN INSIGHTS: Central and Southeastern European monetary policy is either on autopilot or in a tightrope act

MITTELEUROPEAN INSIGHTS: Central and Southeastern European monetary policy is either on autopilot or in a tightrope act
The leading central banks in CESEE – with the partial exception of Hungary – have earned themselves some (market) credibility because most of them already tightened policy when central banks such as the Fed or the ECB still held the narrative of " transitory inflation". / Refinitiv, RBI/Raiffeisen Research
By Gunter Deuber and Dorota Strauch of Raiffeisen Research in Vienna and Warsaw July 25, 2023

The most important central banks in Central and Southeastern Europe (CE/SEE) started to raise their key interest rates – in some cases drastically – in summer or autumn 2021. This means that the region's central banks have been on a tightening course at least 6-12 months ahead of leading central banks such as the Fed and the ECB. By the end of 2022, average key interest rates had already reached levels at least as high as in 2008 (before the global financial crisis).  

Since then, monetary policy has been recalibrated, while leading central banks such as the ECB and the Fed have had to tighten monetary policy further, in some cases decisively. As a result, the leading central banks in CESEE – with the partial exception of Hungary – have earned themselves some (market) credibility because most of them already tightened when central banks such as the Fed or the ECB still held the narrative of " transitory inflation". 

Chart: Earlier and larger hiking cycles in CE/SEE allow for a debate on policy easing 

Source: Refinitiv, RBI/Raiffeisen Research 

The Fed and the ECB are not expected to cut interest rates in 2023; in fact, interest rates may not fall until H2 2024. In CE and SEE, the situation could be rather different. Disinflationary tendencies are already more clearly discernible than in Western Europe or the US. This is of course to some extent driven by high base effects from 2022 but also by visible signs of lower monthly inflation dynamics.

While core, and in particular services inflation, are still elevated, even in these price categories signs of disinflationary changes are finally visible. This is most pronounced in Czechia, but less so in the case of Romania and Hungary (core inflation still above 20% yoy and higher than CPI). 

Chart: CPI developments: steep disinflation in CE/SEE as peaks were much higher than euro area 

Source: Refinitiv, RBI/Raiffeisen Research 

Moreover, compared to the euro area or the US, the impact of the very restrictive monetary policy pursued for some time is also becoming increasingly visible, for example on credit development, especially in the area of housing lending. This argues in favour of monetary policy easing.  

In addition, the high key interest rates are increasingly becoming a political issue. There are elections in some of the CE/SEE core markets (Czech Republic, Romania, Poland) over the next 1-2 years, with effects on monetary policy and investor sentiment that are not always entirely clear. Furthermore, some central banks seem to be benefiting from strong currencies (Czech Republic), while others may benefit from a clearer fiscal consolidation policy (Hungary). 

In the following, we want to shed some light on the local CESEE "jungle" of monetary policy influences and uncertainties. At the same time, it should be emphasised: monetary policy normalisation in CE/SEE is not taking place in a vacuum, but a rather unique international setting. Spillover effects of monetary policy in the U.S. and the euro area must always be taken into account. And there are some non-trivial unknowns here. The leading central banks in Central and Southeastern Europe would have to manage an easing cycle while major central banks continue to tighten monetary policy.  

Here, we are not only thinking about policy rates, but the long stretch of unconventional tightening ("quantitative tightening") that lies ahead. Of course, QT has effects on international liquidity and also on financial market sentiment. What is interesting for the central banks in CE/SEE is that the ECB in particular could still be forced into QT surprises, given the hardened inflation dynamics within the euro area.  

At the same time, international investor confidence in monetary loosening processes in the small and open markets of CESEE must be maintained at all times. Thus, the upcoming monetary easing in region will also become a high-wire balancing act. Here we would see some advantages stemming from accumulated central bank credibility in Czechia and Poland that could allow for bolder monetary easing as compared to Romania and especially the MNB in Hungary.  

On a positive note it will be fundamentally supportive for all four countries that the high current account deficits in CE are already in reverse, with even surpluses recorded already in Poland and Czechia (hence the two countries again standing out more to the positive side here vs Hungary and Romania). From a fundamental perspective, this should limit the currency depreciation risk in the current cycle. Especially since investors should then be less concerned about "double deficits" in fiscally sound economies. Interestingly enough, Hungary might be forced to be one of them. And now let's turn to the country analysis. 

Table: Raiffeisen Research forecasts for key rates  

Source: Refinitiv, RBI/Raiffeisen Research 

In Czechia, the exciting question will be whether interest rate cuts are already possible this year. There is currently an interesting disconnect between market expectations and verbal central bank communication. The market expects interest rate cuts this year and there is a possibility here when looking at expected inflation data.  

More importantly, we do not expect a very drastic interest rate cycle. We see the CNB remaining committed to a stability-oriented central bank course. By not cutting key rates too low, it probably also wants to keep the currency more on the stronger side and, at the same time, send a warning signal to policymakers not to put fiscal consolidation on the back burner. That's why we still see the key rate at 4.5% at the end of 2024. After all, parliamentary elections are due in 2025... 

In Poland, it should be noted that this is not just about monetary policy in the narrower sense. We are currently observing a very expansionary fiscal policy, which is due to the election calendar. The budget deficit should be above 5% of GDP this year, after below 4% last year. And this spending policy is taking place in tandem with a very tight labour market, which makes it difficult for the NBP to adopt a clear monetary policy stance.  

Still, a recent shift in wording from the NBP governor implies the central bank is set to launch the easing cycle already after the summer (and before parliamentary elections). Like in Czechia, and due to factors mentioned above, we do not expect this to be a fast cutting cycle. Thus, with possibly two cuts in 2023 and gradual easing in 2024, we expect the key rate to be lowered from 6.75% currently to 4.5% by the end of 2024. 

In Romania, we currently see no scope for monetary policy easing for a long time, despite initial signs of consolidation in price pressures. At present, the inflation data do not yet clearly point to a drastic disinflation in the near future, while the economy continues to grow very dynamically. In this respect, we do not see key rate cuts before Q2 2024 at the earliest. Also, it is worth mentioning that the NBR stated many times that the decisions of the Fed, ECB and the other central banks in the regions are of key relevance for the conduct of domestic monetary policy.  

However, the large liquidity surplus that persists in the banking system is not actively sterilised by the central bank, which allows the money market interest rates to trade at levels much below the level of the monetary policy (i.e. ROBOR 1M is quoted now close to 6.13%, and ROBOR 3M at 6.54%). The management of money market liquidity conditions is providing flexibility to the NBR to adjust rapidly the monetary policy stance if needed (also to support the RON) – without touching the key rate. 

We expect the most exciting monetary policy tightrope act to be in the case of Hungary. Here, we currently still have very pronounced inflation dynamics. To put this into perspective, 70% of the goods in the inflation basket here are rising by more than 10%! Core inflation, which is relevant for monetary policy, could still be 10% by the end of the year.  

The central bank (MNB) should get a tailwind in terms of monetary easing from politicians this time. In Hungary, we expect the strongest fiscal consolidation in 2023 and 2024 in regional terms. The government budget deficit should fall from over 6% in 2022 to 3% in 2024.  

In this respect, there is some scope for monetary easing. We see the key interest rate in Hungary at 12% by the end of 2023 and at 6% by the end of 2024. This substantial rate-cutting cycle may bring significant opportunities for financial market investors in the local bond market. In a way, we see the MNB betting on this as well. Because then the local currency should be able to remain stable because of the solid and stable capital inflows. 

However, in the case of Hungary, imponderables are always to be expected on the investor side. And in this respect,  the regional key interest rate cycle is most of all a balancing act between easing and market or capital flow risks.

Gunter Deuber is head of research at Raiffeisen Bank International in Vienna. Dorota Strauch is head of research for Poland.



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