With inflation passing its peak in most of the countries of Central and Eastern Europe (CEE) (chart), central bankers are switching gears from aggressively tightening rates to curb price rises to starting to cut rates in the hopes of avoiding a tightening overshoot that could cause recessions across the region.
It’s a delicate balance, as while growth is already slowing nearly everywhere, inflation remains persistently high. Economists warn that the band between inflation curbing hikes and growth promoting cuts is very narrow and easy to get wrong. Nevertheless, some central banks in CEE have already started to cut rates.
Expectations for monetary easing cycles in Poland and Czechia have strengthened last week, Capital Economics reports, driven by weaker-than-expected Polish inflation figures for July and a shift in language at the Czech central bank's MPC meeting. It is now anticipated that both central banks will deliver interest rate cuts in the fourth quarter.
“The flash estimate of Polish inflation for July came in at 10.8% year on year, its lowest level since early 2022. Core inflation probably eased further last month too. The pace of disinflation this year has been much faster than we had expected and there’s now a possibility that inflation falls to single digits as soon as August, meeting the criteria outlined by some MPC members as the trigger to start an easing cycle,” Liam Peach, an emerging market economist with Capital Economics, said in a note.
The Czech central bank (CNB) made a clear shift in language at its recent monetary policy meeting, dropping its previous guidance on further interest rate hikes and stating that policy decisions will be based on incoming data. This opens the door for an easing cycle to start soon. While a rate cut in September is a possibility, the CNB maintained a somewhat hawkish tone, and Governor Michl tried to temper expectations for easing this year. Nonetheless, monetary easing is on the horizon, says Peach.
“The debate in Poland and Czechia now is whether or not interest rate cuts start at the next meeting in September. Inflation data for August will be key. In our view, we think September is just a little early for the first rate cuts. But the big picture is that monetary easing is around the corner. Investors are pricing in 100-125bp of easing over the next six months. This is possible, particularly in Czechia, but inflation pressures are a lot stronger in Poland and we think the bulk of easing there is unlikely until the second half of next year,” Peach said.
In general, the pressure on Europe’s households' real incomes from high inflation appears to be easing in Central Europe, and there are encouraging signs that the downturn in retail sales may have bottomed out in the second quarter, Peach says.
“Data released this week for June showed that retail sales increased in Czechia (by 0.3% month on month) and in Hungary (by 0.8% m/m). In Czechia, this was the first consecutive monthly expansion in two years and in both countries followed large declines in sales earlier this year. Inflation is falling so quickly across CEE that real private sector wage growth could turn positive in y/y terms in all major economies in Q3. We think this will support a recovery in consumer spending in the second half of the year, although any rebound is likely to be gradual while consumer confidence remains so depressed and interest rates stay high,” says Peach.
“More generally, we don’t expect a marked recovery in GDP growth for some time. Manufacturing PMIs released for July this week were weak and support our view that the recent resilience of exports will fade. We expect weaker external demand to weigh on exports and keep GDP growth soft until 2024,” Peach concluded.
In related news, the National Bank of Ukraine (NBU) cut the key policy rate from 25% to 22%, effective from July 28, the NBU stated in a press release on July 27 (chart). The cut was forced on the NBU due to the rapid fall in inflation, as the central bank had not intended to cut rates this year, while the war continues to rage.
On the flip side, the Central Bank of Russia (CBR) was forced to hike rates by 100bp at the policy meeting on July 21 from 7.5% to 8.5% per annum, the regulator said in a statement. Prior to that, the rate had remained unchanged since September 2022. (chart) Although inflation remained at an extremely low 3.2% in June – by far the lowest rate in the region – the central bank seems to be deliberately devaluing the ruble in an effort to support the budget and reduce the deficit. (chart)
Russia’s budget is based on a calculation of oil tax revenues calculated in dollars, but the spending is in rubles. That means a devaluation of the ruble creates more rubles for expenditures even if they are worth less in dollar terms – a cheap and easy way to close the budget deficit that does not involved borrowing or printing money.
However, the sharp devaluation of the ruble is fuelling inflation, which is now expected to climb to around 6% by the end of this year, before falling back to the CBR’s target rate of 4% next year, the regulator says. The need to devalue the ruble to close the deficit hole may be temporary after budget revenues surged in June as oil exports completed their switch from Europe to Asia, as reported by bne IntelliNews.