Inflation is being driven up by the food crisis and disrupted supply chains, first during the pandemic and now due to the war in Ukraine, leading to fears of stagflation for the whole world. Inflation forecasts have been constantly revised upwards in the first half of this year, as the chart shows, as central banks struggle, and largely fail, to play catch up with aggressive rate hikes.
“Central and Eastern European economies are experiencing their worst bout of inflation since the late 1990s as surging food and energy prices have added to strong core price pressures across a broad range of goods and services. Monetary tightening cycles are likely to continue with interest rates rising to 8% or so over the next few months and we think that rates will remain above neutral for several years,” said Liam Peach, an emerging market economist with Capital Economics, in a note.
Inflation rates have jumped to levels not seen since the 1990s. The headline inflation in Czechia surged from 11.1% year on year in February to 16.0% y/y in May – its highest level since 1993. Poland is also losing control of the battle to control prices rises after the headline rate jumped from 8.5% to 13.9% in the same period. And in Hungary inflation was up a similar amount from 8.3% to 10.7%.
“These rates have come in far above expectations and are now at their highest since the 1990s. In the Baltic States, inflation is close to 20% y/y,” Peach said.
Surging food and energy prices are the main culprits, accounting for 85% of the rise in Poland since February, and 70-75% in Czechia and Hungary, Capital Economics calculated.
Food inflation has surged to rates of 15-20% y/y, in large part due to supply disruptions that have been exacerbated by the war in Ukraine, and is broad-based: inflation of grains and vegetable oils has unsurprisingly accelerated, meat inflation in Poland is at its highest rate since the 1990s, and dairy inflation in Hungary is running at its highest in at least two decades, Capital Economics reports.
The war, and especially the attempt to sanction Russian oil and gas exports, has also lifted energy prices, feeding through into higher inflation in most countries of the world. That has pushed up motor fuels and utility bills up sharply.
Fuel inflation is more than 30% y/y in Czechia and Romania. Gas CPI inflation ranges from 50% y/y in Poland and Czechia to 85% y/y in Romania and the more extreme 200% y/y in Estonia, Capital Economics reports. In Poland, coal prices have surged and the contribution to inflation from “solid fuels” is now twice that of gas.
“While energy prices have increased across the region, government support has been effective at shielding households in a few countries. Gas inflation is less than 20% y/y in Croatia and Slovakia. Hungary’s government has capped utility bills since 2014 and introduced a fuel price cap in November – inflation in May was 2 percentage pts lower than where it otherwise would have been without the latter cap,” says Peach.
“Looking ahead, we think food and energy inflation will rise further this year. Motor fuel inflation should peak soon if, as we expect, oil prices fall steadily from $113 per barrel now to $100 per barrel by year-end. But this will be more than offset by higher food and utilities inflation,” Peach added.
Food inflation is less likely to taper off in the meantime, as the reduced supplies of grain affect the whole food complex. While the price of grain and vegetable oils will obviously increase after Ukraine’s supplies are cut off from the market by Russia’s embargo of Ukrainian ports, the role of grain as an animal feed means that the cost of meat and poultry will also rise. Pork prices in Poland look set to surge, says Peach, who says he expects food inflation to climb to 20-25% y/y soon.
While prices are being driven up by all these shocks to the system, underneath these extraordinary effects regular inflationary pressures are also at work, adding to the upward pressure on prices, says Capital Economics.
“Eurostat’s measure of the Harmonised Index of Consumer Prices (HICP), excluding food and energy, has surged to multi-decade highs of 9% y/y in Poland and Hungary and 12% y/y in Czechia,” says Peach.
These pressures are broadening out, with the prices of most goods and services growing at their fastest rates since the 1990s. Goods inflation is particularly strong in Czechia and Hungary, while services inflation is hotter in Poland, likely due to its tighter labour market, reports Capital Economics.
“Even so, inflation of “sticky” items such as housing rentals has risen everywhere, which is particularly worrying, as it suggests the presence of more lasting price pressures even though interest rates have risen by 500bp since mid-2021,” says Peach.
Just how persistent inflation will be remains a topic of hot debate. Ironically it was the Eastern European countries that were early to raise the alarm after Ukraine became the first to reverse its easing of monetary policy with a rate hike in April last year, shortly followed by CBR Governor Elvia Nabiullina in May. Nabiullina, dubbed the world’s “most conservative central banker”, warned from the start that she believed inflationary pressures were larger and more persistent than the consensus, and she has been proved right in the meantime. Thanks to their early start, both the National Bank of Ukraine (NBU) and the CBR are thought to be at, or close to, the end of their tightening cycle, whereas most of the other central banks in CEE are still in the early stages of theirs.
Peach predicts that the pressure will come off next year as the global economy adjusts to the new realities. For example, while Russia and Ukraine together account for some 30% of the global trade in grain, they only account for just under 1% of global grain production – a point that Russian President Vladimir Putin is fond of making to downplay Russia’s culpability in pushing up the price of grain this year – so that as farmers are expected to step up the amount of grain sown next year, the pressure on supply is anticipated to fall sharply.
“Easing supply shortages should drag goods inflation down next year, but services inflation is likely to stay strong and we think inflation will remain above 10% well into 2023,” says Peach.
In the meantime, the countries of Central and Southeast Europe, which have found themselves behind the tightening curve in the effort to fight inflation – most of the countries in the region are sporting deeply negative real interest rates – will have to continue to hike rates and will probably cause a pan-regional recession as a result.
“We think central banks will tighten policy further, with rates rising to 8% in Hungary and Poland and 7% in Czechia over the coming months. Our inflation and interest rate forecasts generally lie above the consensus,” says Peach.
“Once these price shocks pass through, we think the shift will turn to rate cuts from mid-2023. But there’s a risk that, with inflation expectations so high, second-round effects become stronger and inflation becomes entrenched at high rates. The upshot is that we think central banks will keep policy tight for a few years by keeping interest rates far above their estimated neutral levels through to at least 2024,” Peach concludes.