Stagflation looming as wage growth in CEE runs behind inflation

Stagflation looming as wage growth in CEE runs behind inflation
Central banks have been aggressively hiking interest rates to curb soaring inflation and employers have been increasing salaries to try to keep pace with prices, but real wage increases have fallen behind. / bne IntelliNews
By Ben Aris in Berlin October 28, 2022

Stagflation is looming as wage growth across Central and Eastern Europe (CEE) falls behind inflation, which could deepen the coming recession and impoverish millions of people.

The International Monetary Fund (IMF) argued in a blog last April that Europe faces the very real danger of stagflation, and in its latest update it added that policymakers will have a hard time striking a balance between the need for aggressive rate hikes to curb inflation and not overdoing it, which would plunge their economies into a deep and long-lasting recession.

Gas prices have tumbled in recent weeks and actually turned negative on October 25 after Europe’s gas storage tanks became almost full. But in what most analysts take to be a lull before the storm, this respite from the energy crisis will be brief. According to a report from Fitch, energy prices will continue to be high in 2023 and that will also keep inflation high for the foreseeable future.

“European governments are responding aggressively to minimise rises in consumer energy prices as wholesale gas and electricity prices soar following the near-shut-off of Russian gas,” Fitch said. “However, wholesale gas prices look set to remain high for some time, and a return to 2021 levels is highly unlikely, making it costly to maintain a wedge between wholesale and consumer energy prices… Furthermore, energy will continue to [put] pressure [on] eurozone consumer price inflation (CPI) despite ongoing government intervention.”

Inflation has been rising relentlessly all year. Eurozone inflation soared to 9.9% year on year in September and energy prices directly accounted for 4.2pp of this, rising 40.7% y/y, while comprising just under 11% of the CPI basket.

Consumer prices have still yet to reflect the approximately six-fold rise in wholesale gas prices since prices began to climb in April 2021. Fitch’s September Global Economic Outlook forecasts eurozone inflation to end 2022 at 9.3% and 2023 at 4.3%. The ratings agency also estimates that gas prices will average €190/MWh ($55/thousand cubic feet) in 2023 – triple the 2021 average.


Economists are becoming alarmed at the fast growth in inflation in some of the key markets in Central Europe. Average wage growth accelerated in Hungary in August due to additional, intra-year wage increases. However, real wage growth is on the brink of sinking into negative territory, ING reported in a recent note.

Hungarian gross average wages rose by 16.6% y/y in August, causing a minor upside surprise. Net average wages showed an even stronger rise (17.3%) due to the changes in the personal income tax system for those below the age of 25, ING reports. Underlying wage growth strengthened in a significant manner as well, showing a 15.6% y/y increase.

“Typically, double-digit wage growth would generate a lot of talk about a rosy economic outlook and wage convergence. Unfortunately, this is not the case today,” said Peter Virovacz, ING’s senior economist in Hungary.

But these pay rises are still lagging well behind inflation (chart), which jumped to a 24-year high of 20% in September, despite a series of emergency rate hikes by the central bank (MNB).

“The inflation picture in CEE remains alarming. Our core inflation measures are highest here – and particularly in Hungary, where it is at least twice as high as anywhere else. And core inflation hasn’t really shown signs of peaking. This strength of core inflation reflects a number of factors, including the pass-through from exchange rate weakness, tight labour markets and second-round effects from the energy price spike (which has been much worse in CEE than in other emerging markets),” William Jackson, the chief emerging markets economist at Capital Economics, said in a note.

The most recent was on October 14 when the MNB (National Bank of Hungary) was forced to introduce a number of emergency measures to stabilise the financial markets and to halt the collapse of the forint, which had broken record lows several times the same week. The forint appreciated 3% against major currencies after the announcement, the largest intra-day gain in more than 10 years.

The Monetary Policy Council introduced a new 1-day deposit facility with an interest rate of 18%, which will effectively replace the base interest rate of 13% as the main monetary tool. And policymakers raised the overnight collateralised loan rate – the top of the interest rate corridor – by 950bp to 25.0%, amongst other measures.


Poland is in the same boat, with inflation topping 17.2% in September, but open warfare broke out amongst the members of the Monetary Policy committee last week, with members threatening to call in prosecutors to arrest their colleagues because of disagreements on policy.

As the IMF pointed out, the dilemma is choosing between big growth-killing rate hikes now to tackle inflation, or sitting on your hands doing nothing, but waiting for the all-but-certain coming recession to reduce demand and bring prices down on its own.

Poland’s Monetary Policy Council paused its tightening streak in October, arguing that an economic slowdown was becoming more evident, which would “support a decline in inflation in Poland towards the National Bank of Poland (NBP) inflation target”.

Central bankers across the region are at a loss over what to do in these unprecedented conditions. The NBP has already taken the cost of money to a 20-year high of 6.75% in a series of 12 nearly consecutive hikes, which began when the rates were still at their pandemic super-low of 0.1%. However, the gap between inflation and the prime interest rates is even wider than that in Hungary. (chart)

Painfully high inflation is already proving to be a drag on consumption, ING reports. There has been a deep fall in fuel sales (-20.4% y/y). Sales of durable goods continue to fall (cars: -2.9% y/y; furniture, consumer electronics, household appliances: -4.3% y/y).

“The retail sales data suggest that high inflation is undermining consumers' purchasing power to such an extent that they are more cautious in their purchasing decisions,” said Rafal Benecki and Adam Antoniak, ING’s Polish economists. “This is especially visible in poor demand for durable goods, where high uncertainty and unfavourable consumer sentiment are taking their toll. Some households are struggling to secure heating fuel for the winter and face high fuel prices.”

In addition to slower growth in demand for goods, ING also reports that Poland’s post-pandemic rebound in services is fading. Earlier this year consumers were eager to spend on services (tourism, eating out) but with prices exploding they are now choosing to stay at home.

The situation has become so dire that economists are now talking about the dangers of a “wage-price spiral” that would mark the start of true stagflation.

Average corporate wages grew by 14.5% y/y in September – still well behind inflation – which was significantly higher than the consensus 13.1% and also the 12.7% increase in August.

“In our view, the high minimum wage increase in 2023 will yield a wage-price spiral regardless of the market structure,” the ING economists said.

However, the dislocation has not yet affected the labour market, where employment in Poland rose by 2.3% y/y in September, mostly in services and representing the appearance of a large number of Ukrainian refugees arriving in the country: Poland is hosting over 1mn refugees and the Polish statistics agency reports that an estimated 400,000 have already found work, mostly in the services industry.


Czechia is the exception in the story, as the central bank seems to have regained control over inflation, but wage increases are not keeping pace with price rises.

Czech inflation is running at 17.2% in September y/y but unlike most other countries, inflation may have already peaked, as the September result was down from 17.5% inflation in August. The Czech National Bank (CNB) has kept rates at 7% at its last two meetings, betting that a slowing economy is already doing the work of pulling prices down for it. (chart)

In June the CNB board was the first central bank in Central Europe to end its tightening cycle. It has refrained from increasing interest rates since changes on the board took place early in the summer,  with Ales Michl taking over as the new governor, ending a series of nine rises under the previous board. Michl always voted against rises in the interest rates while a board member.  

“CNB interest rates are at the level which dampens domestic demand pressure. It slows down the growth of bank loans for households and companies and so it slows down growth of the amount of money in the economy,” the CNB said in a statement at the time.

Nominal wages went up 4.4% to CZK 40,086 in the second quarter, way behind the 15.8% increase in inflation. The wage volume climbed by 5.7%, and the number of employees rose by 1.3%. Compared to the previous quarter, wages grew 1.3% in Q2 2022. 

Like everywhere else in the region, Czechia is suffering from the same cost-of-living crisis, but according to the OECD it will probably avoid a recession this year and wage growth is already slowing in parallel with decelerating inflation.

“The Czech economy is projected to grow by 1.8% in 2022 and 2% in 2023. The recovery is facing headwinds from further supply disruptions, rising prices and overall uncertainty related to the war in Ukraine. Trade and manufacturing output will slow. A tight labour market will buttress private incomes, but weaker sentiment and rising prices will weigh on domestic demand. Inflation is expected to increase further, before gradually returning towards the tolerance band around the 2% target,” the OECD said in June.

And even if inflation has peaked in Czechia it is likely to remain higher for longer across the whole region. 

“A closer look at core inflation across EMs suggests that underlying price pressures have started to ease. But they remain very strong by historic standards in most countries – and particularly so in CEE. The CEE economies face the highest risk that inflation won’t return to target for a number of years, which underpins our hawkish interest rate forecasts for this part of the emerging world,” Capital Economics said in a note.