Central Europe’s rate-setters have pause for thought
With steep falls in ination over and the timing of the
rst Federal Reserve rate cut pushed back by strong U.S. data, a period of carefree rate easing appears to be over for central Europe’s rate-setters now facing a growing list of concerns.
A collapse in price growth from last year’s double-digit rates in Poland, the Czech Republic and Hungary allowed central banks to reduce borrowing costs sharply, helping their economies back to growth from recession or stagation.
March headline ination sank to 2% in Poland and the Czech Republic and 3.6% in Hungary, which experienced the worst inationary surge in the European Union with levels exceeding 25% in the rst quarter of last year.
Lows are unsustainable
But economists believe the current lows are unsustainable and project a rebound in price growth to around 5% by the end of 2024 in both Poland and Hungary, as helpful base e§ects fade and the Polish government unwinds cost-of-living subsidies.
Amid risks from higher fuel prices, weaker exchange rates, persistently strong services ination and the prospect of the region’s economic recovery gaining traction, central bankers have grown cautious about cutting rates further.
“The situation has changed,” economists at Allianz said. “As markets have dialled back their expectations for cuts in advanced economies, they have also done the same for emerging markets.”
An analysis of changes in market pricing based on JP Morgan gures shows investors have priced out about 100 basis points of rate cuts in the Czech Republic and Poland by December compared with end-2024 levels expected in early January.
The shift is the largest in Hungary, with investors slashing the scope of expected easing by nearly 200 bps. Late-April market pricing showed just 35 bps of cuts in Poland’s main rate by the end of 2024, less than a third of what was priced in at the start of the year.
Vulnerable currencies
While 2024 ination is seen hovering around 2% in the Czech Republic, by far the lowest in central Europe, some rate-setters there too have expressed concerns over real wage growth and currency weakness as the economy begins to show signs of life.
The region’s currencies, like other emerging market assets, were hammered by data showing the strength of the U.S. economy, which boosted the dollar and pushed back investor bets on the timing of the rst Federal Reserve rate cut to September or later.
The Czech crown (CZK) and the Hungarian forint are both in the red for 2024, due in part to their narrowing rate di§erential, with the ripple e§ects of the dollar’s rally knocking even Poland’s zloty (PLN) o§ the four-year-highs it scaled early this month.
“CZK and PLN are among the most vulnerable emerging market currencies to persisting ination, U.S. economic outperformance, and higher repricing of the Fed funds rate path,” strategists at Societe Generale said, citing the currencies’ strong ties with the euro.
Last week Czech National Bank Governor Ales Michl said even if the bank cuts rates on Thursday, with analysts projecting another 50 bps reduction, the CNB would take a “very cautious” approach to rate easing beyond that point.
“The more cautious approach of monetary institutions to rate cuts in view of possible reation is evident on both sides of the Atlantic,” ING economists said. “After all, the European Central Bank is watching the Federal Reserve, and the CNB is watching the ECB.”
Hungary’s central bank has also agged a cautious approach to further easing, with Deputy Governor Barnabas Virag all but ruling out rate cuts in the second half.