Deflationary Situation In Core Central And Eastern European States

The headline for this EMEA Weekly could seem highly unlikely for most people that have been following the Hungarian economy in post-communist times, as the Hungarian central bank has for years overshot its official 3% inflation target and inflation has remained well above the inflation level also in other central and eastern European economies.

However, deflation in Hungary now looks quite likely. Our inflation models indicate that it could even turn negative in January, but more likely in March-April. Furthermore, even though we expect a slight pick-up in inflation in the second half of 2014, we expect it to average only 0.2% during 2014. This is well below the Hungarian central bank’s official 3% inflation target.

We are seeing a similar disinflationary situation in the other core central and eastern European countries. Hence, inflation is very subdued in Poland and the Czech Republic and could even fall further in coming months and the impact of particularly lower global commodity prices feeds through to the economies. In both Poland and the Czech Republic, inflation is like to remain around or just below 1.0% during 2014 and therefore also below the official inflation targets in both countries (2.5% in Poland and 2% in the Czech Republic).

Even though the recent decline in inflation in the CEE3 is mostly due to lower commodity prices, the underlining inflation picture is also one of weak domestic demand and hence one of weak domestic inflation pressures. Therefore, further monetary easing from all three central banks would seem justified. The Hungarian central bank seems to be continuing its ‘mini cuts’ of 20bp and this is likely to continue for some time to come – particularly if the forint remains fairly stable – and in the Czech Republic the central bank (CNB) has recently started using the exchange rate as a policy instrument to ease monetary policy as the interest rate is effectively stuck at 0%. We expect the CNB to actively further weaken the currency in coming months to ease monetary conditions. The ‘outlier’ is the Polish central bank (NBP), which has been reluctant to ease monetary policy further to curb deflationary pressures in the Polish economy. This was further confirmed by this week’s meeting of the NBP’s monetary policy council. The Council did not announce any plans for further monetary easing and instead continues to sound upbeat about the Polish economy.

We find this somewhat odd given that the NBP’s own forecast continues to show that inflation will remain very subdued in the coming one to two years and is likely to stay below the NBP’s inflation target of 2.5% in the coming three years. However, given the outlook for continued very low inflation in Poland, we do expect the NBP to react to this sooner or later and cut its key policy rate further – if not, then the deflationary pressures in the Polish economy are likely to deepen.

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