External Risks Prevents CEE Banks of Stronger Tightening

FED and ECB paused their tightening as they fear of more significant slowdown and recession. Meanwhile, CEE central banks are weighing whether to listen internal factors that are pushing inflation upwards or external ones that are blowing in the opposite way.

In the last several weeks we have seen central bankers from all over the world changing their stance saying that we need patience to see whether global slowdown is only temporary or is it more serious. Namely, it all started with Mr Powell who obviously scrutinized financial markets saying in November that rates are just below the neutral level which nevertheless driven market scare of recession and pushed equity in red in December. After that, Mr Draghi confirmed that slowdown in Euro Area is evident, disappointing all the bulls out there and pushing bund yield to 10bps, where it stood more than two years ago (when ECB maintained its heavy bond-buying programme). For the moment market prices do not imply any hikes in USA, nor in Euro Area, this year.

Meanwhile, unemployment rate in both USA and EA is close to their multi-decade lows, wages are rising strongly while inflation is showing signs of some weakness, most likely due to oil-base effect. However, monthly data for EA show that peak of the cycle is way behind us with industrial production and PMIs leading the pack of negative indicators. Although CEE countries also decelerated due to their opened economies and stage of the cycle, we think that they will rise at above average pace while inflation could be held around central banks’ targets which should push them to tighten their policies until it’s not to late.  

Czech Republic has seen the biggest slowdown in 2018 although having the lowest unemployment level in the whole EU. Due to the weakness of Czech krona, central bank decided to lift reference rates five times in 2018 but did not manage to keep krona below 25.50 for one euro. Most likely, that was driven by external factors such as Sino-US trade war and Brexit that could hit Czech economy strongly while unselective EM sell off did not bring much happiness for CZK bulls either. Czech central bank decided to postpone its next hike on their last meeting due to foreign risks, although saying that depreciation of krona could lift inflation above their target of 2.0% and that 1.0% appreciation of CZK is equal to a 0.25% hike. The most recent inflation data for January revealed that CPI hit 2.5% in January versus 2.0% in December last year due to higher food, housing and energy prices. In case koruna weakness continues, we wouldn’t be surprised in case CNB decides to lift rates on the next meeting on March 28th.

Polish central bank on the other hand did not change its stance to dovish as is the only country in CEE besides Croatia that maintains still ultra-loose policy. Despite unemployment rate being solidly low and GDP rising by robust 5.1% in 2018, inflation in Poland came at only 0.9% YoY which backed-up central bank in leaving its reference rate at 1.5% on its meeting in February.

Hungarian inflation rate came at 2.7% YoY in January, flat compared to December while core inflation surprised upwards, as it accelerated from 2.8% in December up to 3.2% in January. On the last monetary policy meeting Hungarian central bank said that a near 3.0% in adjusted core inflation ex-taxes would hint to normalization of the monetary policy. Hence, one should expect reference rate hike in Hungary already in first half of 2019.

Going a bit South, Romanian central bank is at the very peculiar position, as it is negotiating with the government on the newest greed tax and how it could change calculation of the ROBOR to ensure profitability of the banks which could be erased in case government continues pushing its legislation to fill public budget. Nevertheless, inflation in Romania fell from above 5.0% in the summer 2018 into the CB’s target band and central bank could now go on auto-pilot ceteris paribus. However, in case greed tax is pushed forward and inflation bounces once again, it will be interesting to see central bank reacting to another Romanian crisis.

Last but not least, Croatian central bank is obviously one of the most dovish bank in the region and is still pumping money through FX interventions. The last one, maintained last week was most likely driven by government’s bond and treasury auctions so it is for investors to wait until EURHRK drops below 7.40 once again to see whether central bank will intervene. Until then, high liquidity surplus ensures yields on Croatian LCY papers being below EUR denominated Eurobonds and we could imagine them grinding even lower. 

Marin Onorato, CFA
Category : Blog

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