After spiking to 20-year highs thanks to the pandemic and Europe’s Russian induced energy crisis, inflation rates across the EU have tumbled in recent months. That trend has run out of steam and central banks are expected to start hiking rates again soon, Capital Economics said in a note on April 11.

“While inflation fell further across Central and Eastern Europe (CEE) in March, we think that the recent run of good CPI news is largely over. We expect inflation to rise back above central banks’ target ranges in Hungary and Poland by end-2024 (to near 5%), which will limit scope for interest rate cuts. Our interest rate forecasts across the region generally lie towards the hawkish end of expectations,” Nicholas Farr, an emerging Europe economist with Capital Economics, said in a note.

In March, Poland recorded a significant reduction in inflation to 1.9% year on year (chart), Hungary followed at 3.6% (chart) and Romania at 6.6% (chart), while Czechia maintained a steady rate of 2.0% (chart). These figures align with central banks’ targets, except for Romania, signalling a momentary easing of price pressures.

 

 

 

“The falls in inflation have been relatively broad-based, but declines in food and fuel inflation have been particularly sharp. Our measures of regional food and fuel inflation were both in negative territory last month (down a long way from their peaks of over 20% y/y in 2022/23). Core inflation has fallen too, but (outside Czechia) it remains above central banks’ target ranges,” says Farr.

Analysts caution that the factors contributing to the recent disinflation are likely concluding, with expectations of a rebound in inflation in the coming months. Notably, food price inflation is projected to rise from -0.4% y/y in March to about 3% by the third quarter of 2023. Similarly, a recent uptick in Brent crude oil prices to over $90 per barrel is expected to drive fuel price inflation upwards again. According to recent reports, the oil markets are currently tight thanks to OPEC’s voluntary production cuts and will only get tighter in the second half of this year, with $100 oil on the cards. However, Capital Economics has a baseline forecast suggesting a potential fall in oil prices to $75 per barrel by year-end.

The outlook for oil prices is particularly uncertain has tensions in the Middle East spike after Israel destroyed the Iranian consulate in Damascus on January 20 and is expected to respond in kind in  a move that could spark a region-wide war that will affect the oil markets. If oil prices increase above $100 per barrel that will increase increasing headline inflation by 0.5-0.8 percentage points by the end of the year, says Capital Economics.

The tight labour market and strong wage growth in the region could also amplify these inflationary pressures, raising concerns about their secondary effects throughout the economies of Central Europe.

In addition to food prices, services inflation has remained stubbornly high across CEE, significantly higher than the historical norm.

“Regardless of developments in the oil market, we think that core inflation will remain a worry for most central banks over the coming year. Like in many economies globally, services inflation has remained high across CEE in recent months. Selling price expectations of services firms’ point to regional services inflation falling only a bit further (from 8% y/y currently) to around 6% y/y by the end of this year. This would leave services inflation around twice as high as during the 2015-19 period,” says Farr.

Capital Economics remains most concerned about core inflation remaining high in countries with strong rates of wage growth and loose fiscal policy. Poland, Hungary, and Romania are all exposed to this problem, nations characterised by vigorous wage growth and expansive fiscal policies, which contribute to persistent core inflation. Conversely in Czechia, the growth laggard of the region, demand is weaker and fiscal policies are more stringent, so inflation pressures are less pronounced.

“Overall, our forecasts envisage headline inflation in Poland and Hungary rising back above central banks’ targets ranges by the end of this year, and remaining above target in Romania,” says Farr. “In Poland’s case, the rebound in inflation could be even larger than we are expecting as it depends partly on what measures are taken to offset the expiry of the government’s utility price freeze from July.”

Capital Economics’ expectations for interest rate cuts have been pared back this year as a result of inflation expectations. The analysts still expect cuts in Romania and Hungary, but its monetary policy forecasts for end-2024 generally lie towards the hawkish end of analysts’ forecasts.

In contrast, Capital Economics thinks Czech inflation will remain within the central bank’s target range (of 1-3%) and that interest rates there will be cut the further and by more than most currently expect from 5.75% now to 3.50% by year-end.