Financial basis

Inflation shines soaring central Europe


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Central Europe is at the forefront of a surge in inflationary pressures in Europe. Inflation in Poland reached 4.7% in May before falling back to 4.4% in June. Hungary has the highest inflation rate in the EU at 5.1 percent. This is partly due to transient factors. But there is also reason to believe that the price pressures are here to stay in these two countries, creating potential tensions between their central banks and their nationalist spending governments.

It also risks undermining their reputation for carefully nurtured macroeconomic orthodoxy. The appreciation in Brussels and Berlin of their economic management – which makes them a prime destination for German investment – has helped protect Budapest and Warsaw from further scrutiny of their national programs to restrict media freedom, limitation of minority rights and politicization of the justice system.

Inflation in Poland and Hungary is well above the respective median targets of the two central banks of 2.5 and 3 percent in the medium term. Yet Adam Glapinski, governor of Poland’s central bank, is in no rush to raise rates. Glapinski told the FT that there was “no reason to be alarmed” about inflation in his country. The rise was largely caused by supply and regulatory factors, he said.

In Hungary, Gyorgy Matolcsy, the governor of the central bank, last month called on the government to drastically tighten fiscal policy, reducing the deficit of 7.5% of gross domestic product expected this year to 3% next year. The government’s budget plans were a “mistake,” he said.

Matolcsy was rejected by Prime Minister Viktor Orban who dangled the prospect of a major income tax cut for families with children (an echo of the ‘Polish deal’) just in time for the parliamentary elections next year, which are shaping up to be a tight time. race.

Orban also appeared to be shooting over the governor’s arcs, saying he hoped any interest rate hike would be “prudent and measured.” The central bank then raised its main policy rate by 30 basis points to 0.9%, the first hike in a decade. He also said he would continue to tighten on a monthly basis.

Capital Economics said in a recent Note that the economies of Central Europe were experiencing “stubbornly high inflation” before the latest pressures associated with the end of the pandemic and that “the risks over the coming years are skewed towards a prolonged period of much higher inflation and, for example, then, more aggressive monetary tightening ”.

The European Bank for Reconstruction and Development, the multilateral lender, has also expressed concern. Beata Javorcik, chief economist, said there were short-term factors such as pent-up demand when the pandemic ended, but there were also longer-term ones.

The first is the region’s hot labor market, exacerbated by its low demographics. Average wages rose 10.6 percent and 7.8 percent in Hungary and Poland respectively last year, despite the economic crisis. Unemployment in Poland is only 3.1 percent. It may be able to bring in Ukrainian migrant labor, but Hungary’s anti-immigration government is less inclined to do so. Second, EU stimulus fund money will start flowing later this summer over the next four years, further increasing demand, as will income tax cuts from the two governments.

Third, decarbonization will drive up producer prices in these economies still heavily dependent on fossil fuels. Finally, unlike West Europeans, Hungarians and older Poles still have memories of hyperinflation at the end of communism, which means their expectations of price hikes could change faster – a headache for them. central banks with only a short history of independence. “If these expectations rise, the cost of reducing inflation will be high,” Javorcik said.

The return of inflation in advanced economies may turn out to be more of a phantom than a threat, but in central Europe, thanks in large part to demographics, it is a real threat. The region is rapidly recovering from the pandemic, supported by the rebound in trade. And with higher inflation and wage growth comes economic convergence with richer neighbors. But for many people, rising prices are already eating into their standard of living. Unless central banks take decisive action, problems could arise.

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