By Jan Lopatka, Pawel Florkiewicz and Gergely Szakacs
PRAGUE (Reuters) – The Czech National Bank’s “less haste, more speed” rate cut strategy seems to be paying off with central Europe’s clearest path to low inflation, just as upside risks loom afresh in neighbours Hungary and Poland.
While its Polish and Hungarian counterparts slashed borrowing costs by hundreds of basis points last year as inflation retreated from double-digits, the Czech central bank waited until December for its first reduction, of just 25 bps.
It followed up on Thursday with a 50 bps cut, its largest in nearly four years, taking its main rate to 6.25%. Analysts now see the rate declining to 4% by the end of the year, the lowest in the region according to their forecasts.
With favourable base effects set to fade, strong wage hikes in Poland and Hungary could meanwhile reinforce underlying price pressures by fuelling a consumer-driven recovery.
Possible cuts in household energy subsidies in Poland and Hungary in the second half, after European Parliament elections, represent further risks to the outlook, with inflation seen at between 5% and 6% in both countries at the end of 2024.
Czech inflation, which the government’s tight fiscal stance also helps curb, is seen below 3% at the end of 2024, near the CNB’s target, giving it room to cut borrowing costs. That could be a boon for the sagging economy.
“Domestic and external demand remain weak,” CNB Governor Ales Michl told a press conference on Thursday.
“The pace of any further reduction in rates will depend mainly on … the persistence of the disinflationary trend, the effect of fiscal policy on the economy, … the labour market situation, and the evolution of domestic and external demand.”
A senior IMF official said the CNB should nevertheless be mindful of risks to inflation expectations, which remain above its policy target, as well as possible upside pressure from solid wage growth or a stronger repricing of goods and services.
“In the absence of sharp downside surprises in inflation, staff advises to maintain a tight monetary policy stance to consolidate the disinflation process and provide insurance against a costly de-anchoring of inflation expectations through early 2024,” Geoff Gottlieb, IMF Senior Regional Representative for Central, Eastern and South-Eastern Europe, told Reuters.
“Thereafter, the nominal policy interest rate could be lowered cautiously and gradually, consistent with the expected decline in inflation, with a pace that could be accelerated if inflation expectations align faster to the target than envisaged.”
A Feb. 5 tally by JP Morgan showed investors had priced in the CNB nearly halving its main rate to 3.6% over the next nine months. Hungary’s base rate was seen falling to 5.25%, followed by Poland at 5%, where the smallest amount of cuts is priced in.
Leaving its main interest rate on hold at 5.75% on Wednesday, the Polish central bank flagged several upside risks despite a decline in inflation in the first quarter.
Economists polled by Reuters see Poland’s main rate falling to 5.25% by the end of the year, though some expect no change after cuts in 2023 totalling 100 bps, with Polish inflation still projected at an average 5.6% in the fourth quarter.
National Bank of Poland Governor Adam Glapinski appears to be coming around to that view.
“In my opinion, there will not be such a majority (for a rate cut) by the end of this year, unless unexpected circumstances arise,” Glapinski told a press conference on Thursday, sending the zloty 0.8% stronger on the day.
The Polish Finance Ministry said its decision whether to extend energy subsidies would depend on inflation developments and the public finances, adding that it was likely to lower its 2024 inflation forecast from 6.6% projected in the budget.
Hungary’s central bank has said it plans to cut its base rate to 6%-7% by the middle of the year, though falls in the forint amid clashes with the European Union derailed its plan to temporarily accelerate the pace of rate cuts.
Economists see Hungary’s base rate at 6% at the end of 2024, while inflation is seen rebounding to 5.3% by December from 4.4% expected in January.
Should the bank succeed in lowering the rate to 6% by mid-year, deeper cuts amid a projected rebound in inflation could upend its strategy of keeping interest rates above the level of price growth.
“Overall, we expect year-end inflation to exceed 6.5% if utility and energy prices are raised later this year. This contrasts with a 6% policy rate, which could mean that (at least temporarily due to base effects) the real interest rate may turn negative again,” UniCredit economist Zsolt Becsey said.