Central banks in CEECs take proactive approach to inflation
More and more monetary authorities in Central and Eastern Europe have embarked on the path of “normal” interest rates and normalization of monetary policy. The Czech National Bank leads the hikes, with a recent eye-catching increase of 1.25%. Despite the different institutional and policy frameworks in which CEEC central banks operate, the countries of the region share similarities which explain their strong anti-inflationary zeal and distinguish them from the large central banks.
The latest two CNB hikes, which raised the key rate from 2.25% to 2.75%, are a record. Even the normally much less hawkish Narodowy Bank Polski has raised rates by 1.15% overall in its last two moves. Such changes cannot be called moderate. Other central banks in the region have also started to work. The Banca Naţională a României made two hikes in careful stages of 0.15%. Hungarian bank Magyar Nemzeti has limited quantitative easing measures, as well as a rate hike this week. The biggest increase for the year can be attributed to the Bank of Russia, which started the year with an interest rate of 4.25%, but increased it to 7.5%.
All this contrasts with the hesitations of the big central banks, like the European Central Bank, the Bank of England or the Federal Reserve, which see the pressures on prices as temporary. It is hard to believe that these contrasting perspectives can be explained by geography alone.
At the same time, there are important differences between the economies and the monetary configuration of the countries of Central and Eastern Europe. The economy of Poland is a larger economy, although much less open, than that of the Czech Republic or Hungary. The CNB believes that its key rate can quickly influence all segments of the financial markets, while the MNB uses specific tools to influence every important segment of its financial market. The Russian economy still relies to a large extent on energy exports. Romania’s central bank secures its independence by remaining loyal to Constantin Mugur Isărescu, whose 30-year term, which began in 1990 with a brief hiatus in 1999-2000 when he was Romanian Prime Minister, is the longest in the world of all central bank governors.
However, all CEEC economies share two main characteristics. First, the EEC entered the pandemic at the peak of the business cycle and at the threshold of overheating. The pandemic measures have only partially cooled this overheating and the region’s central banks do not think they will freeze their economies with overly strict monetary policies. Second, their constituents, including political leaders, have new memories of financial crises marked by high inflation. Even the now stable Czech economy experienced high inflation in the 1990s. These two powerful impulses combine to make policymakers more sensitive to inflationary risks.
The economies of the CEECs benefit from rather solid and robust financial systems. These have been working well for over a decade, which is often taken for granted. This cannot be said for the eurozone, the UK or the US. Balance sheets and gross domestic product are roughly proportional in Central and Eastern Europe, while in Western countries, where balance sheets have exploded.
But there are other reasons for the different perspectives. The ECB, Fed or BoE will watch parts of their financial system with at least some nervousness as they start to raise their key rates. The ECB must, of course, take into account the financial sustainability of the debt accumulated by some members of the euro area. In Anglo-Saxon financial systems, there has always been a tendency to be surprised when certain segments, considered very safe, find themselves starved by a liquidity problem as soon as monetary conditions harden.
I ended my last OMFIF article on the EEC central bank with the prediction that you should “prepare for more hikes”. These have come. However, there is a risk associated with the different conditions in which central banks operate. As monetary institutions in CEECs move towards normalization ahead of their more advanced counterparts, savers in large currency areas may need to prepare for higher inflation.
Miroslav Singer is Director of Institutional Affairs and Chief Economist of the Generali Group and former Governor of the Czech National Bank.