Inflation makes booming Central Europe shine
Central Europe is at the forefront of a surge in European inflationary pressures. Poland’s inflation rate reached 4.7% in May and then slowed to 4.4% in June. Hungary’s inflation rate is the highest in the European Union, at 5.1%. Some of them are caused by transitional factors. But there are also reasons to believe that price pressures in these two countries will continue, which creates potential tensions between their central banks and profligate nationalist governments.
This may also damage the reputation of the macroeconomic orthodoxy they carefully cultivated. The appreciation of Brussels and Berlin for their economic management—making them a favoured destination for German investment—helped to protect Budapest and Warsaw from stricter scrutiny of their domestic agendas, namely controlling media freedom, curbing minority rights and Politicize the judiciary.
Inflation rates in Poland and Hungary are much higher than the medium-term targets set by the two central banks of 2.5% and 3% respectively. However, the governor of the Polish Central Bank Adam Grapinski is not in a hurry to raise interest rates.Grapinski tell The British “Financial Times” “has no reason to panic” about inflation in his country. He said that the rise was mainly caused by supply-side and regulatory factors.
In Hungary, central bank governor Gyorgy Matolcsy last month called on the government to substantially tighten fiscal policy-reducing the deficit from 7.5% of GDP this year to 3% next year. He said that the government’s fiscal plan was a “mistake.”
Matolcsy was rejected by Prime Minister Viktor Orban. He believed that families with children had the prospect of substantial tax cuts (Warsaw’s “Polish transaction“) Just in time for next year’s parliamentary elections, this will be an intense game.
Orban also appeared to be dissatisfied with the governor’s bow, saying that he hoped that any rate hike would be “cautious and restrained.” The central bank subsequently raised the main policy rate by 30 basis points to 0.9%, which was the first rate hike in a decade. It also stated that it will continue to tighten on a monthly basis.
Capital Investment said in a recent report notes Prior to the latest pressures related to the end of the pandemic, the Central European economies are experiencing “stubborn high inflation” and “the risks in the next few years tend towards long-term high inflation, followed by more aggressive monetary tightening policies.”
The European Bank for Reconstruction and Development, a multilateral lending institution, also expressed concern. Chief economist Beata Javorcik said that there are short-term factors, such as suppressed demand at the end of the pandemic, but also long-term factors.
The first is the hot labor market in the region, which is exacerbated by its poor demographic structure. Despite the economic downturn, the average wages in Hungary and Poland rose by 10.6% and 7.8% respectively last year. The unemployment rate in Poland is only 3.1%. It may be able to absorb Ukrainian migrant workers, but Hungary’s anti-immigration government is reluctant to do so. Secondly, funds from the European Union Recovery Fund will begin to flow into the next four years later this summer, further boosting demand-and the income tax reductions of the two governments will also be the same.
Third, decarbonization will push up producer prices in these economies that still rely heavily on fossil fuels. Finally, unlike Western Europeans, older Hungarians and Poles still have memories of the hyperinflation at the end of communism, which means that their expectations of price increases may change more quickly-which makes independent history more difficult. The short central bank feels a headache. “If these expectations rise, the cost of reducing inflation will be high,” Javorcik said.
The return of inflation in advanced economies may be more of an illusion than a threat, but in Central Europe, it is a real threat, mainly due to demographic data. Supported by the trade rebound, the region is quickly rebounding from the pandemic. Higher inflation and wage growth are accompanied by economic convergence with wealthy neighbors. But for many people, rising prices have eroded their standard of living. Unless the central bank acts decisively, there may be trouble in the future.