Articles
2 July 2020

Central and Eastern Europe: Gradual recovery but no deflation

It seems that Central and Eastern European economies are through the worst and a gradual recovery lies ahead. Despite the sharp fall in growth, there aren't any deflationary pressures as these economies were running hot prior to the Covid-19 crisis. All this is likely to translate into limited monetary easing ahead, but Poland remains very dovish

Romanian seasonal workers wait for check-in at the Avram Iancu international airport, in central Romania.
Romanian seasonal workers wait for check-in at the Avram Iancu international airport, in central Romania.
Source: Shutterstock

Economic growth to gradually recover

Despite the high degree of uncertainty, the worst seems to be behind the CEE region. Significantly downward revisions to growth have been made vs pre-Covid-19 (Figure 1), but 2Q looks to be the bottom and the second half of the year should offer a gradual recovery. Still, local economies are unlikely to reach pre-Covid-19 levels until late 2021 or 2022.

2021 growth should range around 4% for the Czech Republic, Poland and Hungary, while around 7% in Romania

The Czech economy is set to see the most negative growth in the region this year (-7.0%) though in terms of the scale of the outlook downgrades vs pre-Covid-19 situation, the almost 9% downward revision to Czech growth (+1.7% pre-crisis vs -7.0% now) is equal to the one in Hungary and larger than in Poland and Romania. This partly reflects the mix of the large openness of these two CEE economies (as very evident in Figure 3) as well as their exposure to the cyclical auto industry (particularly when compared to Poland).

The CEE growth recovery should stem from a mix of improving foreign demand and stabilising domestic demand, both underscored by the low base, generating solid YoY figures. The 2021 growth should range around 4% for the Czech Republic, Poland and Hungary, while around 7% in Romania.

Declining CPI from above target levels means no deflation risks

As for the inflation outlook, the trend into the year-end is largely similar across the region. That is declining CPI (with the exception of stable inflation in Romania) from the rather high, well above the inflation target level starting points. The decline is to be mainly driven by lacklustre demand.

But any talk of deflation is premature and the regional inflation outlook for next year points to either at-target CPI (Czech and Romania) or modestly below the target CPI (Hungary and Poland) – Figure 2.

As pre-Covid starting point for CEE inflation numbers was rather high vs the rest of Europe (due to most CEE economies running above their potential, solid labour market and high wage growth), the subsequent decline is not strong enough to cause deflation concerns.

Limited easing ahead

As the worst seems to be over, there is a gradual recovery ahead and no imminent deflation pressures, this also means the bulk of the across-the-board aggressive monetary policy easing is behind us.

Note that Poland's central bank delivered one of the largest QE programmes globally while the cumulative 200bp worth of Czech national bank rate cuts was one of the largest conventional easings. We see both the CNB and the NBR as largely done.

In Hungary, the central bank started the process of reversing the previous FX stabilising hikes, but additional easing should be only modest (one last 15bp cut and we don’t see 3m Bubor below 0.60% this year) while the central bank has paused its QE programme. In this respect, the NBP should be the leader on the policy loosening front and we expect QE in Poland to be extended into 2021.

FX: CZK to outperform, PLN to underperform

In terms of allocation and preferences, we would argue that overweight CZK, neutral HUF and RON and underweight PLN makes sense.

CZK is our preferred CEE currency given limited scope for further Czech central bank easing, the solid fiscal position and the low odds of the central bank leaning against CZK strength (due to the low risk of deflation – vs the clear deflation risks in 2013 ahead of the start of FX interventions). We see EUR/CZK at 26.00 by the year-end.

In contrast, the dovish bias of Poland's central bank should translate into the PLN underperformance as the NBP is likely to extend QE beyond this year. With inflation still high and rates at the zero lower bound, PLN currently suffers from one of the most negative real rates in the emerging market space (Figure 4).

While HUF weakened noticeably in recent days (following the surprising June National bank of Hungary cut), we don’t see this as long-lasting. Not only was the 15bp cut modest, but the latest guidance suggests that only one additional 15bp cut will be delivered and the base rate is to stay at 0.60% - which is higher than in the Czech Republic and Poland.

We expect EUR/HUF to range trade around the 355 level in coming months


Disclaimer

"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.

This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.

The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.

Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.

ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).