More central and eastern European monetary authorities have started on the path towards ‘normal’ interest rates and the normalisation of monetary policy. The Czech National Bank is leading the hikes, with its eye-catching 1.25 percentage point rise in policy rates announced on 4 November. Despite the different institutional and political frameworks, countries in the region share similarities that explain their strong anti-inflationary zeal and set them apart from major western economies.
The CNB’s last two increases, lifting policy rates by as much as 2.75 points, amount to a record move. Even the normally much less hawkish Narodowy Bank Polski lifted its rates by a total of 1.15 points in its last two moves. Such changes cannot be called moderate. Other central banks in the region have started hiking too. The Banca Naţională a României hiked twice in careful steps of 0.15 percentage points. Hungary’s Magyar Nemzeti Bank has cut back quantitative easing measures, as well as raising rates, the latest increase on 17 November. The largest increase of the year has been carried out by the Bank of Russia, which started the year with an interest rate of 4.25%, but has increased it to 7.5%.
All this contrasts with the hesitancy of large central banks, such as the European Central Bank, Bank of England or Federal Reserve, which see price pressures as temporary. It is difficult to believe that geography alone accounts for these contrasting outlooks.
At the same time, there are some important differences between the economies and monetary setup of CEE countries. Poland’s economy is a larger, though much less open, economy than that of Czechia or Hungary. The CNB believes that its policy rate can quickly influence all segments of financial markets, while the MNB uses specific tools to influence each important segment. The Russian economy is still largely based on energy exports. The Romanian central bank ensures its independence by sticking with Constantin Mugur Isărescu, whose 30 year tenure, started in 1990 with a brief hiatus in 1999-2000 when he was Romania’s prime minister, is the world’s longest of any central bank governor.
Still, all CEE economies share two major characteristics. First, CEE entered the pandemic at the top of the business cycle and on the cusp of overheating. Pandemic measures only partially cooled this overheating and central banks in the region are confident they will not unduly harm their economies with overly strict monetary policies. Second, their constituencies, including political leaders, still have fresh memories of financial crises marked by high inflation. Czechia’s now stable economy experienced high inflation in the 90s. These two powerful impulses combine to make monetary policy-makers more sensitive to inflationary risks.
CEE economies enjoy rather robust financial systems. They have been working smoothly for over a decade. This cannot be said for the euro area, UK or US. Central bank balance sheets in central and eastern Europe have remained in rough equilibrium with gross domestic product, whereas they have exploded in the leading advanced economies.
There are further reasons for the different approaches. The ECB, Fed or BoE will watch certain parts of their financial system with at least some nervousness as they start to increase their policy rates. The ECB has to consider the financial sustainability of the debt some euro area members have accumulated. Anglo-Saxon financial systems habitually face periods of acute strain when certain market sectors, earlier considered safe, are hit by liquidity shortages when monetary conditions tighten.
I ended my 11 October OMFIF piece on CEE central banking with the prediction that you should ‘brace for more hikes’. Those have come. Divergent behaviour in different jurisdictions brings growing risks. With good reason, central and eastern European monetary institutions are moving towards normalisation ahead of advanced country counterparts. But no one should be under any illusions. In the larger monetary areas, too, higher inflation is on the way.
Miroslav Singer is Director of Institutional Affairs and Chief Economist at Generali Group and a former Governor of the Czech National Bank.