As a response to US and EU sanctions towards Russia, Russia has imposed a ban on food imports from a large number of countries including the CEE countries. Given that Russia has been an important market for Polish, Czech and Hungarian food products, the implications of the ban are quite clear – further downward pressure on inflation and downward pressure on these economies.
While inflation in the Czech Republic is still positive, although close to zero and well below the Czech central bank’s (CNB) 2% inflation target, Hungary and Poland are already dealing with outright deflation. Yesterday, headline inflation in Poland in July fell by 0.2% y/y and posted its first y/y decrease in 32 years. Apart from a temporary positive 0.1% y/y rise in July, the Hungarian economy has also been dealing with outright inflation. Our inflation model indicates that we will see further falls in consumer prices in both Poland and Hungary. Despite the Czech Republic still having positive consumer prices, supported recently by higher food prices, the risk of deflation in the Czech Republic is high and it is highly likely that we will see deflation here in coming months.
So, what is the likely outcome of the Russian food sanctions for the CEE economies? In addition to the clear downward pressure on the economy, food prices are likely to fall, dragging consumer prices down further. Hence, deeper deflation in CEE is the most likely scenario, in our view, putting even more pressure on the local banks to fight this. The Hungarian central bank (MNB), which has already cut interest rates quite sharply, could deliver some additional rate cuts and we believe the Polish central bank will be forced to cut interest rates further, despite it having been reluctant to acknowledge the need for further monetary easing. Hence, we now expect the NBP to reinitiate its easing cycle and deliver a rate cut fairly soon. The CNB no longer has the option to use interest rates as a monetary policy tool, as the key policy rate is already at a technical zero at 0.05%. Although the CNB is already using the exchange rate as an unconventional monetary policy tool, given the increasing deflationary risks in the Czech economy and, at the same time, it seems that the recovery has lost momentum, at some point the CNB is likely to be forced to deliver additional easing to fight deflationary pressure. Hence, the possibility of the CNB lifting the EUR/CZK floor is high.
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