Wide Angle Shot: Inflation (forecasting) challenges globally & in CEE

Most economists underestimated the post-pandemic recovery pace. This holds true for GDP and inflation. We had to add 1-2 percentage points to our 2021/22 CPI calls in CEE since Jun 2021. "Reflation forecasting errors" in CEE are in the neighbourhood to forecasting glitches for US price growth in the forecast community; (core) inflation and reflation dynamics for the euro area are still more subdued. For 2022 we see upside risks to our CEE inflation calls (possible exception Hungary), with the strongest (core) inflation dynamics in Central Europe.

Retrospective: Upside revisions CPI forecasts global & CEE (avg. CPI, % yoy)

* Euro area under revision, upside risk to a level above 2% / below 2.5%; ** for US FocusEconomics Consenus; RBI/Raiffeisen Research

2021 inflation with constant upside surprises, 2022 even higher

The inflation path in CEE in 2021 has surprised to the upside due to several factors prompting us to make significant upward revisions in forecasts during the year; on average by 1-2 percentage points compared to Jan and/or Jun 2021, in some cases by 2-3 percentage points (when taking our Jan 2021 forecasts as benchmark). That said economist also upped their 2021 inflation forecast for the US by 1.4 (!) percentage points since Jun 21, up to 4.3% from 2.9%. On the one hand, the dynamic increase in oil prices followed by gas prices lately not only raises fuel prices but also translates into more broad-based price pressures in other areas of the economy. Meanwhile, supply-side disruptions which we had expected to last for several quarters turned out to be even stronger and more protracted than we assumed.

These unexpected developments were combined with other upside factors which were assumed in our forecasts like reopening effects in services or the overall demand-driven price pressures as the economic recovery gathered pace. That said, we also upped our regional GDP growth forecasts in CEE by 0.5-1 percentage points in 2021 on the back on stronger-than-expected reopening dynamics.

Despite already being at or close to historical highs, inflation in CE/SEE (less so in EE) will climb even higher which leads to our average 2022 CPI forecasts mostly above 2021; in major CEE economies — with the possible exception of Hungary — there are additional upside price risks stemming from increases in regulated prices. Certain moderation is expected going into the year-end of 2022, but this projection will largely be dependent on global issues, in particular supply-side disruptions (raw materials and intermediate goods shortages as well as high shipping costs), which we expect to abate throughout 2022 in our baseline scenario.

Average inflation in 2022 expected to remain high or even rise compared to 2021

* 2022 forecast under revision upside risk to a level above 2% / below 2.5%; Source: Refinitiv, RBI/Raiffeisen Research

Inflationary pressures the highest in Central Europe plus Romania

Structural inflationary pressures are the highest among CE-3 countries (Czechia, Hungary, Poland) which were partially facing them already before the pandemic. The increase is accelerated by tight labour market conditions (visible now and before the pandemic), while at the same time the CE countries have not seen a “deflationary” shock like inside the euro area or parts of SEE in 2020. This leads to a more broad-based rise in inflation in CE with relatively elevated core inflation (which in Czechia is now even above CPI). Moreover, these developments are now accompanied by rising inflation expectations which only adds pressure on the central banks to react. As a result, we expect core inflation to be even higher in those countries in 2022 reaching on average 4.5% yoy vs 4.1% yoy expected this year. Core inflation is so far lower in SEE, with high fuel, electricity and food prices, as well as global supply disruptions, being key drivers of higher CPI. However, as distortions persist there is a risk of upward pressures intensifying and feeding into more price categories also in SEE. In case of Romania there are substantive country-specific upside risks with 2022 inflation expected above 7% (7.7% vs previous long-term peak at 7.9% in 2008).

Multiple factors still affecting prices to the upside in 2022

Looking at the outlook for inflation next year in more detail we assessed the possible impact of key near-term drivers (see also our in depth regional inflation study "CEE Insights"). The main takeaways from this exercise for the CEE region reveal that despite expectations that by the end of 2022 inflation in CEE countries will be lower than it is forecasted in December this year, risks to this scenario point to the upside as underlined by higher forecasted average inflation during 2022.

One group of factors we looked at are supply-side driven, some strictly related to the pandemic like reopening effects which are expected to fade (and were not strong anyway), others possibly more durable like the high energy and commodity/materials prices amid disruptions which keep prolonging and may therefore feed into other price categories as firms pass higher costs on finished goods prices. Pricing power of (Western) European corporates seems to be on a very strong level according to current sentiment indicators, a trend that may also spillover to CEE.

We also looked at wage costs with most CEE countries facing tighter labour market conditions and minimum wage increases planned in 2022. This is, as mentioned, especially the case for Central Europe. Furthermore, we see significant upside risks to food prices in 2022 which will be impacted not only by weather conditions but also by labour shortages as well as by high fertilizer prices (resulting again from high gas prices but also lower imports from Belarus and China), which limit their use in agriculture and with that negatively affect the harvest.

On the demand side risks also point to the upside despite our already high inflation outlook. We expect consumer demand to remain solid, in some countries (Hungary in particular, also Romania) still boosted by very loose fiscal policy (incl. pre-election spending in case of Hungary). The ongoing strong European and regional investment recovery stimulated by the inflow of Next Generation EU will also add to inflationary pressures (with stronger upside risks in small and open economies in CE/SEE), with supply-side disruptions still present.

The key risk is how strong the current uptrend in inflation impacts inflation expectations — which are usually less well anchored in Emerging Markets and countries with higher historic inflation rates and less successful disinflation dynamics compared to Advanced Economies.

2021/2022 Reflation dynamics in historical context (avg. CPI, % yoy)

national sources, RBI/Raiffeisen Research
* Average inflation forecasts 2021/2022; for US FocusEconomics; historic peaks 2007-2019 in brackets (differing for countries/regions)

Monetary policy response most in need in Central Europe

Central banks in CE and EE already responded to high CPI levels with interest rate hikes in 2021, joined by Romania in SEE. Front-loaded and bold monetary tightening in CEE seems reasonable in light of less well-anchored inflation expectations compared to developed markets, a traditionally higher pass-through from producer prices to CPI and certain pockets of FX weakness. Also, bold rates hikes by individual central banks (like the CNB) are contributing to upward adjustment competition. Moreover, central banking in CEE and Emerging Markets is now no longer just a matter of building a hedge against tapering announcements and tapering (as was the case in early 2021), but for increasingly earlier-than-expected US rate hikes and market risks that the Fed could turn the interest rate screw faster and/or more decisively. This holds especially true as the mid-term inflation outlook in the US seems much more challenging nowadays (with inflation staying above Fed target levels from 2021 until 2023) compared to the situation a few months ago.

From a longer-term perspective inflationary pressure and challenges are more in "unchartered territory" in Advanced economies and the US in particular, with average 2021/2022 inflation in the US and the euro area at 3.8% and 2.3% respectively vs. long-term averages at 1.9% and 1.5% (2007-2019). The picture is a bit similar and in between US and euro area relationships in CE with avg. 2021/2022 inflation at 4.1% vs a long-term average at 2.2%; in SEE the respective relations are at 4.2% vs 3.3% or at 6.7% in EE 2021/22 vs long-term averages at above 8%.

Given the frontloaded tightening in 2021 most central banks in CEE may finish their rate hike cycles at not too excessive terminal rates compared to previous cycles in 2022 — if and when major central banks manage to arrest global inflation expectation dynamics in the course of 2022 and assuming the supply-side disruptions indeed abate during the course of the year as we expect in our baseline scenario. In an alternative scenario, however, this would require a much bolder reaction than the one we (and the markets) assume currently.

Inflation: It is possibly all about (arresting) inflation expectations

Inflation (forecasting) uncertainty remains high in any case in the coming 12-24 months. Possibly we are heading to a new global inflation regime in Advanced Economies, with higher inflation than in the last decade (see Special Analysis: lnflation Fears and Inflation Potential). That said, inflation is one of the most complex economic variables to model and project. And apart from complex and interdependent supply and demand mechanisms, inflation can also arise purely from expectation components. Especially the latter are directly in the hands of central banks — when and if they do not react too late.

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Dorota Strauch is leading economic research on Poland from the RBI Branch located in Warsaw. She began working in Polish RBI network bank in 2010. In 2017 she became the Head of Polish Research team. Having a master’s degree in Financial Markets and Banking she deepened her knowledge by becoming the CFA charterholder in 2016. In the following years she has been focusing on improving data analysis skills with the use of Python programming language. Apart from current economic developments in Poland and the CEE region she is particularly interested in the impact of new technologies on the economy, politics and society.

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Gunter Deuber is heading the Economics and Financial Analysis division (Raiffeisen Research) at Raiffeisen Bank International (RBI) since 1 January 2021. Since 2011, Gunter Deuber has held leading positions in RBI's Economic and CEE Research and has continuously expanded the cooperation with his research colleagues in RBI’s subsidiary banks in CEE. Since the early 2000s, he has been analysing economies, banking sectors and market topics with a focus on CEE and EU/euro area topics for RBI in Vienna, but also in the international (investment) banking context in Frankfurt. He regularly presents the views of Raiffeisen Research and his research team at meetings with investors and clients. He is a well sought-after speaker at landmark events in the finance and banking industry and a guest lecturer at several universities/teaching institutions. In 2019, he was nominated for the US State Department's IVLP (International Visitor Leadership Program). Gunter has published several edited volumes on Euro/EU crisis issues and published various articles in professional journals and industry magazines. Outside the office, Gunter enjoys travelling with his family and long-distance running.