Wide Angle Shot: Monetary policy in motion in Western Europe & CE/SEE

Like other Emerging Markets central banks, major CE/SEE central banks also stepped up their policy responses in order to mitigate the effects of the COVID-19 crisis on local economies and markets. For the first time central banks in Poland, Hungary and Romania started (larger scale) asset purchases. On an interesting note the relatively high pre-crisis key rate in Czechia (as a consequence of more proactive approach and hikes before the pandemic) resulted in relatively deeper rate cuts in response to the COVID-19 recession. While the legal foundations for a QE program were laid in Czechia, it has not been introduced after all by the Czech National Bank (CNB); not to forget that sizable anti-cyclical tools in terms of banking sector regulatory measures were at hand here.

Poland, which introduced the most sizable QE program in CE/SEE, aimed it mainly at providing liquidity to the market in anticipation for a large supply of government bonds. Thus, with the largest purchases at the start of the program, NBP’s QE has remained at above 5% of Polish GDP (estimated for 2021) and so far, the purchases amounted to around EUR 30 bn or 13% of outstanding bonds. This is still much less than the QE program led by the ECB inside the euro area, which stands for 27% of GDP or 33% of outstanding bonds (25% of German GDP, 43% of German Bunds). In Hungary, and Romania QE programs started in a much smaller scale (although recently higher in Hungary) and were mainly aimed at stabilizing financial markets. In particular, the Romanian central bank implemented a de facto “QE light” with ad-hoc purchases so far amounting to merely 0.5% of GDP or some 2-3% of outstanding government bonds.

Differences in the size of QE programs in CE/SEE countries (or in Emerging Markets in general) compared to Advanced Economies like the euro area are in our opinion not surprising. Such countries are more vulnerable to capital flight and FX depreciation, which are (market) limitations to large scale and long-term QE policies.

This has been proven by market developments during the pandemic. The Romanian central bank intervened on the FX market to limit depreciation pressure. Similarly, the Hungarian central bank needed to react with a rate hike in order to arrest the depreciation of the HUF. There is however again some differentiation in the region as in Poland, the central bank actually acted on the other side of the FX market. The action was aimed at supporting the economy via the exchange rate channel, after the NBP had indicated for months that PLN adjustment to expansionary policies had been too small. This difference of FX market reaction is a good indication of why Poland could afford to launch a QE program on a relatively larger scale compared to Romania and Hungary as the country has been much less vulnerable to market turmoil. This leads to a conclusion that the higher the market confidence and accumulated central bank credibility, the greater the QE leeway. And with regard to those dimensions ECB is definitely ahead of its CE/SEE peers. However, above all, QE in the euro area is a response to years of undershooting of inflation and inflation expectations. And in this context, it is important to stress the divergence with the CE/SEE region as reflation developments here are currently more pronounced (than in euro area), which only adds to confidence that QE is not sustainably needed in the region from this monetary policy point of view.

Just as the COVID-19 crisis was quickly overcome in the CE/SEE region in the real economy, QE seems to be leaving just as quickly. In Poland, we can already see active discussions on the future of monetary policy and QE. According to suggestions from the NBP Governor, before interest rates are increased, an end to QE will be announced as a step towards normalization of monetary policy. We expect this to happen by the end of this year. As to the reduction in the asset balance in the years to come, the path seems less predictable with the NBP Governor stressing it is too soon for such considerations. The Hungarian National Bank (MNB) is planning a different trajectory for the exit from crisis management than major central banks and the likely path at NBP. MNB started with rate hikes (from June), which may be followed by the withdrawal of certain unconventional policy tools designed to manage the crisis (e.g. special lending schemes) while keeping its QE program for the time being and into 2022. Most probably the MNB will keep its QE program for longer, and we identify the ECB (where some reduction of bond buying is looming for 2022) as a benchmark for the timing of the tapering in Hungary. Finally, in the case of Romania we don’t expect any major changes in the central bank’s behavior in purchasing RON T-bonds from the secondary market. Very likely, the NBR will continue to provide a backstop for the local bond market during episodes of strong turbulence, targeting to limit fluctuations in sovereign yields and to ensure an appropriate functioning of the market (incl. non-resident flows).

Surely, the QE announcement effects and positive initial impact on market liquidity and investor confidence at the onset of the pandemic were very important. However, going forward, in view of the solid growth and inflation dynamics currently, we do not see monetary policy reasons to continue with the QE programmes in CE/SEE as open-ended packages nor as long-running measures of fixed, regular and substantial bond purchases with reinvestments. Still, QE may be a helpful tool to retain some temporary market-stabilising flexibility as the unwinding of ultra-expansionary monetary policy in the US and the euro area may be definitely marked by (market) uncertainties going forward.

Looking at the overall regional monetary policy stance, we see the “Hawks” currently more in the driver seat in CE/SEE, as underlined by the recently launched hiking cycles in Czechia and Hungary. In fact, the central bank in Hungary has actually announced a shift towards more proactive policy which may even result in interest rate hikes at each MPC meeting in the near term. With that key monetary policy changes focus mostly on the conventional toolbox. The situation seems to be totally different at the ECB where it seems that the “Doves” are in the driver seat at present. The most recent inflation target adaption at the ECB can be interpreted as an implicit slight increase in the inflation target (in order not to delivery too early rate hikes), while the ECB finally declared unconventional policy tools as standard ones. ECB thus intends to continue to use (previously unconventional) instruments such as forward guidance, asset purchases and longer-term refinancing operations as "new" standard instruments in certain phases of the monetary policy cycle or at the so-called "effective interest rate floor". The ECB is open to react flexibly in the future and to examine "new monetary policy instruments". See also our comment "ECB Watch: New strategy hot off the press - any news or status quo continued?".

The period of active usage of QE in CE/SEE may last 12-36 months (depending on further tapering) and has never started in Czechia. Meanwhile, we are already in the seventh year of QE inside the euro area with current round of active purchases likely on the market for additional 12-24 months. Not to speak about reinvestments that may last for longer in this region.

Overall, in our opinion the market impact of the regional QE programmes and unconventional monetary policy measures in CE/SEE on long-term interest rates is and remains much lower than in the euro area or the US. In the US, estimates point to a (combined) yield-dampening effect of unconventional monetary policies of at least 100-150 basis points, in the euro area of 150-200 basis points. However, much higher relative magnitudes, stock effects of QE (reinvestments), combined with sizable new purchases and forward guidances play an important role here to come to such a market impact. In the euro area, of course, negative interest rates are also of importance. Since measures such as a clear forward guidances or negative interest rates do not play a role in CE/SEE and the stock effects of QE are limited, we would see the interest rate-dampening impact on the long-term yields in a range of 10-40 basis points (i.e. more similar to effects like at the beginning of QE in Western markets). At present, those effects are possibly even overshadowed by certain “monetary policy surprises”, i.e. earlier interest rate hikes than expected. Moreover, limiting buying activity already currently (in times of still sizable fiscal deficits and strong GDP growth) like in Romania and looming QE exits in countries like Poland also point to more limited long-term stock effects. Therefore, we think that (yield-dampening) QE effects on long-term interest rates in CE/SEE can be quickly washed out, a totally different situation compared to Western Europe. Here QE induced yield-dampening effects could stay with us well into the 2030ies, depending on the re-investment horizon.

Currently, post-pandemic objectives and new (increasingly popular) economic narratives focus on economic growth rather than a rapid return to low deficits which indirectly also lowers the pressure to retreat from the QE programmes. This holds especially for re-investments of the purchased bonds. However, the current approval, visible in financial market indicators or in comments from rating agencies, for the policies used in order to recover from the pandemic is not given forever. Such considerations are all the more relevant as there are some signs that market investors are increasingly concerned about the restrictions to operational independence at the major central banks, partly because of QE side effects and related market expectations.

QE programs launched as a response to the pandemic in the CE/SEE countries were much lower in scale than in Advanced Economies which is reasonable given the very different fundamentals and risk perception. That said, market investors could more quickly feel unease with large-scale and long-running QE programmes in Emerging Markets, where there is less fixed or determined international demand for government bonds than in the large, developed economies offering “safe assets”. However, we think that Advanced Economies shall not take the “exorbitant” privilege to be in a position to deploy large scale QE without any side effects as a given.

Finally, recent monetary policy developments are reflecting our long-held view that monetary policy cycles between the euro area and CE/SEE may diverge for a very long-time to come. Therefore, even putting aside the political debate, euro area entries in CE/SEE beyond the current candidates (Croatia and Bulgaria) are in our view a very distant option, nothing to bet on before 2030.

For a more extensive view on the CE/SEE monetary policy outlook see our long-read "CEE Insights: Monetary policy in the (post-)pandemic era".