Inflation gives Eastern European currencies wings

The Czech currency, the koruna, hit a 14-year high and the Hungarian forint a 10-month record earlier this year, boosted by high interest rates, falling energy prices and a strong euro. The two currencies — later joined by the Polish zloty and Romanian leu — have gained despite economic activity contracting. 

Observers are asking how this happened and how long it is likely to last.

The currencies in Central and Eastern Europe (CEE) —  all outside the euro areaexcept Slovakia — have benefited above all from a high interest rate differential, known as the real interest rate, which is calculated by subtracting the rate of inflation from the nominal interest rate. The CEE currencies now look attractive in comparison with ECB and US Fed rates.

After inflation surged to double-digit rates across CEE countries last year, it now seems to have peaked. But interest rates remain high and central banks are not in a hurry to ease policy until price growth is reined in. 

Hence the widening gap between inflation and interest rates, which makes the region attractive to capital looking for a high-yielding home. This is also despite further interest rate increases in the US and the eurozone. 

Why are CEE currencies doing well?

Piotr Arak, director of the Polish Economic institute (PIE), explains that as a rule of thumb growing exports, cheaper energy, inflows of capital due to higher interest rates "result in stable currencies."

"During recent quarters, there has been a noticeable improvement in current account balances and exports as the countries in the region continue to grow, while the decrease in commodity prices has led to lower import burdens," Arak told DW.

Zloty experiences 'golden spring'

In Poland, the central bank on May 10 held its main interest rate at 6.75%, its level since last September, while inflation fell to 14.7% in April from 16.1% in March.   

In an interview with the weekly Gazeta Polska, the governor of the National Bank of Poland, Adam Glapinski, said he expected inflation to fall to single digits at the beginning of September. This would make an interest rate cut possible at the end of the year provided inflation eases further. 

ING bank's monetary policy expert Rafal Benecki, however, finds the March data from the Polish economy wasn't "a pretty picture" in this respect, indicating the current high interest rates are taking some heat out of the economy.

Core inflation remained broadly unchanged, which suggests enterprises are passing on higher costs onto prices and that disinflation is mainly due to the easing energy shock and lower food price pressure. 

ING expects the central bank to keep policy rates unchanged by the end of this year and cuts may start in 2024 at the earliest, meaning short-term scope for further zloty gains may have been "largely exhausted," as Benecki said in a note to clients.

In the opinion of the ING expert, declines in commodity prices, particularly natural gas, had an impact on the direction of lower price dynamics. So did the government's spending pledges ahead of November's general election. "Pre-election fiscal promises remain a major risk," Benecki wrote.

Forint, koruna and leu's fate hinges on risk appetite

The Hungarian forint has strengthened since the beginning of the year by 6.6% against the euro and is up 9.3% against the dollar. The National Bank of Hungary (NBH) has left the interest rate unchanged at 13% since October. 

Nevertheless, most analysts believe Hungary could see a first interest rate cut by the end of the year because the country's economy has been in a technical recession for three quarters now.

ING predicts the economy will emerge from it in the second quarter, with full-year GDP growth of 0.7%. Despite the meagre growth, the trade balance has benefitted from lower energy prices, which also bolstered the national currency.

In Romania, meanwhile, the central bank kept the benchmark interest rate on hold at 7% for the second month in April. Economists expect it to leave interests unchanged in 2023. The Romanian economy has shown relative resilience compared with its Central European peers. 

As everywhere in the region, inflation was rather high in Romania, and the central bank has forecast a rise to 7% by December. Therefore, rate cuts will "likely not happen" before the inflation rate matches interest rate levels, it said in a report recently.

The Czech koruna has remained strong in 2023 even though it retreated in mid-April from a 15-year high against the euro. The gross domestic product (GDP) of Czechia was up 0.1% quarter-on-quarter, pulling the economy out of recession, with trade driving the expansion. 

What are the threats?

PIE's Piotr Arak believes much of the value development of CEE currencies depends on inflation pathways, which are expected to remain high for a longer period than in the eurozone.

"This may lead to a weakening of the purchasing power. Additionally, an economic slowdown may result in lower foreign investments and higher government deficits. Both factors would be negative," he said.

Subsequently, PIE analyses anticipate the current strengthening of the zloty and other CEE currencies will not last long. "Our long-term projections indicate that these currencies will likely depreciate. But there may be variations among the countries."

Hovering above many outlooks for national economies at the moment is however the prospect of a recession in the United States, which would also put CEE currencies on the back foot.  Similarly, uncertainty remains high about the global banking system's health after a number of collapses recently. Any stress there could see a weakening of capital inflows especially into emerging markets like the CEE countries.

Edited by: Uwe Hessler