Most of the CEE currencies that we cover ended 2021 with small losses against the euro, with the Czech koruna the only one bucking this trend, rallying by approximately 5%.
The contrasting currency performances can, in our view, be largely attributed to differences in macroeconomic fundamentals, monetary policy, and risk sensitivity. Those continue to be important.
The Czech Republic arguably has the best macroeconomic fundamentals in the region, which include the most balanced current account and hefty FX reserves, indicating relative external stability. Its current account deﬁcit ﬁnished the year at below 1% of GDP based on preliminary data and was the lowest of the four countries covered in this report.
Czech Republic’s FX reserves were equal to 157.6 billion EUR in March, or approximately 11.5 months of imports. Relative to imports, this is roughly twice the level seen in Poland and Romania. Hungary is an outlier, with reserves covering only approximately 3 months of imports. The amount of reserves should allow Czech Republic, Poland, and Romania to conduct interventions if they assume them necessary. Considering its limited chest of reserves, this is unlikely to be a preferred option for Hungary.
Inﬂation in the Czech Republic is also currently the highest in the CEE, and the third-highest in the EU (HICP at 10% in February vs. 8.1% average for Poland, Hungary, and Romania). That said, we’d expect inﬂation to decline to more normal levels faster than its peers, partly because of its proactive and aggressive monetary policy.
High interest rates are also a factor that can limit the vulnerability of a currency to external risks. Hungary and Czech Republic have the highest interest rates in the region, having begun raising them at around the same time, in June 2021. We think that rates in Czech Republic are nearing their expected maximum level, while those in Hungary still have room to increase further and will most likely be the highest in the CEE. Rates in Poland are likely to reach levels similar to, or higher, than those in Czech Republic, in our view, at 5.5% or more. Rates in Romania are currently the lowest and it looks like the monetary tightening cycle in the country will be the longest in the region, with rates likely reaching levels lower than those in Czech Republic and Poland, in our view.
With regards to economic activity, Poland and Hungary clearly stand out as best-performers, having regained their pandemic losses in mid-2021 in real terms. Romania also recovered around that time, but it recently surprised with an unexpected quarterly contraction in the fourth quarter of 2021. Czech Republic, on the other hand, still most likely has at least a few months before it recovers all losses from the pandemic. The country was severely hit by the pandemic downturn, has a relatively conservative economic policy, and arguably has the lowest growth potential.
Despite the war in Ukraine, economic growth in most of the CEE countries, with a likely exception of Czech Republic, is set to remain relatively strong this year, supported by very tight labour markets. At least some of the negative effects on growth have to do with worsening business and consumer conﬁdence, and may be offset by additional consumer spending from refugees ﬂeeing Ukraine, with most of them (more than 2 million) choosing Poland as their immediate destination. Growth should also be supported by the disbursement of the EU recovery funds, with Romania and Czech Republic already receiving part of the assigned funds, while Poland and Hungary are still waiting for the process to move forward due to political issues. Both of the latter have, however, announced ﬁscal policy easing in recent months, which should also be supportive of growth. We think that the EU recovery funds for Poland and Hungary will also be unlocked this year, with the war in Ukraine adding pressure to distribute the money and help countries deal with economic challenges posed by the conﬂict. Poland seems to be on course to receive the green light for the funds in the next few months, with the timing and approval of funds for Hungary more uncertain.
Inﬂation is set to remain very high, at least in the near-term, and this poses a challenge to domestic decisionmakers that need to strike a balance between limiting risks associated with inﬂation and not causing too signiﬁcant of an economic slowdown. This is expected to be elevated further due to the energy shock posed by the war in Ukraine, and we have already seen the ﬁrst evidence of that.
We continue to expect an appreciation of the Czech koruna, Polish zloty, and the Hungarian forint and a mild, gradual depreciation of the Romanian leu.
We think the ﬁrst three have a chance to outperform as we expect these currencies to shake off most, if not all, of the remaining risks associated with war in Ukraine in the coming quarters. Negative macroeconomic consequences of the conﬂict, including higher inﬂation, slower growth, deteriorating terms of trade and likely heightened imbalances in the balance of payments will continue to negatively affect the exchange rate, even when aforementioned risk dissipates. In our view, this effect on the currency will be only partly balanced by tighter monetary policy. We have, therefore, recently revised our CZK, PLN, and HUF forecast lower compared to our previous assessment from the beginning of the year. At the same time, the stabilisation in RON, and our view that the central bank has a strong case for not allowing too signiﬁcant of a depreciation in the coming quarters due to high inﬂation, means that we have revised our RON forecast higher. We do, however, still expect the currency to gradually depreciate in the coming quarters.
Given already relatively high-interest rates, our expectations regarding the monetary policy tightening in the Eurozone, and our view that most CEE currencies are undervalued, we don’t think an expected rapid policy tightening in the US poses a particular threat to the CEE currencies. The actual risk we see is that of a potential further deterioration of the security situation in Europe and in the case of Hungary, consequences of clashing with the EU.
We are optimistic it will be avoided, but if the war in Ukraine was to escalate much further and for long, the currencies in the region would likely come under renewed pressure. In the near-term, developments with regards to the war will be key for the region and CEE currencies, particularly the most sensitive Polish zloty and Hungarian forint.