Approaching turning point
CEE central banks have intensified their fight against inflation in recent months. Inflation is to peak in 3Q, but the timing of the peak could be affected by the government’s price policies. CEE central banks will end their tightening in 2H22 and LCY yield curves will become more inverted.
We have seen an unprecedented increase in LCY bond yields in CEE this year, which, in combination with the weakening of currencies, has led to huge losses in the value of these assets for non-resident investors. In recent months, as inflation continued to surprise to the upside, driven by increasing food and energy prices, central banks have also been intensifying their efforts to fight inflation. Since March, the CNB has increased rates by 200bp and since May has started to use balance sheet operations – FX interventions, to reduce excess CZK liquidity. The Hungarian central bank more than doubled its interest rates, surpassing Czech rates. Hungary is currently running the highest interest rates in the region (9.75%).
However, going forward, we see the current yield levels of LCY government bonds as attractive, given that inflation and interest rate increases are close to their peaks and yield curves should turn even more inverse, especially if signs of an economic slowdown start to materialize. Prices of metal and agricultural commodities corrected strongly in recent months. The UN Food and Commodity World Index has fallen 10% since March. Only gas prices remain elevated, due to the ongoing Russian war in Ukraine and fears that the temporary halt of gas supply through Nord Stream 1 (due to scheduled maintenance work) will become permanent.
A visible correction on bond markets has already taken place in Czechia and Poland, which are two countries where the end of tightening is expected in 3Q. 10Y yields are already about 110bp down from their highs reached in June. In our baseline, we expect 10Y LCY government bond yields to fall 30-150bp by next summer, while yields for EA members (Slovakia, Slovenia) should edge up 40-60bp, due to the very late start of normalization of monetary policy, which includes rate hikes and the end of QE.
Rating agencies have already appraised Croatia’s euro adoption and all of them delivered at least one-notch upgrade (Fitch to BBB+ from BBB, S&P to BBB+ from BBB- and Moody’s to Baa2 from Ba1). Croatia’s ratings from Fitch and S&P now sit one notch above those for Hungary and one notch below those for Poland. In the second half of July, Fitch is supposed to issue its assessment of Hungary, in which it may raise concerns about the unresolved situation regarding access to EU funds and mounting twin deficit issues by changing the outlook to negative. In Romania, despite very limited progress on the fiscal side, we do not expect a downgrade to non-investment grade this autumn.