January 13, 2017 / 9:42 AM / in 6 months

Inflation rebounds in Central Europe, tight labour markets a risk

4 Min Read

A shopper walks by the stand of a meat vendor at the Grand Market hall in Budapest, Hungary, May 15, 2016.Laszlo Balogh

BUDAPEST (Reuters) - Inflation in Central Europe rebounded in December to multi-year highs, in a turnaround likely to continue this year on rising oil prices, a jump in wages and loose fiscal policies.

Central banks in the eastern wing of the European Union have been easing monetary policy since 2012 amid anaemic inflation. But they are unlikely to raise interest rates due to the changing inflation picture just yet, as price growth does not exceed their targets.

Among them, the National Bank of Hungary could be the most dovish, potentially making Hungarian bonds the most exposed to "reflation trade" in the region, some analysts said.

Hungarian annual inflation accelerated to 1.8 percent in December - its highest level since July 2013 and above analysts' consensus forecast for 1.6 percent, data showed on Friday.

In the Czech Republic, annual inflation hit its highest rate in four years in December at 2 percent, while Poland saw prices climb 0.8 percent in the year through December, up from no change in November based on preliminary data.

Romanian annual inflation was still negative in December, however.

"In the short term inflation is fuelled by oil prices and a jump in food prices, but we can also see that there are more and more factors that will also raise core inflation," said Eszter Gargyan, an economist at Citibank.

She cited loose fiscal policies, rising wages across the region, a shortage of labour and higher energy prices feeding through into services prices.

"The market has started to price this in, as we could see Hungarian (bond) yields rising significantly in recent days," she added.

The yield on three-year Hungarian government bonds has risen about 15 basis points and the 10-year yield has climbed about 20 basis points since the start of the year.

Hungary's central bank has pushed down short-term yields with its policies, so the yield curve could steepen as inflation picks up.

Years of emigration to western Europe have created labour shortages across Central Europe, leading governments to hike wages sharply as unemployment rates dropped.

Analysts say this all poses an upward risk to inflation which is hard to estimate.

"The market is getting somewhat distracted by oil price moves and base effect CPI inflation narratives when the real and more substantive risk to CEE inflation is labour markets," Nomura said in a note.

No Rate Hikes Yet

Nomura said Hungary's negative short term real rates would make it "a particular target for reflation trades from the market, but the NBH won't react."

The central bank has pledged to keep its base rate steady and is not expected to hike rates before 2018 parliamentary elections, as politically that would be difficult for the ruling government of Prime Minister Viktor Orban.

The bank said inflation would reach its 3 percent target, which has a one percentage point tolerance range on either side, only in the first half of 2018.

The governor of the Polish central bank has also said there was no reason for Poland to raise rates this year but they could be increased in 2018 if the economy accelerated.

The Czech central bank, which has kept the currency at 27 crowns or more to the euro since 2013 to keep the local currency weak, has pledged to maintain its policy at least until the second quarter. Some analysts said pressure on the cap was growing due to rising inflation.

Editing by Hugh Lawson

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