There is no doubt that the growth outlook in the euro zone has deteriorated sharply in recent months. This is now beginning to have a clear impact on the EMEA economies. Hence, Hungary and the Czech Republic are already in recession and the outlook for the rest of the year does not seem too bright either. Furthermore, even in Poland, where growth has long remained robust, there are increasing worries about a slowdown in growth. This is also the case in Turkey where growth has also slowed considerably.
Despite the slowdown in growth across the region the currencies have all done very well. This is contrary to the situation in 2008-09 when they in general came under extreme pressure as the crisis developed. This might be providing central banks across the region with some comfort but we believe the central banks should actually be concerned that their currencies are strengthening – and that monetary conditions are therefore tightening – in a situation where growth is slowing. The strengthening of the currencies in the region is likely to put further downward pressure on growth and inflation.
The outlook for further disinflation and weaker growth is already leading the markets to price in further monetary easing around the region over the next 12 months. However, so far the region’s central banks have been quite reluctant to respond aggressively to the deterioration in the situation. Fundamentally, monetary easing is clearly warranted across the region but we might still be some distance from more aggressive easing being implemented.
Some central banks such as the Polish and Turkish central banks could easily move towards an easier stance without changing their modus operandi. However, for central banks such as the Romanian and the Hungarian central banks, worries over foreign currency lending are keeping them from engineering a currency sell-off through aggressive rate cuts. In the case of the Czech central bank (CNB), it is ‘institutionally’ constrained by the fact the CNB’s key policy rate is already close to zero. This means that the CNB will soon have to contemplate some form of quantitative easing. The CNB so far has seemed very reluctant to move in that direction despite an increasingly desperate need for monetary easing in the Czech Republic.
Overall, we believe that the region’s central banks will remain reluctant to ease monetary policy in the immediate future and that this is likely to keep the region’s currencies on its current strengthening path. However, sooner or later the sharply deteriorating macroeconomic will force the region’s central banks into action and at that time we might see the present bullish trend in the region’s currencies turning around. However, that time has not yet arrived.