Raise interest rates to curb inflation or keep them low and risk higher inflation, but maintain fragile growth: That is the dilemma for bankers and politicians in Central and Eastern Europe as the economic impact of the pandemic wears off. Richer countries further west face the same issue, but have largely avoided it thus far.

Brazil and Russia have been hawkish, upping rates several times this year, while Turkey and Poland had been among the "doves" pushing for economic growth by keeping interest rates low. Adam Glapinski, head of the National Bank of Poland (NBP), recently said raising borrowing costs would be "very risky" for the economy.

But last week the NBP joined central banks in the Czech Republic, Hungary and Romania in raising interest rates, for the first time in nine years, from 0.10% to 0.50%. The Czech and Hungarian central banks started their own tightening cycles in June, while Romania raised rates a day before Poland. The Czech National Bank raised its main interest rate by 75 basis points, its biggest hike since 1997, and said more rate hikes would follow.

Inflation increases, prices up

Consumer prices grew considerably in countries where the pandemic-related economic rebound has happened quickly between the third quarter of 2020 and the second quarter of 2021, S&P Global Ratings' lead economist, Tatiana Lysenko, told Reuters. She pointed to Poland, Hungary, Russia and Brazil as examples. 

Central Europe is facing some of the highest inflation rates in the European Union. Poland's inflation hit a 20-year high of 5.8% in September, which is above the central bank's target range of 2.5% plus or minus 1 percentage point. The NBP's inflation outlook, published in July, is 3.8% to 4.4% in 2021.

"What the bank underestimated was the increase in energy prices due to a 12.4% rise in natural gas prices for households," Netherlands-based ING bank said in a statement to DW. Benchmark European gas prices have risen by more than 300% this year. Energy and utilities make up a large share of the inflation baskets in Central and Eastern European countries, and their electricity supplies are more exposed to carbon-intensive sources such as coal.

The rise in inflation was also due to global supply delays — and increasingly, from rising domestic demand and tight labor markets, ING told DW. Global food prices are also near their highest levels in a decade, according to a key United Nations index.

"The rise in global prices for both energy and agricultural commodities seen in recent months may still increase price pressures in the coming quarters," ING added.

The Office for Investment and Economic Cycles (BIEC), a Polish economic think tank, believes there are no signs of inflationary pressure dropping off in the near term.

"Since the beginning of the year, in every monthly study, almost 90% of polled households believe that in the coming months prices will rise, of which one-third assert that they will rise faster than to date," said the BIEC in a report.

The report added that inflationary expectations among managers in the industrial sector are now at their highest level since 2004, and that 20% more companies plan to increase prices in the near term rather than to cut them.

More to come?

The NBP will review new inflation and GDP projections at a meeting in November, which will be vital for the course of Poland's monetary policy. 

The central bank indicated that a move away from loose monetary policy could happen as soon as Poland's post-pandemic economic recovery was sustainable. In March 2020, the NBP cut the mandatory reserve rate from 3.50% to 0.50%, and GDP fell 2.7% in 2020. But it picked up again to more than 5% growth this year.

According to analysts, this may not be the end of the rate hikes. 

"The key question is whether this is an introduction to further regular hikes, or after this decision there will be a break," Piotr Bielski, director of the economic analysis department of Santander Bank Polska, told news agency Reuters.

"In our opinion, high CPI [consumer price index] readings for November and December will be deciding factors here. We expect that at the end of the year, CPI inflation in Poland may approach 6%," ING said in its statement.

Analysts at Poland's mBank even believe the rate move was likely the start of a cycle. "We are more inclined to think that the entire monetary tightening will be concluded by the end of 2022," they said. Analysts there could picture a scenario of 50 increased basis points this November, along with another 50 in March of next year.