East Europe on Alert to Old Foe as Wages Jolt Central Banks
(Bloomberg) -- Like central banks elsewhere, policy makers in eastern Europe haven’t been too adept at fighting deflation. A burst of wage growth suggests they may not have to worry about that much longer.
A bonanza for workers among the former communist members of the European Union has sent paychecks soaring at a pace unseen for years, with Romanian salaries growing faster than 10 percent for nine months. Average gross wages in Poland, the EU’s biggest eastern economy, jumped 4.7 percent from a year earlier in August, near a four-year high of 5.3 percent in June, data from the Warsaw-based statistics office showed. For Morgan Stanley, that signals inflation risks in the region are “skewed to the upside” for the first time since 2013.
The gathering threat is setting the stage for policy whiplash in nations just emerging from the slumber of deflation and price growth still below zero in three of the four largest economies in the EU’s east. With Poland in the grip of its longest stretch of falling prices in six decades, Governor Adam Glapinski said this month the central bank is “moving closer” to its first interest-rate increase since 2012 after having held its benchmark at a record low for a 17th month.
“This is a growing concern in all of the region,” said Roxana Hulea, an emerging-market strategist at Societe Generale SA in London. In Poland, “wage growth is an element that is being considered very carefully, given the ongoing tightening of the labor market.”
Higher salaries are buoying consumer demand that’s kept eastern European economies growing at the fastest clip in the EU. While that’s helping the bloc’s poorest countries catch up with richer neighbors in the west, productivity gains haven’t kept up, meaning there’s a greater risk that companies will have to raise prices to cover higher labor costs.
The salary spike is the latest challenge for central banks in Poland, Romania, Hungary and the Czech Republic. While policy makers have credited deflation for propping up household spending without clouding the economic outlook, their credibility is on the line because inflation has for years undershot their targets, which are between 2 percent and 3 percent.
Czech wage growth accelerated in the first quarter even as labor productivity slowed significantly, the central bank said in its latest inflation report. In Hungary, the exodus of skilled workers to more affluent European states has tightened the labor market and helped push net salaries 8.3 percent higher in the first seven months from a year earlier, heading for the fastest annual growth since at least 2008.
That pressure will gradually translate into faster consumer-price growth through next year, according to the National Bank of Hungary, which ended a three-month rate-cut cycle in May with a pledge to keep borrowing costs on hold for an “extended period.” Czech policy makers, meanwhile, are counting on wage growth to help them meet their 2 percent inflation target next year, a condition for removing a cap on the koruna they imposed in November 2013 to weaken the currency.
“Labor markets have tightened sharply across emerging-market Europe, and wage growth has picked up,” Morgan Stanley analysts Pasquale Diana and Georgi Deyanov said in a report earlier this month. “While this does not mean inflation getting out of control, it would nevertheless be a significant break from the recent past.”
Forward-rate agreements used to wager on Polish rates in 12 months have priced out 22 basis points, or 0.22 percentage point, in cuts in the past three weeks and now show bets for six basis points in decreases for the next year. Koruna forwards for 12 months indicate increased anticipation the Czech National Bank will abandon its limit on currency appreciation.
While Hungary’s three-year bond yields fell to a record-low on Friday, the rate on 10-year notes traded near the highest in more than two months, lifting the yield curve to the steepest in almost a year. That’s a sign investors are betting on an uptick in inflation and accelerating growth.
Polish Monetary Policy Council member Eugeniusz Gatnar has cited rising wages among the key reasons that the end for deflation is near, signaling the next rate move will be an increase. ING estimates a labor-market overhaul, including the introduction of minimum hourly wages, will raise the inflation rate by 0.2 percentage points and contribute to a rebound in consumer-price growth, according to a report by economist Jakub Rybacki.
Still, no policy action is imminent, with Glapinski saying Sept. 7 that tightening won’t start until late next year if inflation and economic growth pick up as predicted.
Household spending barely perked up last quarter, even as the government in Warsaw deployed its largest-ever program of family benefits, while investment dwindled the most in almost four years. Despite record-low unemployment and gains in wages, price declines continued for a 26th month in August. The persistent deflation has so far prompted no policy response because the economy has expanded by at least 3 percent every quarter for the past two years.
“The MPC is right in not doing anything as we’ll be nearing the inflation target only gradually,” said Michal Dybula, an economist at BNP Paribas SA in Warsaw.