IMF: the West is winning the battle against inflation, but the situation in Eastern Europe is still dangerous

Progress has been made in bringing inflation down and the likelihood of a soft landing has increased both globally and in Europe, but the downside risks are significant, Laura Papi told the conference. Decelerating growth and productivity, the occurrence of global fault lines, and the green transition all raise the question of whether we will ever return to an era of high growth. These are also testing policy makers globally and in Hungary.

Europe could grow by 1.3% this year and 1.5% next year, so the IMF expects a slow recovery. Monetary policy tightening has brought down the headline inflation rate, which has helped real wages to recover. Growth is slowing but could remain in positive territory, meaning a soft landing is taking place. However, the picture varies across Europe, with Hungary and Germany, for example, performing weakly, due to energy and industrial exposure, according to the IMF.

However, the headline inflation rate in some countries will not even reach the target in 2026.

The IMF is most concerned about core inflation, with nominal wages rising significantly, especially in Central and Eastern Europe. In Hungary, prices have been rising rapidly and partial catching-up of wages is reasonable, but there are concerns about this. Wage pressures raise the risk that inflation will pick up again, while also undermining competitiveness. Short-term inflation expectations may play a bigger role in inflation rebound than previously thought, Papi said.

The labour market is strong in Europe, which is good news. At the same time, we can expect further nominal wage growth, raising the possibility of a price-wage spiral.

We do not see the risk of a price-wage spiral in developed Europe, but in Eastern Europe this risk cannot be ignored.

The IMF has already seen a fall in corporate profits, which is good news because it suggests that companies have been able to absorb higher wage increases, but there is no certainty that this will continue.

geopolitical fault lines also have inflationary effects.

The IMF Deputy Director says that initially policymakers thought that disruptions to supply chains would be temporary, but that geopolitical fault lines mean that there is a possibility that these disruptions could have lasting inflationary effects. Europe's growth prospects have already deteriorated since the financial crisis and geopolitical disruptions could further undermine Europe's productivity. The impact could be as high as 7% of GDP in the long run, with geopolitical fault lines having a lasting impact on the economy.

The fractures in the global economy will be painful for the whole world,

warned Papi.

The green transition can bring the prospect of accelerated growth, but it comes at a cost in the short term. These costs can arise either in the short or the long term, depending on how effectively the transition is managed. For example, the transition in the automotive sector is already having an impact on employment.

Europe is also facing a demographic crisis, she said, adding that encouraging greater labour market participation could offset population decline and thus have a positive impact on growth.

What can be done? - asks Laura Papi. First and foremost, she says, central banks should not give up too soon on monetary policy tightening in response to inflation. Here she cited an earlier IMF study.

In it, the IMF found that easing prematurely in a period of disinflation triggers a spike in inflation. In many countries, the benchmark interest rate is currently below the neutral level - this is not the case in Hungary, she added. In many places, tightening has simply not yet reached the level needed to bring inflation down permanently.

The fight against inflation is painful in the short term - especially in developing countries - but pays off in the long term,

said Papi.

She also touched on the role of fiscal policy. She said governments should build a fiscal buffer to be resilient to the next crisis. Governments should invest in a targeted way to support productivity growth.

Many countries have costly and inefficient energy subsidy schemes that slow down the green transition. As bond yields rise, governments should pay even closer attention to public debt than usual. In addition, governments should coordinate investments internationally for greater efficiency and the green transition should be implemented at EU level.

Cover photo: Ákos Stiller/Portfolio