Rapid wage increases could lead to problems in Hungary and the CEE region

Central and eastern European central banks may become cautious amid double-digit wage growth and economic recovery. Wage dynamics are well above the European Union average, so interest rate cuts may be moderating, according to a Reuters analysis. The National Bank of Hungary (MNB) slowed the pace of interest rate cuts last week, easing by only 25 basis points after the earlier 50 basis point cuts, and may well cut rates little further this year. The Czech central bank may also slow the pace of rate cuts after a surge in demand, driven by strong wage growth, poses inflation risks. And the Polish central bank may delay easing further.

Hourly labour costs in the EU rose by 5.5% in the first quarter of this year compared to the same period last year. But in the Central and Eastern European region, the increase is several times higher, according to Eurostat.

In Hungary, both labour costs and wages rose by 13.7%, the fifth highest increase in the EU for both.

In Hungary, the construction and services sectors have the third highest wage growth rate. The central bank also seems to be paying attention to wage developments.

Inflation has just tamed after double-digit increases in the region last year. According to Reuters analysis, the Central and Eastern European region is experiencing very significant labour shortages, while wage growth is rapid, posing a risk to inflation in the region. This is also a concern for Polish policymakers, where wages are growing at over 10%. "What is happening to wages is very worrying," said Ludwik Kotecki, a policymaker at Poland's central bank, this month, who also said it was the main risk to price developments. And judging by his words, it looks very likely that the Polish central bank will not ease monetary conditions.

The situation is slightly different in the Czech Republic, where the main concern is more about rising service prices than wages. Eva Zamrazilová, Deputy Governor of the Czech central bank, told Reuters last week that she was not overly concerned about wage growth in the first quarter, while high service prices were a risk. According to an economist at Morgan Stanley, the Czechs may slow the pace of monetary easing because of inflation risks, so the next cut could be as little as 25 basis points instead of the previous 50 basis points.

The main problem in Poland is therefore more likely to be the rapid rise in wages, whereas in the Czech Republic it may be the problem of inflation in services. And in Hungary, it seems very much the case that both rapid wage growth and services inflation need to be taken into account, given the prevalence of backward-looking inflation-based pricing. Speaking at a central bank conference earlier, Barnabás Virág, Deputy Governor of the National Bank of Hungary (MNB), said that given the inflation in the services sector and high wage dynamics, "we cannot sit back" and inflation could rise in the coming months.

This is confirmed by recent wage data. Average gross earnings in April were HUF 645,300, up 13.5% on a year earlier. Regular average gross earnings (excluding bonuses, bonuses, one-month special allowances) were estimated at HUF 596,200, 13.9% higher than in the same period last year.

As much as high wage dynamics can induce positive changes in the real economy, they also signal risk,

Péter Virovácz, Chief Economist at ING Bank, wrote in his analysis. Based on the data so far, we now expect wage growth of around 10% in the private sector to be sustained for the rest of the year, which, taking into account changes in the public and non-profit sectors, could lead to earnings growth of up to 12% for the economy as a whole, he added. This, coupled with an easing of households' cautionary motives and stronger demand, could also boost companies' ability and willingness to reprice.

This again raises the question of a possible price-wage spiral,

Virovácz wrote.

Analysts therefore expect the MNB will not make any further substantial cuts in interest rates. The central bank also stressed caution after its latest interest rate decision, writing that "the risks surrounding global and domestic disinflation, the volatility of international investor sentiment and the expected interest rate policies of the major global central banks warrant cautious and patient monetary policy looking ahead". It was stressed that the Council will continuously assess incoming macroeconomic data, the inflation outlook and developments in the risk environment, which will inform its prudent and data-driven decisions on the level of the key policy rate. Barnabás Virág said that a pause in interest rate cuts is also on the table.

Cover photo: Getty Images