Stagflation is here. The world is facing a global recession that could go on for several years as central banks everywhere will be forced to put through growth-crushing large rate hikes to control runaway inflation just as production is already falling.
Inflation surged following the coronavirus (COVID-19) pandemic due to surging food prices and disrupted supply chains, amongst other things. The problem has now only been made worse by the war in Ukraine.
But it has only been more recently that central banks have started to lose control of the situation as inflation has surged passed their rising prime monetary policy rate hikes, sending real interest rates deep into negative territory.
As inflation accelerates many central banks, especially in Central Europe, are increasingly finding themselves behind the curve, where their hikes leave rates in negative territory, which means they will have to hike again and harder at the next meeting.
In Eastern Europe and Eurasia the central banks are doing better. In March several massively increased their rates and put their real rates back into positive territory. Real rates have to be positive if they are to bring inflation down and so these countries are back ahead of the curve and they stand the best chances of suffering the least damage from stagflation.
But it may be too late. In June the World Bank slashed its global growth forecast for the third time this year to 2.8%, warning that stagflation was on us.
“The most common accusation is that the slow reaction to the build-up of inflationary pressure in 2021 will now require such a serious hike in interest rates that it will precipitate a “hard landing” and severe economic pain,” Adam Tooze, an economist at Columbia University, wrote in a recent blog, citing the “ghost of Paul Volcker,” the Fed chairman who famously ended the stagflation of the 1970s with a very painful rate hike that caused a brutal recession and led to a debt crisis but also brought price rises back under control.
Tooze speculates that the fact that central banks are reacting to the runaway inflation and hiking rates means the worst effects of stagflation be avoided. But the jury is still out on whether the switch to much tighter monetary policy has come soon enough and is aggressive enough.
“If inflation does peak in the next few months – as is still widely expected – and then comes down with no more than a short and mild recession, perhaps it will be possible in due course to stand back and recognise the rollercoaster of 2020-2022 for what it is, not a disastrous failure of policy, but a story of difficult policy-making under conditions of huge uncertainty in the wake of the unprecedented COVID shock,” Tooze said.
Just how bad is the situation in New Europe? With all the statistics and interlocking inflation dynamics vs central bank policy hikes it's easy to get lost. So bne IntelliNews has published a series of visualisations that hopefully make the current state of affairs a bit clearer.
Inflation in double digits
Ironically it was Ukraine that was the first to warn that the rising inflation was a problem, and the National Bank of Ukraine (NBU) was the first to end several years of dramatic easing and start hiking rates in February 2021.
From a peak of 9.6% in April 2019, the NBU enjoyed extraordinary success in not only containing inflation but completely crushing it. To bring the rate down to a post-Soviet low of 1.7% in May 2020 it had begun to slash the prime rate in whole percentage point steps, which also fell to an all-time low of 6% (chart)
But then the coronavirus pandemic happened, and May 2021 marks the low-water mark for inflation around the world. Russia was also enjoying tumbling inflation and was also slashing rates with one large cut after another. However, the Central Bank of Russia (CBR) followed the NBU and put in a surprise 25bp hike to 4.5% in February 2021.
Most central bankers were convinced that the rising inflation was a temporary phenomenon and the upward pressures on prices would fade once the pandemic was over. CBR Governor Elvia Nabiullina was not convinced and came out very early, warning that the causes of inflation ran much deeper and that this was going to be a persistent problem.
She set off on a series of aggressively large rate hikes almost every month subsequently, including an extraordinary 10.5% one-time emergency rate hike four days after Russia’s invasion of Ukraine in February to contain the special inflation and currency instability caused by the attack. But she was right, and inflation peaked in April at 17.8% (chart) and is now falling. Nabiullina’s tightening cycle had now also peaked and she began to cut rates again in April and has since put through three cuts to bring the prime rate back down to the pre-war level of 9.5% (chart). Currently Russia is the only country in Europe where inflation is falling again.
The NBU also put in an extraordinary rate hike last month, bringing the overnight rate up to 25%, after suspending rate meetings in the first months after the war started. But inflation in Ukraine is still rising strongly as the economy has more or less collapsed and is expected to contract by at least 30% this year due to the war. With little income and access to only about $1bn a month from the local bond market, the government has been funding itself by simply printing about $5bn a month. Ukraine is running out of money. Even with the extremely high prime rate, Ukraine’s inflation will continue to soar unless the international community comes to its rescue with significant financial support. Inflation there is currently 21.5% (chart)and set to go higher.
The other country in real trouble is Turkey, which has basically ignored the stagflation crisis thanks to Turkish President Recep Tayyip Erdogan's bizarre views on inflation. He believes that high interest rates cause inflation, the opposite of orthodox theory, and that to bring inflation down you need cut rates, not increase them.
Inflation in Turkey was already high, but it started to run away from policy makers' control in December, when it topped 30%. The Central Bank of Turkey has poured petrol on the flames of inflation and started cutting rates in October last year, taking them down from 19% to 14% now (chart). Inflation has soared to the current 73.5% (chart), but that is only the official figure. The government has been accused of massaging the figures and that the real rate of inflation is believed to be closer to 150%.
As the bar chart race shows, inflation has been a problem everywhere, with rates being particularly high in Central Asia, but since the middle of 2020 they started to climb everywhere quickly, with Turkey rapidly leaping into the lead.
The inflation line chart and its animation shows that inflation has been rising fast everywhere, but that Russia is the only country that has seen it peak. The charts show that in Moldova the situation has also been particularly bad, but Moldova is also one of the few countries that has put in massive rate hikes to bring real interest rates back into positive territory and so should see its inflation rate start to fall now.
Looking through the charts and inflation is already high in both Eastern and Central Europe in the mid to high teens. Hungary is doing best with inflation of 11.7% in May, but that is still in double digits and rising steeply.
Southeastern Europe is facing similar problems with inflation at between 10% and 15% across the region, with Moldova doing worst with 27% and Albania doing best with 7.4% – one of the few countries in the region to still have single-digit inflation. Bulgaria and Romania are in the same boat with 15.6% and 13.8% respectively, with Turkey crashing out from the whole region as inflation exploded to 73.5%, according to the most recent figures.
Finally, in Central Asia the numbers are better than those for much of the rest of the region, although all the Central Asian countries have long suffered from high inflation as central banks there have only recently implemented inflation-targeting policies that have yet to anchor expectations amongst their populations. Tajikistan is doing best with 7.3% and Mongolia worst with 14.4%. Everyone else is around 10% or in the low teens.
(Use the four regional buttons to filter the results and see the development of inflation in each region or in direct comparison to another. In the line chart at the end of the animation you can also use the filter to pick out individual countries or groups of countries.)
Hiking the prime rate
The classic response to rising inflation is to hike the prime monetary policy rate to encourage people and companies to take money out of circulation and put it in the bank.
As stagflation fears mount central banks have started to hike rates aggressively, and counterintuitively, many of the central banks in New Europe have started tightening earlier and more aggressively than their peers in the bigger and richer countries to the west.
The reasons for this are not obvious but may be connected to the recessions that big growth-killing hikes can cause. The poorer countries have been through multiple crises and are used to hard times. Moreover, many of these countries are run by authoritarian regimes and so are less accountable to the general public, and thus more willing to inflict pain on the population.
The bar chart race shows that at the start of 2020 high interest rates marked all of Central Asia, which have never mastered inflation, but as the effects of the coronavirus pandemic kicked in Eastern Europe central banks there started hiking rates aggressively up to the same levels.
With the exception of Turkey that has been dealing with a currency crisis for several years, interest rates in Southeastern Europe were low at the start of 2020, at around 3%, and stayed these for most of 2021 too. It was only in the last quarter of last year that the problem of inflation was starting to become clear and rates began to rise, led by Moldova, which was also having the biggest problems with inflation. Turkey was bizarrely cutting its rates at this time. By March this year Moldova overtook Turkey to have the highest rates in the southern region at 15%.
The interest rates in Central Europe were at 1% or nothing for years before the 2020 crisis hit, but central banks began to raise them in the middle of 2021 as inflation grew. However, it was not until the first quarter of this year that Central European central banks started to play catch-up with runaway inflation with some very large rate hikes.
Real interest rates go negative
Eastern Europe has led the field in fighting mounting stagflation and soaring inflation by reversing the loose monetary policy early in 2021 and its countries are largely ahead of the curve now.
These policies show up in the increasing number of countries that now have negative real interest rates, where the rate of inflation is higher than the prime monetary policy interest rate. That is a problem, as it means those central banks will have to put in more growth-killing rate hikes to regain control of price growth, whereas a country like Russia has already passed peak inflation and has already started to cut rates.
In general, Western central bankers have been timid in their rate hikes, as charts below show. In the real rates race chart all the countries in New Europe are tightly grouped within a range of +/- 5%. Many countries dealing with inflation compromised with lower rates to encourage growth and allowed mild negative interest rates – a trade-off many central bankers in Emerging Markets regularly make.
However, as the race chart shows, in about October 2021 the spread between all the countries begins to widen dramatically before ending in June 2022 within a range of +/- 20%. Turkey crashes out of the race completely in December and the real interest rates in March all start to quickly fall into negative real rate territory in the first quarter of this year.
But then between March and April central bankers start reacting to the accelerating inflation crisis and start putting in big hikes, large enough so their real rates jump back well into positive territory. (Hover over any of the lines in the real rate race chart to pick out an individual story.) From all 30 countries in our survey, only eight (not including Turkey) have yet to put in hikes big enough to lift their real rates back into positive real interest rate territory.
The line chart gives more detail on the individual stories. Belarus and Ukraine are back in positive territory. In Ukraine’s case, because it is printing money to pay for the war, the inflationary pressures are still very high (chart), whereas although Russia’s real interest rates are still deeply negative, the CBR's Governor Nabiullina believes she has already defeated inflation and that it will continue to fall in the coming months, lifting real interest rates back towards zero (chart).
The problem with negative interest rates is far worse in Central Europe, as although central banks have begun to hike rates aggressively, their real interest rates are all deeply negative and still appear to be falling. Czechia (chart) and Poland (chart) both seem to still be well behind the curve.
Hungary is doing best with its real interest rate of -5.7% in June, and the Monetary Council of the National Bank of Hungary (MNB) raised the base rate by 200bp to 9.75% at an unscheduled rate setting meeting on July 12, as the governor woke up to the dangers and took emergency action (chart).
In Southeastern Europe things look a lot better. The big rates in April and May are apparent at the end of the series of the line chart, and both Bosnia and Croatia have real rates back in positive territory and so should be able to reduce inflation. The real interest rates in Montenegro are at zero and Moldova’s prime rate hike to a crushingly painful 18.5% in May should also diminish the gap from the current -4% real interest rate as inflation falls in the coming months.
The same is true in Romania and Bulgaria, which both sport the characteristic dog’s leg, at the end of the series, of a central banker that has taken emergency action and put in a very large rate hike. It seems everyone in this region has the problem in hand.
Except Turkey of course, which currently has a negative real interest rate of -60%.
In Central Asia the same themes are even more pronounced, where the dramatic rate hike dog’s leg is very prominent in almost all the markets. The only country that is still in negative territory is Mongolia, where a rate hike imposed in March was clearly not aggressive enough, leaving it with a negative real rate of -5.4%.
On balance, it seems that Eastern Europe and Southern Europe, as well as Central Asia, have the problem of stagflation in hand, with the exceptions of Ukraine and Turkey, but Central Europe is behind the curve and have more painful rate hikes ahead of its countries.