Optimistic outlook but many risks remain
The central and eastern European region has been hit by a number of negative shocks in the past year due to geopolitical issues but is now probably out of the woods. For next year, the markets are optimistic but there are still many unresolved issues and risks. So the glass half full could become half empty very quickly and we should be vigilant despite our bullish outlook on FX.
On the macro side, this year we have seen optimistic expectations and subsequent disappointment. Most of the time, economies in the region have teetered on the edge of recession, or GDP growth estimates have been revised significantly downwards. Still, most currencies eventually found their way to stronger levels supported by high interest rates and a current account recovery. For next year, on paper, the economy is expected to recover across the board but the end of this year already shows that the outlook is not as positive as it may seem. The market consensus for economic growth next year is already slowly deteriorating and unless we see a recovery in the major European economies, this trend will continue. So recovery is still our baseline but the risks are more to the downside. Moreover, geographic location means that risks from this year carry over into next, and new ones are opening up given the tensions in the Middle East. Commodity and energy prices will thus continue to play a key role for both central banks and FX.
In the CEE4 space, FX will be driven by balancing falling interest rate differentials against a higher EUR/USD. The cutting cycle has started in Hungary and Poland and it is only a matter of time before it starts in the Czech Republic and Romania. Financial markets have largely priced in most of the easing but we still see room to move further in this direction. Meanwhile, global central banks remain at the peak of their cycles, and rate cutting is not yet on the table. Interest rate differentials have already shrunk significantly and the trend here is clearly negative for local currencies. FX carry is thus becoming less and less of a benefit for CEE FX and can no longer rely on this to the same extent. On the other hand, despite the risks, we expect an economic recovery, a current account surplus across the board and a higher EUR/USD at 1.15 by the end of next year. This should drive CEE FX to stronger levels in our base case scenario, overcoming the negative impact of the interest rate differential. However, based on the risks we mentioned, it is clear that it will be a bumpy road.
Elsewhere, investors are turning a little more optimistic on Turkey as the Erdogan administration embraces more conventional policy. Here, the Central Bank of Turkey (CBT) should take the policy rate up to 40% by year-end and regulatory reforms are now placing more emphasis on the policy rate – hence increasing upside risks to the terminal rate. We expect the CBT to allow a further steady decline in the lira in 2024 – but probably not quite as much as the 30% priced in by the current forwards. South Africa’s rand may continue to stay soft ahead of key elections next May. Weak growth may prompt the ANC-led government to increase spending and bring South Africa’s fiscal problems back to the fore.
Military activity in both Ukraine and Israel has taken its toll on both the hryvnia and the shekel. On the former, we suspect the National Bank of Ukraine might struggle to hold the hryvnia stronger in the face of a large current account deficit. The Bank of Israel, however, has access to larger FX reserves and the shekel has a strong balance of payments position. Having allocated a large proportion of FX reserves to support the shekel, we suspect USD/ILS can sustain its recent move below 4.00 – especially if the dollar turns lower through 2024.