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By Jason Hovet and Krisztina Than

PRAGUE/BUDAPEST, Jan 27 (Reuters) — Central Europe’s bond yields have dropped sharply to begin 2023 in a debt market rally unlikely to fizzle out this year, as stubborn double-digit inflation is expected to ease, a Reuters poll showed on Friday.

Yields in the European Union’s emerging east climbed to more than decade-old highs in the last quarter of 2022, but have dropped since.

They have fallen sharply this month due to risk-friendly global sentiment and signs of easing inflation pressures domestically and abroad.

A Reuters poll of analysts forecast the rally would continue, but at a calmer pace.

«We expect this year to be rather positive for CEE fixed income markets, as yields should be dropping throughout the year from their elevated levels,» Erste Group Bank said in a Jan. 18 outlook.

«The main game-changer should be inflation, which we believe has already peaked and will start visibly falling in the spring.»

Last year, central European policymakers lifted interest rates to multi-decade highs to combat inflation. Global banks like the European Central Bank and U.S.Federal Reserve then also tightened, pushing up core market rates.

At the same time, governments spent more to combat spiralling energy prices, pushing up borrowing.

The result was soaring yields.In Hungary, url shortener the 10-year benchmark bond yield peaked above 11% in October.

But by the close on Wednesday this week, the Hungarian yield had already dropped 168 basis points in January, to 7.55%.

A Reuters poll saw it falling to 7.00% by the end of 2023, according to the median forecast.The lowest forecast was 6.40%.

Erste said it may be a bumpy path because of EU funds still locked in rule-of-law disputes and risks to Hungary’s ratings.

Hungary and the Czech Republic are top candidates to be the first this year to cut interest rates.

On Tuesday, Hungary’s central bank kept its base rate at 13% and other conditions tight, pledging «patience» in policy.

In the Czech Republic, the central bank has held rates stable since June and analysts see a high chance cuts could begin in mid-2023.

In the poll, analysts saw the 10-year Czech benchmark yield falling by 40 basis points to 4.00% this year.

However, high bond issuance in 2023 is weighing.

«(Czech) government bonds are unlikely to become significantly more expensive relative to market rates due to the persistently elevated supply,» Komercni Banka said on Wednesday, adding market rates would drive bond yields.

In Poland, the 10-year yield this year was down 92 basis points, to 5.996%, as of Wednesday’s close.The median poll forecast saw it at 5.95% at year-end. Similarly, Romania’s 10-year bond yield should hover at 7.50% at the end of the year.

There was still upside potential for Poland and Hungary, according to some.

«Hungary and Poland are our top picks (in the region) due to the yield premium above advanced markets, while inflation risks will drop significantly in the second half of 2023,» said Andras Horvath of Takarekbank in Budapest.

(Reporting by Jason Hovet in Prague and Krisztina Than in Budapest; editing by Sharon Singleton)