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Can emerging Europe’s central banks fight the Fed?

Peter Weber | Getty Images

Being a central banker in the ex-communist European countries may sometimes seem like a thankless task.

As with many other emerging market economies, there have been times over the past few years where exchange rates and bond yields have been rocked by the actions of the West and their central banks: the U.S. Federal Reserve and the European Central Bank (ECB).

And the long-term actions of the big two central banks will continue to have a big impact. "As global interest rates normalize, the financing environment will become more challenging," Reza Moghadam, Director of the European Department, IMF, warned CNBC.

More than $66 billion poured into emerging market bonds during the three periods of quantitative easing launched since 2008 by the Fed, according to Emerging Portfolio Fund Research (EPFR) data. However, when it looked as though the Fed was going to start rolling back its bond-buying program in September, money flew out of emerging market bonds - $320 million in the week to September 15, according to EPFR.

(Read more: Emerging markets party as Fed stays put)

The ECB is even more important to the region. Many western European banks have operations in eastern Europe, and their subsidiaries tend to have deposit funding from their parent banks. This means that any ECB mechanisms designed for euro zone banks – such as the long-term cheap-rate LTRO initiative – will result in more funding for eastern Europe.

(Read more: ECB leaves door open for more funding)

And while some emerging markets such as Brazil and China have escaped the global economic crisis relatively unscathed, eastern European countries like Poland and the Czech Republic were not so lucky, according to Dina Ahmad, CEEMEA strategist at BNP Paribas. Gross domestic product (GDP) in emerging European economies grew by an average of 1.5 percent a year over the past five years, compared to an average of 6.5 percent a year over the previous five years, according to Capital Economics.

(Read more: Is Poland the new Ireland?)

Another problem in rebalancing these countries' current accounts is that foreign investors are not reinvesting their profits, which "represent as much as 7 percent of GDP per annum" for some of these countries, according to Societe Generale analysis.

"Domestic monetary or fiscal policy does not appear to be an effective tool to address this part of the current account if a country needs to redress an external imbalance," the bank argued.

Meanwhile, Hungary and Romania have relatively high levels of foreign currency debt, which means that if their own currencies weaken, then these debts will be more expensive to pay off.

In the face of these external forces, what can central banks in countries like Poland, Hungary, Romania or the Czech Republic do?

(Read more: Emerging markets' central bank reserves drop)

They have been pretty busy in recent weeks. The Czech Republic's National Bank surprised the markets on November 7 by targeting an exchange rate of 27 Czech korunas to one euro - it had been around the 25-26 mark. The bank said it would buy up euros to force the exchange rate down so that the country could become more competitive. This was dubbed one of the most "important monetary policy decision in post-communist Czech monetary policy history" by Danske Bank analysts.

The National Bank of Romania cut base rates to 4 percent, and the National Bank of Poland said it will keep its base rate on hold at 2.5 percent until July 2014 at the earliest.

The "loose" monetary policies, designed to make more money available to borrowers and encourage economic growth pursued by the region's banks are likely to continue, according to most economists.

"The direction of travel seems to be towards more easing which should be supportive of asset prices in Central and Eastern Europe. The monetary backdrop should be more supportive than for Latin America or Asia," Neil Shearing, chief emerging markets economist at Capital Economics, told CNBC.

(Read more: Why emerging markets could force euro rally)

Across the region, inflation appears to have returned to rates closer to central banks' targets – such as 1.5-3.5 percent for Poland and 2 percent for the Czech Republic.

"Given the very low price increases, some might fear that the threat of deflation is looming for CEE, but for most of the countries, this is not the case," analysts at Erste Bank argue.

If growth in the region's key euro zone export markets picks up, and the improvement in household balance sheets continues, its economic growth should improve – Capital Economics thinks eastern Europe could grow by around 4 percent annually over the next couple of years.

Unemployment is still high, and wages are low, suggesting that euro zone companies can continue the trend to outsource manufacturing to eastern Europe if they want to cut costs.

"Assuming we don't see shock food or energy price rises, inflation should remain relatively low, and monetary policy can now remain supportive of economic recovery," Shearling said.

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