Central & Eastern Europe economy likely lost steam in Q1

Central & Eastern Europe economy likely lost steam in Q1

May 11, 2016

Despite strong external headwinds, the economies of Central and Eastern Europe (CEE) picked up pace in the last quarter of 2015 on the back of solid growth in domestic drivers. More complete data show that regional GDP growth accelerated from 3.4% in Q3 over the same period of the previous year to 3.7% in Q4. While many of the conditions that drove last year’s growth—improving labor markets, lack of inflationary pressures and supportive monetary policies—remain in place, the latest indicators suggest that region’s economy lost steam at the start of 2016 and FocusEconomics Consensus Forecast panelists project that GDP growth decelerated to 3.1% in Q1.  

Behind Q1’s likely slowdown is a drop in investment funding in the region. The depletion of EU development funds along with base effects from last year’s high absorption rate will present one of the main challenges to growth this year. In addition, high-frequency data point to slower growth in Poland—the region’s largest economy—while flash GDP estimates for Latvia andLithuania yielded conflicting results. Lithuania’s economy picked up pace in Q1, growing at the fastest pace since Q3 2014, and Latvia’s economy lost steam with the slowest pace of expansion in one year. 

Meanwhile, political events continue to cast a shadow on the region’s outlook. In Poland, controversial political policies are undermining investor confidence and Polish assets are taking a hit as a result.  The zloty hit an over-three-month low in May as the government remains locked in a conflict with the country’s top court. On a broader scale, the migrant crisis has sparked a rift between a number of governments in the CEE region and EU authorities and it is fueling Euroscepticism in the region. In addition, the United Kingdom’s 23 June vote on whether to remain in the EU is adding to uncertainties. A vote to stay is far from certain and the UK is a large contributor to the EU’s budget, while many CEE economies receive more EU funds than they contribute.      

Click here to see our most recent economic outlook for Central and Eastern Europe

See April's CEE economic outlook

Growth outlook remains stable

The economy of Central and Eastern Europe is projected to continue growing solidly this year, although at a slightly more moderate pace than last year. Favorable tailwinds from low oil pricesand improving labor market conditions should drive a healthy expansion in private consumption, while a weak external environment and a slowdown in EU funds will likely drive an overall moderation in GDP growth. Following the seven-year high expansion in GDP of 3.4% last year, forecasters surveyed by FocusEconomics foresee a solid 3.1% expansion in 2016, which is in line with last month’s forecast. Key downside risks to the forecast include slower-than-expectedEurozone growth and rising political uncertainty. 

This month’s outlook reflects unchanged growth prospects for 8 of the 11 economies surveyed, including Poland, the largest economy in the region. Romania’s forecast was raised this month, while, analysts cut their projections for the Czech Republic and Estonia

See the Full FocusEconomics Central and Eastern Europe Report

CZECH REPUBLIC | Data points to cooling growth momentum 

The strong economic expansion recorded last year was largely supported by a drop in energy prices and increased investment thanks to the absorption of nearly EUR 7.6 billion in EU structural payments. These factors were mostly transitory and much of the momentum gained in 2015 will be lost heading into 2016. This is already evident in high-frequency data for April.Consumer sentiment inched down as households grew more concerned about their current financial situations and business sentiment has moderated consistently since the start of the year. Nevertheless, the economy is still in good shape, as evidenced by a 0.3 percentage point decrease in the unemployment rate over the first quarter of the year. 

Growth is expected to moderate this year as the Czech Republic eases to a more stable growth path. The economy will be supported by accommodative monetary policy, low energy prices and by private consumption, which should remain robust as the labor market improves. Panelists see GDP growth moderating to 2.5% in 2016, which is down 0.1 percentage points from last month’s forecast. For next year, they see growth picking up to 2.8%. 

HUNGARY | Leading indicators suggest lackluster economic performance 

Hungary’s economy decelerated somewhat in 2015 as subdued public spending and fixed investment more than offset strong private consumption and exports. Latest indicators suggest that weakness in the industrial sector carried over into this year, while consumption likely remained robust. Industrial production weakened gradually in the first three months of the year and exports were volatile in January and February. Economic sentiment cooled down steadily from January to April. Conversely, falling unemployment—as evidenced by February’s record-low reading—and the Central Bank’s monetary policy easing measures coupled with low inflationbode well for private consumption. 

The economy will likely continue to slow this year on the back of weaker external demand and falling investment due to lower absorption of EU funds. Nevertheless, authorities’ efforts to shore up growth along with healthy household spending will support the economy. FocusEconomics Consensus Forecast panelists see GDP expanding 2.4% in 2016, which is unchanged from last month’s forecast. For 2017, the panel sees GDP growing 2.6%.

POLAND | Political risks spark investors’ concerns 

Strong domestic demand provided a cushion to the economy amid external headwinds in the final quarter of last year and allowed Poland’s economic activity to gain speed. While many of last year’s economic drivers remain in place in the first half of 2016, recent data suggest that the economy has lost some steam. Industrial production grew at the slowest pace in over one year in March and the manufacturing PMI fell in April. Meanwhile, ongoing political uncertainties continue to raise investors’ concerns. The zloty fell sharply and yields on 10-year bonds rose at the start of May as the government’s conflict with the constitutional court continues. Moreover, Moody’s will issue Poland’s credit rating on 13 May and some analysts are predicting a downgrade amid heightened political risk. 

Despite risks from political uncertainty, Poland’s solid fundamentals should continue to propel strong growth. Our panelists expect the economy to expand 3.6% in 2016, which is unchanged from last month’s forecast. For 2017, the panel sees economic growth broadly stable at 3.5%.

ROMANIA | Positive economic signals emerge 

The Romanian economy expanded in 2015 at the fastest rate since 2008. Economic activity was supported by an aggressive fiscal policy and notable wage hikes ahead of legislative elections this year. Latest indicators confirm that the positive momentum from last year carried over well into the first quarter of this year. Industrial production improved in February and retail sales tallied double-digit growth for the eighth consecutive month in March. Against a backdrop of solid growth in domestic demand, Standard & Poor’s confirmed Romania’s rating and outlook. The agency highlighted that future rating increases are possible if the government resumes implementing budgetary consolidation measures and reduces the public debt. 

Growth this year will be fueled by strong private consumption, which will more than compensate for a slowdown in fixed investment and deteriorating exports. However, widening fiscal and current account deficits pose downside risks. Our panelists revised up Romania’s growth forecast for 2016 for the fifth consecutive month and they now see GDP expanding 4.1%. For next year, they expect slower, but still solid, growth of 3.5%.

See the Full FocusEconomics Central and Eastern Europe Report

INFLATION | Consumer prices languish in negative territory 

Almost all of the economies in the CEE region continued to face falling prices at the end of Q1. An estimate elaborated by FocusEconomics indicates that consumer prices declined 0.9% in March over the same month of the previous year, which was a more pronounced fall than February’s 0.7% drop. Low oil prices have driven ten consecutive months of falling prices and have led to record low interest rates in the region. 

Inflation is expected to return this year, although it will be minimal overall. Economists surveyed this month by FocusEconomics expect inflation of 0.1% in 2016, which represents a downward revision from the 0.2% expected last month. The cut in this month’s projection reflected cuts to the inflation projection for 10 of the 11 economies in the region. Slovenia was the only country to see its forecast raised. Going forward, inflation is expected to rise and forecasters predict that it will average 1.8% in 2017.

Written by: Angela Bouzanis, Senior Economist

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