Central & Eastern Europe Economic Outlook September 2018

Central & Eastern Europe: Economic Snapshot for Central & Eastern Europe

September 3, 2018

CEE economy grows solidly in Q2


Preliminary data revealed that the Central and Eastern European (CEE) economy grew robustly in the second quarter of the year, although the pace of expansion continued to slow after peaking in Q3 2017. Regional GDP expanded a healthy 4.2% annually in Q2, down modestly from Q1’s 4.4%. Tight labor markets, accommodative monetary policy and greater absorption of EU-linked funds are fueling a hot domestic economy; however, growth continued to wane after a stellar 2017 amid labor shortages and slower growth in major-trading partner, the Eurozone.


Looking at the individual economies in the region, growth slowed notably in the Czech Republic largely driving the region’s overall deceleration. Moderating, but still robust, private consumption and fixed investment growth led the economy’s slowdown, while inventories and net exports subtracted from growth in the quarter. Bulgaria’s economy also lost momentum in the second quarter on the back of slower export growth most likely due to cooling demand from trading partners within the European Union. Meanwhile, Poland, the region’s largest economy, largely kept pace in the period, with growth only inching down marginally. High consumer sentiment and a tight labor market boosted activity, while fixed investment growth lost steam. 


In contrast, Hungary’s economy continued to accelerate in Q2, with growth hitting the highest level since Q2 2014. Although the details behind the reading are not yet available, the domestic economy likely drove the result, underpinned by strong household spending and fixed investment. Romania’s economy also saw growth pick up modestly, although the economy is showing some signs of overheating. Rising inflation is expected to have dampened household consumption, while exports outpaced imports in the quarter.


On the political front, anti-government protests in Romania were in the spotlight in mid-August. The country has seen multiple protests since the Social Democrats took office last year against changes to the criminal code and concerns over corruption in the country. However, the political uncertainty has had little direct economic effect. Meanwhile, the EU escalated its conflict with Poland over controversial changes to the country’s judicial system. The EU sent a ‘reasoned opinion’, the next step in its infringement procedure, and urged the country to act or it could be called to the European Court of Justice over the matter.


 Buoyant domestic economy drives healthy growth in 2018


The CEE economy is expected to remain strong this year, after it grew at an over one-decade high of 4.7% in 2017. Several of last year’s tailwinds continued to propel growth, including low unemployment, rising wages, accommodative monetary policy and spending of EU-developmental funds. However, growth is seen moderating from last year’s high due to slower growth in key trading partner, the Eurozone, and due to overheating in certain economies. Some countries are experiencing labor shortages, which are denting firms’ abilities to ramp up production, while rising inflationary pressures could take a bite out of household spending. 


 


This year, regional growth is seen clocking in at a healthy 4.0%, unchanged from last month’s forecast. Next year, growth is seen continuing to moderate and coming in at 3.3%. Over half of the economies saw no changes to their 2018 GDP forecasts this month, including Czech Republic, Hungary and Romania. However, Poland’s prospects were revised up after a solid H1 outturn, along with Bulgaria, Latvia and Lithuania’s projections. Estonia was the only economy to have its growth projection downgraded.


Slovenia, Poland and Romania are expected to be the region’s top performers this year, each expanding over 4.0%. On the flipside, only Croatia—the region’s worst performer this year—is expected to grow at below 3.0%.


POLAND | Activity holds up in Q2


The economy broadly kept pace in the second quarter, recording another period of solid growth. Household spending once again drove the expansion, riding on the back of a tight labor market. However, although surging exports partly offset the slowdown, fixed investment growth moderated in Q2. More recent data for the third quarter points to continued healthy, but decelerating, momentum: Industrial output accelerated, and the unemployment rate remained at a multi-year low in July. Meanwhile, the manufacturing PMI fell sharply in August. On the political front, the government is working on the budget for 2019 and approved a preliminary draft on 21 August. The draft envisions a fiscal balance of 1.8% of GDP despite an expected slowdown in economic growth. The budget centers on several social spending initiatives, including the government’s 500-plus child benefit scheme, while better tax collection should help buttress revenues. In addition, recent media reports have suggested that the government may introduce an exit tax on assets moved abroad to bolster finances, although this could ultimately reduce foreign investment in the country.


Strong household spending and robust government spending ahead of next year’s elections should fuel healthy growth going forward. FocusEconomics analysts expect growth of 4.5% in 2018, up 0.1 percentage points from last month’s forecast, and 3.5% in 2019.


CZECH REPUBLIC | Growth wanes in Q2; credit rating upgraded


Recently released GDP data revealed the economy entered a soft patch in Q2, growing at the slowest annual clip in a year and a half. Despite the deceleration, however, economic performance was still robust given the quarterly expansion outpaced Q1’s solid rate. Growth in Q2 was fueled primarily by domestic demand, led by buoyant capital spending and healthy household consumption, which has been buttressed by an extremely tight labor market and brisk wage growth. Heading into Q3, the unemployment rate edged up in July from a record-low in June, but this was mainly due to seasonal factors. Moreover, the number of job vacancies reached a new all-time high in the same month, which has also exceeded the number of unemployed since April. This suggests that room for further declines in unemployment is extremely limited. Meanwhile, on 4 August, Fitch Ratings upgraded the country’s credit rating from A+ to AA-, with a positive outlook, citing its solid fiscal metrics and external position.


Growth is expected to wane this year but will nevertheless remain strong. Healthy private consumption growth will be sustained by an exceedingly tight job market and robust real wage gains. Government plans to increase spending, including wage hikes for public servants, should also lend further support to household expenditures. The main downside risk to the outlook stems from escalating global trade tensions which could dent external sector performance given the highly-open nature of the economy and dependence on exports of its industrial base. FocusEconomics Consensus Forecast panelists see GDP growing 3.4% in 2018, which is unchanged from last month’s projection, and 3.0% in 2019.


ROMANIA | Activity remains solid in Q2, political tensions escalate in August


Economic growth edged up in the second quarter in annual terms according to recent figures. Although a detailed breakdown has not yet been released, monthly data suggests that the expansion was driven by household expenditure, as highlighted by solid retail sales growth throughout the quarter, while fixed investment growth likely slowed. Private consumption is likely to have been supported by still-low unemployment and strong wage growth through June. On the external front, despite strong merchandise export growth, the trade deficit rose in the second quarter year-on-year on strong imports. In August, Moody’s confirmed the country’s Baa3 credit rating with a stable outlook, citing robust growth potential and a low public debt ratio that ranks among the lowest in the European Union. However, the agency also warned that current pro-cyclical fiscal policy could gradually erode fiscal strength. In the same month, a multi-day anti-corruption protest erupted with protesters demanding that Prime Minister Viorica Dancila resigns amid a backlash over changes to the country’s criminal code.


Growth should be solid going forward but will gradually tail off from 2017’s extraordinarily high level on slower private and government consumption growth. Risks to the outlook stem from widening fiscal and current account deficits. FocusEconomics panelists expect growth of 4.1% for 2018, which is unchanged from last month’s forecast.


HUNGARY | Domestic economy drives acceleration in Q2


Preliminary GDP data showed that the economy gained traction in the second quarter, growing at the fastest clip in four years. The second-quarter expansion was likely underpinned by healthy private consumption dynamics, reflected through the resilient growth of retail sales and higher consumer confidence, on average, in the quarter. This in turn has been supported by a double-digit growth in real earnings—buoyed by minimum wage and public sector wage hikes—and a strengthening labor market which saw the unemployment rate dip to a new all-time low in June. In addition, the external sector likely yielded a stronger contribution to growth given the acceleration in goods exports and larger trade surplus logged in the second quarter. Meanwhile, survey-based data sent mixed signals for the third quarter: While consumer sentiment deteriorated on average in July–August, business sentiment improved in the same period compared to the previous quarter.


Economic growth is expected to remain robust this year on the back of strong domestic demand. The combination of a tight labor market, minimum wage hikes and pay raises for public sector workers should prop up consumer spending. Moreover, public investment should continue to rise thanks to further inflows of EU structural funds while private investment is seen being supported by the recent corporate tax cuts and still-low borrowing costs. Potential capital flight stemming from the Fed’s tightening cycle and escalating global trade tensions are the main downside risks to the outlook. FocusEconomics panelists see the economy expanding 4.0% in 2018, unchanged from last month’s forecast, and 3.1% in 2019.


MONETARY SECTOR | Inflation eases in July


According to a comprehensive estimate produced by FocusEconomics, inflation fell in July, ending a four-month streak of rising price pressures. Regional inflation came in at 2.7%, down from June’s 2.9%. Lower price pressures were seen in eight of the region’s economies. A preliminary estimate for August suggests that inflation remained broadly stable.


Buoyant consumer spending and rising fuel prices have stoked inflation this year, causing a handful of Central Banks to begin tightening interest rates from ultra-accommodative levels. In August, the Czech National Bank raised rates for the second meeting in a row. However, policymakers in Hungary and Romania left interest rates unchanged.


Inflation is seen averaging 2.6% in 2018, unchanged from last month’s forecast. Next year, inflation is seen broadly stable at 2.5%.


See the Full FocusEconomics Central and Eastern Europe Report


 


Christopher Thomas


Economist


 


 


 

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