Central & Eastern Europe Economic Forecast

Economic Snapshot for Central & Eastern Europe

June 6, 2018

Growth slides at the start of 2018

Preliminary data revealed that the Central and Eastern European (CEE) economy lost steam in the first quarter of 2018, following a vigorous growth spell last year. Regional GDP expanded 4.5% annually in the first quarter, down from the fourth quarter’s robust 5.0% growth. Despite the slowdown, the first-quarter reading still marks a healthy growth rate for the CEE economy, which is benefiting from a solid domestic economy amid tight labor markets, robust investment and accommodative monetary policy. However, reduced impetus from the external sector, largely due to a slowdown in the Eurozone, tempered activity in Q1.

Several CEE economies saw growth slow in the first quarter, including the area’s major players, the Czech Republic and Romania. For the first time in over four years, the external sector did not contribute to growth in the Czech Republic, causing activity to slide. However, soaring fixed investment and healthy private consumption kept activity at a solid pace overall. In Romania, and although a breakdown behind the GDP reading has yet to be released, monthly data suggests that household spending slowed in the first quarter and that the external sector likely also dragged on growth.

The region’s largest economy, Poland, gained steam in the first quarter, recording one of the strongest readings seen in the past decade. Increased absorption of EU funds, wage growth and healthy employment bolstered domestic demand, driving the acceleration. Meanwhile, Hungary also recorded a solid expansion, matching the fourth quarter’s pace—which had marked the fastest expansion since Q2 2014.  

In the political arena, the Slovenian Democratic Party (SDS) came out on top in Slovenia’s 3 June elections. The SDS campaigned on an anti-immigration platform as well as pledges to reduce taxes and promote privatizations. However, the SDS may struggle to form a government, as they only won 25% of the vote and the parliament was fractured, meaning that they will need to work with at least two other coalition partners to hold a majority. Romania’s government is also on shaky ground after the former prime minister, Victor Ponta, launched a new political party in May, prompting a string of defections from the ruling Social Democratic Party. As a result, the ruling coalition lost its majority in the lower house of parliament and will have to rely on other parties to support legislative initiatives. 

Meanwhile, the Czech Republic is still without a government following long coalition negotiations after the October elections. However, an encouraging step was made in May when the ruling ANO party struck a coalition agreement with the Social Democrats. An internal referendum is now being held by the Social Democrats to decide if the party will move forward with the deal.

See the Full FocusEconomics Central and Eastern Europe Report

Domestic economy should fuel solid growth this year

Low unemployment, rising wages and soaring investment should fuel another year of buoyant growth in the CEE economy, although activity is seen moderating from 2017’s over 10-year high. Regional growth is forecast to come in at 3.9% in 2018, which is unchanged from last month’s forecast. The moderation from 2017’s stellar 4.7% expansion will chiefly be due to reduced impact from fiscal stimulus measures and slower growth in the region’s major trading partner, the Eurozone. Next year, growth is forecast to decelerate to 3.3%.

This month, 4 of the 11 economies saw their forecasts revised up following an influx of healthy data, including Hungary and Poland. However, the upward revisions were balanced out by downgraded prospects for Bulgaria, Latvia and Romania. Meanwhile, Croatia, the Czech Republic, Estonia and Slovakia saw no changes to their growth forecasts.

Slovenia, Romania and Poland are expected to be the fastest growing economies in the region, expanding over 4.0% this year. At the other end of the spectrum, Croatia is projected to be the region’s worst performer, growing 2.7%.

POLAND | Buoyant fixed investment drives faster growth in Q1

Comprehensive national accounts data for the first quarter confirmed that the economy accelerated from an already robust fourth quarter last year. Domestically, resilient consumption dynamics were met with a jump in fixed capital outlays—bolstered by greater EU-funded infrastructure investment—and higher inventories. Externally, exports and imports each moderated as decelerating growth in the EU hit foreign trade. Meanwhile, available data for the second quarter has been erratic; while the unemployment rate continued falling in April, growth in retail sales tanked. Moreover, stronger industrial output in the month was met with mixed survey-based data. Concerns over the upcoming 2021–27 EU budget continued mounting in May as Polish officials rebuffed the bloc’s proposals to reallocate more than a quarter of the country’s cohesion funding, threatening to delay passing any blocwide budget into next year.

Domestic demand is expected to again buoy growth this year. A tighter labor market and robust wage growth will underpin consumer spending, while fixed investment will benefit from EU-linked funding inflows, upbeat business sentiment and a nascent construction boom. Export growth, meanwhile, is set to moderate somewhat. Furthermore, and despite stronger government revenues, election-related fiscal slippage ahead of next year’s vote is likely to widen the deficit. Growing uncertainty over the next EU budget is hanging over the long-term outlook. Analysts expect growth of 4.2% in 2018, up 0.1 percentage points from last month’s forecast, and 3.4% in 2019.

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CZECH REPUBLIC | Social Democrats to vote on coalition deal

Recently released detailed GDP data confirmed that the economy lost some steam at the start of the year, growing 4.4% in Q1 on a year-on-year basis, down from the 5.5% expansion recorded in Q4. Despite the slowdown, the pace of growth remained robust. Solid household spending—underpinned by an extremely tight labor market and substantial wage gains in both the public and private sectors—and buoyant fixed investment growth were the key drivers behind the expansion. Meanwhile, weaker Eurozone demand bruised export activity, weighing on the overall first-quarter performance. On the political front, the ruling ANO party struck a coalition agreement with the Social Democrats on 11 May, but it remains subject to approval by Social Democrats members in an internal referendum that will run until 14 June. Regardless of the outcome, however, President Miloš Zeman declared on 28 May that he plans to name Andrej Babiš as prime minister for a second time by mid-June, putting pressure on the Social Democrats to accept the deal. He has also ruled out early elections.

Household consumption is expected to remain the main engine of healthy economic growth this year. Fixed investment growth is also seen maintaining strong momentum, supported by EU funds deployed by the public sector and solid capital spending by the private sector to compensate in part for labor shortages. FocusEconomics Consensus Forecast panelists see GDP growing 3.5% in 2018, which is unchanged from last month’s projection, and 3.0% in 2019.

ROMANIA | Political tensions continue as government pursues fiscal stimulus despite healthy growth

Following buoyant growth in 2017 on the back of surging consumer spending and lax fiscal policies, the economy slowed sharply in the first quarter. While a breakdown has yet to be released, much weaker growth in retail sales in Q1, together with soaring inflation, indicates that a marked weakening in household spending drove the deceleration. Economic overheating leading to growing capacity bottlenecks—as suggested by some weakness in industrial activity—was also likely responsible for the slowdown. Moreover, the government’s spendthrift fiscal stance led to the consolidated budget recording a deficit in the first four months of this year, swinging from a surplus in the same period of 2017. This prompted a severe reprimand of the cabinet by President Iohannis, further complicating already strained relations. The government, however, stated that it will maintain an expansionary fiscal stance until 2020. Compounding political tensions, anti-corruption demonstrators returned to the streets in mid-May to protest the government’s attempted overhaul of the judiciary.

Growth will ease considerably this year but should remain healthy. Although fixed investment is expected to increase faster than last year on rising EU funds, higher inflation and a moderation in wage gains will lead to a pronounced cooling in consumer spending, the main driver of growth. Intensifying macroeconomic imbalances represent the main risk to economic stability. FocusEconomics panelists expect growth of 4.4% for 2018, down 0.2 percentage points from last month, and 3.6% in 2019.   

HUNGARY | Economy starts 2018 on solid note

Growth continued unabated in the first quarter, and survey-based data suggests that the economy also performed robustly in the first two months of Q2. Although a breakdown by components is still missing, the strong GDP expansion in Q1 likely came on the back of buoyant consumer spending: Retail sales soared, labor market conditions were extremely tight and wages continued to rise solidly throughout the quarter. However, weak data for both exports and industrial production in March suggests that the slowdown in the Eurozone economy was felt. The economic environment has remained favorable in Q2 so far, with both business and consumer confidence at high levels in April and May. In the political arena, the landscape is somewhat more turbulent. Prime Minister Viktor Orbán’s ruling party, Fidesz, announced its intention to amend the constitution to be able to reject migrants resettled by the EU. Moreover, Orbán voiced his opposition to the cuts provided for in the new EU budget. Thus, relations with the EU seem set to remain strained.

The economy should expand robustly this year, underpinned by strong domestic demand and healthy foreign orders. Consumer spending will grow significantly, as wages continue to rise on intensified labor shortages, while fixed investment will be fuelled by rising EU funds and favorable financing conditions. The government’s fiscal stance is also expected to remain supportive of growth, although it will remain prudent overall. FocusEconomics panelists see the economy expanding 3.8% in 2018, up 0.1 percentage points from last month, and 3.1% in 2019.

MONETARY SECTOR | Inflation rises in April

According to a preliminary estimate produced by FocusEconomics, inflation rose for a second consecutive month in April, coming in at 2.4% (March: 2.2%). Higher price pressures were recorded in 8 of the 11 economies surveyed, including Poland and Romania. Buoyant consumer spending, along with higher commodity prices, is exerting upward inflationary pressures in the CEE economy. A preliminary estimate for May suggests that inflation remained steady at 2.4%.

Although inflation is slowly rising, it remains below most central banks’ targets, allowing policymakers to maintain accommodative monetary policies in recent weeks. Policymakers in Hungary and Poland left rates unchanged at their May meetings.

Inflation is projected to average 2.5% this year, up a notch from last month’s forecast, amid robust consumer spending. In 2019, inflation is seen stable at 2.5%.

See the Full FocusEconomics Central and Eastern Europe Report

 

Angela Bouzanis

Senior Economist 

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