Central & Eastern Europe Economic Forecast

Economic Snapshot for Central & Eastern Europe

November 29, 2017

GDP growth in Q3 surges to highest rate in nearly a decade

The Central and Eastern European (CEE) economy fired on all cylinders in the third quarter, buttressed by domestic activity and external demand. According to a preliminary estimate compiled by FocusEconomics, regional GDP growth soared 5.0% annually in Q3, notably above Q2’s 4.3% expansion. Q3’s result, the highest growth rate since Q2 2008, marked the fourth consecutive quarter of accelerating economic activity. Several tailwinds underpinned the region’s positive performance including tight labor markets, loose fiscal policies, accommodative financial conditions, reviving investment and strong Euro area demand for exports. 

The surge in growth was led by stronger activity in Poland, the region’s largest economy. GDP growth hit a multi-year high as consumers continued a spending spree. Investment is also expected to have picked up. Activity in Romania also surged in Q3, with GDP expanding at the fastest pace since Q3 2008 thanks to expansionary fiscal policy and robust household spending. Bulgaria’s economy also accelerated and low employment and rising wages fueled a pick up in the Czech Republic’s economy.

Although economic growth is strong, the region’s political scene remains turbulent, and political uncertainty could undermine investor optimism going forward. On 24 November, the Polish government gave initial backing to two controversial bills that would overhaul the country’s judicial system and could escalate its clash with the EU over the rule of law in Poland. The move would give the parliament greater control over courts and justices, and certain provisions are expected to conflict with EU law. The proposals sparked large protests across the country. If the measures are adopted, the EU could retaliate with sanctions or reduced funding in the future, which would likely shake confidence.

Romania also saw widespread protests on 26 November, in response to the government’s planned changes to the judicial system. The government is also seeking greater control over the country’s judiciary, and the proposed changes would likely weaken the country’s anti-corruption body. The protests are reminiscent of February’s mass demonstrations that toppled the previous government.  

In the Czech Republic, a new government has yet to be formed following the October elections, which yielded the most fragmented Chamber of Deputies in the country’s modern history. Election winner Andrej Babis, who has been unable to create a coalition government, will now attempt to form a minority government. Political wrangling is likely to persist for weeks and could jeopardize a timely approval of the 2018 budget and dampen investment in the country.

Despite the uncertain political environment, the region’s economic trajectory is expected to remain bright in the fourth quarter, as tailwinds remain largely in place. Nevertheless, growth should slow modestly from Q3’s stellar result. FocusEconomics Consensus Forecast panelists project GDP to expand 3.9% annually in the final quarter of this year.

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2018 Prospects upgraded on solid outlook for domestic demand

A string of positive GDP readings has put the CEE economy on track to grow at the fastest pace in 11 years in 2017. FocusEconomics panelists see GDP increasing 4.3% this year. Next year, growth is expected to wane moderately, as this year’s tailwinds fade. Financial conditions are expected to turn less accommodative and higher inflation will take a bite out of household consumption. Export growth is also seen edging down from 2017’s high. Whether investors shrug off political uncertainty will be key to the evolution of the region’s forecast, along with activity in its most important trading partner, the Eurozone. On the upside, tight labor markets and buoyant investment will keep activity healthy overall. Our panelists see regional GDP growing a healthy 3.5% in 2018, which is up 0.1 percentage points from last month’s forecast. In 2019, growth is projected to come in at 3.1%. 

This month’s upgraded 2018 outlook is due to upward revisions for five of the economies in the region, including all of the Baltic countries. Croatia was the only economy to see its prospects downgraded, as sustained uncertainty over the effects from the restructuring of food giant Agrokor weighs on its outlook. All other economies in the region, including major player Poland, saw no changes to their forecasts.

Romania is projected to be the region’s fastest-growing economy next year, with an expected expansion of 4.0%. Latvia and Poland are also seen achieving fast growth rates of 3.7% and 3.6%, respectively. On the other end of the spectrum, Croatia is projected to be the CEE region’s slowest-growing economy, with an expansion of 2.7%. 

POLAND | GDP expands at fastest pace in six years in Q3

The Polish economy continued to fire on all cylinders in Q3, according to a recent release. Growth accelerated in both quarter-on-quarter and annual terms, with the latter marking the strongest result in nearly six years. While a complete breakdown is not yet available, data on retail sales and declining unemployment suggests household spending once again drove growth. According to monthly indicators, momentum seems to have carried over into Q4. In October industrial production soared, posting multi-year high growth, and the manufacturing PMI remained firmly in expansionary territory. Retail sales also continued to expand significantly in the same month, driven by an impressive annual rise in wages and a record-low unemployment rate. In late November, Parliament resumed work on laws giving it authority over judicial appointments, a subject of concern for the EU given its possible impact on the rule of law in Poland.

Next year growth should remain robust, albeit moderating from this year’s outstanding performance. Private consumption will likely prove resilient, underpinned by a further tightening in the labor market and strong wage increases. Meanwhile, higher EU fund inflows and supportive financing conditions should boost fixed investment. However, increased disbursements for public investment and the lowering of the retirement age will cause the government deficit to widen. FocusEconomics panelists expect GDP to grow 3.6% in 2018, unchanged from last month, and 3.3% in 2019.

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CZECH REPUBLIC | Babis faces hurdles in forming a coalition government 

Economic growth in the third quarter was broad-based: All main expenditure components increased at a robust pace. The solid run is likely to continue into the final quarter of the year, according to leading data. The PMI came in at its highest level in over six years in October, signaling ongoing expansion in the manufacturing sector. On 21 November, police asked parliament to lift prospective Prime Minister Andrej Babis’ immunity, to investigate an alleged case of fraud involving EU subsidies. Babis will seek to form a minority government after nearly all parties in the lower house have refused to join forces with his party amid the allegations.

It is likely that the country will be subject to further political turmoil, which could last for months, possibly jeopardizing the approval of the 2018 budget and curbing fixed investment. The current prudent fiscal stance is unlikely to change, however. Furthermore, economic growth should continue to be solid in 2018 on the back of strong private consumption. Fixed investment is also expected to contribute, although it might be curbed by political uncertainty. A possible distortion in the relationship with the EU could drag on investment flows. Panelists see GDP growing 3.2% in 2018, up 0.1 percentage points from last month’s projection, and 2.8% in 2019.

ROMANIA | Leu hits record lows in November

Preliminary data revealed that growth remained in full swing in the third quarter, with GDP expanding at the fastest pace since Q3 2008. Although details are not yet available, a spending spree by households thanks to a tightening labor market and government stimulus policies likely drove activity. In addition, a rebound in investment on the back of greater absorption of EU funds is expected to have added steam to growth. While loose fiscal policies have put the economy on track to grow at the fastest pace since 2008 this year, a lack of structural reforms, ballooning government spending, rising inflation and a widening trade deficit have sparked fears that the economy could overheat. These concerns, along with controversial politics, have taken a toll on the leu, which fell to record lows in November. On 23 November, the government survived a no confidence vote, as widely expected.

Growth is expected to wane somewhat next year as higher inflation and tighter monetary policy take a bite out of household spending. FocusEconomics panelists expect growth of 4.0% for 2018, which is unchanged from last month’s forecast. They see the economy expanding 3.4% in 2019.  

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HUNGARY | Momentum gains steam in H2

Preliminary data showed that the economy picked up steam in Q3. Annual GDP growth accelerated from 3.3% in Q2 to 3.6%. While a breakdown by components is not yet available, the acceleration was most likely buttressed by the domestic economy. Consumer and business confidence readings throughout the third quarter were extremely elevated due to the rapid rise in disposable incomes, declining unemployment, loose monetary conditions and inflows of EU investment funds. The far-reaching fiscal stimulus measures implemented by the government, together with the resilience of the economic drivers, should guarantee that the momentum in growth will carry through the final quarter of the year. Noting these developments, Fitch Ratings revised Hungary’s outlook from stable to positive and affirmed its credit rating at BBB- on 10 November. The agency pointed out that Hungary’s vast current account surplus and declining external debt have reduced its exposure to external shocks.      

Economic growth is set to moderate in the next two years but should nevertheless remain strong on the back of expansionary monetary and fiscal policies. FocusEconomics panelists project the economy will expand 3.4% in 2018, which is unchanged from last month’s forecast. For 2019, they pencil in growth of 2.8%.

MONETARY SECTOR | Inflation inches up in October

According to an estimate produced by FocusEconomics, inflation in the CEE region rose to 2.4% in October, up slightly from 2.3% in September. October’s result marked the highest reading since February 2013 and the fourth month of rising price pressures, led by higher commodity prices and surging consumption. Higher inflation and robust growth prompted the Czech National Bank to increase the two-week repo rate from 0.25% to 0.50% at its November meeting. Policymakers in Hungary, Poland and Romania, however, left key interest rates unchanged in the same month.

Robust economic activity will push up inflation in the coming months. FocusEconomics panelists see inflation rising gradually throughout 2018. Inflation is seen averaging 2.4% next year, which is up 0.1 percentage points from last month’s forecast. In 2019, inflation is seen averaging slightly higher, at 2.5%. 

 

Angela Bouzanis

Senior Economist 

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