Central & Eastern Europe Economic Outlook May 2018

Economy loses steam in Q1 after stellar 2017

Central & Eastern Europe: Economy loses steam in Q1 after stellar 2017

May 9, 2018

Recent data suggests that the Central and Eastern European (CEE) economy lost some momentum at the start of 2018, following the best performance in a decade last year. The Consensus Forecast is for regional GDP to have expanded 4.4% annually in Q1, below Q4’s 5.0% increase. Despite the anticipated slowdown, the estimate still marks a robust reading for the CEE economy, which is benefiting from several tailwinds including tight labor markets, soaring investment and accommodative monetary policy.


While official national accounts data is still outstanding for all the economies in the region, monthly indicators suggest that growth decelerated in most of the countries in Q1. A slowdown in the Eurozone, the region’s major trading partner, likely weighed on CEE’s external sector, while the positive impact of some fiscal stimulus measures enacted last year is expected to have begun fading. In major player Poland, weaker demand from the Eurozone is expected to have hampered growth somewhat. Although export growth slowed notably in February, booming investment thanks to a high absorption of EU developmental funds and optimistic business confidence likely kept activity strong overall. Likewise, industrial production data for the Czech Republic and Romania suggests that those economies lost steam from last year’s blistering pace; however, tight labor markets are keeping activity robust.


After nearly two years of planning, the European Commission unveiled its proposed 2021–2027 EU budget on 2 May, setting the stage for long negotiations between EU nations. The EUR 1.1 trillion budget is based on higher contributions from countries to cover the gap left by Brexit and contains several changes to how spending is set to be allocated. The EU budget is particularly important for CEE economies, which have been some of the largest beneficiaries of funds over the past decade; EU funding is a large source of investment in the region.


Notably, the proposed budget contains a new “rule of law” clause, which would allow the EU to curb funding to countries where the rule of law is at risk. This has been a particularly contentious issue between EU officials and Hungary and Poland over the past year. However, the new clause needs to be unanimously approved by EU member nations, and it remains to be seen if it will have the needed support. In addition, the budget proposes a new method to distribute cohesion funding. Previously, funding was allocated based on GDP per capita, leading to high allocations for many CEE economies. The new proposal, however, would take into account additional indicators such as youth unemployment, which could see a partial shift of funds away from CEE to economies such as Greece and Spain.


Read the most recen economic outlook for the Central and Eastern Europe region


Robust, albeit slower, growth seen for 2018


The CEE economy is seen growing at a healthy, albeit less stellar, pace this year thanks to vibrant domestic economies. Rising wages, low unemployment, accommodative monetary policy and robust inflows of EU funds are seen supporting activity. Slower export growth, slightly higher inflation and the reduced impact of fiscal stimulus will, however, take some wind out of the economy’s sails. Regional growth is forecast to come in at 3.9% this year, unchanged from last month’s estimate. Next year, growth is projected to slow to 3.3%.


This month’s unchanged 2018 outlook is due to stable projections for 3 of the 11 economies in the region, including major players Hungary and Poland. In addition, a number of upward and downward revisions balanced out. Five economies saw their prospects upgraded, including the Czech Republic and Romania, while Croatia, Latvia and Lithuania all had their GDP forecasts revised down.


Romania is projected to be the region’s top performer in 2018 for the third year in a row, with GDP growth of 4.6%. Poland and Slovenia are also seen achieving high growth rates this year of above 4.0%. On the other end of the spectrum, Croatia is projected to be the region’s laggard, with an expansion of 2.7%.


POLAND | Government offers concessions to end standoff with the EU over rule of law


Available data for the first quarter suggests last year’s momentum persisted at the outset of 2018, with upbeat growth in the quarter likely driven by resilient domestic demand. Strong job creation and buoyant retail sales in the quarter point to a consumer spending-led expansion. Moreover, tighter labor market dynamics have kept real wage growth elevated despite the continued influx of migrant workers. Furthermore, soaring business confidence and healthy PMI readings through March are likely to have translated into robust fixed investment in the quarter, which is also expected to have benefitted from the recent surge in construction activity. In early May, the government offered some concessions to the EU in its ongoing standoff over the rule of law; officials on all sides have been trying to end the dispute as the bloc begins drafting its upcoming 2021–27 budget.


Domestic demand will again support buoyant growth this year. Consumer spending will be underpinned by strong wage growth and higher employment, while fixed investment will benefit from heavy EU-linked funding inflows, upbeat business sentiment and a nascent construction boom. Meanwhile, export growth is set to moderate and, despite stronger government revenue flows, fiscal slippage ahead of the next election cycle is likely to widen the deficit. Recent uncertainty over the next EU budget is clouding the long-term outlook. Analysts expect growth of 4.1% in 2018, unchanged from last month’s forecast, and 3.4% in 2019.


See the Full FocusEconomics Central and Eastern Europe Report


CZECH REPUBLIC | Coalition negotiations yield progress


Recently released data suggests the economy was in good shape early this year, largely holding pace from the solid performance logged in Q4 2017. A tightening labor market, rising wages in the public and private sectors, and low inflation in recent months likely boosted private consumption in Q1. In parallel, economic sentiment was at its highest level in 10 years in April, propelled by record-high consumer confidence. However, a slowdown in the Eurozone economy in the first quarter likely tempered economic activity, and industrial production growth decelerated markedly in Q1 compared to Q4. Meanwhile, a milestone was reached on the political scene, as the ruling ANO party declared on 2 May that a coalition agreement with the Social Democrats (CSSD) was close to being finalized, which could put an end to months of political turmoil.


Economic growth is expected to moderate this year but nonetheless remain solid on the back of robust domestic demand. A strengthening labor market should continue fueling private consumption growth, while high capacity utilization should support strong capital spending in the months ahead. FocusEconomics Consensus Forecast panelists see GDP growing 3.5% in 2018, which is up 0.1 percentage points from last month’s projection, and 3.0% in 2019.


ROMANIA | PM and president clash, upping political uncertainty


In the first quarter growth likely moderated further but remained solid, according to available data. Softer growth in retail sales suggests consumer spending lost some steam. Although supported by a strong labor market and rapidly rising wages, consumer spending was restrained by soaring inflation stemming from an overheating economy. Industrial production also moderated, reinforcing evidence that growth is easing from last year’s blistering pace. In mid-April, President Klaus Iohannis refused to comply with the interior minister’s request to fire the head of the country’s anti-corruption agency. Moreover, in late April Iohannis asked Prime Minister Viorica Dancila to step down due to foreign policy disagreements; she refused. Compounding political tensions, in early May the president announced he will not approve a controversial judicial reform sponsored by the government, a source of protracted friction between Romania and the EU. If political tensions persist, they could hit investor confidence.


This year growth should remain strong but moderate, held back by growing capacity constraints. Consumer spending will remain the main driver of growth, although it will be weighed down by rising inflation, while a pick-up in EU-backed investment projects will underpin fixed investment. However, a widening budget deficit due to an expansionary fiscal stance and a large current account deficit pose the main risks to economic stability. FocusEconomics panelists expect growth of 4.6% for 2018, up 0.1 percentage points from last month, and


Economic policy untouched by government reshuffle as Varga stays on as economy minister


Fueled by buoyant domestic demand, strong momentum from the final quarter of 2017 likely carried over into this year. Soaring retail sales in the first two months of 2018 point to strong consumer spending, underpinned by extremely tight labor market conditions, robustly rising wages and improved consumer confidence. Moreover, public budget data for Q1 hints at a solid expansion in fixed investment, as pre-financing for EU-funded projects increased notably. Budget data also revealed that revenue from income tax and VAT jumped, another testimony to the economy’s good health. That said, above-potential growth could be leading to increased capacity bottlenecks. In the political arena, Prime Minister Viktor Orbán announced some reshuffling of his government after his landslide victory in April’s elections. However, the continuity of economic policy seems to be guaranteed by the confirmation of the current economy minister, Mihály Varga.


Growth should remain vigorous but moderate somewhat in the second half of this year, held back by growing capacity constraints. Further inflows of EU funds and favorable financing conditions will spur fixed investment, while a strong labor market and robust wage growth is expected to buttress household spending. A buoyant domestic economy will, however, lead to some deterioration in the external balance, despite healthy external demand. FocusEconomics panelists see the economy expanding 3.7% in 2018, unchanged from last month´s forecast. For 2019, the panel sees growth slowing to 3.1%.


MONETARY SECTOR | Inflation inches up in March


According to an estimate produced by FocusEconomics, inflationary pressures in the region increased slightly in March. Inflation rose from 2.1% in February to 2.2%. Higher price pressures were recorded in 6 of the 11 economies surveyed, including Hungary and Romania. Robust economic activity, along with higher commodity prices, is exerting inflationary pressure in the CEE economy. A preliminary estimate for April suggests that inflation inched up further to 2.3%.


Still-moderate inflationary pressures have allowed most regional central banks to maintain accommodative monetary policies in recent weeks. Policymakers in Hungary and Poland left rates stable at their April meetings. However, rising inflation in Romania amid strong domestic demand and capacity restraints caused the Central Bank to hike rates in May.


Inflation is seen gradually rising this year on the back of buoyant economic momentum. It is expected to average 2.4% this year, down 0.1 percentage points from last month’s forecast. In 2019, inflation is seen broadly stable at


See the Full FocusEconomics Central and Eastern Europe Report


 


Angela Bouzanis


Senior Economist 

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