Central & Eastern Europe: Central & Eastern Europe
February 6, 2019
Q4 2018 slowdown now appears inevitable
Central and Eastern Europe’s (CEE) once-averted slowdown now almost certainly appears to have materialized in the fourth quarter of last year. On the heels of an expectations-defying outturn in the third quarter (Q3 2018: +4.2% year-on-year), and ahead of most year-end national accounts, FocusEconomics estimates regional growth to have cooled to 4.0% year-on-year in the fourth quarter. Available fourth-quarter indicators suggest that the moderating factors were twofold: On the external front, a slowdown in the Eurozone weighed on exports and, in turn, industrial output; meanwhile, domestically, tight labor markets appeared to no longer be delivering the returns they once did. Nevertheless, lower fuel costs are expected to have padded internal demand somewhat.
Ahead of fourth-quarter national accounts, Hungary, Poland and Romania—three of the region’s heavyweights—are expected to have posted weaker growth through last year-end. In Hungary and Poland, cooler domestic demand is expected to fall in line with tepid economic sentiment and stalled labor-market gains. Meanwhile, industrial output in Romania, which analysts have warned could be overheating, has witnessed a reversal in recent months, likely exacerbated by pullback across the Eurozone. On the other hand, economic activity in Czech Republic—another heavyweight—is expected to have accelerated in the quarter, although familiar concerns over exports have begun to swirl.
Looking northward to the Baltics, Latvia and Lithuania—the only two economies for which fourth-quarter national accounts are currently available—each surpassed analysts’ expectations by a wide margin. Ahead of comprehensive estimates, economic activity in Latvia appeared to be buoyed by a construction boom, while broad-based dynamism looks to have underpinned Lithuania’s expansion. Notably, a strong outturn from Lithuania’s external sector surprised analysts who feared worse amid the broader Eurozone cool-off.
CEE slowdown to materialize amid Eurozone pullback
CEE’s economy is expected to slow this year as the region’s major economies approach the tail-end of the current business cycle. External-sector uncertainty looms and weaker activity across the Eurozone, as well as a pullback in global trade, could upend the region’s export-oriented industries. Internally, however, tight labor markets and low borrowing costs should keep most economies growing above potential, although emerging-market (EM) capital outflows threaten to expose structural weaknesses. In the event of a household-spending pullback, sound fiscal metrics will enable some governments to cushion a downturn; Hungary and Romania, however, are unlikely to be afforded this luxury. Over the forecast horizon, aging populations and the region’s complicated relationship with the European Union will remain front-and-center concerns.
Analysts expect full-year regional growth last year to have clocked in at 4.3%. That said, despite deteriorating fourth-quarter metrics, they held firm in recent weeks on short-term economic prospects and still see regional growth this year and next at 3.4% and 2.9%, respectively—unchanged from last month’s forecasts.
Four of the region’s economies, including Hungary, had their full-year growth forecasts for 2019 left intact in recent weeks. Meanwhile, six economies—including Czech Republic, Poland and Romania—had their growth forecasts lowered. On the other hand, growth forecasts for Latvia were raised. Poland and Slovakia are expected to be the region’s top-performers this year, each expanding at over 3.5%. On the flipside, Croatia, Czech Republic and Lithuania are expected to grow at below 3.0%.
POLAND | Q4 2018 slowdown to be cushioned by low inflation
Available fourth-quarter data suggests momentum finally began to ebb, on the heels of an unexpectedly robust third-quarter outturn. Domestic demand remained firmly in the driver’s seat, although dwindling consumer confidence and slipping retail sales, together with a rare uptick in the unemployment rate in December, hint that consumers proceeded more cautiously in recent months. The sharp fall in inflation through the quarter, however, should have cushioned the slowdown somewhat. Weaker manufacturing-sector sentiment, meanwhile, likely pushed firms to tap the brakes on fixed-capital spending and appeared to align with the ongoing Eurozone pullback, which continued hammering late-year export orders. All this follows a buoyant third quarter underpinned by strong earnings and low unemployment, as well as the continued absorption of EU-linked structural funds.
Although full-year growth hit 5.1% last year, the strongest outturn in more than a decade, growth is expected to moderate going forward, as an uncertain global backdrop and the late-stage business cycle increasingly taper gains. Domestically, household spending and fixed investment will be hit by slower wage and credit growth, respectively, as well as higher borrowing costs. On the external front, a Eurozone slowdown and, more broadly, an on-edge global economy will bruise activity. Moreover, election-year spending risks stretching the fiscal deficit, while concerns over the 2021–2027 EU budget are weighing on long-term economic prospects. FocusEconomics analysts see growth at 3.6% in 2019, down 0.1 percentage points from last month’s forecast, before decelerating further to 3.1% in 2020.
CZECH REPUBLIC | Momentum builds through last year-end despite shakier industrial-sector metrics
The economy appeared to gain some momentum in the final quarter of 2018, following a modest showing in the third quarter which was buttressed by upbeat domestic demand. Industrial output slowed in November but nevertheless remained solid on the back of strong car production, which also translated into buoyant growth of sales abroad. Furthermore, although the unemployment rate edged up in December, this was mainly due to seasonal factors and the labor market remains extremely tight. Coupled with the multi-year high wage growth that has been logged in recent months, this indicates robust household spending at year-end. The strong retail sales’ figures in October and November—particularly in the core sectors which exclude fuel, food and cars—reinforce this trend. It seems, however, that the economy entered 2019 on softer footing: The PMI dipped to a six-year low in January due to a fall in output and new orders amid weaker external demand.
Growth is expected to slow a tad but remain solid this year. An overly tight job market and buoyant wage dynamics should continue propelling private consumption ahead. Meanwhile, despite losing some strength, capital expenditure should continue expanding at a healthy clip, in part supported by increased infrastructure investments. On the downside, ongoing global trade tensions and a faster-than-expected slowdown in activity in the EU could weigh on the external sector’s contribution to growth. FocusEconomics Consensus Forecast panelists see GDP growing 2.7% in 2019, which is down 0.2 percentage points from last month’s projection, and 2.6% in 2020.
ROMANIA | 2019 draft budget to include sorely-needed bump in public investment
Economic activity appears to have moderated in the fourth quarter of last year, following the third quarter’s acceleration which was propelled by a jump in inventories. Industrial production growth was weak in October−November, as was external demand, both of which suffered from a cooling industrial sector in the EU. On the other hand, retail sales surged in Q4, likely benefiting from declining inflation. Heading into Q1, economic prospects appear downbeat: In mid-January, several major financial institutions announced they are considering the postponement of investment plans, due to the recently-introduced tax on banks’ assets. On the political front, on 31 January the government presented the draft budget for 2019. Among other measures, it includes a notable increase in public investment, part of which will be co-financed by EU funds. Meanwhile, relationships with EU institutions remain turbulent: In mid-January, the European Commission criticized the government for its regressive steps in fighting corruption, after the justice minister drafted an emergency decree which could invalidate several corruption cases.
Growth should moderate further this year, restrained by softer consumer spending and a smaller contribution from the inventory build-up, even as fixed investment likely rebounds. Higher taxes on multiple industries present a clear downside risk to business activity, while persistent political clashes with the EU and a sizeable fiscal deficit also darken the outlook. FocusEconomics panelists expect growth of 3.3% for 2019, down 0.1 percentage points from last month’s forecast, and 2.8% in 2020.
HUNGARY | Labor-law protests persist as economy appears to downshift
Although GDP growth likely moderated in the fourth quarter of 2018, the performance of the economy remained robust, supported by sturdy domestic demand. This followed an impressive showing in the third quarter, which saw surging fixed investment and consumer spending soaring on the back of an extremely tight labor market. Industrial production expanded at a healthy pace in October−November, fueled by solid domestic sales, and business sentiment was upbeat throughout the quarter, which bodes well for private-sector activity. Meanwhile, retail sales recorded robust expansions in the first two months of the quarter, underpinned by notable wage growth and low unemployment, although the pace of increase was lower on average than in Q3. On the political front, protests against Hungary’s overtime work law continued in January, although they are unlikely to influence the government’s political mandate.
Growth is set to moderate this year following an outstanding 2018, but it will nevertheless remain robust. Fixed investment should continue to increase solidly, although its pace of expansion will likely slow due to rising interest rates and reduced inflows of EU funds. Likewise, household spending should remain healthy on tight labor market conditions and rising wages, although it will moderate due to stronger inflationary pressures. FocusEconomics panelists see the economy expanding 3.4% in 2019, unchanged from last month’s forecast, and 2.6% in 2020.
MONETARY SECTOR | Inflation recedes through last year-end on lower fuel costs
A comprehensive estimate produced by FocusEconomics revealed that regional inflation fell to 1.9% in December 2018 (November 2018: 2.1%), with all economies except Czech Republic and Estonia experiencing weaker inflationary pressures amid notably lower fuel costs. All told, annual average inflation across the region clocked in at 2.5% in 2018 (2017: 2.0%).
Low inflation and shakier growth prospects, in turn, led policymakers in Hungary, Poland and Romania to hold interest rates at existing levels at their first monetary policy meetings of the year. Both announcements were expected by analysts.
Regional inflation is expected to remain broadly stable over the coming years and is seen averaging 2.4% in 2019, down 0.1 percentage points from last month’s forecast, and 2.5% in 2020.