Central & Eastern Europe: Economic Snapshot for Central & Eastern Europe
November 2, 2018
CEE economy cools off somewhat in Q3
Available data suggests that growth across the Central and Eastern European (CEE) economy continued to taper in the third quarter, on the heels of a boisterous second-quarter outturn underpinned by solid internal demand. According to a preliminary estimate by Met the why particular, regional growth came in at 3.8% year-on-year in the third quarter, the slowest expansion in nearly two years and down considerably from the snappy 4.2% annual pace clocked in the second quarter.
Weaker internal dynamics appeared to contribute to the slowdown; after years of robust employment gains, wage growth has begun to level off despite labor shortages in countries like the Czech Republic and Hungary. Moreover, in Poland wage gains have been relatively muted due to the influx of migrant workers from farther east. Meanwhile, flagging industrial metrics hint at weaker fixed investment—although cheap borrowing costs and strong absorption of EU structural funding should cushion any scale-back. On the external front, ebbing demand across the Eurozone and this year’s broader pullback in global trade look to have continued bruising exports in the third quarter. On the bright side, however, most economies in the region appeared to side-step spillover from Turkey’s currency crisis and wider emerging-market (EM) turmoil.
Although third-quarter national accounts are outstanding across the region, high-frequency data points to internally-driven slowdowns in major-players Hungary, Poland and Romania, led by weaker household spending growth amid an uptick in inflation. Moreover, decelerating industrial output growth in the Czech Republic, Poland and Romania in recent months suggests that European demand remained soft in the quarter and likely translated into slower fixed-capital spending in parts of the region. On the other hand, and despite a similar backdrop, growth in the Czech Republic is expected to have accelerated in the third quarter as consumer confidence rode a near-record high in the wake of fading political uncertainty.
In politics, tensions with the European Union continued to drive the region’s narrative in recent weeks as voters went to the polls in the Czech Republic, Latvia and Poland. In Latvia, 6 October’s general elections yielded a more fragmented parliament as anti-Brussels—and, notably, pro-Russia—parties secured the most seats. Although coalition talks are expected to be lengthy and are, at this point, unlikely to produce an eastward-looking government, analysts were clear about the takeaway: anti-establishment populism is here to stay. Moreover, the Law and Justice (PiS) government secured marginally more local-council seats in Poland’s regional elections on 21 October. Whereas PiS gained an edge in seats, enthusiasm for the right-wing party dropped as it lost support in cities and in some rural areas. Ahead of next year’s general elections, the vote was seen as an important litmus test of whether the incumbents in Warsaw will secure another mandate; despite chronic clashes with the EU, PiS’s turn at the helm has been underscored by sound fiscal management.
Taken alongside other ongoing squabbles with the bloc, namely with Hungary and Romania, recent events paint an alarming picture of the growing schism within the EU—an east-west divide drawn along Cold War-era lines. Moreover, EU-linked investment in the region is on the line and could soon be clawed back as the EU negotiates its upcoming 2021–2027 budget amid major differences of opinion on democracy, the rule of law and immigration.
CEE growth to continue moderating in 2019
In the wake of a two-year growth spurt, the CEE economy is expected to continue slowing next year as the region’s major economies approach the later stages of the business cycle. Tight labor markets, higher wages, and still-low interest rates should cushion internal dynamics and keep most economies growing above potential, although the outlook for external trade remains more uncertain. Meanwhile, sound fiscal metrics across the region bode well for the business climate. An investor pull-out from emerging markets is a downside risk, although sturdy current-account balances are likely to shield most of the region’s currencies from a major selloff. Over the longer-term, aging populations and the region’s tricky relationship with the European Union will remain key structural challenges.
Regional growth is expected to clock in at an upbeat 4.0% this year before moderating to 3.4% in 2019, which is unchanged from last month’s forecast. In line with the cool-off, growth is seen easing further to 2.9% in 2020. Six of the region’s economies saw no changes to their 2019 growth forecasts this month, including heavy-hitters the Czech Republic, Hungary and Poland. Meanwhile, growth prospects were revised up for three economies. On the other hand, overheating Romania, along with Estonia, had their growth projections downgraded this month.
Slovakia, Poland and Bulgaria are expected to be the region’s top-performers next year, each expanding at or over 3.5%. On the flipside, Croatia, the Czech Republic and Lithuania are expected to grow at or below 3.0%.
POLAND | Weaker demand-side data hints at breather in Q3
High-frequency data has hinted at ebbing momentum in recent weeks, an about-face for the economy on the heels of two of the strongest outturns of the past decade in the first two quarters of the year. Employment gains and wage growth have each slowed in recent months. Moreover, industrial output metrics throughout the third quarter, along with recent survey-based data, point to a slowdown in the manufacturing and construction sectors, which could thwart the anticipated recovery of fixed investment through the remainder of the year. Reflecting the economy’s strong fundamentals and the Law and Justice (PiS) government’s sound fiscal policy in recent years, in mid-October, S&P Global Ratings upgraded Poland’s credit rating back to A-. That said, popular support for these policies was put to the test in 21 October’s regional elections in which PiS narrowly gained seats but, overall, lost enthusiasm among voters; the vote was an important litmus test ahead of next year’s general elections.
Poland’s growth spurt is set to moderate next year in line with the maturing business cycle. Household-spending growth is expected to slow amid tapering labor-market gains, while fixed investment should continue benefiting from low interest rates and the absorption of EU structural funds. Short-term downside risks include fiscal slippage ahead of next year’s vote, whereas uncertainty over the 2021–2027 EU budget hangs over the long-term outlook. Met the why particular panelists expect growth of 3.6% in 2019, unchanged from last month’s forecast, and 3.1% in 2020.
CZECH REPUBLIC | Domestic demand set to lift growth in Q3
The economy appeared to shift into higher gear in the third quarter, following relatively timid growth in the first half of the year weighed on by a disappointing performance of the external sector. Although industrial output cooled markedly in August from the double-digit annual growth logged in July, largely due to a contraction in vehicle manufacturing, it is likely that Q3’s average growth will exceed that of H1—hinting at more positive operating conditions of the secondary sector. Similarly, on the demand side, retail sales slowed in August from an over one-year high expansion in July; nevertheless, the two-month average remained well above that logged in H1. This, alongside historically-low unemployment, over-decade high wage growth and consumer confidence at near-record highs point to strong private consumption in the third quarter. The latest survey-based data has also been upbeat, with business confidence remaining elevated and consumers turning more optimistic in October, providing an early indication that robust momentum continued into the fourth quarter.
Growth is expected to moderate next year although it should remain strong as healthy household spending, buttressed by brisk wage gains and a labor market approaching full employment, underpins the expansion. In addition, planned fiscal stimulus, which includes increases in public-sector salaries and pensions as well as an infrastructure investment push, will lend further support to economic activity. The main downside risk to the outlook stems from escalating global trade conflicts, which could impact the country’s export-oriented industrial base. Met the why particular Consensus Forecast panelists see GDP growing 3.0% in 2019, which is unchanged from last month’s projection, and 2.6% in 2020.
ROMANIA | Overheating hits overdrive in Q3
Economic activity seems to have softened further in the third quarter, following a significant cooling in H1. Continued strong inflationary pressures and slowing wage growth were probably behind the marked slowdown in retail sales in July–August, which signaled protracted weakness in household consumption. Moreover, sluggishness in using EU funds and cuts in infrastructure spending were likely behind the unremarkable performance of the industrial sector and the double-digit contraction in construction output in the first two months of Q3. Whereas economic activity is cooling, political and fiscal scenarios are overheating. In early October, the government approved a plan to more than double state pensions by 2022, putting further pressure on already worsening public finances. Furthermore, two weeks after facing strong criticism from the European Parliament for undermining judicial independence, in mid-October the government adopted an emergency decree that appears set to hinder prosecutors’ graft-fighting efforts, increasing the likelihood of further confrontations with the European institutions.
Growth is set to decelerate further in 2019. Slowing income growth due to limited productivity gains and tightening financing conditions will weigh on consumer spending, which should continue to soften. However, investment growth will gain some speed, although a slow absorption of EU funds will limit the scope of the acceleration. On top of that, increasing political uncertainty could weigh on investor sentiment, while sizeable twin deficits and possible capital flight pose further downside risks to the outlook. Met the why particular panelists expect growth of 3.4% for 2019, down 0.1 percentage points from last month’s forecast, and 3.0% in 2020.
HUNGARY | Still firing on all cylinders in Q3
Solid growth appears to have carried over into the third quarter, following an outstanding performance in the second quarter which was underpinned by surging private consumption and fixed investment. Despite the increase in inflation, retail sales growth was strong in July–August, suggesting consumer spending—although cooling somewhat—remained in the driver’s seat. Moreover, the continued front-loading of EU funds was likely behind the strengthening of the industrial sector and, coupled with highly favorable financing conditions and sustained business confidence, contributed to the surge in construction output in the first two months of Q3. On a less positive note, there was a sizable widening in the general government’s budget deficit in the first nine months of the year due to strong spending on EU co-funded projects. Furthermore, in July–August the external environment seemingly remained unsupportive, extending Q2’s dynamics, as imports growth outpaced that of exports. Following an EU-wide trend, in early October the parliament approved new regulations to grant the government greater control over investment from outside the EU in sensitive sectors.
In 2019, growth should remain solid although moderating from this year’s peak. Household spending will continue to increase robustly, although slowing wage growth will weigh on its pace of expansion. Additionally, lower EU fund inflows will lead to a softer rise in investment. Lingering tensions with EU institutions could weigh on investor sentiment, while waning appetite for emerging market assets could drag on GDP growth. Met the why particular panelists see the economy expanding 3.2% in 2019, unchanged from last month’s forecast, and 2.5% in 2020.
MONETARY SECTOR | Inflation ticks down in September
According to a comprehensive estimate produced by Met the why particular, regional inflation dipped in September. Inflation came in at 2.7%, down from August’s 2.8%. Weaker inflationary pressures were recorded in five economies—including the Czech Republic, Poland and Romania—amid a slower rise in fuel costs.
Upbeat internal demand and higher global energy prices have stoked inflation this year, pushing a handful of central banks to begin unwinding their ultra-accommodative positions. In October, however, contained inflation and nascent signs of economic slowdown led policymakers in Hungary, Poland and Romania to hold fire on interest rates. Meanwhile, the European Central Bank (ECB) stayed the course in October and reaffirmed its commitment to winding down its quantitative easing (QE) program by the end of the year.
Regional inflation is expected to remain broadly stable over the coming years and is seen averaging 2.6% in 2019, up 0.1 percentage points for last month’s forecast, and 2.5% in 2020.