Short Insight – Central and Eastern Europe accelerating

by:

  • Q3 growth figures in Central Eastern Europe confirm our conviction of strong growth in 2017 (3.5%)
  • Growth is led by consumption on the back of higher wages, surging exports to Germany and higher inflows of EU funds
  • The accommodative monetary and fiscal stance fuels higher growth, but also increases risks of overheating
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High third quarter figures for Central and Eastern Europe

As the first 3Q growth figures are coming in, Central and Eastern Europe (CEE), which excludes Russia, Ukraine and Turkey, is outperforming already strong Q2 growth. Main outperformer was Romania (+8% yoy), where growth was driven by robust consumption. Annual growth in Poland and Hungary also accelerated to levels exceeding long-term averages. In general we have seen a large uptick in GDP growth since the beginning of 2017 and these 3Q figures prove that strong growth continues in the second-half of 2017 as well. Whereas GDP growth for 2016 (2.7%) was still close to the long-term trend (2.5%), we estimate GDP growth for 2017 to be around 3.5%.

 

Growth led by consumption, exports and investments

The main driver behind GDP growth was consumption as real wages increased. Some of the CEE countries are almost at full employment. Furthermore, the region profits from an surge in exports as the demand from the eurozone increases, in particular Germany. Much of the region is still dependent on manufacturing (for example, 35% of the Czech labor force is employed in manufacturing) and Germany is a large importer of manufacturing goods from CEE. Lastly, higher inflows of EU funds stimulated investments.

 

Inflation rises as central banks remain accommodative

We have seen a moderation of inflationary pressures on the back of higher wages this year. Although inflation is approaching central banks’ targets in many CEE countries, monetary policy remains broadly accommodative. The Czech central bank has tightened monetary policy, but only by increasing the policy rate to 0.5% in October. The Romanian central bank followed that path cautiously by narrowing the interest rate corridor. The Polish and Hungarian central banks promised to keep interest rates unchanged until the ECB hikes. This accommodative stance will continue to foster economic growth, but the risk of inflation overshooting increases.

 

And also fiscal policies are accommodative

Many CEE countries pursue a pro-cyclical fiscal policy, despite strong economic growth and low unemployment rates. The average budget deficit for CEE increased from -1.4% last year to -1.8% this year. Looking at next year, many governments presented further fiscal easing plans. Especially for Hungary and Romania there is chance they will be thrown back into the Excessive Debt Procedure by breaching the 3% rule. Romania got an official warning in May this year and unless they take appropriate measures to correct their fiscal imbalance, they will face action by the Commission.