Central and Eastern Europe

Central and Eastern Europe

CEE currencies

EUR/HUF (light blue):

1 April 2018: President Orban is re-elected. Political uncertainty launches an upward trend in EUR/HUF. The pair leaves the 305/315 sideways trading band.

2 The currencies of both the Czech Republic and Hungary often show inverse correlation with the US dollar. The strong performance of the USD since April/May leads to a weakening of the krona and forint.

3 Markets doubts economic sustainability of Turkey and massively sell the Turkish lira. Hungarian forint (and Czech koruna) suffers collateral damage.

4 Despite strong economic data, Hungarian forint slips because of pressure on emerging countries (Turkey, Russia, etc.).

5 The European Union activates the sanctions procedure (the infamous Article 7) against Hungary, which may ultimately end in the deprivation of voting rights. The effective implementation is highly uncertain because every EU member has a veto. The forint hardly reacts.

6 During a speech, the vice governor of Hungary’s central bank Marton Nagy flags the start of monetary tightening by the central bank. The central bank kept that option on the table when it held its policy meeting just a few days later, further supporting the recent foriny rally.

EUR/CZK (dark blue):

1 Unfortunate combination of pressure on the emerging countries, temporarily reduced liquidity in the run-up to a few holidays and the news regarding a possible reduction in European funding for some Central European countries affects the Czech koruna in the middle of the year.

2 A tough confrontation between Italy's brand new populist government (Lega, 5SM) and Europe seems inevitable. The negative risk climate leads to a collapse of Italian assets and drags along central European currencies, including the krona (and the forint).

3 The currencies of both the Czech Republic and Hungary often show inverse correlation with the US dollar. The strong performance of the USD since April/May leads to a weakening of the krona and forint.

4 ‘Buy the rumor, sell the news': In September, the Czech koruna strongly anticipated more central bank interest rate hikes. The central bank put its money where its mouth is, but the krona no longer benefited from it.

5 Despite multiple rate hikes, the Czech koruna remains under pressure as growth slowed down more than anticipated. Political uncertainty (vote of no confidence) keeps the currency in the defensive also. Meanwhile, prime minister Andres Babis’ government survived the vote.

6 The Czech koruna’s rally amid a constructive risk climate and on prospects of a new rate hike in February by the Czech National Bank, stalls. The recently sworn in CNB governor Holub casts doubt on a February hike after world leading central banks (a.o. the ECB) staged a dovish turn just recently.

7  The Czech koruna strenghtens following better than expected growth (1.0% QoQ) in the fourth quarter of 2018, bolstering the case for more rate hikes from the Czech national bank.

Latest updates on economic growth in the region

GDP growth figures for Q4 2018 are now available for most Central and Eastern European (CEE) countries. Generally speaking, these figures indicate a continued strong growth performance throughout the region. This performance is even more remarkable given the general economic slowdown in the euro area, and in particular in Germany. Hence, it is clear that there are mitigating factors at play keeping the growth level up in Central and Eastern Europe. Strong domestic economic performances, supported by EU funding and accommodating fiscal policies, play an important role. Despite the overall solid growth performance, there are differences across countries though (figure CEE1). For example, while growth accelerated in the Czech Republic between Q3 and Q4, there is a clear downward trend in Slovakia and there was a disappointing Q4 in Poland. The short-term developments are markedly different from the long-term trends, however, as Poland and Slovakia have experienced the most impressive growth paths in the past decade (figure CEE2). More generally, growth developments in the CEE region in recent years have been substantially stronger than the euro area trend.

Figure CEE1 – Real GDP (% change quarter-on-quarter)

Source: KBC Economics based on Eurostat

Figure CEE2 – Real GDP (index, Q1 2008 = 100)

Source: KBC Economics based on Eurostat

Resilience despite German slowdown

The latest GDP growth figures across Central Europe clearly point to resilience against the slowdown in the German economy - by far the most important export destination for all of the Central and Eastern European economies. The German economy slowed significantly in the second half of 2018, declining by 0.2% qoq in Q3 and stagnating in Q4. Hence, it only narrowly escaped a technical recession, which is defined as two consecutive quarters of negative growth. The significant slowdown was the result of both temporary factors (such as new emission regulations in the automotive industry) and more permanent factors (such as slower Chinese demand growth). At first glance, it might seem surprising that growth is holding up in Central and Eastern Europe. For now, the region appears to be resilient to the evolutions in the German business cycle.
What is behind this resilience towards the German slowdown? First, it may be the nature of the slowdown, which is widely believed to be driven by temporary factors. It therefore should not have a significant negative impact on investment activity in the region. Second, some of the more permanent negative factors, such as weaker growth in China, are less damaging to the Central and Eastern European economies since the regional exposure towards China is significantly lower compared to Germany. Finally, the fiscal stance of the Central and Eastern European economies is in many cases much more relaxed than in Germany, where the budget surplus has been growing (as a share of GDP) since 2014. The argument holds especially for Poland and Hungary that have significant cyclically adjusted deficits. Looking ahead, the disparity may become even larger now that Poland has announced a new fiscal stimulus package amounting to 2% of the country’s GDP.

Looking forward

Despite the region’s current resilience to the German economic slowdown, we expect slower German growth to have a moderately negative influence on the Central and Eastern European region in the first half of 2019. This is also signaled by the recent worsening of the Czech and Polish business confidence indicators (PMIs). Several other leading indicators, including new orders (based on European Commission´s surveys), appear to be resistant to the German slowdown so far. In addition, our own economic models, based on a variety of soft indicators, do not point to a major slowdown. However, if the German slowdown persists longer than expected, its impact on the CEE region could become more significant.

Consequently, our growth forecasts indicate a mild slowdown throughout the region. The expected growth slowdown in some countries is larger due to country-specific factors. Hungarian growth, for example, is expected to slow significantly. This is because the current growth rate is strongly supported by EU funding which will gradually fade out in the years ahead. Romanian and Bulgarian growth is expected to be under pressure too, given the weak economic outlook in some of their important trading partners, such as Turkey, Greece and Italy.

Tight labour markets

The encouraging growth environment in Central and Eastern Europe is supportive of regional labour markets. Throughout the region, unemployment rates continue their declining trend. Tight labour markets, in turn, cause wage acceleration. Nominal labour costs (compensation including taxes and excluding subsidies) increased on an annual basis by 9% in Hungary, 7.7% in the Czech Republic and by 6.9% in Slovakia (figures for Q3 2018). Throughout the region we notice attempts to increase participation rates, support the labour market by allowing migrant workers, and to implement further labour market reforms. In addition, the private sectors in various countries are aiming to reduce their dependence on labour through new investments. It is, however, unlikely that these initiatives will be sufficient to overcome capacity constraints. Tight labour markets may jeopardize further economic growth in the longer run. Some growth slowdown may, however, lead to some bottoming out in the unemployment rate, although no signs of this are visible yet.

Latest updates on economic growth in individual countries

Czech Republic - Economic update March 2019

201903 Czech Republic - Economic update

Bulgaria - Economic update March 2019

201903 Bulgaria - Economic update

Hungary - Economic update March 2019

201903 Hungary - Economic update

Slovakia - Economic update March 2019

201903 Slovakia - Economic update

Forecasts for the Central and Eastern European countries in numbers:

In-depth credit reviews

In depth review: Slovakia

MR20181218 In depth review: Slovakia

Most recent publications on Central and Eastern Europe:

EU funding for Central and Eastern European regions remains essential

EU-fondsen voor Centraal- en Oost-Europese regio’s blijven noodzakelijk

Diversity in European income trends...but education pays off everywhere

Geen eenheid maar diversiteit in Europese inkomenstrends
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