Most recent Economic Perspectives for Central and Eastern Europe
CEE economic growth in Q2 neither impresses nor disappoints
Economic activity in the CEE region picked up in the second quarter compared with the previous period. Hungary recorded the highest seasonally adjusted growth (2.7%), followed by Poland (2.1%), Slovakia (2.0%), Romania (1.8%), Czechia (1.0%) and Bulgaria (0.6%).
Household demand was the main driver of economic growth in Czechia, Slovakia, and Bulgaria. Meanwhile, in Poland, Hungary and Romania, growth was led by an increase in inventories. Fixed capital investment was the second most important driver of the recovery in Slovakia, Czechia, Hungary, and Romania, while household demand was the second largest driver in Poland. In Bulgaria, it was net exports of goods and services.
The components of aggregate demand which, in turn, were the major (accounting) drag on real GDP growth in the second quarter in the countries under review, also varied: in Czechia, Slovakia, and Hungary it was negative net exports, in Bulgaria the decline in inventories, in Romania household consumption, and in Poland fixed investment.
Despite all these differences, the above-mentioned facts reflect the common backdrop against which economic activity in the CEE region took place in the second quarter of 2021.
In early Q2 2021, the waning of the pandemic and the gradual easing of containment measures boosted consumer and business confidence across economic sectors. Demand started to recover from record low levels, but it soon became clear that the recovery will not be as rapid as businesses had hoped. Since the outbreak of the pandemic, some consumer preferences have changed, fears of contagion have persisted, and many people have been still spending cautiously due to concerns about negative (delayed) effects of the pandemic on their incomes. On the supply side, GDP growth was hampered by disruptions in global supply chains, shortages in the raw materials of specialized components, and bottlenecks in international transport.
Labor market developments were another important factor affecting aggregate demand in the region in the second quarter. Unemployment rates declined in all CEE economies, with the only exception being Hungary, where the rate remained stable. The persistently low unemployment rate is good news for households, supporting their consumption appetite. From the business sector’s perspective, it nonetheless signals a risk of a serious shortage of available labour. As a result of the tightening labour markets, wage growth is firming across the region.
What to expect for the CEE growth dynamics in the third quarter of this year? The available data suggest that, except for Czechia, where we foresee a slight acceleration in economic activity due to the relatively weak performance in the second quarter, we expect the same or slightly weaker growth across the regional economies. This will be due to the unwinding of the initial growth momentum triggered by the spring release of anti-pandemic measures, persistent uncertainty arising from the rapid spread of new Covid-19 variants, and ongoing supply chain disruptions. In addition, a moderation in the euro area in Q3 is also expected to contribute to somewhat slower momentum across the regional economies.
The NBP shrugs-off inflation at a two-decade high
In Poland, August inflation at 5.4% yoy gave the impression that the tightening of the NBP’s monetary policy must be around the corner. However, the NBP’s communication, primarily led by governor Glapinski, has fully destroyed this hawkish impression. At the latest press conference, the NBP’s governor confirmed the view that the current elevated inflation is caused by supply-side factors (for example, by the green policy of the EU). That said, these factors are considered to be beyond the NBP’s control, and, as governor Glapinski reiterated, it would be a mistake to hike interest rates in such a situation (which is what the Polish money market was betting on earlier). In addition, the NBP’s head underpinned his dovish opinions by stating that he does not see any signs of a wage spiral (which would imply the tightening of monetary policy).
We believe the current rhetoric of the NBP is set to add downward pressure on the zloty since it will keep the real interest rates at very negative levels. This in turn may lead to a sharp outflow of short-term capital if the sentiment on global markets were to deteriorate (e.g., as a result of hawkish Fed rhetoric). Despite the fact that high inflation has already become a political topic in Poland, the recent NBP’s rhetoric suggests that a majority of the Board members are still of the opinion that the rate hikes are pre-mature this year.
The NBH is on the road to further monetary tightening
The latest high frequency data, in particular the elevated inflation print (4.9% yoy in August) confirms our view that the National Bank of Hungary will continue its tightening cycle in the coming months. The vice-governor of the NBH referred to the September 24th Inflation Report as a milestone, which will determine the monetary policy path until the end of the year. Both the inflation and GDP forecasts may be increased substantially compared to the June report, when the NBH started the tightening cycle. The main question is how the NBH assesses its steps so far and the persistence of the current inflationary pressures. The NBH has highlighted that inflation is expected to return to the inflation target in the middle of 2022. We share this view as base effects may start to push down inflation from the beginning of next year, yet we think that the tightness of labor market and strong domestic demand may keep inflation on the upper side of the NBH’s tolerance range of 3% +/- 1 pp. At the same time, we see an upward risk for our year-end baseline interest rate forecast of 2.1%, possibly moving to around 2.5% if core inflation is to accelerate further in the coming months. We also expect that the NBH’s government bond purchasing programme may be reduced from its current weekly HUF 50 billion purchasing limit to HUF 40 billion.
August inflation strengthens hawks in the CNB Board
The Czech National Bank will have no other option than to hike its key interest rate further and continue its monetary tightening at all of the remaining policy meetings this year. While its August staff forecast has been largely validated by hard data coming from the real economy, the inflation path surprised significantly to the upside both in July and in August. In August, CPI inflation shot up to 4.1% yoy, reaching its 13-year high. The acceleration was driven by exceptionally high core inflation and subsequent comments by the central bank indicate that the risks to their official interest rate forecast are clearly tilted to the upside. While not our baseline scenario at the moment, a 50-bps rate hike is on the radar for the September policy meeting.