Central and Eastern Europe Economic Outlook: Divergent Policy Responses Amidst Disappointing Activity

Economic activity in the first half of the year has been disappointing across Central and Eastern Europe, leading us to expect a gloomier full-year outlook. Despite this synchronised bottoming, we see a divergence in economic policy responses, driven by country-specific challenges.

Poland: A weak third quarter so far

The Polish economy started the third quarter on a soft note. All real economy figures for July underperformed, showing generally lacklustre domestic demand, while global conditions remain unfavourable. This indicates that the recovery will be slow and more visible in the fourth quarter than in the third. This suggests downside risks to our 2023 GDP forecast of 1%.

CPI inflation in July came in at 10.8% year-on-year (down from 11.5% YoY in June), largely owing to food (-0.6pp) and energy (-0.2pp) prices. Core inflation receded as well to 10.6%, but subtracted only 0.2pp from CPI. Compared to the CPI peak in February, CPI has already slowed by nearly 8pp, mainly due to fading external supply shocks. We estimate CPI will dip near 10% YoY in August, but not lower. It should decisively reach single digits in September and hover around 7% by the year-end.

We expect the Monetary Policy Council to start its easing cycle in September, even without meeting the governor's guidance on CPI reaching single digits. The recent real economy data proved lacklustre, i.e. the second quarter GDP print of -0.5% YoY came in below the July National Bank of Poland projection (-0.1% YoY), and the outlook for the second half of the year is also subject to downside risks. At the same time, inflation is on a clear path to reach single-digit levels later in the second half of the year. Still, recent MPC statements do not indicate the Council is willing to cut rates by more than 25bp at a single meeting. Consequently, we look for two or three 25bp cuts in 2023.

€/PLN remains range-bound against the euro and it’s unlikely to change prior to the mid-October general elections. The zloty remains supported by the trade surplus and presumably Ministry of Finance activity, which offsets rather unsupportive emerging market sentiment. The zloty may ease after the elections, as opinion polls suggest that the political set-up may prevent prompt access to the Recovery Fund. Moreover, we see domestic demand recovering gradually in the second half, which should trim Poland’s trade surplus, given limited external demand.

We expect further Polish government bond curve steepening. The 2024 budget draft presents a strong rise (by 55%) in net borrowing needs (to PLN225bn vs. PLN143bn in 2023), while local banks may cover one-third of it in 2024 vs. two-thirds in 2023, and the Ministry of Finance should rely strongly on foreign demand. Also, core market developments are generally unsupportive for the local long end, while domestic data should maintain, or even strengthen, market views on central bank easing.