Europe: the effects of easy monetary conditions and falling unemployment

The ramp-up of disbursements of EU funds and the strengthening of key western European trade partners are bolstering growth in central and eastern Europe.

europe economic growthEmerging Europe Sovereign Credit country-by-country overview by Fitch Ratings: the strengthening of growth across the region, diverging fiscal policy trends in central Europe and the risks posed by political developments.

The ramp-up of disbursements of EU funds and the strengthening of key western European trade partners are bolstering growth in central and eastern Europe. Domestic demand is also robust, supported by easy monetary conditions and falling unemployment, while tourism is benefiting from adverse security conditions in competitor markets.

The recovery in Russia continues to gain traction. Domestic demand is responding to greater confidence in the economic policy framework, particularly as the inflation-targeting regime becomes entrenched. Activity in Turkey has bounced back rapidly from the coup attempt, with growth hitting 5% yoy in 1Q17. Momentum was supported by government incentives, including temporary fiscal measures and a jump in the Treasury commitment to the fund that backs lending to SMEs.

Stronger growth and low government bond yields provide a favourable backdrop for public finances, although some are using the fiscal space for pro-cyclical policy. The European Commission is projecting a deterioration in the structural balance for most countries in the region. Strengthening growth is putting pressure on wage rates, but output gaps generally remain negative, with the pick-up in inflation in 1Q17 due to higher commodity prices.

Political risks seem relatively contained. A trade blockade with non-government controlled territories in eastern Ukraine will hit economic performance, but the armed conflict remains low-intensity. Domestic politics are challenging the implementation of the IMF programme. Recent changes to the ruling coalitions in Bulgaria and Croatia, a new government in Romania, and elections in the Czech Republic are not expected to change economic policy. More serious political stability risks in Macedonia seem to have been avoided after external pressure. The constitutional referendum in Turkey in April passed smoothly.

So far in 2017, Fitch Ratings has taken three rating actions in the region, two positive (Bulgaria and Croatia) and one negative (Turkey). The agency revised Bulgaria’s Outlook to Positive from Stable, reflecting a marked improvement in external metrics, strong public finances, rising growth and reduced fiscal risks from the banks, and Croatia’s Outlook to Stable from Negative due to fiscal consolidation, lower political risks and strengthening economic growth.

Fitch downgraded Turkey because of political and security developments undermining economic performance and institutional independence, failure to address long-standing external vulnerabilities, and banks having been hit by the slowing economy.