Regional Economic Outlook Spring 2018 Key Messages Strong - - PDF document

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Emerging Europe Advanced Europe

Regional Economic Outlook

Spring 2018

E U R

Key Messages

 Strong economic growth but lead indicators point to a peak  Much lower wage growth in most of advanced Europe than in new EU member states because of slack, a flatter Phillips curve, and entrenched low inflation expectations  Monetary policy normalization to proceed more slowly in most of advanced Europe: implications for capital flows to new EU member states and exchange rates  Fiscal adjustment insufficiently ambitious, given the strength of the cycle. Some countries have even relaxed  Policymakers need to seize the good times to advance further with fiscal consolidation and structural reforms

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Developments and Outlook

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Europe continues to enjoy strong growth

Sources: IMF, World Economic Outlook; and IMF staff calculations. 1/ The upper and lower bounds of the shaded areas depict the minimum - maximum growth range.

Advanced Europe: Real GDP Growth (Year-over-year percent change) Emerging Europe: Real GDP Growth (Year-over-year percent change)

• 15
• 10
• 5

5 10 15 2000 2006 2012 Advanced Europe Euro area 2017

Min-max range 1/

• 15
• 10
• 5

5 10 15 2000 2006 2012 Emerging Europe Russia 2017

Min-max range 1/

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Growth is driven by domestic demand

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Advanced Europe: Contributions to Growth (Percentage points) Emerging Europe: Contributions to Growth (Percentage points)

• 3
• 2
• 1

1 2 3 4 5 2015 2016 2017 Consumption Investment Net exports Real GDP growth

• 3
• 2
• 1

1 2 3 4 5 2015 2016 2017 Consumption Investment Net exports Real GDP growth

• 40
• 20

20 40 60

Euro area United Kingdom Switzerland Czech Republic, Hungary, Poland, Turkey, and South Africa

March-18 2017

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High-frequency data suggest that momentum is peaking

Manufacturing PMIs (Three-month moving average; deviations from 50)

Sources: European Commission; Haver Analytics; IMF World Economic Outlook; and IMF staff calculations. 1/ Measures macroeconomic data surprises relative to market expectations. A positive/negative reading means that the data releases have been stronger/worse than expected.

Citigroup Economic Surprise Index 1/ (Period average; in percent)

More-positive surprises

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• 4
• 2

2 4 6 8 10 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Advanced Europe Emerging Europe Mar-18

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Risks

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Near-term risks balanced. Medium-term risks to the downside

Medium-term downside risks have become more acute:

• Inward looking policies and rising protectionism
• Protracted policy and economic uncertainty
• Richly valued asset prices could correct abruptly

Medium-term downside risks have become more acute:

• Inward looking policies and rising protectionism
• Protracted policy and economic uncertainty
• Richly valued asset prices could correct abruptly

Near-term risks balanced:

• Robust confidence and still strong conjunctural indicators
• But greater trade tensions and market volatility

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Cyclical Position and Inflation

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Output gaps appear largely closed

Output Gap, 2018 (Percent of potential GDP)

Sources: IMF World Economic Outlook; and IMF staff estimates.

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Inflation pressures are diverging across economies

Core Inflation (Year-over-year percent change; period average)

Sources: Haver Analytics; and IMF staff calculations. Note: Other advanced economies include: Czech Republic, Israel, San Marino, Switzerland, and the United Kingdom.

• 0.5

0.0 0.5 1.0 1.5 2.0 2.5 2014Q1 15Q1 16Q1 17Q1 18Q1 Euro area Nordics Other advanced economies

• 0.5

0.0 0.5 1.0 1.5 2.0 2.5 2014Q1 15Q1 16Q1 17Q1 18Q1 Central Europe SEE EU SEE non-EU 5 10 15 20 25 30 35 2014Q1 15Q1 16Q1 17Q1 18Q1 CIS excl. Russia Turkey Russia

Labor Markets and Wages

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Labor market slack has declined, but remains high in EU-15, unlike in NMS

Sources: Eurostat; and IMF staff calculations. 1/ Additional slack includes persons marginally attached to the labor force and underemployed part-time workers. 2/ EU-15: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, and the United Kingdom 3/ New member states: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia.

EU: Unemployment and Additional Labor Market Slack 1/ (Percent) 8 10 12 14 16 18 20 22 2008Q1 2010Q3 2013Q1 2015Q3 2017Q New member states 3/ EU-15 2/

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Wage growth is sluggish in EU-15 and strong in NMS

Source: Eurostat.

2 4 6 8 10 12 14 16 2001Q4 2005Q4 2009Q4 2013Q4 2017Q4 New member states EU-15

Nominal Wage Growth (Percent change y/y in four-quarter averages)

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• 1.0
• 0.5

0.0 0.5 1.0 1.5 1 Inflation Residual and

• ther

Slack Productivity

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In selected EU-15, low inflation, labor slack, and sluggish productivity are weighing on wages

Contributions to Wage Growth: Selected EU-15, 2017 (Percentage point)

Source: IMF staff calculations.

Actual wage growth 1 2 3 4 5 6 7 1 Spillover Inflation Productivity Slack Residual and

• ther

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In NMS, tight labor markets and spillovers from EU integration will push wages up

Source: IMF staff calculations.

New Member States: Contributions to Wage Growth, 2017 (Percentage point)

Inflation Actual wage growth

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Overall, euro area current account still broadly in equilibrium; deficits shrinking, surpluses flat

Sources: IMF, World Economic Outlook (WEO); and IMF staff calculations.

Euro Area: Current Account Balance (Percent of GDP)

• 25
• 20
• 15
• 10
• 5

5 10 15 2001 2003 2005 2007 2009 2011 2013 2015 2017 Max Euro area Min

Policies

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In most of advanced Europe, maintain accommodative monetary policy

Sources: Bloomberg Finance L.P.; Haver Analytics; and IMF staff calculations. 1/ Derived from government securities adjusted for the difference between the RPI inflation and CPI inflation, which has been, on average, 1 percentage point in recent years. 2/ Real policy rate is the difference between nominal policy rate and one-year ahead IMF’s WEO inflation forecast. Market expectation of interest rate is calculated as a difference between

• ne-year-ahead interest rate swap rate and three-month interbank rate. Positive values indicate expectation of monetary tightening.

Ten-year Breakeven Inflation (Percent; based on generic nominal government bonds and inflation-linked bonds) Real Policy Rates and Market Expectations 2/ (Percent)

1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2014 2015 2016 2017 2018

Inflation target

United Kingdom 1/ Sweden Euro area

• 2.5
• 2.0
• 1.5
• 1.0
• 0.5

0.0 0.5 United Kingdom Czech Republic Euro area Sweden Real Policy rate Direction of market expectations

Monetary Policy Challenges in NMS

NMS are more advanced in the cycle  Output gaps appear largely closed, wage growth is strong Thus, they have to tighten sooner, but mind spillovers  Policy rates low for longer in advanced Europe  Pressure for capital inflows and exchange rate appreciation

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A picture of procyclical fiscal policies

Sources: IMF World Economic Outlook; and IMF staff calculations. 1/ The fiscal stance is considered to have tightened if the ratio of the structural primary balance to potential GDP improves by at least 0.25 percent per year, to have loosened if that ratio deteriorates by at least 0.25 percent per year, and to have remained neutral otherwise. General government non-oil primary structural balance is used for Russia, and structural non-oil balance in percent of mainland trend GDP is used for Norway. No data for ALB, BLR, UVK, MKD, MDA, MNE, and SMR.

Fiscal Stance, 2013-18 1/ (Number of European countries)

10 20 30 40 2013 2014 2015 2016 2017 2018 Loosened Remained neutral Tightened

Forecast 22

Strengthen the EU Architecture

Complete the Banking Union Fiscal Institutional Reforms Advance the Capital Market Union Role of the European Stability Mechanism (ESM)

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Thank You