E U R Advanced Europe Emerging Europe Regional Economic Outlook Spring 18 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 1
Developments and Outlook Europe continues to enjoy strong growth Advanced Europe: Real GDP Growth (Year-over-year percent change) Emerging Europe: Real GDP Growth (Year-over-year percent change) 1 Advanced Europe Euro area 1 Emerging Europe Russia Min-max range 1/ Min-max range 1/ - - - - -1 6 1 17-1 6 1 17 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.
Growth is driven by domestic demand Advanced Europe: Contributions to Growth (Percentage points) Emerging Europe: Contributions to Growth (Percentage points) Consumption Net exports Investment Real GDP growth Consumption Net exports Investment Real GDP growth 3 3 1 1-1 -1 - - -3 1 16 17-3 1 16 17 Sources: IMF, World Economic Outlook; and IMF staff calculations. High-frequency data suggest that momentum is peaking Manufacturing PMIs (Three-month moving average; deviations from ) Citigroup Economic Surprise Index 1/ (Period average; in percent) 8 Czech Republic, Hungary, Poland, Turkey, and South Africa More-positive surprises 6 Advanced Europe Switzerland March-18 17 United Kingdom - Emerging Europe - Euro area -6 Jan- Jan-1 Jan-1 Jan-16 Mar-18 Jan-18 - - 6 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. 6 3
Risks Near-term risks balanced. Medium-term risks to the downside Near-term risks balanced: Robust confidence and still strong conjunctural indicators But greater trade tensions and market volatility 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 8
Cyclical Position and Inflation Output gaps appear largely closed Output Gap, 18 (Percent of potential GDP) Sources: IMF World Economic Outlook; and IMF staff estimates.
Inflation pressures are diverging across economies Core Inflation (Year-over-year percent change; period average).. Euro area Nordics Other advanced economies.. Central Europe SEE EU SEE non-eu 3 3 CIS excl. Russia Turkey Russia 1. 1. 1. 1. 1.... -. 1Q1 1Q1 16Q1 17Q1 18Q1 Sources: Haver Analytics; and IMF staff calculations. Note: Other advanced economies include: Czech Republic, Israel, San Marino, Switzerland, and the United Kingdom. -. 1Q1 1Q1 16Q1 17Q1 18Q1 1Q1 1Q1 16Q1 17Q1 18Q1 11 Labor Markets and Wages 6
Labor market slack has declined, but remains high in EU-1, unlike in NMS EU: Unemployment and Additional Labor Market Slack 1/ (Percent) EU-1 / 18 16 1 New member states 3/ 1 8 8Q1 Q3 13Q1 1Q3 17Q Sources: Eurostat; and IMF staff calculations. 1/ Additional slack includes persons marginally attached to the labor force and underemployed part-time workers. / EU-1: 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. 13 Wage growth is sluggish in EU-1 and strong in NMS 16 Nominal Wage Growth (Percent change y/y in four-quarter averages) 1 1 New member states 8 6 EU-1 1Q Q 9Q 13Q 17Q Source: Eurostat. 1 7
In selected EU-1, low inflation, labor slack, and sluggish productivity are weighing on wages 1. Contributions to Wage Growth: Selected EU-1, 17 (Percentage point) Productivity 1. Slack Actual wage growth. Inflation. -. Residual and other -1. Source: IMF staff calculations. 1 1 In NMS, tight labor markets and spillovers from EU integration will push wages up New Member States: Contributions to Wage Growth, 17 (Percentage point) 7 Actual wage growth 6 3 Residual and other Inflation Productivity Spillover 1 Slack Inflation 1 Source: IMF staff calculations. 16 8
Overall, euro area current account still broadly in equilibrium; deficits shrinking, surpluses flat 1 Euro Area: Current Account Balance (Percent of GDP) Max - Euro area - -1 - - Min 1 3 7 9 11 13 1 17 Sources: IMF, World Economic Outlook (WEO); and IMF staff calculations. 17 Policies 9
In most of advanced Europe, maintain accommodative monetary policy... 1.8 1.6 1. 1. Ten-year Breakeven Inflation (Percent; based on generic nominal government bonds and inflation-linked bonds) Sweden Inflation target United Kingdom 1/ Euro area 1. 1 1 16 17 18 Real Policy Rates and Market Expectations / (Percent) 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. / 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 one-year-ahead interest rate swap rate and three-month interbank rate. Positive values indicate expectation of monetary tightening... -. -1. -1. -. -. Real Policy rate United Kingdom Czech Republic Direction of market expectations Euro area Sweden 19 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
A picture of procyclical fiscal policies Fiscal Stance, 13-18 1/ (Number of European countries) Loosened Remained neutral Tightened Forecast 3 13 1 1 16 17 18 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. percent per year, to have loosened if that ratio deteriorates by at least. 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. 1 Strengthen the EU Architecture Complete the Banking Union Advance the Capital Market Union Fiscal Institutional Reforms Role of the European Stability Mechanism (ESM) 11
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