• Europe: reforms are pushed in the background
• US is waiting for “Trump effect”
• National interests threaten economic development in CEE
• Bulgaria – In line with the growth trend in CEE

On 21 December 2016, Raiffeisen RESEARCH, an organizational unit of Raiffeisen Bank International AG (RBI), published its two capital market strategies “Central & Eastern European^[1] Strategy“ and “Global Markets“ for the first quarter of 2017. In front of journalists, Head of Global Research Peter Brezinschek put a special focus on recent political events, which will have an impact on growth and capital markets in the euro area and CEE, as well as on international markets.

“2016 was the year of political surprises, whose significance will go far beyond 2016. For the capital markets, in addition to the Brexit in June, the unexpected US elections in November and the failure of the Italian constitutional reform in December were defining. In 2017, important elections are planned in the Netherlands, France, Germany and probably also in Italy, which are already casting their long shadows over the overall investment climate. The equity gap of Italian banks was already a main reason for the extension of the Quantitative Easing (QE) by the European Central Bank (ECB) in the amount of EUR 60 billion a month, which was extended until the end of December 2017,” says Brezinschek.

Europe: reforms are pushed in the background

Great Britain’s “yes” to the EU exit and the Italian “no” to a constitutional reform are indicative for the mistrust of large parts of the European population towards European institutions and their own national governments. Political parties that do not see themselves as part of the unpopular “establishment”, promote job security and higher wages through more protectionism. As a consequence, the "established" political parties, at least to some extent, start to comply with these populist demands in their own economic policies. Countries such as Portugal, Italy or Spain, announced spending programs to support the economy, although the Stability and Growth Pact would require a more restrictive budgetary policy.

However, it is not only on a national level but also on the European level that attempts are being made to counter the prevailing skepticism and rejection of further reforms. The abandonment of sanctions for violations of the Stability and Growth Pact, as well as the demand for a more expansive fiscal policy of the entire euro area, are both seen as a signal to some core countries of the euro area to increase their government spending. “It is not the quickly achieved, but the sustainable economic growth that permanently increases a nation’s prosperity level. But to achieve this, further structural reforms would be necessary,” makes Brezinschek clear.

 The analysts of Raiffeisen RESEARCH expect a real GDP growth of 1.5 per cent (2016e: 1.6 per cent) for the euro area in 2017, and 1.7 per cent in the core countries Germany (2016e: 1.8 per cent), France 1.3 per cent (2016e: 1.2 per cent), Spain 2.5 per cent (2016e: 3.3 per cent) and Italy 0.6 per cent (2016e: 0.9 per cent). In Great Britain, the negotiations over the Brexit seem to already cause a significant slowdown in 2017 real GDP growth down to 1.0 per cent (2016e: 1.9 per cent).

US is waiting for “Trump effect”

In the US, the analysts of Raiffeisen RESEARCH expect for 2017 a clearly accelerated GDP growth of 2.4 per cent (2016e: 1.6 per cent). However, this forecast does not include any effects of possible legislative proposals of Trump’s government. However, there is some evidence for a slightly positive effect on the present forecast.

The course setting in the US towards an extremely expansive fiscal policy with a strong expansion of budget deficits brings new dynamics into the markets. One of Donald Trump's first steps as US President is likely to be a massive tax reduction program (both for companies and private households). Also, the announced infrastructure investments were quickly anticipated on the stock markets. Inflation expectations are beginning to rise as commodities and energy prices have also shown a significant upturn. At the same time, long-term capital market interest rates have risen sharply since Trump’s election. In the US, the yield rise is 90 basis points, in Germany 55 basis points, in some Emerging Markets more than 100 basis points. Thus, the return curve has become steeper. A development that is likely to be characteristic throughout 2017.

The interest rates are also rising in the US, albeit not as quickly as in the historical context. Since the US elections, the divergence between market expectations and central bank forward guidance on key interest rates has significantly declined. The quicker the interest rate adjustments are, the lower the long-term rise in yields, which is also relevant for the long end of the European bond market.

National interests threaten economic development in CEE

For 2017, the analysts of Raiffeisen RESEARCH expect a real GDP growth of 3.0 per cent (2016e: 2.6 per cent) for the CEE subregion CE, 3.3 per cent for SEE (2016e: 3.8 per cent) and for EE a growth of 1.0 per cent (2016e: -0.5 per cent). Particularly noteworthy are the growth leaders Albania with a GDP growth rate of 4.0 per cent (2016e: 3.5 per cent), Romania with 3.6 per cent (2016e: 4.7 per cent) and Slovakia with 3.3 per cent (2016e: 3.3 per cent).

“The tendency to increasingly favor national interests over market solutions is, unfortunately, also noticeable in CEE. In the short term, this will not threaten the strong growth dynamics, but in the longer term the great advantages of flexibility and deregulation in these markets will decrease,” outlines Brezinschek the situation in the CEE region.

In CE/SEE, the strong domestic demand still dominates in 2017, leading to an average GDP growth of just over 3 per cent, but investment should remain below expectations. While in the short term the utilization of EU funds remains important, foreign direct investment is influenced in the long term by the political environment. The encouraging trend on the labor market and the relatively high wage increases continue to support private consumption as a growth driver. Russia returns to modest growth at 1.0 per cent (2016e: -0.5 per cent) and Ukraine at 2.0 per cent (2016e: 1.0 per cent).

Oil price

For the first time since December 2008, the OPEC member states agreed to reduce their oil production by 1.2 million barrels per day to 32.5 million barrels per day. The agreement will apply from1 January 2017 and is valid for six months. In any case, this deal will now speed up the approximation of supply and demand. As a consequence, the currently oversupplied oil market should therefore turn into a deficit in the first half of 2017. Raiffeisen RESEARCH hence adjusted its previous forecast for 2017 by USD 3 and assumes an average price of USD 58 per barrel of Brent for the coming year.

Impact on currency markets

The rise in interest rate differentials between the US and the euro area should benefit the US dollar, particularly in the first half of 2017. By mid-2017, the analysts of Raiffeisen RESEARCH hold their forecast of 1.02 EUR/USD. In contrast, they see little movement in the Swiss franc against the Euro. Due to the political environment in Poland and the expansive monetary policy, the EUR/PLN forecast is significantly more cautious than previously. Raiffeisen RESEARCH also sees little movement in HUF and CZK, although the fixation to the Euro is likely to be lifted in the second half of 2017. The stronger oil price and the interest rate differential support the RUB.

Bulgaria - In line with the growth trend in CEE

In addition to the tense external environment (Syria, Turkey), the domestic political situation also deteriorated. Presidential elections were held in November. As the candidate of the ruling party lost, the prime minister resigned from the government, which means that early parliamentary elections are on the horizon. Moreover, it is still not clear what system will be used for the early elections, as voters were in favour of the new majority system in the referendum held in the first round of the election. The president is expected to nominate a caretaker government to hold the elections after taking office on 22 January 2017.

Despite the precarious political environment, real GDP grew faster than anticipated (3.4% in Q3 2016) amidst a low deflationary environment, benefiting from the better economic conditions (weaker euro, low oil prices and cheaper money). As expected, the main drivers were net exports and moderately increasing household consumption on the back of declining deposit interest rates and rising salaries. On the other hand, the expanding gross budget surplus (EUR 3.4 bn as of October) is evidence of sound fiscal policy.

The continuing effects of the ECB’s quantitative easing policy will continue to support GDP growth in 2017 (forecasted real growth of 3.0%) amidst a moderate inflation environment. Otherwise, investments will remain sluggish due to the domestic political situation, not least because of expected weak administrative capacity to absorb EU funds and programmes. Absorption is projected to remain under the EU average for 2017.

After successful performance in the asset quality revue and stress tests in 2016, the banking sector is expected to grow in 2017, supported by the expected moderate inflation.

The rating agencies Fitch and S&P confirmed the long-term credit rating of the country. However, they point out the instable political prospects and the associated potential implications for the Bulgarian economy.