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Central Europe's recovery prospects took a hard hit on October 7, with the release of figures showing that German industrial production fell sharply in August. Industrial production in the Czech Republic also fell, while Hungary, also heavily dependent on its role in the German supply chain, stagnated.

German industrial output fell 4% in August, according to the Federal Statistical Office, with factory orders declining substantially, suggesting manufacturing is in the midst of a slowdown. The drop was the sharpest since 2009. Excluding construction and energy, manufacturing output dropped 4.7%, the largest monthly decline in well over five years.

The German figures followed data released the previous day which showed that factory orders dropped 5.7% in August, having increased 4.9% in July. Although the numbers could recover somewhat in September, after the summer holidays, analysts at Markit suggested the writing is on the wall.

"[T]here can be little doubt that Germany's mighty industrial sector (which accounts for more than 20% of the economy) has lost considerable momentum since the start of the year," they said. "The manufacturing PMI is currently tracking around seven points lower than its January reading, slipping into slight contraction territory in September as Russian sanctions and geopolitical uncertainties weighed on performance."

The data hint that Germany will do well to avoid slipping into contraction. "This weakening of the industrial sector is likely to act as a major drag on third quarter GDP, which now looks set to rise by just 0.2%," Markit added. "Although this means Germany may skirt recession after GDP fell 0.2% in the second quarter, a further loss of momentum signalled by the business surveys in September suggests a renewed downturn in the fourth quarter should not be ruled out."

Spillover

Data released the same day only added to the concern that Central Europe is facing a severe drag because of the impact of the Eurozone slowdown. 

Hungarian and Czech industrial production, as well as exports out of the latter, sagged alarmingly in August, data out on October 7 showed. While analysts suggested one-off closures for holidays at vital car plants were a factor - the auto sector has driven much of the recent economic recovery in both countries  - the results are clearly worrying in the context of the German slowdown. The German supply chain offers the biggest demand for exports in Central Europe, with cars again a major force.

In Hungary, after three months of double-digit growth on an annual basis, "the slowdown in August was evident”, note analysts at KBC. Industrial output rose by just 0.5%, a stunning fall compared with a reading of more than 12% in July. 

Czech industrial production fell 5.2% year on year. "As in Hungary, the decline was partly driven by lower number of working days," admits KBC. "Nevertheless even [the] working-day adjusted number of minus 3.6% Y/Y remained below the market consensus as well as our estimations."

"Both slowdowns likely have similar causes," the analysts wrote. "The biggest drop was recorded in the car industry, which traditionally experiences fluctuations due to company vacations. In Hungary, a big carmaker even stopped production for an entire month in August, which is unusual."

At the same time, they add, "it would have been quite a surprise if deterioration in Germany had not been at least partly reflected in the regional figures." Summing up recent disappointing macro results in the Czech Republic, Commerzbank noted "the data, so far, portray a discernibly slower economy during Q3 compared with H1."

Better than many

However, in the October update of its World Economic Outlook, released on October 7, the International Monetary Fund forecast Central Europe will still do better than most of CEE.  

Overall, the IMF expects the region to grow 2.7% in 2014, a downward revision of 0.1 percentage points from its July estimate, before expanding by 2.9% in 2015. However, that growth will remain uneven, the international lender expects, with countries to the south set to struggle most. The IMF called for continued support from monetary policy and  structural reforms.

Hungarian growth is projected to hit 2.8% in 2014. However, concern remains that recent strong performance remains overwhelmingly state driven, and that a lack of investment and bank lending threatens mid-term prospects. The IMF expects the Hungarian economy to slow to 2.3% next year.

The Czech Republic, which the IMF does not include in CEE having promoted it to "advanced Europe”, logged a 0.9% contraction last year after emerging from a record-long 18-month recession, but the IMF expects growth to push to 2.5% both this year and next. Next door, Slovakia - also rated an advanced economy and hugely dependent on the auto sector and German demand - is forecast to expand by 2.4% this year and 2.7% in 2015.

Poland, which is less exposed to export demand out of the Eurozone thanks to its relatively strong domestic demand, is projected to grow 3.2% this year, and push to 3.3% next. Recent macro-economic data out of the country has surprisingly lagged that of its neighbours, and the National Bank of Poland is widely expected to offer a interest rate cut at its October 8 meeting, after months of calls from analysts. 

Growth should remain relatively strong this year in the three Baltic states, with forecasts of 3% for Lithuania, 2.7% in Latvia and 1.2% in Estonia. The economies are expected to continue to expand in 2015, when they will all be Eurozone members, with forecasts of 3.3%, 3.2% and 2.5% respectively. 

"With downside risks remaining, monetary and exchange rate policies should be used to support demand and manage the risks from market volatility," the IMF said in summing up its recommendations for CEE. "Enhancing debt resolution frameworks and advancing labor market reforms remain priorities for most countries in the region."