Tim Gosling in Prague -

Domestic demand in Central Europe finally showed signs of life in the second quarter following long-term decline, lasting years in some countries, according to data released on September 4. Coming on top of continued growth in manufacturing, the figures offer added optimism of momentum to the region's economic recovery.

Breakdowns of GDP and retail sales data for the April-June period showed consumers in Central Europe finally found the confidence to loosen the purse strings a little. That will be a relief for governments across the region, who have for the most part watched exports - overwhelmingly headed into the crisis hit Eurozone - become the only meaningful driver of their economies in the last few years.

In Slovakia, at 1.5% year on year household consumption growth turned positive for the first time since 2009. In Hungary, the contribution of domestic demand to GDP growth finally turned positive, as both household consumption and investments managed to improve on yearly basis.

Czech retail sales offered a pleasant surprise of 4% growth. Analysts at Komercni Banka write that the figures are another positive signal household demand is slowly strengthening. "Apart from labour market stabilisation, declining inflation also helps," the Czech bank notes. "The past several years demonstrated that the Czech conservative consumer is very sensitive to price development. Finally, the end of fiscal consolidation, which affected especially households' budgets, is positive for consumption, as well."

The improved domestic consumption picture comes in the wake of purchasing managers index (PMI) data on September 2 showing that the vital manufacturing sectors in the region are putting in strong growth. While the brighter data was largely based on improved export orders from the Eurozone - and Germany in particular - analysts noted that domestic orders were also starting to play a small role.

Not plain sailing

However, it's not all plain sailing. As Erste Bank notes, Czech retail sales rose in general, but it was not a broad-based rise. Car sales contributed a full 3 percentage points of the overall 4% growth, while the retail segment proper added no more than 1pp.

"Cars are thus the channel through which better confidence seeps into the real economy," the analysts note. "Retail, as such, won't improve until the situation on the ground [does], and that won't happen before unemployment and wages improve."

The Slovak retail data looks more solid. "This is in congruence with the development of retail sales in Q2 and was helped by the fact that unemployment was lower than expected (14.0% - which represents a 0.4pp. increase as compared to 2Q12) and also to the faster growth in wages," Erste notes. "The average wage rose by 3.2% year on year and reached €818."

However, overall domestic demand dropped through the second quarter due to falling investment to the tune of 18.5% on year. Falling inventories and government investment did the most damage, and the analysts suggest that although the ongoing recovery should boost overall economic growth to 0.5-1%, that's not quick enough to avoid shortfalls in tax revenues and further challenges for Bratislava in terms of fiscal management,

Dogged by erratic government policy, Hungary saw similarly subdued investment activity by the private sector in the second quarter, but with elections due next year state spending boosted overall investment to annual growth of 4.9%. That suggests a continued struggle for economic growth.

"The recovery seems fragile," fret Erste analysts. "Household consumption may be somewhat higher than predicted earlier, however recovery in the Euro area seems to be a slow process, and apart from car production, Hungarian industry has still not managed to considerably improve. We maintain our prediction for this year's annual GDP growth of a tiny 0.2%."