Czechia in last place as rest of the EU starts to recover

Czechia in last place as rest of the EU starts to recover
Czechia is still struggling with multiple headwinds. / bne IntelliNews
By Ben Aris in Berlin November 7, 2023

Czechia is the only EU country not to have recovered its pre-pandemic level of output and its economy is teetering on the edge of another recession, economic consultancies Oxford Economics and Capital Economics warned in their recent reports.

Gross domestic product decreased in the third quarter by 0.3% quarter-on-quarter and by 0.6% year-on-year. The third quarter figures follow a stagnant performance q/q and a 0.6% decline y/y in the second quarter. This means that over the past two quarters the economy has shrunk, putting it once again technically in a recession. 

“The Czech Republic is the only EU economy yet to recover to its pre-pandemic size. That won't happen this year, as we expect the economy to stagnate before resuming a lacklustre recovery in 2024, remaining at the bottom of the EU economies' table,” Tomas Dvorak, an analyst with Oxford Economics, said in the note. “The economic structure and its exposure to the recent shocks still reverberating through the economy make Czech Republic the "sick man of Europe", even more so than Germany.”

All EU economies except Czechia have clawed back all the ground they lost during the two-year shut down caused by the coronacrisis. It now remains the sole laggard, with GDP still over 1% below its end-2019 peak. Although revisions to the volatile national accounts data of recent years might yet shake up the standings, the Czech economy is visibly struggling to make a convincing recovery since the pandemic.

1123 Czech macro Czech Republic is the only EU economy yet to recover to its pre-pandemic size in real terms OXFORD ECONOMICS

The Czech economy has been harder hit than most by the economic dislocations and soaring inflation caused by first the polycrisis  that followed the coronavirus pandemic, which was then exacerbated by the economic repercussions of Russia's brutal invasion of Ukraine.  Both private consumption and fixed investment remain below pre-pandemic levels.

“The collapse in consumption is particularly noteworthy, as six quarterly contractions – some of them the largest on record, excluding during the pandemic lockdowns – through to the first quarter 2023 have pushed private consumption back to 2015 levels in real terms, a cumulative 9% peak-to-trough decline. Household spending then only eked out 0.2% q/q growth in the second quarter, hardly a start of a swift rebound. High-frequency data point to another possible contraction in the third quarter,” says Dvorak.

Czechia fell into recession over the second half of last year, and GDP has broadly stagnated over the first half of this year. The hit to households’ real incomes from high inflation and interest rates has weighed particularly heavily on household spending, which fell by 4.5% y/y in the second quarter, according to Capital Economics. There is some good news too, though Czechia continues to lag behind its regional peers.

“The monthly activity data for the third quarter (available up until August) have offered some slightly more encouraging signs. While retail sales and services sector activity have remained weak, the downturns in these sectors appear to be bottoming out. Consumer confidence has recovered too, which on past form suggests that the largest falls in household spending have now passed,” says Nicholas Farr, an Emerging Europe economist with Capital Economics.

1123 Czech macro consumer confidence and household income CAPECON

The Czech economy has been buffeted by a number of headwinds, including large exposure to supply-driven inflation, double-digit real earnings falls, restrictive monetary policy, lukewarm fiscal support, and the eurozone-wide industrial downturn. These adverse factors, coupled with incoming fiscal consolidation, will continue to dampen growth in the coming quarters, says Farr.

The supply shocks that have hit the EU countries over the last three years reverberated particularly strongly in the Czech economy. The shortage of microchips and severe supply disruptions during the pandemic hit the country's large manufacturing sector hard, particularly automotive production.

In general, manufacturing output is currently only 5.6% above the pre-pandemic level and well short of the pre-pandemic trend. The still high interest rates continues to weigh on manufacturing and Oxford Economics expects that industrial production will decline by another 2.7% in the second half of this year as a result.

But falling inflation will gradually take the pressure off as real incomes resume growth and the Czech National Bank (CNB) starts to normalise its restrictive policy. But government's spending cuts will dampen growth in 2024 and with Germany, Czech Republic's key export market, also struggling, the near-term outlook for manufacturing and exports is also dim.

“Policy support is needed to address fledgling growth, easing inflation, and a risk of lasting damage to the demand and supply sides. But this is unlikely to be heeded as the centre-right governing coalition's focus is on balancing the budget. The CNB might need to loosen policy quicker, particularly as inflation falls below target, but this won't shore up growth immediately,” Dvorak says.

All central banks in Europe have gone through substantial hiking cycles in order to tame inflation. However, the CNB was an early mover in June 2021 and its policy tightening was unusually front-loaded. Now, some analysts expect the CNB  to start monetary easing at the next monetary policy meeting in December in an effort to give the economy a shot in the arm, perhaps with a cut in its policy rate of 25bp, from 7% to 6.75%. (chart)

Falling inflation in CE

In general, Central Europe has experienced significant drops in inflation this year, providing central banks with increased flexibility in their monetary policies as they start to switch from fighting inflation to supporting growth.

Hungary's central bank implemented a rate cut of 75 basis points in the first half of November, surpassing market expectations, after inflation fell to 12.2% in September – the highest rate amongst the Visegrad countries. (chart) However, Hungary  still grapples with inflationary pressures, with the current inflation rate of 12.2% y/y on average -- well above the central bank’s target range. Recent data released this week also shows that wage growth in August continued to soar, registering at over 15% y/y.

And after running record inflation rates of almost 20% in the last year, Polish consumer price inflation (CPI) has been falling consistently to reach 6.5% in October. (chart) Likewise, Slovak inflation has fallen to 8.2% in September and Czech inflation to 6.9%. (chart)