Europe and Central Asia - EU8+2 Regular Economic Report

EU8+2 Regular Economic Report January 2008

Disturbances originating in the US sub-prime mortgage market have widened to affect other markets, but the fundamentals for the EU8+2 are broadly unchanged, although the level of uncertainty has risen.: A prolonged period of globally lower risk appetite is likely along with continuing volatility. This will be challenging for the EU8+2, and the soundness and credibility of policy frameworks will be appreciated by market participants.
The economic outlook for the EU8+2 in 2008 and 2009 is generally positive. However, the baseline scenario is subject to substantial downside risk to economic growth and upside risk to inflation.: In 2008-2009, the region will take further, albeit shorter steps on its long road of catching-up to the EU15. GDP growth rates have probably peaked in many countries in the first half of 2007, even though they remained robust in the second half of the year.
In some respects passing through the turning point in the business cycle is a good thing.: The rate of growth was clearly unsustainable in some countries, resulting in the buildup of internal and external imbalances. The challenge going forward is to ensure that this turning point marks the entry into a period of orderly adjustments.
Inflationary trends are reasserting themselves across the region despite somewhat weaker pressure on the demand side.: Food and oil price rises are a main factor. If these are one-off changes due to such things as the effect of unusual weather on crop yields, the impact should dissipate or reverse relatively quickly. However, to the extent that they reflect more deeply rooted shifts in global energy supply and demand patterns, progressive displacement of food production by biofuel agriculture and the changing tastes and rapid income growth in food deficit countries, more lasting effects are likely.
Current account deficits (CADs) stabilized in the Baltic countries but are still widening in Bulgaria and Romania.: These CADs represent the greatest vulnerability to deteriorating international conditions and are particularly worrisome for those countries with high levels of foreign currency debt.
It is important however to look beyond the immediate market gyrations to see the bigger picture.: The ability of the EU8+2 so far to withstand the global turbulence is attributable to several factors. Their banks were not as exposed to the subprime market. Their economies are linked more directly to the EU than the US.
Policy responses have so far been relatively muted.: The trend has been towards moderate monetary tightening in Poland, the Czech Republic, and Romania. But countries maintaining fixed or tightly managed exchange rate regimes are limited in the extent to which they can rely on monetary policy for demand management, and they will have to use fiscal policy more actively to deal with the reemerging inflationary pressures and still high CADs.

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EU8+2 Regular Economic Report
January 2008
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