Weaker euro and slow growth in Western Europe may weigh on CEE economies

Hungary, Poland and Czech Republic's PMI numbers for February were pretty strong. The PMI for Hungary and Poland both rose to 54.8 and 52.8, respectively, whereas for Czech Republic it dropped from 56.9 to 55.5. However, it continues to be at a high level. The strong PMI numbers for the Eastern Europe is not consistent with the trends seen elsewhere in Europe. The euro area PMI fell to 51.2 in February, while Germany's dropped to 50.2.

There are several reasons for the CEE economies to have strong PMI numbers. Firstly, the economies are recording strong domestic growth. They posted strong Q4 growth numbers, with Czech and Poland posting 3.9% y/y growth and Hungary posting 3.2% y/y growth. The February PMI number for Poland is the strongest since the new government came into power and shows that the businesses in the country are not much worried regarding the domestic policy uncertainty.

With the exposure of Eastern European exporters, a weaker euro and slowing growth in Western Europe might have negative impact in coming months. For the three Eastern European economies, Western Europe continues to be the most important export market which receives more than half of their exports. Therefore exporters from Easter Europe have likely benefitted from the relatively strong euro since late November.

In recent weeks, however, the euro has depreciated as the markets have begun expecting additional aggressive monetary policy action. The euro might further depreciate if the ECB eases monetary policies. Considerable weakening of the euro might weigh on CEE exporters' competitiveness, probably leading to weaker PMI's in coming months.

Today, the CEE currencies are trading stronger. Since the political disturbance in mid-January, the Polish zloty has appreciated against the euro by 3.5%, while the HUF has gained 4.3% against the euro during that period. The CZK is trading close to the floor, while markets still doubt that the Czech central bank can hold onto the peg, particularly if the ECB loosens policy aggressively.

If economies of these three nations grow strongly, the currencies will continue to trade strongly in future. However, the likelihood of the conflict between Poland and the EU regarding the constitutional court issue might impact the zloty. A negative verdict by the EU might weigh on the currency.