Overheating tendencies – How long will the economic cycle still last?


The high growth rates in the euro area during the third quarter and sentiment indicators at record-setting levels have prompted us to raise our GDP estimates for 2017 and 2018.


At 2.4% and 2.5%, real economic growth in these two years will be about twice as high as the long-term average,“ says Peter Brezinschek, chief analyst at Raiffeisen RESEARCH, an organizational unit of Vienna-based Raiffeisen Bank International AG (RBI), in the course of publishing the capital market strategies “Austria & CEE“1 and “Global“ for the first quarter 2018. Since the fourth quarter of 2016, GDP in the euro area has risen by 0.65% qoq on average. “Economic growth this strong was last seen at the end of 2009 to early 2011 and was only exceeded during the boom periods in the years 1999 to 2000 and 2005 to 2007. The immediate outlook also still looks great,” Brezinschek adds. The acceleration of value added in Austria stands out in particular. The strong GDP growth of 3.2% in 2017 should also be followed by above-average growth of 2.6% in 2018. The positive momentum is being sustained by the unusually strong development of investment in plant and equipment.


The CEE region is already in its fourth year of economic recovery, which accelerated again in 2017. Above all, private consumption and in some cases strong fixed asset investments are the cornerstones of growth, which will also be decisive in 2018. Thanks to renewed growth momentum since the middle of the year, Raiffeisen RESEARCH has once again upgraded some of its GDP estimates for the CE and SEE region. Poland and Romania in particular exhibit growth rates that are far higher than their respective potential rates. “Nevertheless, it is clear that the robust growth in 2017 - CE average of 4.3% and SEE average of 5.1% - will be followed by a period of more strong growth in 2018”, Brezinschek explains and expects Russia’s GDP growth to remain stuck at below 2% in 2018.


On the whole, Raiffeisen RESEARCH’s analysts expect to see a synchronised global upswing of around 3.5% in 2017 and 2018. “That said, however, it must be noted that the quarterly growth rates will gradually decline over the coming two years”, Brezinschek adds.


Return to positive inflation rates in CEE


Higher wage increases in various countries within the euro area should also begin to have an influence on the core rate of inflation as the year progresses. The pressure from energy prices – which amounted to almost 5.0% yoy in November – should ease at the start of 2018. As a result of this, the rate of inflation will slip back towards the 1% mark early in 2018. From March to June 2018, the analysts then expect to see a rebound in the rate of inflation to around 1.5% yoy. “On average, inflation, which is estimated at 1.3% p.a., will remain well below the ECB's cap on inflation in 2018,” explains Brezinschek. But the trend until the end of 2019 is slightly upwards.


Positive inflation rates will continue to make a comeback in the CEE region in 2018, driven by vigorous wage growth (partially related to increases in the minimum wage in Hungary and Romania) of between 4% and slightly above 10%, which cannot be underpinned by productivity gains in any of these countries. By contrast, Russia is marked by a decline in prices well below the inflation target.


Euro area: end of the extremely expansionary monetary policy


“We assume that the ECB will probably not raise interest rates at all in 2018. Terminating the bond purchase programme in September, however, would represent the first step towards exiting the ECB’s extremely accommodating monetary policy,” says Brezinschek.


The analysts expect that there will also be significant differences in interest rate policies in CEE. “The Czech central bank led the way as the first in the region and has already hiked its interest rates twice. The Romanian central bank is likely to follow starting from Q1 2018. We believe that Poland may also move ahead with initial rate hikes, but only in the second half of the year. By contrast, the Hungarian central bank will stick with its recently announced expansive measures until the ECB executes its turnaround. In Russia, there is still some modest potential for rates to be lowered,” reports Brezinschek.


Impact on the currency markets


In light of the anticipated widening of the interest rate differential, Brezinschek expects a temporary recovery of the US dollar versus the euro: “In the second half of the year, the foreseeable end of the ECB’s expansionary policy may enable a continuation of EUR strengthening until well into 2019. An increase to 1.30 would then be quite realistic.” For CHF, he projects a more steady weakening until the break-out level of 1.20. In 2019, a change to the negative CHF interest rates should foster renewed appreciation.


In CEE, CZK and PLN should, in principle, tend to be moderately stronger versus EUR over the course of the year, whereas HUF and RON may be more on the weak side.

For the Russian rouble, Raiffeisen RESEARCH’s analysts anticipate some mild depreciation versus USD and EUR, in line with additional rate cuts and a temporarily lower oil price trend.


Impact on the bond and equity markets


Due to the increase in yields in the USA and the gradual price increases in 2018, yields on long-dated government bonds in the euro area should move higher in stages. Yields on core euro area bonds, however, should still remain well below the rate of inflation. Corporate bonds continue to profit from the ECB’s purchase programme.


Turning to the equity markets, stronger ups and downs, and thus also setbacks over 10%, should be expected during the year. “Ultimately, however, the good development of earnings, negative real interest rates, and the sustained liquidity should ensure positive performance over a one-year horizon,” Brezinschek explains. The high level of valuations may dampen risk tolerance at times.


The extremely low yields in CE and SEE could, in analogy to the euro and USD bond yields, may rise slightly over a 12-month horizon. In Russia, the low point in yields will probably be reached in 2018. The stock markets in CEE and Austria should also continue to be bolstered by the robust performance of the real economy and monetary factors. That said one must keep an eye out for risks of higher price volatility as the year progresses. “Taking a one-year view, we generally have Buy recommendations for the respective equity indices,” Brezinschek says.


Stock markets: ATX is a clear outperformer this year but the air is getting thinner


A few trading days before the end of the stock market year 2017, the Austrian leading index ATX shows an increase of approximately 30% since the beginning of 2017. As a result, the ATX is one of the world's fastest-growing stock indices this year. The current index increase of about 30% shows the strongest price increase since 2009. Since 1990, the Vienna Stock Exchange Index ATX has achieved a performance of over 30% five times.


As a result of the dynamic economic development, Bernd Maurer, chief analyst of Raiffeisen Centrobank, expects robust earnings growth of around 10% for Austrian companies next year. Based on these estimates, the ATX is currently trading at a price-earnings ratio of around 12 for 2018e. "We consider that to be appropriate," explains Maurer. Valuations for European Standard Indices have recently increased significantly. Stock markets continue to be favored due to the relative valuation versus fixed income securities. However, the currently strong economic momentum and increases in the international stock markets limit the positive surprise potential in the coming months. The withdrawal of monetary stimuli will also be an increasing factor in the markets as the year progresses. Over the course of the year, experts at Raiffeisen Centrobank forecast a further slight increase in the index to around 3,600 points, but expect the share price to become more volatile over the course of the year.