Central and Eastern Europe has experienced a sharp downturn in GDP in the fourth quarter of 2022 figures, but while the worst of the economic decline has passed, the region is likely to stagnate this year.

Despite the milder than expected impact of the impact of the Ukrainian war, Capital Economics predicts that economic activity in Central and Eastern Europe (CEE) will remain stagnant at best over the first half of this year and Europe could slip into recession, writes Nicholas Farr, an emerging Europe economist with Capital Economics in a note.

Farr says that Capital Economics is erring on the downside for 2023 and has GDP forecasts for 2023 as a whole are generally lower than the consensus.

In Hungary and Czechia, the output fell by 0.4% and 0.3% q/q respectively, which caused both economies to experience a technical recession. Hungary in particular has been suffering from extremely high 25%+ inflation that is now impacting retail sales, even if industrial production recovered somewhat in the first months of this year. On balance, economists say the country’s recession will be extended this year as the only CEE country to see negative economic growth this year, according to Vienna Institute for International Economic Studies (wiiw) Winter Forecast.

Poland's GDP contracted by 2.4% q/q, a much worse result than the predicted 0.4% q/q contraction, despite putting in 4.9% growth for the whole of 2022 y/y. However, other countries in the region, such as Romania, Bulgaria, and Slovakia, recorded q/q expansions, indicating a greater level of resilience, says Farr.

“The sharp contraction in Poland looks inconsistent with some of the other hard activity data and may not be quite as bad as it seems, as we think it may have been partly driven by a large fall in inventories (although a breakdown hasn’t been released yet),” says Farr. “In any case, the big picture is that the impact of surging inflation and policy tightening last year clearly took its toll on a number of economies in the region.”

Governments across the region have been scrambling to shore up their economies with relief and support packages, to cap energy price spikes in particular. A recent study found that last year’s energy crisis has cost Europe an estimated €800bn in subsidies and support spending. Romania's economy is an example where the government's decision to cap household energy bills helped to offset the hit to households' purchasing power, Capital Economics reports. Romanian retail sales accelerated strongly by 3.8% in December as consumers shrugged off pessimism, taking the quarterly advance to 3.8% and full-year 2022 to 5.1%. ING is predicting a robust fourth-quarter GDP reading for Romania, but also expects the ongoing problems to drag the economy down with a visible slowdown in the first quarter of this year.

In recent months, the outlook for growth in the region has improved slightly, after natural gas prices tumbled thanks to mild weather and full to bursting gas storage facilities, but economists warn the respite may be temporary depending on weather for the rest of the year. Nevertheless, it is likely that the extent of the regional downturn may be smaller than previously expected thanks to the easing of energy crisis for now.

But high interest rates introduced by central banks across the region to counter the soaring inflation continue to weaken domestic demand. That could lead the Eurozone economy into a recession soon, says Farr, which will weigh on exports.

“We still expect a muted performance across the region this year. We think that activity will (at best) stagnate over the first half of the year, and our GDP growth forecasts for 2023 as a whole are generally below consensus,” says Farr.