There is work to do, however, in order to return inflation closer to target, and policy rates may remain higher for longer in the region, even if central banks in Hungary and Poland have started to ease. Indeed, real policy rates in Poland and Hungary remain in negative territory.

In Greece, headline inflation, despite a recent pickup, has fallen to a comparatively lower level and was 3.4% year-on-year (y/y) in October. As a eurozone member, monetary policy for Greece is set by the European Central Bank (ECB). After hiking its policy rates to 4.0% and 4.5% in September, Schroders’ economics team expects the ECB to remain on hold until next year when rate cuts are anticipated.

The status of natural gas storage in the EU has been monitored closely since Russia invaded Ukraine, after which energy supplies to Western Europe began to be cut off. The restructuring of energy markets from a regional perspective has so far achieved its aim. Warm northern hemisphere autumn temperatures have also helped. Data from the Schroders Investors Insights Unit shows that the temperature in the EU 27 for September, October and to the 19 November has been above the average of the last decade. Successful gas procurement combined with higher temperatures means that eurozone gas storage sits at a record level versus the average of the last 10 years with storage at 99.5% of capacity.

The exception: Turkey

Turkey remains something of an exception to the rule. We wrote a more detailed note on Turkey earlier this year, making the comparison to the positive outlook in Greece.

The headline rate of inflation in Turkey remains unanchored and has accelerated to 61% y/y with pass-through from Turkish lira weakness. The central bank, following the appointment of a new governor, has hiked its policy rate by more than 25 percentage points to 35%, but the real rate remains deeply negative. Ahead of municipal elections in 2024, there is significant incentive to support the economy, and therefore the risk of another policy U-turn remains high.

Attractive long-term growth drivers

In the long term, EU recovery and cohesion funding should be supportive for member economies. Politics complicates this driver for Hungary, and until recently Poland, but the latest elections could change this.

Various regional markets are also projected to be among the key beneficiaries of de-globalisation and the nearshoring trend. This should help to attract foreign direct investment (FDI), with some of this related to the energy transition.

Our research shows that Poland is among the most attractive economies globally for multi-national companies looking to diversify their manufacturing exposure. The election results reinforce this outlook, given that relations with the EU are expected to normalise (more on this below). The announcement from semiconductor manufacturer Intel of plans to build a new assembly and test facility in Poland highlights this potential. Electric vehicle battery manufacturing is another sector attracting FDI in Poland. South Korea’s LG Energy Solution operates one of Europe’s largest giga-factories in Poland, and other multi-national companies such as Mercedes-Benz have plants under construction.

Other regional markets also rank highly as beneficiaries of deglobalisation – some which are not in the MSCI Europe Index, but which are investible. The ranking is shown in the table below.

Balance sheet positions improving

Fiscal accounts across the region are in deficit but, with the exception of Hungary, are at reasonable levels. EU projections suggest improvements into 2024, even if Poland may see some deterioration this year due to higher spending ahead of the election. The incoming government is likely to honour the pre-election pledges from the previous government. Even so, debt-to-GDP remains reasonable relative to other major economies at below 50%.

In Hungary, the fiscal deficit is expected to fall to 4% for this year, down from 6.2% in 2022, according to EU forecasts. Debt-to-GDP was 74% at the end of 2022. Gross debt to GDP is also elevated at more than 70% of GDP, far higher than its CE3 neighbours.

From an external account perspective, current accounts moved into deficit or widened following last year’s energy price shock. Most current account deficits are now improving on lower energy prices and, in some economies, as activity decelerates.

As noted, Turkey is an exception. The economy has recorded an annual current account deficit since 2003 and funding the deficit is increasingly complex and now expensive due to higher global interest rates.

The elections that boosted the equity markets

Falling inflation, and receding energy price risks, have supported various regional markets this year. For Greece, and more recently Poland, politics has provided another boost.

In Greece, the centre-right New Democracy party was re-elected with a majority in the second round in June. The result provides greater confidence in the outlook for reforms over the next four years. This includes measures targeted at reducing bureaucracy, lifting investment and judicial reform.

In Poland, the Law, and Justice Party (PiS), which led the governing coalition, won the most seats in October’s election, but fell short of securing a majority. The opposition coalition is expected to form the next government. This may take time as PiS has been given the first opportunity to form a government by President Duda; current projections are for a new opposition-led government to be in place by the end of the year.

This outcome was market positive as under PiS relations with the EU had deteriorated. Rule of law was a key issue and had led to the withholding of RRF funds. The anticipated normalisation of EU relations under a prospective new government should unlock this funding in time. Less risk of intervention in markets and better management of state-owned enterprises were also perceived by markets. These two factors should also improve the attractiveness of the economy to FDI.

What are the risks to the outlook?

One clear risk to these economies is the potential for another energy price shock, and a more severe slowdown in the eurozone. This risk has to some extent eased, with global energy prices having moderated, and EU gas storage in good shape. However, the scenario of high energy prices remains a threat to the outlook, given the potential impact on growth and inflation. Renewed escalation in Russia’s conflict with Ukraine could also drive risk premiums higher again.

While Poland’s relations with the EU are expected to improve, in Hungary these risks remain. Poor relations with the EU have been a long-term feature under the leadership of Prime Minister Orban. It appears that some cohesion funding of around €13 billion may be released in relation to judicial reform. Recovery and Resilience Funding (RRF) remains held up. If external funding requirements increase in 2024, further agreement may be found in order to release at least some of these funds. Higher fiscal deficits are a further risk for Hungary in particular, as is the potential for new sector taxes.

In Turkey, the key risk is that policy becomes more unconventional once again.

What do valuations look like?

Valuations on a combined z-score basis, which is relative to their own historical average, are cheap across the region. Hungary stands out relative to the rest of the region, as well as broader emerging markets, although macroeconomic risks are also higher.

From a currency perspective, the Czech koruna is expensive on a real exchange rate basis versus the long-term average. Other CE3 markets are more reasonably valued. Turkey appears to be cheap versus history, but this cheapness is more than justified given where inflation sits, the negative real policy rate, wide current account deficit and ongoing uncertainty over the policy outlook.