COPENHAGEN - Danske Bank financial analysts Lars Christensen and David Pedersen have signalled the dangers of runaway inflation rates in both Latvia and Lithuania in two new memos, poitning out that the need to curb domestic demand via policy measures is urgent.
Inflation exceeded the psychologically important 10 percent barrier in August, up from 9.5 percent in July, giving Latvia the dubious honor of possessing the European Union's highest inflation rate.
"This is yet another sign that the Latvian economy is overheating - the risk of a hard landing should not be ignored," said the memo's authors.
"The acceleration in inflation continues to underline the need to curb domestic demand by urgent policy action. Given the fact that the opportunity to manoeuvre in terms of monetary policy is very limited due to Latvia's fixed exchange rate, the only viable policy instrument is fiscal policy. The plan put forward in March by the Latvian government to 'combat inflation' has definitely not shown much sign of success, and more policy action is clearly needed to maintain the credibility of economic policy in Latvia.
"Inflation numbers in excess of 10% are completely unsustainable in a country with a fixed exchange rate.
"The latest inflation numbers for August further underline the concerns about the financial and economic stability in Latvia," the memo concludes.
In a second memo concerning the situation in Lithuania, the Danske Bank experts note more cause for concern, if to a lesser extent than in Latvia.
They say that that inflation for August rose to 5.5 percent annually, a jump from 5.1 percent in July, but roughly in line with expectations. Christensen and Pedersen stated that the rise was due to an increase in household expenses, driven by large hikes in gas, electricity and food prices.
"The overheating of the Baltic economies, especially the labor markets with wage growth of more than 20 per cent annually… continues to be a worry. The economy in Lithuania looks a bit more balanced than Estonia and Latvia, however, but the imbalances in the economy are, nonetheless, large.
"Urgent policy measures to curb inflation are still needed in the Baltic states," is the concluding advice.
