Deflation fears turning to inflation worries

  • 2010-07-15
  • From wire reports

RIGA -  Inflation may prove to be the Latvian economic recovery’s Achilles heel, as bank economists and analysts forecast that price rises will return by the end of this year, despite an annual deflation rate in June coming in at 1.4 percent, reports

Some economists believe that external factors and rapidly increasing prices for energy resources are the main reasons for the coming inflation, which in June reached a month-to-month increase of 0.4 percent.

Swedbank senior economist Lija Strasuna said that deflation would be recorded again in July and August, month-on-month, due to seasonal factors, but low inflation could be recorded in the fall, and Latvia could also register annual inflation by the end of the year. Strasuna said she was surprised that consumer prices had increased in June from May, pointing out that this was due to higher prices for services, which in June increased 0.1 percent, for the first time in the past twelve months.
SEB bank macroeconomics expert Dainis Gaspuitis said that the consumer price index was quickly moving toward inflation. The key factors here include administratively regulated prices - mostly heating tariffs, new tax rates and developments in the euro area. Gaspuitis said that oil product price fluctuations are hard to predict.

DnB Nord bank analyst Peteris Strautins said that the average price level would decrease again in July and August - as it usually does at this time of the year, but the prices will hardly go below the level of last December.
Over the past ten years, the average consumer price level used to drop 0.1 percent in July and 0.4 percent in August and, in Strautins’ opinion, this year will be no exception. However, price growth will resume in the fall because of the excise tax on natural gas, which will prompt heating tariffs, as well as growing prices for dairy products. Grain prices will also increase in the fall, which means that bread and, after a while meat, will also become more expensive.

For June, year-on-year prices for goods increased 0.1 percent, whereas prices for services dropped 5.1 percent. Compared to the previous month, the average consumer price level increased 0.4 percent in June, including a 0.5 percent increase in prices for goods and a 0.1 percent increase in prices for services.

Latvia’s austerity program, which relies on lower wages to deflate the economy, defend the currency peg and boost competitiveness, may be frustrated by growing inflation, warns Zigurds Vaikulis at Parex Asset Management, reports Bloomberg. The consumer price increase, on a monthly basis, in June was the fifth increase in six months. That signals annual deflation may swing to inflation as fast as 2 percent by year-end, Vaikulis said.

The country is trying to restore competitiveness lost during its economic boom while keeping its currency pegged to the euro and meeting the terms of an emergency bailout from the European Union and IMF. That process, a so-called internal devaluation, requires prices and wages to fall, while the value of the currency remains stable. “The inflation development complicates the internal devaluation because it’s hard to cut salaries in this environment,” Vaikulis said. Much of the monthly increases stem from external influences such as heating and food prices, he said.

Public-sector pay in Latvia fell an annual 14.1 percent in the first quarter, after rising almost 30 percent a year during the economic boom triggered by the country’s entry into the EU in 2004. The government implemented austerity measures equal to about 10 percent of GDP last year to narrow the budget deficit.

Though thousands of people staged protests against the program last summer, arguing the budget cuts would hurt pensioners, health-care workers and teachers, investors have welcomed the plan. The country’s 5-year credit default swap was at 373 basis points (3.73 percent) on July 7, compared with a high of about 1,200 basis points in March 2009, when devaluation concerns were at their height.

The real effective exchange rate of the lat, which shows the price development of Latvian goods versus those of major trading partners, has fallen 9.5 percent since reaching a high in February 2009. The measure had increased about 33 percent from the beginning of 2005 until reaching its peak.

“There is a high risk of a strong pass through of global commodities energy prices to local consumer prices,” said Violeta Klyviene, senior Baltic economist at Danske Bank. “It is gradually becoming clear that there is a clear risk that high inflation will adversely affect the recovery trends in all Baltic markets.”