Analytics, Banks, Direct Speech, Economics, Inflation, Latvia

The latest data on economic growth as well as survey results indicate that economic growth is slowing, the year-on-year rise in wages is dropping and consumer confidence indicators have become slightly more pessimistic. Yet the 12-month inflation level is slowly moving upward. In previous years, when the economy grew faster, price rises lagged behind what could have been expected under conditions of growth. Yet the inflation dynamics can still be explained by an impact of supply-side factors (including external ones) and currently it is a reversal of the direction of that impact.  

The world agricultural and food prices, for instance, for the most part tended to follow a rising trend this year after gradually dropping for several years and, since August, are on average 9% higher year-on-year. Oil prices in euro are more than two times lower than the historically achieved monthly averages, yet higher, by at least one third, than on average last December. From the point of view of consumer, the year-on-year rise, in percentage terms, may look even greater and more unpleasant in the coming few months because of the price lows reached early in 2016.

The impact of external supply-side factors on Latvian consumer prices has been observed for several months already. Fuel merchants can show most flexibility in their reaction to the changes in oil prices and the costs for natural gas users are also not far behind.  In its first autumn forecasts, AS Latvijas Gāze hoped for a possible reduction in the natural gas tariffs for industrial users in November, but it did not materialize.  Under the impact of commodity prices, the enterprise increased the tariffs for industrial users by two steps in December, influencing many producers of heat accordingly.

The external factors exerting an influence on inflation are currently joined by domestic factors: the changes in taxation policy are characteristic of Latvia and are continuing to be made. Raising the excise tax according to the previously developed plan continued in 2016 and is also expected in 2017. Meanwhile, there is a rise in the tax on natural resources (as of next year) whose impact on the final consumption prices is rather unclear. Fruitless discussions are still going on about the previously planned changes in direct taxes, for instance on the minimum social contribution whose potential impact on employment and demand changes in the regions can only be surmised. 

It is more difficult to draw a strict boundary between the initiatives of supply and demand for individual domestic factors. Telecommunications has been an area where, with the amount of services used increasing and new participants entering the market, tariffs have more often decreased than increased. In 2014, for example, the prices of telephone services were 40% lower than in 2000. Last year, the average prices of these services already began to rise slightly and this year this trend is becoming more pronounced, with branch representatives arguing that the rising needs of consumers mean additional investments. In December, this trend was followed by Lattelecom, raising the prices of several services.

Even though the inflation in this year will be among the untypically low observed within the last four years, next year it will rise. Inflation will rise both under the impact of costs (including the indirect impact of costs on core inflation) and also under the impact of a faster growth of the economy if the uptake of European Union funds improves.