HUP: By summer, inflation will fall to around three percent

The annual inflation rate in January fell to 4.1 percent from 4.5 percent in December, thanks to a significant drop in inflation of industrial non-food products (three percent after 3.9 percent in December) and a decrease in energy prices.

The decline in prices of industrial non-food products reflects lower energy prices and other raw materials on the global market compared to the previous year, normalized global supply chains, and lower producer prices of industrial products in the domestic market. The greatest uncertainty regarding the prices of imported products in the upcoming period is represented by the Suez crisis, which could have a negative effect on the prices of various goods and global trade in general, states the weekly macroeconomic analysis of the Croatian Employers’ Association Focus of the Week, signed by chief economist Hrvoje Stojić.

Although Croatian exports from Asia or the Middle East account for only two percent of GDP (among the lowest in the EU), our main trading partner Italy is the second most exposed EU member (7.2 percent of GDP), which indirectly affects the availability of many goods from international transit towards our economy and negatively impacts import inflation and overall economic activity.

Namely, trade between the EU and Asia could be significantly affected if disruptions in trade routes through the Suez Canal persist. Although trade exposures to this type of risk vary significantly from country to country, due to strong input-output links across the EU, the consequences of such a disruption will easily spread throughout the EU.

It is important to note that the current annual inflation rate for food, beverages, and tobacco in Croatia (6.1 percent) in January is slightly above the euro area average (5.7 percent), considering that price movements in the EU and Croatia have been equalizing or even decreasing in recent months due to falling producer prices of some agricultural raw materials and products in the EU and a reduction in domestic producer prices of food.

We also note a slightly smaller decline in the internationally comparable harmonized consumer price index of 0.3 percent monthly compared to a decrease of -0.4 percent at the euro area level, due to stronger growth in service prices (+0.7 percent monthly) compared to a decrease of -0.1 percent in the euro area.

The annual inflation rate for services has likely peaked (5.9 percent after 6.9 percent in November), but will slowly decline in the upcoming period due to the economy continuing to face strong pressures on business cost growth. Namely, in 2024, we expect a continuation of strong wage increases and total income of ten percent, or 15 percent, as well as accelerated convergence of service prices, which are still on average 30 percent lower than the euro area average.

By summer this year, we expect the inflation rate to fall to around three percent due to the weakening of food product inflation, stabilization of oil prices and other energy sources, as well as the general cooling of aggregate demand announced through a strong decline in six-month sales price expectations in the euro area. Moreover, the quarterly price expectations of domestic traders remain below those in the euro area, and in recent months, expectations regarding inventory levels have risen again.

 

After an average inflation rate of eight percent last year, in 2024 we expect an average inflation rate of around four percent. Inflation will still be higher than the average rate in the euro area (around 2.5 percent), considering the aforementioned relatively stronger growth in service prices.

 

Although inflation is calming down, this still does not mean that it is completely restrained given the further strong real wage growth of around six hundred percent this year, particularly supported by a 32 percent increase in the wage mass in the public sector and continuous increases in income in the service sectors. This raises the risk of a wage-price spiral, especially since wages are growing significantly faster compared to the average productivity growth in the economy.

 

At the euro area level, and especially in Croatia, strong wage growth will continue to drive service prices and thus prevent the stabilization of the targeted core inflation close to the ECB’s target of around two percent.

 

Although this will not prevent the ECB from starting to reduce interest rates by mid-2024 at the latest, the expected easing of monetary policy is likely to be somewhat slower than the expectations of financial markets. Governor Lagarde therefore reiterates that more certainty is needed regarding the achieved medium-term inflation target of two percent.