The annual inflation rate for February remains unchanged at 4.1 percent, primarily due to a decline in food and beverage prices (-0.4 percent month-on-month), and then in industrial non-food products (-0.2 percent month-on-month). The decline in food prices was expected after the drop in producer prices of some agricultural raw materials and products in the EU and the reduction of domestic producer prices of food, states the latest analysis of the Croatian Employers’ Association’s Focus of the Week, signed by chief economist Hrvoje Stojić.
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.
In the upcoming period, uncertainty in the movement of prices of imported products is represented by increasingly frequent climate disruptions and the crisis in the Suez Canal, which is redirecting a significant portion of goods to a much more expensive and time-consuming route around the Cape of Good Hope. Although the trade exposures of EU member states (our main trading partners) to this type of risk vary significantly from country to country, the consequences of such disruptions will easily spread throughout the EU due to strong input-output trade links across the EU.
The annual inflation rate of food, beverage, and tobacco prices in Croatia (5.5 percent) in February is above the euro area average (4.0 percent). The above-average inflation of food prices in Croatia is associated with a relatively stronger energy shock (electricity!), low absolute price levels due to a lower share of non-commodity costs, resulting in relatively stronger vulnerability to commodity shocks, and several times stronger increases in distribution costs above the euro area average, as shown by a recently published analysis by the European Commission.
Additionally, there is a strong seasonal impact of tourism due to a strong influx of foreign guests with higher purchasing power and insufficient infrastructure. We also note a twofold slower growth of the internationally comparable harmonized consumer price index of 0.3 percent month-on-month compared to an increase of 0.6 percent month-on-month in the euro area, due to weaker growth in service prices (+0.5 percent month-on-month) compared to an increase of +0.8 percent in the euro area.
The annual inflation rate of services stabilizes at relatively high levels (6.4 percent) and will slowly decline as long as the economy faces strong pressures on the growth of total employee earnings. In 2024, we expect a continuation of strong wage increases and total earnings of 10 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.
Real wage growth three times higher than the euro area
This summer, we expect the inflation rate to fall below three percent due to the weakening growth of food prices, stabilization, or reduction of oil and other energy prices, as well as the general cooling of aggregate demand viewed through the renewed 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. In this context, larger traders with more developed logistics will more easily transfer savings on input prices due to the decrease in production inputs.
After an average inflation rate of percent last year, in 2024 we expect an average inflation rate of around 3.5 percent. Inflation will continue to be higher than the average rate in the euro area (around 2.3 percent), considering the aforementioned relatively stronger growth in service prices.
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Although inflation is calming down, it still does not mean that it is completely restrained considering the further strong real wage growth of employees this year of around six percent – approximately three times higher than the euro area average – which is particularly supported by an increase in the wage mass from the state budget by a record 32 percent and the minimum wage by 20 percent, as well as continuous increases in earnings in the service sectors. This raises the risk of a wage and retail price spiral, especially as wages are rising significantly faster than the average productivity growth in the economy.
At the euro area level, strong wage growth (4-5 percent nominally in 2024) will continue to drive service prices, especially those labor-intensive, thus preventing the stabilization of the targeted core inflation at the level of two percent, which is the target inflation rate of the European Central Bank. Data from the employment platform Indeed also show stronger wage growth after a temporary slowdown in growth during the autumn of last year.
It is still expected that the ECB will start lowering interest rates in mid-2024, but the expected easing of monetary policy is likely to be somewhat slower than the expectations of financial markets.
Just a month ago, financial markets were betting on a deposit interest rate of 2.50 percent by the end of this year, but the new consensus is currently at three percent. Central bank leaders in the euro area mostly repeat that more certainty is needed regarding the achievement of the medium-term inflation target of two percent, concludes Stojić in the analysis.
