Croatian wages are growing at a real rate three times faster than the euro area average

The annual inflation rate for April fell to 3.7 percent from 4.1 percent in March, primarily due to a decline in energy prices and a slowdown in inflation across all other major categories compared to the high base in the same month last year. As the Croatian Employers’ Association (HUP) states in its Weekly Focus, a stabilization of food prices was expected due to a favorable base effect as well as a reduction in producer prices of some agricultural raw materials and products in the EU and a decrease in the production price of domestic food.

The annual rate of ‘harmonized’ inflation fell to 4.7 percent from 4.9 percent in March, while the monthly growth rate of this inflation measure at 1.0 percent monthly is somewhat higher than the 0.6 percent in the euro area, due to a much stronger growth in service prices (+1.7 percent monthly) compared to an increase of +0.8 percent in the euro area. The strengthening of the monthly dynamics of service prices is not only a result of the earlier Easter last year but also the fact that the economy is facing strong pressures on the real growth of total employee income.

Compared to the end of 2023, service prices grew almost twice as fast as the euro area average (3.9 percent versus 2.3 percent). In the remainder of the year, strong growth in gross wages and total income of 10 and 15 percent is expected, as well as accelerated convergence of service prices, which are still up to 30 percent below the euro area average. Croatia also leads at the level of the European Union according to the criterion of real wage growth of about six percent for the second consecutive year.

Prices of food products, alcoholic beverages, and tobacco in Croatia have risen slightly more than the euro area average – 1.7 percent compared to 1.4 percent, which is about half the dynamics compared to the same time last year.

Expected inflation drop below 2.5 percent this summer

– This summer, we expect the inflation rate to drop below 2.5 percent due to weakening growth in food prices, a reduction in prices of industrial goods and major energy sources, as well as generally lower import inflation due to weak aggregate demand viewed through a relatively low level of six-month expectations for selling prices in the euro area – stated HUP.

Domestic traders expect a return to price levels from the end of 2023 in the next three months and remain below the price expectations of German traders, with larger traders with more developed logistics more easily transferring savings on input prices due to the decrease in production inputs. Finally, the drop in electricity prices for Croatian companies recorded in the second half of 2023 compared to the first half of the year, when they first rose above the EU average, is encouraging. This will certainly have a stabilizing effect on average inflation and reduce the gap compared to the EU.

After an average rate of ‘harmonized’ inflation of 8.4% recorded last year, an average inflation rate of around 3.5 percent is expected in 2024.

Inflation will still be higher than the average rate in the euro area (around 2.3 percent after 5.5 percent last year), considering the significantly stronger growth in service prices and personal consumption in Croatia. This is a result of strong real growth in total employee income (around 15 percent) and growth in consumer lending (around 12.5 percent).

At the euro area level, strong wage growth (4.5 to 5 percent nominally, around 2 percent real in 2024) will continue to drive service prices, especially those that are labor-intensive, which will likely result in the stabilization of core inflation at around three percent instead of the two percent targeted by the European Central Bank. Data from the employment platform Indeed shows a renewed momentum in wage growth in Germany of around four percent, higher than the euro area average, after a temporary slowdown in growth during the autumn of 2023.

– Due to the strong decline in energy prices, some EU members are abandoning the favorable tax treatment of energy. It is still expected that the ECB will start lowering interest rates in mid-2024 at a pace of 25 basis points quarterly, but given the expected stabilization of inflation significantly above the targeted two percent, the planned easing of monetary policy is likely to be less resolute than the expectations of financial markets. In our baseline scenario, we expect a reduction in the deposit interest rate from the current 4.0 percent to 3.0 percent by the end of the first quarter of 2025 – concluded HUP.