Macro update – October
Inflation in Latvia to remain elevated
Inflation in Latvia in August was 3.2% y/y and has averaged 3.0% y/y since the beginning of the year. This year inflation in Latvia is highest since 2012. Inflation is being driven primarily by the sharp increase in food prices (+5.2% y/y in August). Key food categories to have increased in price in August were dairy products (+13.1% y/y). Among dairy products, butter experienced the biggest increase growing by 84.4% y/y.
Milk prices are increasing all over Europe as supply has decreased significantly in 2017 after very low prices in 2015 and 2016, which was a result of the European Union scrapping milk quotas in March 2015, resulting in overproduction. Supply this year is scarcest for fat, cream and butter products.
Energy price inflation has remained fairly stable in 2017. It posted 3.4% August and has averaged 4.1% since the beginning of the year.
Core inflation, which is total inflation excluding energy and food prices and which reflects internal price developments, stood at 2.0% y/y in August. Core inflation this year is being lifted by higher energy prices, which are feeding into other prices as well. However, the main driver behind core inflation is accelerating wage growth, which is pushing up the price of services. Wage growth in Q2 17 was 8.7%, the highest since the 2008-09 crisis. As demand for labour grows while supply shrinks, this should further accelerate wage growth, thus lifting core inflation up.
We expect inflation in Latvia in 2017 to average 3.0%. We should see inflation moving downward at the end of 2017 as base effects kick in. Next year we expect inflation to average 2.9%, the key driver being growth in the price of services.