Inflation has peaked – and is likely to stop edging up
The recent acceleration in growth in prices has been slowing down; however, headline inflation is substantially higher than a year earlier, standing at 4.4 per cent. For a while inflation was boosted by changes in the prices of oil and some food commodities, later on – by factors related to internal economic development such as rapid wage growth and tax changes.
Comment by Ieva Skačkauskaitė, Economist of the Macroeconomics and Forecasting Division at the Bank of Lithuania
This year, we have been observing a much stronger growth in the prices of dairy products, which reached more than 10 per cent. Once Russia imposed trade restrictions and the EU removed milk production quotas in 2014–2015, raw milk prices in Lithuania fell much more than in the other EU countries. The drastic fall in raw milk prices entailed a significant decrease in the raw milk supply. As a result, we are observing an opposite price trend: after raw milk prices went up, the consumer prices of dairy products increased as well. Nevertheless, the rise in milk farm-gate prices and, concurrently, consumer prices is likely to be limited by growing supply of raw milk.
A sizeable part of currently observed inflation is related to one-off factors – excise duties and VAT on centralised supply of heating. Excise duties on alcohol and tobacco products were raised as of March, the VAT tariff on heat energy – in June (from 9% to 21%). These changes in taxation pushed annual inflation up by about a quarter. However, in October, the VAT tariff on heat energy was reduced again to 9 per cent, which contributed to the deceleration in current inflation.
Overall, price growth in Lithuania this year to a great extent reflects domestic economic developments. Rapid wage growth explains why in Lithuania the prices of services (e.g. restaurant and café, house maintenance services) have been growing stronger than on average. The current wage dynamics provides an incentive to the services sector to push prices up. Rising wages also provide consumers with opportunities to purchase more goods and services, thus this higher demand contributes to price pressures as well.
With respect to purchasing power, it should be said that in the near future prices will not catch up with wage growth. Wages recently rose by an average 8–9 per cent per year, whereas growth in the prices of products and services was half as fast. Nevertheless, with inflation having risen to six-year high, its development should further be monitored. Substantial inflation primarily limits the opportunities for the most vulnerable social groups to purchase goods and services. However, the latest solutions within the social domain are aimed at improving the situation of the most vulnerable residents. Indexation of pensions, under which pensions will climb about 7 per cent, will come into effect next year. It is also planned to increase minimum wage by 5.3 per cent next year. These measures should at least partly offset the negative effects of price growth. In the view of the Bank of Lithuania, these measures will not cause a new inflation wave, although minor fluctuations are possible.
Overall, if nothing unexpected happens, next year the inflation rate should slow down due to the same factors that boosted price increases this year. Firstly, global oil and food commodity prices are projected to grow much less next year than this year. It is not planned to raise excise duties to the same extent as this year because in 2017 raising excise duties substantially boosted the prices of alcohol and tobacco. Nevertheless, there are plans to raise the excise duty on diesel fuel (which would entail a 2 per cent increase in its prices); however, the contribution of such a decision on inflation would be marginal. Finally, while wages are likely to rise in the future, next year their growth will be slower. Owing to a lack of labour force, wages in Lithuania have for some time been rising much faster than labour productivity. This situation is not sustainable as businesses must maintain their competitiveness at the same time.