Initial indications of favourable economic growth in the first half of the year, accompanied by high inflation

In the euro area, including Slovenia, the first half of the year was dominated by the consequences of Russia’s military aggression against Ukraine. This had a limited impact on economic activity, where favourable growth is still being seen. But it has been reflected sharply in rising inflation, which amid the worsening situation on the commodities markets is mainly being driven upwards by extremely high growth in energy prices and food prices. Banka Slovenije should also highlight that the outlook for economic activity over the remainder of the year is less encouraging. 

Initial assessments are that the economic situation in the euro area was reasonably sound in the first half of the year, despite the high inflation. The outlook for the third quarter is less encouraging, given the ongoing disruptions to supply chains, the high inflationary pressures, and the low economic sentiment indicators. The increased uncertainty, decline in confidence and strong inflationary pressures are coinciding with Russia’s military aggression against Ukraine and the resulting tough sanctions. Despite government interventions to mitigate high growth in energy prices, inflation in the euro area hit 8.6% in June, driven not only by energy prices but also by food prices.

The prevailing mood on the financial markets is one of increased uncertainty as a result of the high inflation, and concerns over a slowdown in global economic growth. With investors moving to lower-risk assets, government bond yields have fallen recently, but remain higher than at the beginning of the year on account of the anticipated normalisation of monetary policy by central banks. Asset classes with higher credit risk such as shares and private-sector bonds are continuing to lose value.

The economy in Slovenia remains strong. The majority of indicators were painting a favourable economic picture at the halfway mark of the year, although the economic sentiment is deteriorating. Using model infrastructure and the data currently available, our estimate is that quarterly growth in the second quarter might have amounted to 0.9%.

On the labour market the registered unemployment rate reached its lowest figure to date in April at 5.9%. Firms are increasingly turning to foreign workers, who accounted for more than 58% of the year-on-year rise in the workforce in employment in April. Wage growth remains moderate.

The current account deficit is widening this year, and amounted to EUR 354 million over the first four months of the year. Merchandise imports were up 33.9% in April amid year-on-year growth of 29.2% in import prices, while merchandise exports were up 20.3% amid year-on-year growth of 17.3% in export prices. With the exception of products related to the car industry, no nominal slowdown was evident over the first four months of the year in any merchandise category, while in terms of markets the main highlight was a sharp increase in the value of imports from Russia, driven by high energy prices. The survey indicators suggest tougher conditions on foreign markets for domestic manufacturing firms in May and June, but at the same time give cause for moderate export optimism for the third quarter, despite the geopolitical situation and price pressures.

Domestic inflation rose to 10.8% in June, driven most notably by food prices alongside energy prices. The further downturn in the situation on global commodity markets after the outbreak of the war in Ukraine is putting pressure on their final prices, which were up 36.4% (energy) and 10.6% (food) in year-on-year terms. Together they account for almost two-thirds of year-on-year headline inflation. The disruptions to global supply chains have also continued, and these are driving growth in prices of non-energy industrial goods, while service price inflation is being driven primarily by domestic demand and rising operating costs. Broader wage pressures are not yet evident, but do represent a significant inflation risk in the current circumstances.

The public finances are improving this year. The general government deficit in the first quarter narrowed to 3.1% of GDP, and the current data suggests that developments remained favourable in the second quarter. The general government debt remained approximately at the same level as last year, at 75.1% of GDP.

Figure: Contributions to inflation

Sources: ECB, Eurostat, Banka Slovenije calculations; latest data: June 2022

Publication Review of macroeconomic developments, July 2022, is available here.