Favourable economic developments in first half of year; expectations for remainder of year less encouraging

Economic growth in Slovenia remained high in the first half of this year, in line with Banka Slovenije’s expectations. Amid the continuing Russian military aggression and the resulting sanctions, growth is expected to be slightly lower in the second half of the year, but will nevertheless remain solid. Inflation remains at persistently high levels, in Slovenia and in the broader international environment. In these circumstances central banks including the ECB are opting for the decisive further normalisation of monetary policy. The Governing Council of the ECB will make a decision this week on further interest rate hikes.

Economic growth in the euro area remained favourable in the second quarter of this year. Industrial production strengthened again in the second quarter, but construction activity began to slow after its high growth in the first quarter. There was a notable downturn in services in July and August, with demand for (non-essential) services slowing already. Amid the ongoing geopolitical tensions, the outlook is more uncertain for the remainder of this year and in particular for next year.

With liquidity low in the summer, investors on the financial markets are focusing most on the expectation of future central bank interest rate hikes, and the concerns surrounding high inflation and slowing economic growth. This has led to falls in the yield curves in the US and the euro area, although government bond yields remain higher than at the beginning of the year as a result of the normalisation of monetary policy by central banks.

The domestic economy is keeping pace with Banka Slovenije’s forecast of continuing high economic growth on average over this year. It again outpaced the euro area average in the second quarter. Net foreign demand also played its part, driving exports of services, most notably travel services. Certain segments of manufacturing saw a deterioration in their business conditions at the same time.

Amid the continuing Russian military aggression and the resulting sanctions, Banka Slovenije is expecting economic growth to be slightly slower over the remainder of the year, but solid nevertheless. The average nowcasts for the third quarter suggest a slowdown in quarterly GDP growth to 0.3% (from 0.9% in the second quarter). A slowdown is suggested in particular by the economic sentiment indicator, which remained negative in August, where the most notable factors were consumer reluctance to make major purchases and a decline in the assessment of order books in manufacturing.

On the labour market, employment remains at a record high, and unemployment is low. Firms are largely hiring foreign workers: they accounted for two-thirds of the year-on-year rise in the workforce in employment excluding self-employed farmers in June. Wage growth remains moderate.

High growth in exports of travel services has seen the deterioration in the current account balance come to an end in recent months. Nominal growth in merchandise exports remained high, with positive developments in all the main categories. Developments on the import side were even stronger, most notably merchandise imports from Russia, which in June were ten times higher than the monthly average over the 20 years before the outbreak of the war in Ukraine, as a result of surging energy prices. 

With energy prices surging and the contribution by food prices rising continually, inflation reached 9.1% in the euro area and 11.5% in Slovenia in August. In these circumstances central banks including the ECB are opting for the decisive further normalisation of monetary policy. The interest rate hikes and their impact on the financing conditions will prevent current inflation expectations from extending over the medium term. The Governing Council of the ECB will make a decision this week on further interest rate hikes.

The consolidated general government deficit over the first seven months of the year was down significantly in year-on-year terms at EUR 0.3 billion, as revenues recorded high growth and expenditure declined as payments related to the pandemic fell. The main risks over the following months and next year are a deterioration in the economic situation and potential new measures for mitigating the impact of the energy crisis.

Publication Review of macroeconomic developments, September 2022 is available on the link.