Economy slows as expected in recent months, but core inflation remains high

Signs of a slowdown in economic activity were prevalent in the euro area at the end of the second quarter. Similarly, while the economic picture in Slovenia varies considerably from sector to sector, the indicators and nowcasts point to a slowdown in activity relative to the previous quarter. As in the euro area overall, inflation in Slovenia is gradually slowing, but core inflation remains high. Given the extreme buoyancy of the labour market, and with inflation still elevated, growth in the average gross wage remains well above its long-term average.

Following the encouraging performance in services in previous months, activity in the euro area is slowing in manufacturing and services alike. June’s decline in new orders is indicative of falling demand, which is also being reported by export-oriented firms in Slovenia. According to the ECB’s June projections, the euro area economy is forecast to avoid recession this year, with growth of 0.9%, which is then forecast to strengthen to 1.5% next year. Euro area inflation is slowing (reaching 5.5% in June), but core inflation remains high (5.4%).

In Slovenia developments remain relatively favourable in sectors that are primarily dependent on the domestic market. Construction is being driven by major infrastructure projects, while the labour market is giving employees a significant sense of security amid the continuing high vacancy rate, and is supporting household consumption. This is slowing as the effects of pent-up demand following the end of pandemic wane, but remains at significantly higher levels than before the pandemic. Notable evidence that household consumption remained robust came in the second quarter from the rise in car sales, while real turnover in retail and other private-sector services was down in year-on-year terms.

The situation in industry remains challenging, with new orders declining. Industrial production was highly volatile in the second quarter: April’s sharp decline was followed by a growth correction in May. Amid significant uncertainty and divergence in the indicators, the current nowcasts suggest that GDP growth in the second quarter will be down slightly on the previous quarter.

The labour market remains tight, with employment continuing to rise and unemployment continuing to fall. The workforce in employment rose again in April, very nearly hitting its record high from last December, while the survey indicators suggest that employment will rise further over the remainder of this year. The record low unemployment and empty pool of domestic labour is driving firms to recruit workers abroad. Foreign workers currently account for just over 86% of the year-on-year rise in employment. In the very tight labour market, and with inflation stubbornly high, nominal year-on-year growth in the average gross wage remains well above its long-term average.

After good performance in the first quarter, international trade saw a deterioration at the beginning of the second quarter. The decline in merchandise trade in value terms, which was particularly pronounced on the import side, is primarily attributable to the negative contribution by trade in energy and metal industry products. A slowdown was also seen in a significant number of other categories of goods, which is increasingly being reflected in trade in transport services, and thus explains the weaker developments in services trade. The current account has moved into surplus this year, which over the first five months of the year amounted to close to EUR 1.5 billion.

Inflation remains elevated in Slovenia. Headline inflation as measured by the HICP is slowing, although this is primarily being driven by a negative contribution by energy prices. With domestic price factors playing an increasing part, core inflation remains high, and at 7.2% in June had already surpassed headline inflation (6.6%). Food price inflation also remains high. The nature of the driving factors, which in recent months have become increasingly dependent on the domestic economy, is strengthening calls for greater complementarity in economic policy.

The general government deficit widened in the first quarter, while the ratio of general government debt to GDP declined slightly further. The widening deficit was attributable in part to measures to mitigate the rise in energy prices. These are further reducing growth in revenues, and increasing growth in expenditure. From the perspective of the public finances, revenues have remained under the influence of the buoyant labour market this year. Alongside energy measures, growth in expenditure is also being driven by expenditure on labour compensation, while government investment remains at a high level as the European financial framework comes to a close. The state budget figures according to the cashflow methodology show a widening of the consolidated general government deficit in the second quarter.

Publication Review of macroeconomic developments, July 2023, is available here.