Slowing economic activity in the third quarter; inflation above the euro area average

Economic activity is slowing in the euro area, while inflation is gradually easing but remains well above the central banks’ target. The latter reinforces the expectations of market participants regarding an extended period of high key central bank interest rates. Similarly in Slovenia, indicators point to slowing economic activity during the third quarter of this year, while inflation remains high. Banka Slovenije finds that differences between wage growth in Slovenia and the euro area pose the risk of a comparatively longer-lasting divergence in inflation. On the labour market, unemployment continues to fall, despite first signs of cooling in certain parts of the economy.

Global economic growth is slowing, and has been stagnant for three consecutive quarters in the euro area. Short-term indicators for the euro area point to a further slowdown in economic activity in the third quarter, with the decline in new orders in the manufacturing sector passing through to certain services. Euro area inflation continues to ease in this context but remains well above the monetary policy target. According to the latest IMF forecasts, published before the outbreak of war in the Middle East, the euro area economy should gradually return to moderate growth next year as domestic and foreign demand recovers.

Increased inflation, which remains above the target levels of central banks, reinforces the expectations of market participants regarding an extended period of high key central bank interest rates levels. Also contributing to expectations of a protracted period of increased inflation are rising energy prices and the resilience of certain parts of the global economy, particularly the US. As a result, the required yields on longer-term government bonds were up sharply in September, while the value of equity indices was down. Risk aversion increased in the financial markets following the outbreak of war in the Middle East, which resulted in additional growth in energy prices, and a drop in German and US market yields from previously elevated levels.

The economic situation in Slovenia remains challenging, particularly in the manufacturing sector, where output continued to decline in the summer, with the year-on-year drop deepening further to 10% in August. The construction sector remains in a relatively favourable position and is largely driven by government investment, while private-sector services other than retail are also maintaining activity at last year’s level. There is considerable variation in the retail sector: real retail turnover was down by one-fifth in year-on-year terms in August and up by one-tenth in trade and repair of motor vehicles. Tourism also weakened in August, with a significant year-on-year decline in the number of overnight stays by domestic guests, primarily due to severe storms in August. A model estimate based on available data indicates a 0.7% contraction in GDP during the third quarter.

On a still-tight labour market, the first signs of cooling are being seen in individual sectors, particularly in manufacturing. According to seasonally adjusted data, the monthly rise in the workforce in employment and the fall in registered unemployment came to a halt in the third quarter. Year-on-year growth in the workforce in employment remains positive in service and construction sectors, while stagnation has been noted in the manufacturing sector. Employment expectations indicate a similar trend, as construction and service companies expect employment to continue growing in the months to come. However, there is no such trend evident in the manufacturing sector. At 4.8% in July, the registered unemployment remains historically low. In contrast, growth in the average wage remains high and shows no sign of easing, while real wage growth is also strengthening.

Year-on-year inflation rose to 7.1% in Slovenia in September, primarily due to a base effect in energy prices. Government measures adopted last year to mitigate the effects of rising energy prices contributed 1.2 percentage points to this year’s inflation in September, and will continue to contribute to year-on-year growth in prices until at least August 2024. The contributions of other price sub-categories are declining. Despite signs of easing, core inflation remains high (at 6.5% in September), and is being driven in particular by the prices of services, where the risk of continued growth derives primarily from high wage growth. The gap between wage growth in Slovenia and the euro area poses the risk of a comparatively longer divergence in inflation, which would lead to a further deterioration in the external competitiveness of the domestic economy. In terms of costs, that competitiveness has further deteriorated this year, but remains relatively favourable in terms of prices compared with other euro area countries.

Foreign trade conditions deteriorated during the summer. The value of exports of goods was down by more than one-tenth in year-on-year terms during the first two months of the third quarter, primarily due to more modest exports to the markets of euro area countries. Year-on-year growth in exports of services was also down, and was hindered in particular by weaker exports of transport services. Despite weak export activity, the current account surplus widened further on account of a sharper fall in imports of goods and services.

The general government deficit rose to EUR 1.1 billion or 3.7% of GDP during the first half of the year, an increase of 0.2 percentage points of GDP in year-on-year terms. That rise is the result of the increased amount of measures to mitigate the effects of rising energy prices, high growth in government investment, compensation of employees and rising social benefits, while year-on-year growth in economic activity was lower. Despite the year-on-year increase in the deficit, the ratio of debt to GDP is declining, primarily due to growth in nominal GDP. Addressing the current macroeconomic challenges requires the coordination of economic policies to the greatest extent possible, an approach that has produced positive results in the past.

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