Increasingly heated atmosphere – price growth continues to accelerate

The prices of goods and services in Lithuania continue to grow and this growth rate continues to accelerate according to the newest data from Statistics Lithuania.

Based on preliminary data, the initial forecast for annual inflation in August has now reached 4.5%, while annual inflation continues to rise, therefore price increases are also accelerating.

Due to this some economists feel that there are similarities with the pre-crisis years around 2007 and state that the atmosphere is becoming increasingly heated. The forecasts are not particularly positive – services will rise in price greatly and will continue to do so, at the same time goods prices will not rise as rapidly and wages will continue growing.

Largest price increases

The Statistics Lithuania data reveals that comparing July in 2016 and 2017, over a year the prices of alcoholic beverages, tobacco, transport, hotels, cafes and restaurants rose the most.

Food products and non-alcoholic beverages rose in price by 2.8%, mostly among dairy products and eggs. Prices changed the least for clothing and footwear, while the prices of vegetables declined.

Nevertheless the statistics slated to be released at the end of September will likely be more pessimistic because the preliminary monthly inflation level for August is 4.5%.

DNB bank chief analyst Indrė Genytė-Pikčienė told Delfi that the rise in inflation is clear, stating that, “We know that in July we had nearly 4% [inflation], prior to that it was at 3.5% and now it is 4.5%. Inflation is accelerating, as such prices are not just rising rapidly, but the acceleration itself is increasing.”

She states that one of the core reasons for this is rapid price growth in the service sector, “Service prices are rising far more rapidly than those of goods. For example if goods prices rose by 3.3% in July, service prices rose by an entire 5.5%. Services are the driving force behind this inflation.”

SEB bank president’s advisor, economist Gitanas Nausėda concurred that the preliminary metrics do not set a celebratory mood.

“We are left to make the unconsoling conclusion that price increases are accelerating, however it is happening in a context that can be called economic growth and in certain cases we can already start using the term overheating. Not necessarily drawing comparisons to 2007, but I can see certain similarities and this does not make for a celebratory mood,” he said.

Main culprit – rising wages

The economists are unanimous in their stance that the main culprit behind the price growth is the rapid increase in wages and situation in the jobs market.

“The reasons lie within the particulars of our jobs market because specifically due to emigration, tense situation in the jobs market and a certain lack of qualified hires, wages are rapidly rising and naturally this is most reflected in the service sector. After all in the service sector, the largest portion of expenses goes into wages,” I. Genytė-Pikčienė said.

Swedbank chief economist Nerijus Mačiulis said that so far there is no reason to be overly concerned over the increasing inflation because real wage growth continues to outpace it.

“There’s no reason for most people to be concerned as long as wages outpace prices in growth. Currently that is what we are seeing and predict that next year average inflation will reach only 3% and will be twofold smaller than the increase in the average wage,” he claimed.

However I. Genytė-Pikčienė notes that for some this winding wage and price spiral is particularly painful and compared her to a snake eating its own tail. “Inflation typically does not consume all the wage growth because the real wage is greater, but Lithuania is very fragmented.

Inflation is very painful speaking of the other Lithuania, where the situation is very different than in the Vilnius or Kaunas job markets. There employees do not have the same negotiatory leverage for more favourable working conditions and the employers dictate the conditions,” she stated.

G. Nausėda points out that heightened inflation particularly impacts state sector employees. Here he finds particularly impactful reform lacking – reductions in staff numbers which could help raise wages.

“The base wages in the state sector have not changed around a decade now, thus the state creates problems for itself and loses the best employees who are fleeing to the private sector and this sends the private sector a bad signal, in a certain regard also reducing wage growth in it as well.

Such policy has poor prospects and if this continues, I do not know where it will take us. There needs to finally be a move from constant complaining that nothing can be done and the state sector needs to cut its employee numbers because there are simply too many people in it. I cannot recall a single reform in this, not a single cabinet which would have accomplished these pledges,” he said.

Similarities to pre-crisis years

G. Nausėda observes similarities in the current circumstances to those of the pre-crisis years.

“Call it what you want, but in this regard there likely are similarities to the pre-crisis years because wage growth rates are becoming similar to 2007-2008, albeit inflation was even higher back then, however in a certain regard we are nearing this metric.

Everyone hopes that if we are in the Eurozone, inflation should at least be similar to the Eurozone’s, but we see that it is lower in other countries.

If you look at other countries, wages are rising 1.5-2% at most, meanwhile the situation in the Baltic States is unique because currently we have practically the highest internal wage growth in the EU and businessmen are covertly or overtly trying to translate the wage growth into price growth.

These wages become purchasing power, people take that income to the stores to shop, thus businesses are often able to raise prices because they do not experience a decline in demand,” G. Nausėda said.

N. Mačiulis is more optimistic, stating that, “This declared number – 4.5% means that in August prices will likely be 4.5% higher than a year ago. We do not find out too much from this, only that inflation is on the rise and the reasons for this are well known and not unexpected.

This should definitely not be cause for great concern because in 2007 we saw far more dramatic processes where inflation reached 12%, while wage growth and other factors greatly reduced Lithuania’s external competitiveness, there was a very clear lack of labour, irrational taxes and excess financing in various areas.

We do not have such deviations now, we do not see any danger signs for Lithuania’s external competitiveness because the value of exports rose by 18%, while real growth was 10%. In other words many companies that export services and goods remain competitive even with rising prices and wages,” he said.

Will continue for years

Prices will nonetheless continue rising. G. Nausėda predicts that just as now the increases will be most prominent in the service sector, more so than for food products and other goods.

“Some goods are more sensitive to external competition and some are less. In this case services are far less sensitive to external competition because you cannot move certain services such as barbers or car repair shops across the border, as you can bring goods from one country to another.

Services are primarily oriented to the local market, while food products and other goods can be imported, their prices can be more consistent, furthermore there is overall more competition. There are far more opportunities to raise prices in the service sector, this is why we see some cafés in Vilnius increase their prices several folds, while retaining clients,” he said.

The economist notes that it would not be worth to seek to obstruct price growth by artificially hampering wage growth because this would have even worse consequences, increasing emigration and the lack of potential employees.

Nausėda predicts that the current situation will likely continue for another 2-3 years because this is how long wage growth should continue, with prices keeping apace.

I. Genytė-Pikčienė says that the situation could be remedied somewhat by a decline in demand.

“So far we have observed rapidly growing retail sales metrics, they increased particularly rapidly in the first quarter of this year, but during the middle of summer the rates for comparative prices declined. This shows that demand is gradually declining. In other words consumers, perhaps out of fear of prices, are consuming less. However for now it is very sensitive to talk about it.

As we all well know Lithuania is in the European Union which features free movement of goods and labour, thus shopping in Poland, buying online and other alternatives can help contain this cursed cycle because with a decline in demand it is natural that inflation will be stifled,” she said.