Euro minor villain in Estonia's inflation drama
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This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document 1 are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted f or any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice. Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of investment business in the UK. Euro a minor villain in Estonia’s inflation drama MONDAY 17 JANUARY 2011 Estonia’s inflation rate accelerated rapidly during 2010 – but the drama is exaggerated by strong statistical base effects, due to a sharp downturn during the deep recession of 2009 when GDP fell by 14 per cent. Last year the clearly dominant inflationary forces were higher prices for food, alcoholic beverages, tobacco and energy, with only a weak upturn in underlying price pressures. Euro zone accession is expected to result in minor price-hiking effects. Estonia has now become the third country in Central and Eastern Europe to join the euro zone. The transition from the kroon to the euro took place during the first two weeks of 2011. On New Year’s Eve this event was also celebrated on some of the country’s streets and squares, but basically the Estonians are not overwhelmingly positive towards euro zone membership. Only a slight majority, 52 per cent, believe that adopting the euro will be good for Estonia, according to a large government- sponsored survey in December. This also represented a decline from November’s record level of 54 per cent. Those who believe that this lukewarm attitude towards the euro is rooted in the past year’s acute financial crises in southern Europe and Ireland lack a sense of history. For many years, people in Central and Eastern Europe have been divided in their views of euro zone membership. This has been the pattern in the European Commission’s Eurobarom eter surveys for a long time. However, there is still a broad consensus in favour of the euro among the political establishment, including both governing and opposition political parties. One reason why the people of Estonia are euro-sceptical is probably their concern that membership will lead to markedly higher consumer prices − a concern that may have been reinforced by last year’s rapid upturn in the inflation rate. This may include popular suspicions that companies will take the opportunity to carry out extra price hikes during the transition and that households and businesses will also hoard certain g oods in advance (which in itself drives up actual prices), due to such fears. Similar signs were evident, for example, in the run-up to Estonia’s European Union accession in 2004. The Estonian Ministry of Finance predicts that the Consumer Price Index will rise by a modest 0.1-0.3 per cent because business will round off prices upward during the euro transition. The ministry cites the experiences of other countries that have shifted to the euro. Our assessment is also that the impact of the euro on Estonia’s inflation will be relatively minor, though higher than the government’s forecast. However, it will be generally difficult for businesses to impose price hikes, given the large output gap. The recovery in post- recession domestic demand has hardly begun, and during the third quarter of last year unemployment stood at 15 per cent, although it had fallen from ca 20 per cent early in 2010. Nor does an examination of last year’s inflation trend indicate that any broad price pressure is building up. HICP year-on-year, per cent Inflation and core inflation in Estonia Total HICP HICP excl food, alcoholic beverages, tobacco, energy Source: Reuters EcoWin 06 07 08 09 10 -2.5 0.0 2.5 5.0 7.5 10.0 12.5 -2.5 0.0 2.5 5.0 7.5 10.0 12.5 During 2010 the year-on-year inflation rate – the most common yardstick of inflation – admittedly rose from -1 per cent in January to a full 5.4 per cent in December. The 2010 annual average, compared to 2009, was 2.8 per cent. A very large proportion of last year’s inflation upturn can be explained by higher food, alcoholic beverage, tobacco and energy prices. This, in turn, was largely due to global
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This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document 1
are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted f or
any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice.Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the
US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of
investment business in the UK.
Euro a minor villain in Estonia’s inflation dramaMONDAY
17 JANUARY 2011
Estonia’s inflation rate accelerated rapidly during
2010 – but the drama is exaggerated by strong
statistical base effects, due to a sharp downturn
during the deep recession of 2009 when GDP fell
by 14 per cent.Last year the clearly dominant inflationary forces
were higher prices for food, alcoholic beverages,
tobacco and energy, with only a weak upturn in
underlying price pressures.
Euro zone accession is expected to result in minor
price-hiking effects.
Estonia has now become the third country in Central andEastern Europe to join the euro zone. The transition fromthe kroon to the euro took place during the first two
weeks of 2011. On New Year’s Eve this event was alsocelebrated on some of the country’s streets and squares,but basically the Estonians are not overwhelminglypositive towards euro zone membership. Only a slightmajority, 52 per cent, believe that adopting the euro willbe good for Estonia, according to a large government-sponsored survey in December. This also represented adecline from November’s record level of 54 per cent.
Those who believe that this lukewarm attitude towardsthe euro is rooted in the past year’s acute financial crisesin southern Europe and Ireland lack a sense of history.For many years, people in Central and Eastern Europe
have been divided in their views of euro zonemembership. This has been the pattern in the EuropeanCommission’s Eurobarometer surveys for a long time.However, there is still a broad consensus in favour of theeuro among the political establishment, including bothgoverning and opposition political parties.
One reason why the people of Estonia are euro-scepticalis probably their concern that membership will lead tomarkedly higher consumer prices − a concern that mayhave been reinforced by last year’s rapid upturn in theinflation rate. This may include popular suspicions thatcompanies will take the opportunity to carry out extra
price hikes during the transition and that households and
businesses will also hoard certain goods in advance(which in itself drives up actual prices), due to such fears.Similar signs were evident, for example, in the run-up toEstonia’s European Union accession in 2004.
The Estonian Ministry of Finance predicts that the
Consumer Price Index will rise by a modest 0.1-0.3 percent because business will round off prices upwardduring the euro transition. The ministry cites theexperiences of other countries that have shifted to theeuro. Our assessment is also that the impact of the euroon Estonia’s inflation will be relatively minor, thoughhigher than the government’s forecast. However, it willbe generally difficult for businesses to impose pricehikes, given the large output gap. The recovery in post-recession domestic demand has hardly begun, andduring the third quarter of last year unemployment stoodat 15 per cent, although it had fallen from ca 20 per cent
early in 2010.
Nor does an examination of last year’s inflation trendindicate that any broad price pressure is building up.
HICP year-on-year, per cent
Inflation and core inflation in Estonia
Total HICPHICP excl food, alcoholic beverages, tobacco, energy
Source: Reuters EcoWin
06 07 08 09 10
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
During 2010 the year-on-year inflation rate – the mostcommon yardstick of inflation – admittedly rose from -1per cent in January to a full 5.4 per cent in December.The 2010 annual average, compared to 2009, was 2.8per cent.
A very large proportion of last year’s inflation upturn can
be explained by higher food, alcoholic beverage, tobaccoand energy prices. This, in turn, was largely due to global
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Economic Insights
shock waves as well as administrative increases−
including a value-added tax hike whose impactculminated in July 2010 − that were part of fiscal
tightening, which will be eased this year. The coreinflation rate, after correcting the broad measure for theabove-mentioned four items, increased moremoderately, from -1.5 per cent in January 2010 to 1.3 percent in December 2010.
It should also be noted that 12-month rates were drivenupward by strong base effects. The comparative monthsof 2009 were very weak. In the second half of 2009,year-on-year measures showed growing deflation. Latviaand Lithuania also show similar patterns forcorresponding reasons. The level is higher in Estoniapartly because the economic recovery has progressed
further there; GDP is expected to have increased by 2.5per cent in 2010.
HICP, year-on-year, per cent
I. Comparision to other countries
EstoniaLithuania
LatviaEuro zone
Source: Reuters EcoWin
06 07 08 09 10
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
20.0
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
20.0
We also obtain a more nuanced picture of inflation inEstonia if, we choose to study moving 12-monthaverages. Measured in this way, Estonia’s divergencefrom developments in the euro zone are more modest. InDecember the 12-month average in Estonia stood at 2.7per cent compared to 1.6 per cent in the euro zone.
HICP, 12-month moving averages, per cent
II. Comparision to other countries
Estonia Lithuania Latvia Euro zoneSource: Reuters EcoWin
06 07 08 09 10
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
The outlook for 2011 is for somewhat higher inflation inEstonia, using broad-based measures, but a continuedcalm trend in the underlying inflation rate.
Fading base effects as well as the fading effects ofadministrative increases will have a restraining effect onthe inflation rate. Offsetting this, private sector wagesand salaries will rebound after the major cost adjustmentof the past two years, but this trend will be weak becausethere are still large idle resources in the economy.Economic activity will also continue to strengthengradually, although GDP growth will probably not reachits 4-5 per cent potential level. In addition, global energyand food price increases appear likely to be higher thanpreviously expected − and finally, there will be certain
euro-related effects. Our overall conclusion is that HICP inflation will end upat close to 4 per cent during calendar 2011, whichincidentally is close to the 4.2 per cent average so farduring the 21st century. This represents a clear upwardrevision from the 3 per cent we forecasted in theNovember issue of SEB’s Nordic Outlook report. But thereason is mounting external pressure from energy andfood prices in the past few months, not that Estonia’sdomestic inflation is getting out of control.
Meanwhile it is important to ensure that inflation doesnot get stuck at 4 per cent, which is clearly higher than in
most EU countries and far above the ECB’s inflationtarget for the euro zone countries of just below 2 percent. Otherwise there is a risk that the competitivenessregained by Estonia over the past couple of years willagain be eroded.
It is also notable that in December, Estonia’s moving 12-month average inflation was higher than the Maastrichtinflation criterion. Estonia fulfilled this criterion duringthe convergence evaluations conducted by the EU andthe ECB in the spring of 2010. The criterion stipulate sthat average inflation in the 12 months to the evaluationdate may not exceed 1.5 percentage points above the
three EU countries with the lowest inflation. In Decemberthe average of these three lowest figures (Slovakia 0.7per cent; Netherlands 0.9; and Lithuania, Germany,Czech Republic 1.2) was 0.9 per cent. Adding 1.5percentage points, the maximum was 2.4 per cent. Fourof the 17 euro zone countries (Cyprus 2.6 per cent;Estonia 2.7; Luxembourg 2.8; and Greece 4.7) exceededthe maximum inflation to qualify for euro zonemembership.
Mikael Johansson, Economic Research+ 46 8 763 80 93
