Latvian prices rise for first time in six months as euro comes into play

By bne IntelliNews February 12, 2014

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Latvia's consumer prices increased for the first time in six months in January, data released by Statistics Latvia on February 11 showed. Coinciding with the launch of the euro in the Baltic country, the news is likely to offer grist to the mill of opponents of moves towards the euro by EU member states in the eastern end of the bloc.

Consumer prices rose 0.4% on year in January, the fastest rise since January 2013. The rise in CPI followed five months of deflation on an annual basis, and followed a 0.4% drop in December. January was the first month when residents used the euro for purchasing and the euro replaced the lat in actual price recording. Versus the month before, consumer prices in January climbed 0.6%.

However, analysts suggest that the cost of Latvian shopping baskets was minimally affected by the move to the euro. Prices of goods were actually 0.3% lower on an annual basis, notes Swedbank. A 0.5% rise versus December was "mostly due to higher food prices driven by seasonal rise in prices of fruits and vegetables. In monthly terms prices of clothing and footwear shrank due to winter sales".

By way of contrast, service providers appear to have taken advantage somewhat. At 2.3% annually, prices in the sector saw their steepest rise since 2009. "To a large extent this could have been related to euro changeover and rounding up of prices," the Swedbank analysts write, pointing out that Latvians celebrated joining the euro by paying more to get their hair cut, sleep in hotels, or go out in the evenings.

"However," they conclude, "these services take up only a small fraction of household spending (roughly 8% in 2013 consumer basket). Therefore, although prices of some services indeed rose quite noticeably, its impact on average price level and on total household budget was rather moderate."

Other countries that have adopted the euro such as Estonia, which became the first of the Baltics to join the single currency in 2011, have seen prices climb as a result. The governor of the Bank of Latvia - which, in the face of a skeptical population, ran a high profile campaign to fight unscrupulous price rises by retailers in the run up to the switch - said in October that the impact would be muted.

However, he admitted that the central bank still expected to see inflation stoked somewhat by the move. "Our estimation is somewhere between 0.2 and 0.3 percentage points," Ilmars Rimsevics said, adding that he expected inflation to reach 2% next year. In fact, in its latest report published last month, the central bank forecasts CPI growth at 1.7% in 2014. Inflation finished last year flat, despite Latvia recording the highest GDP growth in the EU at 4%.

Meanwhile, the risk of deflation stalks much of the Eurozone. With average prices dragged down in particular by the southern "periphery" in late 2013, European Central Bank chief Mario Draghi denied in mid-January that the single currency area is facing a vicious circle of falling prices, although he had little choice but to admit that inflation is expected to remain well below target for the next couple of years. The ECB is forecasting annual inflation of just below 2% this year.

On the back of the deflation seen in the second half of last year, Swedbank notes that despite the boost from euro adoption, Latvian inflation in January remained lower than the Eurozone average of 0.7% year on year. However, that's unlikely to persist to the end of 2014.

"[The trend for Latvian inflation below the Eurozone average] has lasted for the last one and half years, but it is expected to reverse this April when inflation in Latvia will pick up notably and will exceed that in the euro area due to household electricity market liberalization," the analysts predict. "Also rising labour costs will gradually put upwards pressure on Latvian CPI, while favourable global commodity price developments will slow the price increase. We expect the average annual inflation in Latvia will reach 2.5% this year."

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