bne -

Serbian inflation eased for the third consecutive month in July, data released by the Statistical Office showed on August 12. However, the central bank cannot offer the economy the stimulus of a rate cut until political risk diminishes.

The consumer price index rose 8.9% from the year before, down from 9.8% in June. Inflation was the lowest since it dropped to 7.9% in August 2012. On August 8, the National Bank of Serbia kept its key policy interest rate at 11% for the third meeting in a row, saying that inflation is set to continue its downward trend in the coming months. The central bank predicts annual inflation will slide within its target band of 3-6% by the end of October.

With inflation falling, there was space for the bank to cut rates to support the fragile economic recovery. However, political risk has risen recently. Having jettisoned finance minister Mladjan Dinkic and his small, fiscally conservative URS party from the government, the coalition now features the Serbian Progressive Party and Socialist Party. Investors are now on tenterhooks over the pair's ability to agree a new cabinet, putting pressure on the dinar.

Tim Ash of Standard Bank points out that the "very high base period effect from last year's devaluation-inspired spike in inflation to 12-13% was always going to crash inflation lower, and this seems to be the case." However, he also notes that "macro data is appearing more encouraging of late - lower inflation, slightly better fiscal performance, plus an improving [current account] position. But key weakness remains domestic politics, where the market needs to see a new cabinet in position ASAP, and the risk of early elections put off."