ANALYSIS - SEE inflation proves stubborn

The slowdown in inflation from the peaks of about 16% across the region in 2022 and 2023 was the easy part, helped by the easing of supply chain disruptions and the normalisation of prices of commodities, particularly energy sources.

But a further decline from the current 3%-7% range is proving more elusive than expected. In some countries, such as Montenegro, Kosovo, Croatia, and North Macedonia inflation rates have stopped falling or even edged up recently.

Inflation in Balkans outpaces EU's levels

Southeastern Europe is not alone in its struggle with persistent inflationary pressures. In the United States, inflation has also stalled well above the Federal Reserve's 2.0% target after prices rose 3.5% on the year in March, accelerating from 3.2% in February. Consumer price growth in the 20 nations sharing the euro currency slowed to 2.4% in March from 2.6% a month earlier, but underlying price growth remains stubbornly high at 2.9%. The European Central Bank (ECB) has kept its deposit rate at record-high 4.0% since September, and inflation remains uncomfortably above its 2.0% target.

The issue, however, is that inflation in Southeastern Europe is stuck at a high level, significantly surpassing that of the EU since 2021. Romania recorded the EU's highest annual inflation rate in February, at 7.1%, followed by Croatia with 4.8%, according to Eurostat. It was the failure to meet the inflation criterion that dampened Bulgaria’s hopes of joining the eurozone before 2025.

According to ECB economist Matteo Falagiarda, central and eastern European countries have been more vulnerable to the recent price shocks in part due to certain structural features of their economies. These countries are characterised by higher energy intensity of production than the euro area average. In addition, the share of energy and food in their consumption baskets is higher than the euro area average. Also, most of these economies relied heavily on Russian energy before the war, making them more vulnerable to energy supply disruptions.

Why is inflation so stubborn?

Despite the sharp interest rate increases of the past two years, economic growth in Southeastern Europe is resilient, which may be fuelling price growth. Romania's economy is expected to grow by 2.7% in 2024. Croatia's gross domestic product is projected to expand 3.0% this year, while economic output in Albania is projected to increase by 3.3%. The World Bank expects economic growth in the Western Balkans to accelerate to 3.2% in 2024. Against this background, price growth is being driven by the strength of consumption, a brightening outlook, strong job creation, and wage growth. Moreover, oil prices have risen recently.

Central banks themselves may also be adding to inflation pressure. By signaling a willingness to cut interest rates last fall, they reduced global borrowing costs and inflated asset prices, supporting spending. The ECB signalled earlier this month that it could start cutting rates as early as June. ECB president Christine Lagarde, however, remained cautious: “This implies that, even after the first rate cut, we cannot pre-commit to a particular rate path”.

“Our decisions will have to remain data dependent,” she added.