Annual inflation declines in June: supply side tends to understand demand

In June 2015, annual inflation shrank to 0.6%. The dynamics was attributable to the expected fall in energy prices as well as a greater than usual seasonal decrease in vegetable and wearing apparel prices. Demand can be deemed sustainable in Latvia; however, inflation data for June show that the demand side impact is not increasing.

Oil price increase was not observed in June compared to the May average, while the value of the US dollar recorded a slight decline. Fuel prices rose, however, moderately (by 1.5%). Energy prices had a dampening effect on inflation primarily due to the JSC Latvijas Gāze reducing tariffs for industrial consumers (followed by a decline in heat energy price). The contribution of energy prices to the annual inflation is likely to abate further since the above tariffs will decline more pronouncedly in July and natural gas tariffs for households will also be reduced and a fall in heat energy price is expected in Ventspils and Liepāja in the second half of the year.

In May, a higher than usual increase in the prices of seasonally volatile goods and a rise in high-tech goods and services prices pointed to a sustainable impact of the demand side. The data for June do not suggest an excessive seasonal price hike any longer – the trend has even reversed. For instance, in June a fall in vegetable and wearing apparel prices exceeded the average observed in other years, while the prices of only some non-food goods and services (e.g., package holidays and accommodation) continued to follow an upward path. Hence it might be considered that the impact of the demand side on inflation was not strengthening. A slight decline in the annual growth rate of average wages and salaries (the first quarter data) also points to the above development. It gives an impression at the same time that retailers and service providers find it difficult to understand a really solvent demand, since seasonal volatility of goods prices has been atypical for several months (sequentially in both directions).

In June, the declining annual inflation offset to a large extent the upward impact on the average annual inflation following from the actual data for May. Some factors underpinning the decline in inflation might still affect annual inflation this year and next year, while the impact of each individual factor could be very negligible or would be difficult to quantify currently. For instance, a decrease in heat energy prices in Ventspils as of 1 July and the planned reduction in heat energy prices in Liepāja as of 1 October will contribute to the above development of inflation. Approval of a lower than initially required return on equity for the JSC Latvijas Gāze and a decline in the electricity transmission tariffs of the JSC Augstsprieguma tīkls (contrary to the planned increase) will not foster inflation as well. In the case of natural gas prices the above impact depends on the overall consumption. Given the current tariffs, even the reduced return on equity may be difficult to attain due to a decelerating consumption.

Low inflation observed also in other euro area countries is still not expected to facilitate the strengthening of import price impact on inflation in Latvia. The Public Sector Purchase Programme will have an effect on inflation in the euro area in the medium term, similar to the developments in Greece, if the latter affect investors' interest regarding the euro area.