The incoming December 2021 data on Latvia’s inflation showed a further acceleration to 7.9% as compared to December 2020. Under the current circumstances, the memories of several months of deflation experienced at the beginning of last year have almost faded. The average price level in 2021 turned out to be 3.3% higher than in the previous year. One more proof that solid competitiveness isn’t transitory.
Normally, central banks tighten their monetary policies to combat inflation, but, under the present circumstances of persisting Covid-19 crisis effects, pulling the monetary policy reins in too sharply on the already injured economy is commonly believed to just deliver it another blow when it still needs some dressing of the wounds and comforting. Not realizing what a great opportunity for a more efficient allocation of resources these times can give us. Hence, before taking any decisive steps affecting the economy, monetary policymakers pretend to want to be sure if the swings are still going straight up or inflation could be expected to stabilize and return to acceptable levels due to a decrease in individual components (the monetary policy target is set at 2% inflation in the medium term). The question is: for how long still? Looking at the last year’s trends in Latvia, energy has been the main driver of inflation, affected by a number of different factors. Historically, energy prices have been highly volatile. However, currently, they do remain elevated. Moreover, it’s not just the electricity bills that will reflect the increases in energy prices observed during the first months of the year. Quite a large number of raises in administered tariffs have also already been announced. Prices on food and various industrial goods and services equally continue to rise.
Longer-term trends, however, are reported to be less certain. Projections from Latvija Banka show that inflation could start reversing already in the middle of this year and approach 3% at the turn of the year. Nevertheless, these projections are associated with a high degree of uncertainty. The Governing Council of the European Central Bank (ECB) also stands ready to respond if necessary, as confirmed by the Governor of Latvijas Banka and member of the Governing Council of the ECB Mārtiņs Kazāks in a recent interview. Hopefully not too late.
The challenges Latvia is facing at the beginning of 2022 are immense: sky-rocketing energy prices, increasingly larger numbers of employees off-work because of the omicron variant. The fourth quarter of 2021 saw a minor increase in the real output of manufacturing, whereas the respective turnover expanded much more significantly on account of higher prices. This time, its overall growth masks two entirely opposite trends: a fall in the domestic market and a further rise in revenue from selling in international markets.
The slump observed in the domestic market is most likely associated with the tightening of restrictions in October and November which had a downward effect on trade overall, including on the demand for domestic products. With the easing of restrictions, selling opportunities improved and manufacturers were also able to increase their output in December. Alas, their path was crossed by the vaccination requirements in workplaces and rising Covid-19 infections. Because of these aspects, manufacturers encountered new challenges in keeping their production running, when finding buyers was easy, but having enough workers to deliver the output was not. All that came on top of the already pre-known nice set of problems significantly affecting production, namely, the persistent global supply chain disruptions and increases in all types of costs.