Research: War and inflation will hamper growth in the Baltics this year

At the beginning of the year, the Baltic economies are showing strong inertia, which will make it easier to overcome the challenges.

It has already been reported that SEB banka has reduced Latvia’s gross domestic product (GDP) growth forecast for this year to 1.8% compared to the previously forecasted 4.6%. In its turn, in 2023, SEB banka forecasts GDP growth of 2.5%.

According to the Nordic Outlook, GDP growth will be 0.9% in Lithuania this year and 0.6% in Estonia.

An important aspect will be the general mood in the economy, which will determine consumption and investment activity, according to the review. Successfully addressing Russia’s challenges to raw material alternatives, especially energy issues, may ease inflationary pressures. An important aspect will be the epidemiological situation in the autumn and the dynamics of the war in Ukraine.

If these risks are addressed proportionately, growth could turn out to be even higher this year, Nordic Outlook said. Next year, growth in all three countries will pick up again.

The review concludes that the outlook for the international economy has deteriorated in recent months. The war in Ukraine has had a significant impact on the world economy and security policy. New Covid-19 outbreaks in China are exacerbating the authorities’ refusal to ease the strategy. Thus, there is no immediate solution to the disruption of the global supply chain, the review concludes.

SEB expects global GDP to grow by 3% this year, more than one percentage point lower than forecast in January, remaining unchanged at 3.4% until 2023. The US economy will grow by 2.6% this year and by 1.7% next year, while the eurozone will grow by 2.1% and 2.8% respectively.

The outlook for the US economy has deteriorated gradually, prompting the Federal Reserve to pursue a tighter monetary policy. Central banks are currently focusing on inflation, despite lower growth prospects. The rise in prices has widened as companies pass on rising costs to consumers, the survey said.

SEB warns that there are currently signs of overheating in both the goods and labor markets. If central banks do not act, there are risks to long-term inflation expectations. Wage growth is rising in the United States and the United Kingdom, while it is still relatively modest in Germany and the Nordic countries. Wage formation is dictated by the market, and there are signs that it is close to the top in the United States, as the urgency of labor shortages and planned wage increases for small businesses have diminished.

Dainis Gašpuitis, an economist at SEB banka, points out that the bank is still sticking to a “soft landing” scenario, which is based on several positive aspects. New fiscal incentives to compensate for high energy prices, military investment and the implementation of the green exchange rate will provide short-term support for euro area growth.

“Meanwhile, the backlog of household savings will make the private sector more resilient to rate hikes. The debt burden on households is much lower than before the global financial crisis. The supply-side problems currently driving inflation will diminish over time. “It is worth noting that real interest rates will remain low despite the increase in the base rate,” Gašpuitis said.

The review predicts that the European Central Bank (ECB) will be cautious, despite the eurozone’s dependence on Russian energy, despite unexpectedly strong inflation. The review states that the ECB should seek to prevent the spread between euro area securities from widening excessively.

The review also predicts that the US Federal Reserve will raise the key interest rate by 50 basis points at future meetings, gradually moving to 3.5% by the end of 2023. The ECB will also take action in July, raising the deposit rate to 0.25% by the end of 2022 and to 1% by the end of 2023. In parallel with the rate hike, central banks will tighten policy on their balance sheets, SEB forecasts. However, the impact of these measures is difficult to assess.

The rise in inflation is likely to be stronger and more sustained, which will require an even stronger response from central banks, according to the Nordic Outlook. The potential energy crisis in Europe and China’s economies is an additional risk. Upward growth potential is limited, but mainly due to faster-than-expected supply-side normalization. In general, the negative risk background is higher than usual, admits SEB.

The bank expects Russia’s GDP to shrink by 10% this year and 3% next year. Sanctions, combined with a repressive political environment, weak rule of law and widespread corruption, are leading to deep stagnation in the Russian economy. Even companies in countries whose governments do not distance themselves from Russia but sell goods in the US and the EU are following sanctions against Russia.

“The choice between Russia’s stagnant and developed Western economies is clear to most companies. Russia’s economy has not collapsed in part because Moscow has reduced its vulnerability to such cases since the annexation of Crimea in 2014,” the review said.

The outbreak of war has created turbulence in world commodity markets, as Russia is not only a major exporter of oil, natural gas and coal, but also a major supplier of grain, nickel, aluminum, palladium and fertilizers, according to the review. For example, metal shortages can delay the implementation of the green course, but food prices can become a source of social instability in many parts of the world. Wheat prices have doubled and could rise further. Isolation of Russia will not be easy, as creating alternatives to Russian raw materials will be a big challenge, admits SEB.

New Covid-19 outbreaks in China will exacerbate disruptions to global supply systems, the review said. Also, the war in Ukraine and the isolation of Russia are exacerbating the situation. As a result, weaknesses and vulnerabilities in transport systems continue to hamper growth and increase inflation. The Nordic Outlook predicts that the situation could start to improve next year, but in the long run an increasing division of the world into geopolitical blocs is expected. China’s outlook has weakened and SEB expects it to grow by 5% this year.

After an initial rise, energy prices have fallen slightly. The Nordic Outlook explains that this is mainly because the US and other countries have started using oil from their strategic reserves and China’s restrictions have reduced demand. However, both factors are temporary and energy prices will remain high for the foreseeable future. This year, Brent crude will cost an average of $ 106 a barrel and $ 20 in 2023. Gas prices will also be well above normal, Nordic Outlook predicts.

The survey says the US continues to experience strong demand, fueled by large-scale fiscal stimulus. At the outset of the pandemic, they felt supportive as the monetary policy began to fade, but at a time when central banks were moving towards tighter policies, the situation became more difficult.

“The question is how important fiscal policy is to counteract the effects of the inflation shock and higher interest rates. “in a Nordic Outlook review.

High inflation is currently holding back growth, but public sector revenues are more sensitive to inflation than spending, the review explains. For example, even if household consumption declines, the share of nominal consumption in the tax base may rise. In addition to the positive budgetary impact, this also implies a reduction in the government debt-to-GDP ratio.

According to Nordic Outlook, the focus of the post-pandemic stimulus package is currently changing. In Europe in particular, households and businesses are compensated for high energy prices. Flexibility in developing economies is limited, despite high needs, as food and energy account for a larger share of the consumption basket than in richer countries, exacerbating societal tensions.

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