Deflation Has Come To Bulgaria, But How Long Will It Last?

Johannes Vermeer: The Milkmaid // Public domain

Already in May, the National Statistical Institute of Bulgaria announced long-awaited news: on a monthly basis, the general consumer price index recorded a decline for the first time since the beginning of the war, and in June, this trend continued, even more noticeably. This has also been accompanied by a cooling down of the annual price change, which has fallen well below its peak since autumn 2022.

However, it is appropriate to ask whether this moderation in price growth and even isolated declines are the beginning of a lasting trend or just a temporary slowdown in the context of ongoing inflationary processes.

The answer to these questions is largely contained in the structure of inflation. Let’s first look at the monthly change in prices in June compared to May 2023. The most significant decline is in entertainment and culture, with a 3.1% compared to May. There are also encouraging data regarding food prices, with a 1% decrease. At the same time, however, there is a 1.6% rise in prices in hotels and restaurants for the month, and for the other groups of goods and services, the dynamics are weaker. However, if we look at specific goods and services, the distribution looks a bit different.

A substantial share of the decline in food prices is concentrated in the group of vegetables (-7.4%), which traditionally experiences strong seasonal price adjustments. There are also declines in oils and fats (-4.4%) and milk, dairy products, and eggs (-1.9%), which had seen sharp price increases in the spring and summer of 2022, maintaining prices well above European average levels for years. Other sensitive price reductions are concentrated in fuel gases (-8.1%), as well as fuels for personal transport (-1.5%) and package travel services (-6.7%).

Looking at the annual price change, which illustrates long-term and structural changes, compared to June 2022, a significant increase in the general consumer price index of 8.7% remains. Here, we can notice a decline in only one of the large groups: transport, which decreased by as much as 13.7%, mostly due to the record-high prices of liquid fuels last summer. These prices have largely normalized today but are still far from their pre-crisis levels or from their bottom levels in 2020. During the same period, however, food prices grew by 13.3%, and on an annual basis, there is only a drop in prices for the above-mentioned oils and fats (-18.6%), which set records last year.

In other words, the deflation in the last two months is not substantial and even affects a limited range of goods and services. If we want to look ahead, however, it is appropriate to turn to the factors that can cool down consumer prices in the long term. The industrial producer price index (which, as we have recently demonstrated very clearly, is a reliable predictor of consumer inflation with some delay), with a base year 2015, reached 150 points in May – a significant drop from a peak of over 200 points at the end of last year and very close to the pre-war level. The energy index, which affects practically all other industries, remains high (183 points), but far from its peaks of 350-400 points in the fall. The significantly lower fuel prices also point to a gradual calming down of price dynamics.

However, there is a notable increase in labor costs and wages of employees, which in turn means an increase in disposable income and creates additional pressure on price levels. It is here where one of the main risks is locked. Although the current consensus around the state budget does not include significant expansions of either social payments and pensions or the minimum wage – measures that are inevitably pro-inflationary in nature – it appears that during the autumn debate around next year’s budget, such proposals would receive much stronger support, which could fuel inflation, at least to some extent, in the medium term.

All economic growth forecasts (whether the EC’s more conservative one or the Ministry of Finance’s more optimistic one) and GDP growth data for the first quarter point to a slowdown of the economy in 2023. Overall, owergrowth suggests lower inflation due to reduced individual consumption. However, this poses a real risk of a contraction in household income growth, which has so far been catching up with inflation – but it is far from certain if this will continue. The weaker growth is also a result of the significant increases in interest rates both in our country and in the Eurozone, which aims precisely to control inflation.

Despite all these favorable factors, however, inflation forecasts remain rather unfavorable. According to the EC, even in 2024, the increase in prices in Bulgaria will be over 4% – far from the low inflation combined with rapid income growth that was typical of the past decade. This is also relevant for Bulgaria’s ambitions to join the Eurozone in a year, since even if the government manages to control the budget deficit, the country’s ability to meet the inflation criterion remains questionable.

Going back to the original question – yes, we are currently experiencing mild deflation. However, it seems rather isolated in individual groups of goods and services and is at least partly driven by seasonal trends and the normalization of prices for key raw materials. For this reason, the probability of a long-term decline in prices seems rather limited, let alone a return to their levels before 2022. The risk of external shocks to the Bulgarian economy, which ultimately drove the significant price jump last year, also remains existent.

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