Limited solutions to severe price pressures ahead, but strong fundamentals dampen ratings
The ECB’s ability to contain high inflation seems particularly limited in the case of the Baltic countries despite last week’s 75 basis point rate hike, and this is not only due to the dominant role of supply factors in current inflation.
Although inflation in the Baltic region is well above euro area averages, the ECB focuses its monetary policy on the single currency area’s average inflation, inherently biasing its policy in favor of its largest Member States. As such, ECB policies remain too accommodative for inflation conditions in the smaller Baltic economies.
Moreover, demand-driven inflation is stronger than in other eurozone member states, following relatively modest economic contractions in the Baltic region during the peaks of the Covid-19 crisis in 2020, which were quickly followed by robust recoveries. Tight labor markets are likely to foster longer-lasting inflation risk, as vacancies remain high and unemployment rates low, even after recent influxes of Ukrainian refugees.
In addition, Baltic governments are under increasing pressure to step up fiscal support to ease price pressures on businesses and households, although such support – depending on its overall volume and purpose – may contribute more. to the dynamics of underlying inflation.
However, the three countries also share common credit strengths. These include access to significant EU funding over the next few years through Cohesion Policy and the Next Generation EU programme, strong economic fundamentals, profitable banking systems and strong institutions, helping the region to cope with the energy crisis and supporting their respective credit ratings.
In addition, Estonia, Latvia and Lithuania benefit from relatively low public debt ratios. Relatively robust growth in nominal terms should help stabilize the debt-to-GDP ratio despite widening fiscal deficits and rising financing costs within the eurozone.
The next Scope Ratings Sovereign Calendar review dates for the region are:
- Lithuania: November 18, 2022
- Estonia: November 25, 2022
- Latvia: December 2, 2022
For an overview of all of today’s economic events, check out our economic calendar.
Giulia Branz is a senior sovereign and public sector ratings analyst at Scope Ratings GmbH.