CBBH expects extraordinary strong inflatory shock during the first half-year of 2022

The Central Bank of Bosnia and Herzegovina (CBBH) has significantly adjusted at upper level the inflation nowcast for the first half of 2022, compared to December projections. Based on incomplete official data for January 2022, and all available information until mid-March, including the values ​​of futures for oil, gas and food in international markets for deliveries by the end of the half year, as well as specific price shocks related to the country, we project the inflation for the first half of the year to be at the level of 9.2% (Table 1). Based on official data from October and available market information by the end of November, in December 2021, the inflation for the first half of 2022 is projected at 4.5% (Table 1).

As in the current circumstances, the trends in the series, on the basis of which the nowcasts are made, are very variable in terms of magnitude and frequency, Table 1 below also presents the extreme scenario of inflation for the first and second quarters. The base-line scenarios is the value that the CBBH considers to be the most certain. Extreme scenario is possible if inflationary pressures increase further, either due to additional disruptions in international markets, or bottlenecks in distribution chains, or due to domestic price shocks that are not related to price trends in international markets.

Table 1: Annual Inflation in BH, periods

Source: BHAS(*), CBBH  projections. Note: Extreme scenario is base-line scenario increased by two standard deviations.

The expected rise in prices in the first half of the year is caused by the extreme rise in prices of raw materials, energy, food and oil, especially after the war in Ukraine, but also the low base from the first half of 2021, when consumer prices stagnated. We expect inflation to slow down in the second half of the year, primarily due to the base effect from 2021 and the assumption of the absence of further intensive growth in food and energy prices. Given such dramatic corrections in short-term inflation nowcasts, it is already quite certain that, with the spring round of macroeconomic projections, the inflation projections for 2022 and 2023 from November 2021, (2.1% and 1.4% respectively) will be significantly adjusted at upper level.

There are several factors that could result in additional supply-side inflationary pressures in the short to medium term, and rising inflation towards our current extreme projections. First of all, further shocks in the international food, oil and gas markets are possible, which will further increase the prices of production inputs. It is important to note that domestic producer prices have been growing much faster than consumer prices for more than a year. Another possible source of inflationary pressures in the short and medium term is the potential further harmonization of electricity prices on the domestic market with trends on the international market. Finally, there are pressures through the wage-price spiral, not only because of the Union pressures to align wages with rising cost of living, but also because of the outflow of skilled labor abroad.

We estimate that inflationary pressures in the fourth quarter resulted in a slowdown in real economic activity to 6% year on year. Our nowcast of real economic activity for the third quarter of 2021 (8.7%) did not differ significantly from subsequently published official BHAS data (8.4%). Monthly data that are highly correlated with GDP, such as retail trade, industrial production and exports of goods, had the record growth rates. On the other hand, strengthening inflationary pressures and weakening the base effect resulted in a lower projected annual real GDP growth rate in the fourth quarter. With the nowcasted growth of economic activity in BH in the fourth quarter of 6%, the real annual growth of 7.1% in 2021 is implied.

In the November round of macroeconomic projections, according to the data available at the time, we projected the moderate growth in real economic activity in 2022 and 2023 (3.9% and 2.1% respectively) due to the disappearance of the base effect and increasing inflationary pressure. However, information on events and trends from the end of 2021 until mid-March 2022 indicates that real GDP projections for 2022 and 2023 could be significantly revised in the May round of macroeconomic projections.

Primarily, deflators will strengthen significantly due to inflationary shock, which, all other things being unchanged, will result in a lower than currently projected real GDP growth rate in 2022 and 2023. The most significant uncertainties at the time of making the autumn round of medium-term projections were the war in Ukraine and the sanctions imposed on Russia. The full effect is still difficult to estimate, as the war lasts less than a month, but there is a certain slowdown in economic activity in our main trading partners, at least due to rising energy and food prices in international markets, which will negatively affect external demand on our goods and services. This is an additional factor that we expect to slow down economic activity compared to the projected one from November 2021. Another factor, which was not known in the autumn round of projections, and which will result in pressures on the expected economic activity in 2022, is the continuation of action in the mechanism of temporary financing for a part of the fiscal sector. Consequently, new public investment will be limited only to projects that have been funded in previous years, resulting in a revision of the 2022 economic activity projections to lower level, on this basis, too. Finally, perhaps the most important, from the medium term point of view, is the effect that the reduction in real household available income, due to the inflationary shocks, has on real economic activity. In the circumstances of persistent inflationary shocks to the already low level of available income, the future economic activity will be slowing down.