Slovakia aims to be the next eastern European country to adopt the euro, and hopes to be able to do this in 2009. In order to achieve this objective Slovakia must, however, slow inflation to the level set by the EU Commission. The objective then is to try to maintain inflation within the 12-month average rate of the three EU nations with the slowest consumer-price growth. Obviously as the eurozone slows, and inflation rates drop in some countries to what may potentially be very low levels (will any of them have a brush with deflation??) this objective becomes harder and harder to achieve, especially when the Slovak economy - along with the Polish, Romanian, Bulgarian and Baltic ones - has started to show early signs of overheating.
The Slovak koruna was trading at 33.539 against the euro at 11:30 a.m. in Bratislava, from yesterday's close of 33.581 following the news. The currency has now pared some of the gains made when it rose to a record 32.69 against the euro on March 19.
Core inflation, stripping-out the effects of changes to regulated prices and indirect taxes, grew 0.2 percent on the month and 3 percent on the year.
Food prices, which have a significant weighting in the consumer basket used to calculate Slovak inflation, rose at a 1 percent rate from August after three straight months of declines. The biggest increases were in the prices of education, which was up by 2.5 percent, and health-care prices which registered a 1.2 per cent increase.
One part of the annual rate rise registered in September was the knock-on effect of a drop in consumer prices of 0.3 percent in September 2006. If rather than focusing exclusively on the Slovak index we now look at the evolution in the EU harmonized consumer price index itself we will see that since April the upward march in the index has had a strong brake applied and the curve has flattened out considerably.
In order to qualify for euro membership Slovakia will need to meet tests on inflation, state spending and the level of interest rates. The country met the test on inflation in August when its 12-month average rate, at 2.4 percent, fell below the EU's average of 2.5 percent.
The big issue is the extent to which the rise in the September CPI may or may not reflect a deeper capacity overheating in Slovakia. Certainly if overheating is taking place in Slovakia it is not at this point as severe as in some other parts of the EU 10. GDP has been growing strongly in recent quarters though, and there must be questions about the sustainability of this current pace.
If we look at some of the key "heating indicators" we find in the first place that house prices nationally were rising fast in late 2006, but that the rate of increase has now slowed somewhat. So while this situation is not totally desirable, it is well short of being the major headache it might be, although of course it is important to remember that there will be significant regional variations here, and price rises in - for example - Bratislava may by no means be as benign as the aggregate data suggest.
Retail sales, while they have been increasing strongly, do not appear on the surface to be registering the "excesses" which may be found in some other EU10 countries. At least following the peaking out which took place in March they don't.
Finally wages, while not exploding, are increasing strongly, and this will certainly be the data point to watch as we move forward. Labour shortages have been reported in Slovakia as elsewhere, and while the may be able to leverage some of the now surplus to requirements labour which is to be found in Hungary, there are definite limits on how far this can go.
The Slovak central bank now expects the national inflation rate to fall to 1.9 percent by December after peaking at 5.1 percent in August 2006. Policy makers have already trimmed the benchmark two-week interest rate by a half-point (to 4.25 percent) earlier this year - following four counter-inflation rate increases in 2005 - citing a more positive inflation outlook as justification. We will now have to wait to see just how they react to this latest blip on the inflation reading.
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