Gradual strengthening of economic growth and slowdown in inflation over this year and next two years

After being rather subdued last year, economic growth is expected to gradually strengthen over this year and the next two years to approach its long-term average. Inflation will gradually fall over this period, approaching the price stability target. The labour market will continue to see rising employment and record low unemployment, while wage growth will gradually slow but will remain relatively high.

Banka Slovenije has prepared its latest economic projections, according to which economic growth is forecast to strengthen to 2.5% this year after last year’s slightly muted performance (1.6%). The favourable economic activity continues to be supported by high employment, growth in real incomes, and a gradual improvement in the economic sentiment. Alongside the favourable factors in private consumption, this year domestic demand will be further strengthened by government expenditure, including funding related to the post-flood reconstruction. Amid a positive contribution from inventories, the stronger domestic demand will be reflected in stronger growth in imports, which will see net trade make a negative contribution to GDP growth this year.

The anticipated gradual recovery in export demand and cuts in interest rates will further strengthen economic growth over the remainder of the projection horizon to approach its long-term average (2.6% in 2025 and 2.8% in 2026).

Amid the improved economic outlook, employment will continue to rise, and unemployment will remain at record low levels. The persistent tightness of the labour market will keep wage growth high over the projection horizon. Amid a shortage of available labour, growth in employment will continue to be outpaced by GDP growth. Economic growth will thus be driven primarily by the anticipated recovery in productivity growth, which will also play a significant role in mitigating rising unit labour costs.

Inflation will gradually converge on its target rate over the projection horizon, but the fall will be gradual and slower than last year amid persistent domestic price pressures. The slowdown in headline inflation over the projection horizon will also be temporarily curtailed by the expiry of government measures to mitigate high energy prices. According to the projections, inflation will average 2.4% this year, before rising temporarily to 3.0% in 2025 amid the deferred impact of the rise in labour costs and the waning of base effects, and then slowing to 2.3% in 2026.

The projections are accompanied by risks, which are balanced for economic growth, and on the upside for inflation. The projections are based on the anticipated gradual strengthening of labour productivity, which in the event of structural challenges might be less than forecast, which would lead to lower economic growth, higher growth in unit labour costs, and higher inflation. From a forecasting perspective, similar stagflation effects could come from the potential resurgence of supply-side shocks amid the persistent uncertainties in the geopolitical environment. Conversely, domestic demand might be stronger than forecast should households make use of their substantial savings, which would be reflected in higher economic growth and higher inflation.

Review of macroeconomic developments and projections, June 2024.