Ljubljana - Banka Slovenije has upgraded its economic growth forecast for Slovenia by 1.8 percentage points from its December outlook to 5.8% for this year as a result of a carry-over from last year. It downgraded the projection for 2023 by 0.9 points to 2.4%. Inflation is projected to run at 9% this year before easing to 4.5% and 2.3% over the next two years.

"Economic growth is moderating, but annual growth for this year remains high and is largely due to the carry-over effect, which is the result of favourable developments towards the end of 2021," Robert Zorko, deputy head of the central bank's analysis and research centre, told reporters on Wednesday. The growth rate would thus run above the 2.8% projected for the euro area.

Deputy Governor Tina Žumer said growth was driven mainly by consumption, investment and exports.

Consumption is now projected to grow at a rate of 8.7%, double that forecast in December, largely on the back of the carry-on of exceptionally good data from late 2021 and as a result of Covid aid for households, wage growth and gradual reduction in demand accumulated during the pandemic. Intra-year growth is expected to be low.

Gross investment is expected to increase by 8.4%, supported by accelerated EU fund drawing and stepped-up investment ahead of the autumn local elections. Public investment could grow by up to 20% but Zorko noted negative impact from energy and raw materials markets.

Exports are projected to grow at 4.3%, which is a slightly lower rate than in the December forecast, mainly due to poorer-than-expected trends in late 2021. Imports are expected to grow by 7.1%, however export growth is expected to outpace growth in imports again in 2023 and 2024.

The biggest risk at the moment is the war in Ukraine, which Žumer says has begun to reflect in lower current growth and more moderate than initially expected growth next year. The central bank expects GDP growth to slow to 2.4% in 2023 and pick up slightly to 2.5% in 2024, but it will stay above the 2.1% forecast for the euro area.

Inflation is forecast to be above the rate projected for the euro area, which, Zorko said, is due to stronger domestic demand and favourable labour market conditions. Driven mainly by higher prices of services and food, it will average 9% this year, before dropping to 4.5% and 2.3% in 2024.

In the euro area inflation is expected to run at 6.8% this year before slowing to 3.5% in 2023 and 2.1% in 2024.

Inflation is becoming increasingly broad-based, Zorko and Žumer warned. According to Zorko, 70% of all goods and services in the consumer basket that is used to calculate inflation have exceeded 3% price growth at the annual level.

The impact of rising energy and food prices is expected to diminish over the next two years, while the impact is to increase from rising prices of services, which are more affected by wage growth expectations both in response to inflation adjustment and staff shortages.

The baseline forecast of Slovenia's and other central banks of the euro system is based on the assumptions that the intense military conflict in Ukraine will subside by the end of the year and the energy, commodities and food markets will stabilise in 2023. It does not foresee any further tightening of the West's sanctions on Russia.

However, there is a high degree of uncertainty, so Banka Slovenije has also drawn up a downside scenario in case of a protracted war in Ukraine, further tightening of the sanctions and a complete embargo on oil and gas, with an even stronger rise in prices on commodity and energy markets as growing uncertainty would also reduce external and domestic demand.

In this severely negative scenario, Slovenia's growth would still be at 4.3% this year, but would be followed by a 0.4% contraction next year. Growth would then return to 3.6% in 2024. Inflation, meanwhile, would accelerate further to 9.8% this year, remain at a high 6.6% next year before falling to 2.5% in 2024.

A tighter labour market, together with stronger-than-expected wage growth, poses an additional risk to growth and inflation. "However, the Slovenian economy has shown good flexibility and adaptability in recent years," Zorko said.

Under the baseline scenario, employment is to increase by 2.8% this year before its growth is to slow to 1.1% in 2023 and 0.7% in 2024. The survey unemployment rate is expected to fall from 4.7% last year to 4.2% this year before the decline will slow down. Next year, the rate is expected to stand at 3.9%, and in 2024 at 3.7%.

Wage growth will moderate from 5.4% in 2021 to 4.1% this year, mainly as public sector employees no longer get Covid hazard bonuses. However, due to staff shortages and wage demands, wages are expected to increase by 5% in 2023 and by 4.5% in 2024, but labour costs are not expected to go up faster than in comparable EU member states.

The general government deficit is expected to fall from 5.2% of GDP in 2021 to 3.1% of GDP this year and to 2.6% of GDP in 2023, before rising back to 3% in 2024. Public debt is projected to drop from 74.7% of GDP at the end of 2021 to 67.8% of GDP by the end of 2024.