Although the people of Latvia felt the effect of the Middle East war on fuel prices within the first days of the conflict, a more significant rise in inflation may only become visible in the autumn, says Kārlis Purgailis, chief economist at Citadele bank. The prices of certain goods and services can take as long as 10-12 months to respond to a rise in energy prices.
Since the start of the conflict involving Iran on 27 February, energy prices worldwide have risen substantially. The price of Brent crude oil has increased by 45%, while the price of European natural gas (TTF) has gone up by 39%. Although these are global trends, their effects are felt directly in Latvia too – from fuel to the cost of maintaining a home – and they are becoming increasingly noticeable in households.
“The fuel price shock spreads unevenly through the Latvian economy – some prices react immediately, while in other segments the effect only appears several months later. Overall, Latvia's inflation figure starts to respond more markedly to a rise in energy prices after roughly six months on average. Although consumers have yet to feel the initial shock in full, the main price pressure will become visible later,” says Purgailis.
Price rises in Latvia unfold gradually, in several stages
While the transport sector responds to higher fuel prices immediately, food price dynamics in Latvia are characterised by inertia – in this segment, price growth accelerates after roughly 7 months on average. This is due to the structure of supply chains, warehousing services and contract prices, which cushion short-term fluctuations.
A similar lag can be seen in the furniture and household goods segment, where price growth accelerates after about 8 months. The utilities segment – water, electricity and gas – also responds to changes in energy prices after 6 months on average, as this segment is largely regulated and less sensitive to short-term swings in the oil market.
In the services sector the inflation response is delayed even further – price rises in restaurants and hotels only become more pronounced after about 8 months, while in certain segments, such as health and leisure services, the effect may not appear for as long as 11-12 months. This reflects rising labour, rent and other indirect costs.
The strongest inflationary pressure and shift in consumption expected in the autumn
In the economist's view, these differing time lags mean the sharpest acceleration in inflation in Latvia will most likely be seen in the autumn, when several components of inflation begin to bite at once. This will amplify the combined effect of price rises and increase the pressure on household budgets, forcing people to postpone or cut back on spending. In Latvia the first reaction is usually visible in fuel retail – spending in this category starts to fall roughly a month after energy prices rise.
After about two months the decline also reaches pharmacies and cosmetics as budgets grow tighter. After 9-10 months, meanwhile, the drop in demand extends to clothing, footwear, electronics and leisure goods. Households postpone non-essential purchases and focus on basic needs such as energy and food. This is a predictable pattern of development that helps both consumers and businesses to plan ahead. At the same time, households not only spend less but also change their shopping habits. Within roughly a month, spending on e-commerce increases, while the second-hand market picks up after about four months. This shows that people are switching to more affordable channels rather than simply cutting consumption evenly across all categories.
Uncertainty in the gas market
Further adjustments in the second half of the year may also be driven by uncertainty over gas prices. After a cold winter, European gas stocks remain at a relatively low level, and military conflicts in key natural gas supply regions, particularly in the Middle East, could significantly affect the availability of gas on the world market.
If gas stocks are not replenished quickly enough, Europe may be forced to compete with China and other Asian economies for limited – and therefore potentially more expensive – energy resources.
“Although the risks have increased, financial markets are signalling greater calm for now – futures contracts suggest that gas prices in the autumn could remain close to their current level. Market participants currently rate the probability of supply disruptions as limited, or expect supply chains to stabilise over time. These expectations could change rapidly, however, if the geopolitical situation deteriorates,” Purgailis adds.
Differing consumer responses to rising energy prices across the Baltics
A regional nuance is also worth highlighting: in Latvia and Estonia, demand falls in several retail segments after energy prices rise, while in Lithuania the opposite trend is seen in those same categories.
In Latvia and Estonia, spending shrinks on fuel, cosmetics and medical goods, for example, as well as on information and communications equipment. In Lithuania, by contrast, higher energy prices in these categories are more often associated with an increase in spending rather than a decrease.