Iran war driving up inflation and slowing growth in euro area and Finnish economies
The Governing Council of the European Central Bank (ECB) decided at its meeting yesterday to raise the key ECB interest rates. “The interest rate increase is intended to keep inflation expectations firmly around the target and to help prevent price pressures spilling over from energy to other prices and to wages,” says Governor of the Bank of Finland Olli Rehn.
“The ECB Governing Council will continue not to pre-commit to a particular rate path, but instead we are strongly committed to stabilising inflation at our 2% target in the medium term. We will take decisions meeting by meeting and always on the basis of incoming data and other information,” emphasises Rehn.
The outlook for growth in the euro area economy has weakened during the spring as the Middle East crisis continued to unfold. According to the Eurosystem macroeconomic projections released yesterday, the euro area economy will grow by 0.8% this year, 1.2% next year and 1.5% in 2028. In addition to the projections, assessment of the impacts on growth and inflation is supported by the Eurosystem's preparation of alternative scenarios.
Although the inflation statistics contain first indications of the indirect effects of the crisis, there are at least no signs yet of critical second-round effects. The Eurosystem projections foresee inflation averaging 3.0% this year, 2.3% next year and 2.0% in 2028.
The unpredictable operating environment and higher prices of imported energy in Europe are also adversely affecting the Finnish economy, but economic growth is forecast to gradually strengthen in Finland.
The situation in the Middle East is reflected in the Finnish economy through interest rates as well. Since the majority of residential mortgages and corporate loans in Finland are variable rate loans, changes in market interest rates are quickly evident in interest payments. Market rates have been anticipating yesterday's ECB interest rate increase and have risen in recent months. “Yesterday's rate increase has already been reflected in anticipatory market rate rises during the spring, and so this is not a sudden movement in lending rates for borrowers in Finland. The key ECB interest rates were raised in order to maintain price stability in the euro area, which is also in the interests of Finns,” says Governor Rehn.
Challenges for Finland’s public finances will continue
The general government deficit remains high and Finland’s debt ratio is forecast to continue rising. Higher borrowing costs and increased defence expenditure will make the Government's fiscal consolidation efforts more challenging in the coming years.
In January, the Council of the European Union opened an excessive deficit procedure for Finland, giving it until 2028 to put an end to its excessive deficit. Forecasts suggest that more time will be needed for this. However, securing debt sustainability is not solely about complying with EU rules. It is important that the markets, households and businesses are able to see that the trajectory of Finland’s public finances is being brought under control.
“The gathering pace of growth in the economy in 2027 indicated by the forecast will provide a good opportunity to implement fiscal consolidation measures, and this chance should not be missed. There would in fact be good grounds for adjusting the fiscal stance in the government budget session in the autumn. Instead of choosing to loosen fiscal policy, it would be good to design it to be neutral,” says Rehn.