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ECB Says Baltic States’ Euro Adoption Challenged by Inflation

The European Central Bank said the countries most likely to join the euro next, Latvia and Lithuania, face a “challenging” inflation outlook that could hamper their convergence with the single currency.

“Maintaining low inflation rates at all times in Latvia will be challenging in the medium term, given monetary policy’s limited room for maneuver under the fixed exchange-rate regime,” the Frankfurt-based central bank said today in its 2012 Convergence Report. In Lithuania, “it may be difficult to prevent macroeconomic imbalances, including high rates of inflation, from building up again,” the ECB said.

All members of the 27-country European Union, with the exception of the U.K. and Denmark, are in a so-called convergence process, and Latvia and Lithuania are next in line to switch currencies. The two Baltic nations peg their currencies to the euro with the official government goal of joining the monetary union in 2014.

The ECB said the 12-month average rate of inflation in the reference period from April 2011 to March 2012 was 4.2 percent in Lithuania and 4.1 percent in Latvia, both “well above the reference value of 3.1 percent for the criterion on price stability.”

Six other countries, which unlike Latvia and Lithuania, are not in the final stage of the convergence process by being members of the so-called Exchange Rate Mechanism II, are also candidates for eventual membership of the euro. Of Bulgaria, the Czech Republic, Hungary, Poland, Romania and Sweden, none met all conditions on price stability, government deficits or legal rules on central bank independence.

Three out of the eight countries met the ECB’s target on price stability, and all apart from Sweden are subject to an EU decision on excessive deficits. None of the nations met ECB requirements regarding central bank independence.

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