Renewed tensions between the United States and Iran have once again raised concerns about a broader conflict in the Middle East, sending oil prices sharply higher. Following the latest escalation, the price of Brent crude rose by around 20 dollars per barrel. While the increase is unlikely to trigger a significant inflation shock in the Baltic states in the short term, a prolonged period of elevated prices would place considerably greater pressure on the region’s economies, according to Kārlis Purgailis, Chief Economist at Citadele Bank.
Brent crude has climbed from around 70 dollars to 90 dollars per barrel within a short period. Although a 20 dollar increase may appear moderate, its economic impact depends not only on the size of the price rise but also on how long it lasts. A one-day spike has little lasting effect, whereas persistently high oil prices over several months gradually filter through the wider economy.
Oil affects inflation through two main channels. The first is direct and immediate: higher crude prices quickly translate into more expensive fuel, heating and transport, pushing up headline inflation. The second is indirect and slower, as businesses gradually pass higher energy and transport costs on to consumers through the prices of goods and services. This is reflected in core inflation, which excludes volatile energy, food, alcohol and tobacco prices. While core inflation responds more slowly, it is typically more difficult to bring back down.
The immediate impact depends largely on how much households spend on petrol and diesel fuel.
According to Citadele,
fuel accounts for nearly 6% of Lithuania’s consumer basket, making it the most exposed of the Baltic states.
Latvia follows with around 4%, while Estonia’s share is approximately 3.7%, close to the eurozone average.
Citadele’s economic model suggests that if Brent crude stabilised at around US$85 per barrel and remained at that level for two months, the inflationary impact would be noticeable but moderate. Headline inflation in the eurozone would increase by approximately 0.57 percentage points during the first year, assuming other factors remain unchanged.
The Baltic states would experience a somewhat stronger effect. Headline inflation would rise by around 0.82 percentage points in Lithuania, 0.66 percentage points in Latvia, and 0.60 percentage points in Estonia.
The impact on core inflation under this scenario would be significantly smaller, increasing by less than one-tenth of a percentage point across all three Baltic countries.
If tensions in the Middle East were to escalate further and Brent crude reached 100 dollars per barrel, remaining at that level for an extended period,
the inflationary impact would be roughly 50% greater.
In that scenario, headline inflation in the eurozone would increase by around 0.85 percentage points. The Baltic states would again be affected more strongly, with inflation rising by approximately 1.22 percentage points in Lithuania, 1.0 percentage point in Latvia, and 0.9 percentage points in Estonia.
Core inflation would continue to respond more gradually, increasing by around 0.1 percentage points in the eurozone and approximately 0.2 percentage points across the Baltic states. In this measure, Latvia (0.19) and Estonia (0.18) would see a slightly stronger impact than Lithuania (0.16) because their economies are generally more energy-intensive and household energy costs account for a larger share of disposable income.
According to Purgailis, the longer oil prices remain elevated, the greater the risk that higher fuel costs will spread across the wider economy. Businesses would gradually incorporate higher transport and energy costs into the prices of other goods and services, while workers could demand higher wages to offset declining purchasing power.
If employers agree to larger wage increases,
part of those additional labour costs would ultimately be passed on to consumers, creating a second wave of inflation.
“This second-round effect is the greatest concern for central banks because it is much harder to control than the initial energy price shock,” Purgailis explained, noting that increases in core inflation typically unfold gradually over one to two years, rather than immediately.
For now, the recent rise in oil prices does not by itself point to a prolonged inflation problem. The direct impact remains measurable but limited. However, if elevated oil prices persist for several months, the Baltic states are likely to experience somewhat stronger inflationary pressures than the eurozone as a whole.
Read also: Hungary’s OTP Bank to acquire Baltic lender Luminor