Summary

Economic growth in Slovenia exceeded expectations in the second quarter despite heightened geopolitical tensions globally. The limited set of available data and estimates also point to continued growth in the third quarter. Inflation remains elevated.

Euro area economic growth of 0.4% in the second quarter exceeded expectations, pointing to the resilience of the economy despite heightened geopolitical tensions and high energy prices. Survey indicators for July and August suggest that growth continued, particularly amid a strengthening of activity in manufacturing. Risks to further growth nevertheless remain elevated owing to persistent geopolitical uncertainty, as reflected in relatively weak business confidence. Following the renewed escalation of the conflict in the Middle East, headline inflation rose to 2.9% in July. In addition to energy prices, the increase reflected higher core inflation, at 2.5%, although the latest data do not yet point to more pronounced indirect effects.

At its June meeting, amid heightened inflationary pressures, the ECB Governing Council raised all three key ECB interest rates by 0.25 percentage points. At its July meeting, it left them unchanged. The Governing Council justified its July decision with the assessment that, despite the risk of higher inflation, the level of interest rates following the June increase provided a good basis for further action. At its June and July meetings, the US Federal Reserve (the Fed) left its policy rate unchanged due to uncertainty surrounding the impact of the conflict in the Middle East on the long-term path of inflation in the US. In view of persistently higher energy prices, investors expect one increase in the Fed’s key policy rate this year, while one to two further 0.25 percentage point increases in the key ECB interest rates are expected.

Developments in financial markets since the beginning of July have been shaped primarily by the breakdown of the ceasefire between the US and Iran and by further disruptions to energy supplies. Yields on US and German government bonds increased over this period, amid stronger expectations that disruptions to energy supplies would accelerate price growth. At the same time, major global equity indices mostly increased, owing to the more favourable earnings results of large companies and renewed optimism regarding the growth of the artificial intelligence sector. The value of the US dollar declined since the beginning of July following the release of weaker US macroeconomic data, while oil and gold prices increased.

Economic growth in Slovenia significantly exceeded expectations in the second quarter; GDP increased by 1.8% quarter-on-quarter and by as much as 5.0% year-on-year. Robust growth continued to be driven primarily by domestic consumption and investment, particularly in construction, which was further supported by ongoing government infrastructure projects, while long-term lending also increased. Sustained real growth in the wage bill and favourable conditions in tourism contributed to a notable strengthening of services, while export growth also boosted activity in logistics. The growth of value added in manufacturing accelerated markedly despite challenging international conditions, with improvements observed across most sectors. Economic sentiment indicators and other high-frequency data suggest that growth will continue in the third quarter, although at a more moderate pace. Forecasting models currently estimate quarterly GDP growth at 0.5%.

International trade strengthened in the second quarter. The growth of nominal goods trade was strongly influenced by increased trade in petroleum and petroleum products. Otherwise, the year-on-year growth of goods exports was mainly driven by the pharmaceutical and automotive sectors. The growth of goods imports was particularly supported by imports of intermediate goods, reflecting frontloading in procurement and increased domestic production activity; price increases also had a significant impact on nominal growth. Service exports also strengthened, especially in transport services and travel. Data on the number of overnight stays by foreign tourists indicate a favourable tourist season. The 12-month current account surplus reached 3.6% of GDP, contributed exclusively by the services trade balance, while the goods trade balance was again in deficit.

In the labour market, the number of persons in employment remained stable over the summer months, while substantial differences across activities persisted. Employment in manufacturing continued to decline, while increasing in services. As economic activity picked up, firms’ employment expectations strengthened. However, labour shortages remain pronounced, prompting firms to continue hiring foreign workers. Unemployment remains at historically low levels. Wage growth strengthened to 8.3% in June, mainly reflecting the continued implementation of the public-sector pay reform. Amid stronger economic growth, labour productivity improved, while real wage growth remains high.

Headline inflation, as measured by the HICP, increased to 3.4% in August. It has thus remained above 3% since April this year. Price developments in recent months have been driven primarily by energy prices, particularly motor and liquid fuels, whose pronounced increase has been partly offset by government measures. However, food price growth remains relatively low for now, while higher energy prices and the exceptionally dry weather this summer pose significant upside risks. Some price pressures are already emerging along production chains, particularly for intermediate goods. Growth in other goods prices has nevertheless remained subdued, so that core inflation, i.e. inflation excluding energy and food prices, is almost entirely driven by services prices. In August, core inflation stabilised at 2.5%, while services inflation stood at 4.3%, supported by strong growth in labour costs and robust private consumption.

The deficit of the consolidated general government balance increased year-on-year despite solid revenue growth, reaching EUR 1.3 billion in the first seven months, which is approximately EUR 0.3 billion more than in the same period last year. Social security contributions recorded robust growth, while on the expenditure side, the wages and social security contributions of public sector employees, investment, and long-term care services stand out. The largest share of the deficit originates from the state budget, for which a budget revision is currently being prepared. Budgetary plans for the next two years are also in preparation, with the key challenge being to ensure the medium-term sustainability of government debt and expenditure control. Public finances remain exposed to numerous risks, including those related to defence expenditure, energy prices, demographic trends, the green transition, and post-flood reconstruction. Additional uncertainty arises from the potential implementation of measures under the Intervention Act to Promote the Development of Slovenia.

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In this issue, we take a closer look at energy shocks and their impact on the European and domestic economies, both of which are heavily dependent on energy imports. Through higher energy costs, energy shocks feed into inflation and weigh on economic activity by putting pressure on cost competitiveness and reducing households’ purchasing power and firms’ profitability. Their transmission to inflation and the economy varies across countries depending on market characteristics, regulation, tax policy and the energy intensity of production. Energy shocks also intensify competitive pressures from third countries that are more energy self-sufficient, while high energy prices may reduce the attractiveness of investment. Adapting to energy shocks therefore requires greater energy efficiency, economic restructuring and adequate sources of financing for the green transition. An analysis of bank financing shows that energy shocks do not encourage banks with greater exposure to carbon-intensive firms to finance investments in greater energy efficiency. This points to scope for further developing approaches to financing investments that reduce firms’ exposure to fluctuations in the prices of imported energy products.

However, adapting to energy shocks depends not only on the responses of firms and the financial system, but also on adequate support from economic policies. Monetary policy cannot fully offset the direct inflationary effects of energy shocks, but it can limit their persistence and contribute to anchoring inflation expectations. Fiscal measures have also helped mitigate price pressures during the two most recent energy crises, but at the same time increased the general government deficit. Greater fiscal flexibility at the EU level now gives countries more room for manoeuvre to support investment in energy resilience and the green transition. Economic policies can thus help mitigate the short-term effects of energy shocks and create the conditions needed for the economy to adapt over the longer term.

1International Environment

Global economic activity remained positive in the second quarter despite increased geopolitical uncertainty and strong energy price growth, while survey indicators suggest that it continued to expand at the beginning of the third quarter.

Economic growth in the major economies remained positive in the second quarter, even though geopolitical tensions and uncertainty remained elevated. In the United States (US), the economy grew by 0.4%, somewhat below market expectations. Private consumption was a positive surprise, strengthening after a weaker first quarter. Investment, particularly in artificial intelligence technologies, continued to make a significant contribution to growth, while the contributions of net exports and government consumption were negative. In the United Kingdom (UK), economic growth continued at 0.4%, slightly lower than in the previous quarter, when it stood at 0.6%. Growth was driven primarily by investment in information technology and private consumption. In Japan, economic growth surprised on the downside at 0.3%. Cost pressures related to the war in the Middle East contributed to weaker growth by dampening domestic demand. Amid heightened uncertainty, the contribution of investment was also negative, while exports contributed positively to growth. In China, economic growth slowed to 0.9%. Net exports remained the main driver of growth, while domestic demand remained weak.

According to survey indicators, global economic activity continued to grow at the beginning of the third quarter. The composite PMI increased to 52.6 index points in July, driven mainly by stronger growth in services, indicating an improvement in consumer confidence amid lower energy prices and, consequently, higher disposable income (Figure 1.1, left chart). By contrast, growth in manufacturing slowed slightly, partly owing to the fading effects of frontloading and lower inventory accumulation amid lower energy prices.[1] Nevertheless, the growth rate in manufacturing remains relatively high, supported by strong demand for artificial intelligence-related information technology. Pressures in global supply chains continued to ease in July, as reflected in lower input price pressures and a further decline in the Global Supply Chain Pressure Index (GSCPI, Figure 1.1, right chart).

The euro area economy remained resilient in the second quarter, while survey indicators point to continued growth in the third quarter.

The euro area economy proved more resilient than expected in the second quarter, as the deterioration in the near-term economic outlook indicated by survey indicators at the onset of the war in the Middle East did not materialise in economic activity. Excluding Ireland, the economy expanded by 0.3%, the same rate as in the first quarter, while growth in the euro area as a whole was 0.1 percentage points higher (Figure 1.2, left). According to monthly indicators, growth was driven mainly by services and manufacturing, while activity in construction and retail trade remained weak (Figure 1.2, right). Among the larger euro area economies, growth was highest in Spain, at 0.7%, while it stood at 0.3% in Germany and 0.2% in Italy, whereas economic activity stagnated in France.

The resilience of the euro area economy appears to have continued into the third quarter, according to survey indicators. These strengthened in July and August despite the renewed escalation of geopolitical tensions in the Middle East and a renewed rise in energy prices. The composite PMI stood at 52.1 in August, with manufacturing activity expanding at its fastest pace since May 2022 and services activity continuing to grow steadily. Manufacturing activity was supported by stronger demand, partly related to frontloading and inventory building amid renewed geopolitical uncertainty. Additional support came from demand for technology products related to artificial intelligence and higher defence spending. The resilience of the euro area economy is also reflected in the ZEW indicator of economic sentiment, which rose in August to its highest level in six months and exceeded market expectations. Despite favourable current developments in activity and sentiment indicators, downside risks to growth remain elevated, particularly owing to uncertainty surrounding further geopolitical developments, as reflected in weak business confidence.

Headline inflation in the euro area strengthened in July, following renewed escalation of tensions in the Middle East.

Year-on-year price growth in the euro area, as measured by the HICP, increased by 0.1 percentage point to 2.9% in July (Figure 1.3, left). The uptick was driven by energy prices and core inflation, while food price growth declined. Energy prices were 10.3% higher in year-on-year terms, up from 8.5% in June when monthly declines were recorded due to lower global oil prices, which reflected improved prospects for conflict resolution in the Middle East. In addition to higher global market prices, refining costs and margins are once again also contributing significantly to energy inflation, while some fiscal measures implemented by the Member States to curb retail fuel prices also expired in June.[2]

Conversely, year-on-year food price growth continued to decline, reaching 1.2% (1.5% in June). Processed food inflation, standing at 0.7%, continued its months-long downward trend under the influence of previous moderation in global food commodity prices and year-on-year cheaper imported and domestic manufactured food products (Figure 1.3, right). Similarly, growth in unprocessed food prices slowed to 2.4%, which is 0.7 percentage points less than in June. This was driven by further moderation in year-on-year rates for fresh fruit, vegetables, and meat. In the coming months, higher cost pressures related to the ongoing increases in energy prices may be reflected in food prices; additional upside risks are posed by the effects of summer heatwaves and the occurrence of El Niño.

Core inflation, i.e. inflation measured excluding energy and food prices, increased by 0.1 percentage point to 2.5% in July. This is partially due to services inflation, which, at 3.3%, was 0.1 percentage point higher than in the previous month and has remained slightly above 3% for over a year. The limited movement continues to be accompanied by relatively stable domestic price pressures, while the newly published ECB indicators signal no major changes in the labour market up to the first quarter of 2027. Year-on-year growth in the prices of non-energy industrial goods (hereinafter: other goods) increased to 0.9% (0.7% in June) in continuation of their slightly higher growth, which coincides with increased pressures along the pricing chain (Figure 1.3, right).

In July, headline inflation in Slovenia was 0.1 percentage point higher than in the euro area. The difference was 0.8 percentage points lower than in June, mainly due to the moderation of the still larger contribution of energy prices in Slovenia, which resulted from the base effect dropping out of the year-on-year rate calculation for electricity and continued regulation of fuel prices. The difference in core inflation was the same, i.e. 0.1 percentage point. The range of headline inflation among the euro area Member States amounted to 3.4 percentage points. For the second consecutive month, Lithuania recorded the highest headline inflation (5.4%), while Estonia had the lowest (2.0%).

2Monetary Policy, Financial Markets and Terms of Financing

2.1Monetary policy and financial markets

In June, the Eurosystem raised the interest rate on the marginal deposit facility to 2.25%, while the Fed left its policy rate unchanged within the corridor of 3.50% to 3.75% at its two most recent meetings.

In June, the ECB Governing Council raised all three key ECB interest rates by 0.25 percentage points. ECB experts assessed that the war in the Middle East was generating inflationary pressures. The decision to raise interest rates was also considered appropriate across a range of scenarios regarding the evolution of the price shock and its impact on the medium-term outlook for the euro area. At its July meeting, the Governing Council left the interest rates on the deposit facility, the main refinancing operations and the marginal lending facility unchanged at 2.25%, 2.40% and 2.65%, respectively. Given that the inflationary impact of the energy shock has not yet fully materialised, the Governing Council is paying particular attention to monitoring the intensity and duration of the shock, and its indirect and second-round effects.

At both its June and July meetings, the Fed left its key policy rate unchanged within the range of 3.50% to 3.75%, reflecting uncertainty surrounding the impact of the conflict in the Middle East on the long-term path of inflation in the US. Policy rates also remained unchanged at recent meetings in the UK (3.75%), Switzerland (0%), Canada (2.25%), Sweden (1.75%) and Australia (4.35%). At its June meeting, the Bank of Japan raised its policy rate by 0.25 percentage points to 1.00%, in response to persistently elevated inflationary pressures. At its July meeting, it left the rate unchanged.

Since June, expectations have strengthened that disruptions to energy supplies caused by the war in the Middle East will last longer than initially anticipated. Consequently, investors expect central banks to tighten their monetary policy stances. Current overnight index swap (OIS) rates indicate that financial markets now expect one to two further 0.25 percentage point increases in the key ECB interest rates by the end of 2026, which would bring the deposit facility rate to 2.75% (Figure 2.1.1, left). Since the beginning of July, expectations regarding monetary policy tightening by the Fed have decreased slightly, primarily due to somewhat weaker economic growth than previously expected. Nevertheless, market participants expect the Fed to raise its key policy rate by 0.25 percentage points this year, to a range of 3.75% to 4.00%.

The main global equity indices and yields on German and US government bonds have increased since the beginning of July. Energy prices remain elevated.

Amid heightened expectations of a more persistent increase in inflation and a more restrictive monetary policy stance by the ECB and the Fed, yields on German short-term government bonds have risen by 0.38 percentage points since the beginning of July, whereas yields on German long-term government bonds increased by 0.42 percentage points (Figure 2.1.1, right). Yields on US short-term treasuries similarly increased by 0.14 percentage points, while yields on US long-term treasuries rose by 0.24 percentage points. The increase in yields on US treasuries was constrained by recent releases of weaker than expected economic data. Spreads between yields on euro area bonds with higher credit risk and German government bonds narrowed, despite the continuing war in the Middle East, primarily due to more favourable economic data releases in the euro area. Consequently, investors expect fewer credit rating downgrades of European companies.

Major global equity indices have increased since the beginning of July despite geopolitical uncertainty (Figure 2.1.2, left). This was driven primarily by favourable second-quarter earnings releases by listed companies and by investor optimism regarding growth of the artificial intelligence sector. Consequently, the index comprising the seven largest US tech firms (the Magnificent Seven) has risen by 6.8% since the beginning of July, while the main US index, the S&P 500, has gained 2.8% and is currently close to the record levels reached in the first half of August. Similarly, the main European index, the STOXX Europe 600, has increased by 2.1% since the beginning of July, but currently stands 0.8% below its record level from the first half of August. The tech-oriented Hang Seng index in Hong Kong gained 11.3% over the period, reflecting increased optimism in the tech sector.

The value of the US dollar against the euro has declined by 1.5% since the beginning of July, primarily owing to less favourable US labour market data releases, intervention by the US government in support of the Japanese yen, and the Treasury’s announcement of a programme to purchase long-term US sovereign bonds, which raised investor concerns regarding US fiscal credibility. The value of the dollar against a basket of the major global currencies followed a similar path and currently stands 1.6% below its level at the beginning of July (Figure 2.1.2, right). The price of gold has increased by 10.6% since the beginning of July, while the price of Brent crude oil has risen by 24.1%, following the breakdown of the ceasefire between the US and Iran and further disruptions to energy supplies.

2.2Credit activity and financing conditions

Credit activity in Slovenia remains stronger than in the euro area, particularly for households.

Annual growth in loans to households reached 8.5% in July, compared with 3.1% in the euro area, with the difference mainly driven by housing loans, which grew by 9.7% in Slovenia and 3% in the euro area (Figure 2.2.1). Despite strong loan growth, the latest Bank Lending Survey (BLS) data point to a decline in demand for housing loans in both economies, which could translate into a gradual moderation in credit growth over the coming months. The decline in demand also reflects higher borrowing costs following the recent upward turn in interest rates and points to a possible moderation in housing market activity.

Growth in loans to non-financial corporations (NFCs) is also higher in Slovenia than in the euro area (Figure 2.2.1). In July, annual growth stood at 6.9%, compared with 4.4% in the euro area. In Slovenia, long-term loans grew more strongly (7.6%) than short-term loans with a maturity of up to one year (0.4%), while the opposite was observed in the euro area (3.9% and 7.3%, respectively). The difference partly reflects base effects, as growth in short-term loans in Slovenia was higher last year, while growth in long-term loans was low or negative. Despite the strengthening of long-term lending, this cannot be directly linked to corporate investment activity, as previous analyses for Slovenia point to a relatively weak causal relationship between investment and bank lending.[8]

Following the previous decline, lending and deposit rates have turned upwards in recent months, while borrowing conditions for households in Slovenia remain more favourable than in the euro area.

The upward turn in lending rates reflects a shift in expectations regarding the future path of the ECB’s key interest rates and their increase in June (Figure 2.2.2, left). In Slovenia, the interest rate on new housing loans stood at 3.1% in June, remaining below the euro area rate of 3.5%, while the rate on new loans to NFCs, at 3.9%, was broadly in line with the euro area average of 3.8%. Despite the recent upward turn, the cost of new borrowing in Slovenia thus remains relatively favourable, particularly for households.

An upward turn has also been observed in deposit rates in recent months, although they remain considerably lower in Slovenia than in the euro area (Figure 2.2.2, right). The interest rate on new household term deposits stood at 1.3%, compared with 2.1% in the euro area, while overnight deposits were remunerated at 0.08% and 0.28%, respectively. As with lending rates, the renewed increase in deposit rates is related to changing expectations regarding monetary policy and the increase in the ECB’s key interest rates in June. Lower deposit rates in Slovenia reduce households’ incentives to shift funds into term deposits and allow banks to maintain relatively favourable deposit funding costs. This is further supported by the structure of household deposits, with overnight deposits accounting for 87% of total household deposits in Slovenia, compared with 56% in the euro area.

3Domestic Economic Activity

The acceleration of GDP growth in the second quarter was broadly based on both the demand and supply sides, with manufacturing performing better than expected given the uncertain international environment.

In the second quarter, economic conditions were better than expected, especially considering the heightened geopolitical tensions. GDP growth accelerated again, reaching 1.8% quarter-on-quarter and 5.0% year-on-year, significantly outpacing the euro area average. Domestic demand factors continued to dominate the growth structure, while stronger exports also contributed to favourable production results in manufacturing.

All components of domestic demand contributed to strong GDP growth, with investment in fixed assets once again providing the most significant boost. For the second consecutive quarter, these investments were up 13.2% year-on-year. Within this category, construction investment remained dominant, largely linked to government infrastructure projects, which this year have been influenced by local elections and the completion of EU funding from the Recovery and Resilience Plan. Despite high uncertainty, investment in equipment and machinery also increased considerably, accompanied by stronger long-term lending (see also subsection 2.2). Together with higher investment in intellectual property, this is favourable for the economy’s development potential. Private consumption was further strengthened by solid labour market conditions and continued real growth in the wage bill, with households notably increasing purchases of durable goods – most prominently, the number of passenger car registrations rose by 12.7% year-on-year. Final consumption was also visibly supported by the government, driven by the implementation of long-term care entitlements and additional hiring in this sector. Amid robust domestic consumption, strong import growth was a key factor behind the negative contribution of net trade to GDP growth (Figure 3.1, left).

Strong domestic demand and more favourable exports resulted in high value-added growth across most activity groups (Figure 3.1, right). Construction continued to stand out, with value added up 15.9% year-on-year. Activity increased in all segments, most notably in civil engineering. Private services accelerated, among them logistics benefited from stronger goods trade. At the same time, demand in the domestic market was further supported by growth in tourism. Value added in public services also continued to strengthen. In a challenging international environment, manufacturing surprised with a strong rebound. Compared with the first quarter, year-on-year value added growth accelerated by 3.5 percentage points to 4.3% – the highest since the end of 2024. Compared with the beginning of the year, conditions improved in most sectors, including energy-intensive ones. Among sectors, the pharmaceutical industry made a significant contribution to the overall acceleration in production (for a longer-term perspective on manufacturing activities, see Box 3.3).

According to preliminary data, favourable economic conditions continued in July and August.

Business confidence improved noticeably after declining with the outbreak of war in the Middle East (Figure 3.2, left). The value of the economic sentiment indicator edged down slightly in August, but remained above this year’s and last year’s averages. Confidence remains high in private services, including trade, where companies assess current and expected sales very positively. It is also stable in construction, although in recent months there has been more caution in estimates of expected orders. Conditions in manufacturing remain solid given the challenging international environment. In August, confidence declined somewhat due to higher inventories and less favourable assessments of expected production, but evaluations of export and total orders improved again.

In August, consumers were more cautious in their assessments of future financial and economic conditions and major purchases, but their confidence remained significantly higher than a year ago. Continued robust spending in the domestic market during the summer months is also indicated by the real values of card payments and ATM withdrawals, as well as tax-confirmed receipts in July (Figure 3.2, right). The first was up 4.0% year-on-year, and the second by 5.1%, both exceeding the average growth in the second quarter. For the same month, solid economic conditions are also reflected in increased retail sales, the number of tourist overnight stays, and building permits.