Average inflation in Bulgaria will remain high this year and there was "a considerable risk" that recent one-off effects would translate into an even more significant and protracted increase in inflation, the European Central Bank (ECB) said in its latest convergence report on May 7 2008.

The report is the first issued by the ECB after Bulgaria joined the European Union in January 2007.

Between April 2007 and March 2008, the 12-month average rate of the harmonised index of consumer prices inflation was 9.4 per cent. The ECB uses the indicator to assess a country's readiness to adopt the euro under the price stability criterion.

On the basis of the most recent information, the figure is expected to rise further in the coming months, before dropping to around six percent in 2009, according to the bank. The main risks were with larger-than-expected increases in administered prices, as well as in energy and food prices, which combine to account for 40 per cent of Bulgaria's harmonised index of consumer prices.

"Buoyant growth in employment and output growth, as well as a sharp decrease in unemployment, imply a risk of further rises in unit labour costs and, more generally, in domestic prices. In the current economic environment of high inflation and strong growth, there is also a considerable risk that increases in inflation due to one-off effects will lead to second-round effects, which could translate into an even more significant and protracted increase in inflation," the ECB report said.

As Bulgaria's economy catches up with the rest of the EU, that is also likely to push inflation higher in coming years, given that gross domestic product per capita and price levels are still significantly lower in Bulgaria than in the euro area.

To achieve sustainable convergence, Bulgaria had to maintain a tight fiscal policy, ECB said, repeating the message Bulgaria has been hearing from the International Monetary Fund for years.

"In particular, restraining public sector wage growth is important for achieving a reduction in wage growth in the private sector," the report read.

Strong economic growth and dropping unemployment have already led to capacity shortages and signs of labour market tightness in a number of sectors, which put pressure on prices and wages alike. To deal with that, Bulgaria should implement targeted measures to increase human capital and to enhance the flexibility of its labour market, ECB said.

Price stability is one of the two criterions, the other one being exchange rate, on which Bulgaria does not meet the requirements to adopt the common European currency. The other two requirements - government budgetary position and convergence of long-term interest rates - were within ECB's limits.

Additionally, Bulgaria had to amend a number of provisions to the law on the Bulgarian National Bank, which do not comply with all the requirements for central bank independence and legal integration into the euro system, before it can adopt the euro, the ECB report said.