Latvijas Banka has revised its macroeconomic forecasts

Latvijas Banka has published its latest macroeconomic forecasts (prepared in October 2024). Projections indicate that Latvia will experience low inflation (1.3%) and sluggish GDP growth (0.6%) in 2024.

Interest rates continue to decrease. 

– Monetary policy tightening has helped reduce inflation in the euro area and Latvia, allowing the Governing Council of the European Central Bank (ECB) to continue lowering the key ECB interest rates. 

– The euro area inflation continued to decline as projected. According to the ECB September projections, the euro area inflation is expected to reach 2.5% this year and will continue declining in 2025, approaching the 2% target set by the Governing Council of the ECB. 

– On 12 September, the Governing Council of the ECB decided to review the current degree of monetary policy restriction and to lower the key euro interest rate – the deposit facility rate – by 25 basis points. In addition, as announced on 13 March 2024 following the operational framework review, the spread between the interest rate on the main refinancing operations and the deposit facility rate was set at 15 basis points.

– The future decisions on the euro interest rates will also be based on the assessment of the inflation outlook, in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. 

Inflation in Latvia is low; however, growth in service prices remains resilient.

– Inflation in Latvia has been low since the beginning of this year, with inflation data of the recent months being slightly lower than projected in June 2024. Since the preparation of the June forecasts, certain energy and agricultural product futures prices have fallen. Consequently, Latvijas Banka’s inflation forecast for 2024 has been revised to 1.3%, down from 1.5% projected in the June 2024 forecast.

– The inflation forecast for the next two years has also been revised down to 1.5% for 2025 and to 1.6% for 2026, from 2.1% and 1.8% in the June forecast respectively. Energy price movements are expected to lower inflation. Meanwhile, the impact of domestic factors on price developments will persist for a longer period. Risks to the inflation forecast are maintained by the geopolitical uncertainty that does not allow the exclusion of significant energy and commodity price fluctuations in global markets.

– Weakening labour demand in Latvia can be viewed as short-lived. A minor increase in unemployment and the planned cap on growth of the public sector remuneration fund will hinder average wage growth in the short term, while the impact of limited labour supply will prevail in the medium term.

– Wage growth still exceeds the rise in labour productivity, thus weakening competitiveness. Latvia’s export share in the external market will be affected not only by the ability to adapt to structural shifts in the external market, but increasingly also by the dynamics of relative costs. The challenges of competitiveness will replace the previously dominating impact of the weak external market on Latvia’s export.

The revival of GDP growth is held back by cautious confidence of consumers and businesses. The medium-term outlook for GDP growth has become more pessimistic due to a decline in competitiveness.

– The GDP forecast for 2024 has been significantly revised downwards to 0.6% (as opposed to the published June forecast of 1.8%). This revision is driven by weaker than expected growth in the first half of the year and the benchmark revision of national accounts carried out by the Central Statistical Bureau of Latvia. The sentiment of economic agents remains cautious, also implying a more sluggish growth rate in the second half of the year.

– Due to lower levels of private consumption and investment, the GDP forecast for 2025 has been revised downwards from 3.3% to 2.6% compared to the published 2024 June forecast. Despite the surge in real wages, private consumption is currently contained by the restoration of savings following a period of high inflation. The build-up of savings is also motivated by the pessimistic sentiment of consumers. Meanwhile, investments are hindered by delays in implementing projects related to the use of European Union (ES) funds, declining profitability across several sectors, and caution among lenders. The issue of new loans could be further stimulated by a more significant fall in interest rates.

– The October outlook for economic growth in 2026 has become more modest compared to June: 3.0% (the June forecast – 3.8%). Economic growth will be supported by the components of private consumption, investments, and export. Nevertheless, their increase is estimated to be slower than projected in the June forecast, with weaker competitiveness playing a more significant role.

The budget deficit will exceed 3% of GDP, and government debt will grow further.

– The budget deficit is expected to stand above 3% of GDP throughout the entire projection horizon. The deficit assessment for 2024 has improved compared to the June projections on account of labour tax revenue growth that was driven by the substantial rise in wages in the economy.

– However, lower GDP in the medium-term (a significant impact of data revision and lower growth estimates) makes the budget deficit-to-GDP ratio less attractive than projected in June. Owing to these factors, the government debt is also projected to be higher than last year. In light of the need to borrow, the government debt level will be approaching 50% of GDP in the coming years.