Macroeconomic forecasts | June 2024

Lowering of interest rates

Monetary policy tightening has helped significantly reduce inflation in the euro area, allowing the Governing Council of the European Central Bank (ECB) to take a decision to lower the key ECB interest rates.

According to the latest ECB projections, inflation is expected to be approximately 2.5% this year and it will continue declining in 2025, approaching the 2% target set by the Governing Council of the ECB.

The future decisions on the ECB interest rates will also be based on the assessment of the inflation outlook, inter alia considering the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission.

The Governing Council of the ECB decided to advance the normalisation of the Eurosystem's balance sheet by reducing its portfolio of the pandemic emergency purchase programme (PEPP) by 7.5 billion euro per month on average over the second half of the year. Moreover, the Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

Inflation in Latvia remains low, ranking among the lowest in the euro area

During the first months of 2024, electricity and heat supply prices declined, while prices for various services, including the administratively regulated prices, increased. In addition, indirect taxes were raised in this period. Meanwhile, prices for food and industrial goods fluctuated in certain months due to price volatility resulting from sales. Global supply chain disruptions caused by geopolitical tensions have not significantly affected the prices of industrial goods.

Over the next two years, inflation is projected to stand at roughly 2% (2.1% and 1.8% in 2025 and 2026 respectively). As the impact of energy prices on the average price rise diminishes, domestic factors are becoming more influential in driving price developments.

Amid low unemployment and wage increases that substantially outpace productivity, Latvia's labour market remains tight. Wages are expected to sustain growth of over 7% also in the medium term. These wage increases will contribute to a situation where the core inflation rate (3%–4%) remains persistently higher than the headline inflation.

While GDP growth will be sluggish in 2024, it is expected to strengthen in the coming years

Since estimates suggest lower levels of private consumption and investment, the forecast for 2025 has been revised downwards from the 2024 March forecast (from 3.6% to 3.3%). Although less impactful than projected earlier, domestic demand will remain the primary driver over the short term. Moreover, demand growth will be significantly supported by government investment.

The forecast for GDP growth in 2026 has remained unchanged at 3.8%. Faster growth will be supported by stronger private consumption and investment as well as exports.

The poor performance in exports observed so far can be attributed to the weakness in Latvia's export market, rather than a decline in its competitiveness. Nonetheless, concerns about competitiveness remain as relatively steep wage increases, exceeding those of Latvia's trade partners and outpacing productivity growth, are weakening the cost competitiveness of exporters, making it more difficult for them to maintain and expand their market shares.

Budget deficit has increased year on year, and government debt is expected to grow further

The budget deficit assessment for this year has improved compared to the March projections on account of adjustments to certain tax collection assumptions and tax revenue growth. As the expenditure for implementing the projects financed from the European Union funds and the Rail Baltica project has been adjusted for each year according to the latest available information, the balance sheet assessments have been revised downwards for the coming years.

The government debt in 2024 is projected to be higher than last year. Over the next years, the government debt will be higher than previously projected and will follow the previous upward trend.