Lowering interest rates
- Inflation in the euro area has declined and is currently around the 2% medium-term target. According to the latest projections by the European Central Bank (ECB), headline inflation in the euro area is expected to average 2% in 2025, 1.6% in 2026, and 2% in 2027.
- The successful containment of inflation has provided the Governing Council of the ECB with the confidence to proceed with further reductions in key interest rates across the euro area. Last week, on 5 June, the Governing Council of the ECB decided to lower the three key interest rates by 25 basis points. Consequently, the interest rates on the deposit facility, the main refinancing operations, and the marginal lending facility were reduced to 2%, 2.15%, and 2.4% respectively.
- Amid current heightened uncertainty, the Governing Council of the ECB adopts its monetary policy decisions on a meeting-by-meeting basis, based on the latest data. Future interest rate decisions will be contingent upon an assessment of the inflation outlook, including the received economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.
Developments in the Latvian economy. Inflation
The inflation forecast for Latvia in 2025 has been revised upwards to 3.4%, reflecting a sharper-than-anticipated rise in food and services prices. Inflation is projected to persist slightly above 2% in the coming years (2.1% in 2026 and 2.8% in 2027).
- Food prices in Latvia surged markedly at the start of the year, registering a 6.1% increase in the first four months year on year. This development is partly driven by price increases in global commodity markets; nevertheless, the rise in food prices in Latvia has been more pronounced than elsewhere.
- Over the medium term, global energy prices are expected to decline modestly, while the pace of price increases will also be restrained by more moderate wage growth.
Labour market
Unemployment will remain near 7%, with a decline anticipated only in the latter part of the projection horizon. Average wage growth is projected to be moderate.
- External factors and the deceleration of economic growth are constraining more rapid advancements in the labour market. Nonetheless, over the medium term, labour demand will remain relevant, including for the implementation of various large-scale projects.
- At the beginning of this year, wage growth was constrained by restrictions imposed on the public sector wage bill. Nonetheless, owing to the effects of adverse demographic trends constraining labour supply, wage growth will remain robust over the medium term, at around 6%.
GDP
The GDP growth outlook for 2025 has been revised downwards compared to forecasts published earlier, with growth now projected at a modest 1.2%. Advancements in the implementation of major investment projects, increased defence spending, as well as diminished uncertainty in trade policy will bolster economic activity in the years ahead. This enables the medium-term GDP growth forecast to remain aligned closely with prior estimates: 2.8% in 2026 and 3.2% in 2027.
- Economic agents continue to exhibit caution, largely driven by the adverse effects of tariffs imposed by the US and elevated uncertainty surrounding geopolitical tensions and trade policy. This situation is further compounded by domestic developments, notably delays in government investment projects – most prominently Rail Baltica – and the pre-election climate, which adds additional uncertainty about the future.
- Households' real purchasing power is on the rise; however, amid sustained caution, income growth is expected to be directed towards savings for some time.
- Financing conditions have continued to ease, and lending data reflect a strengthening trend, highlighted by a pronounced recent acceleration in mortgage lending and also in corporate lending. Nevertheless, escalating international trade tensions, coupled with competitiveness challenges, impede export growth.
- The anticipated growth in public investment over the medium term will be underpinned by planned increases in security expenditure not only in Latvia but also in its trading partners, thereby strengthening the sense of security among the population and investors. Growth in public investment will be further reinforced by the ongoing implementation of European Union (EU) funded projects and the Rail Baltica project. Investment needs will drive an increase in imports, which will be reflected in widening of the current account deficit.
Fiscal policy over the medium term is regarded as expansionary, with the budget deficit forecasted around 3% of GDP.
- Latvia has submitted a request to the European Commission for the activation of the national escape clause. This provision enables a Member State undertaking increased defence expenditure to temporarily deviate for up to three years from the approved annual net expenditure path, thereby permitting the budget deficit to exceed the 3% of GDP threshold.
- Investments aimed at strengthening security have been consistently increased throughout the entire projection horizon. These investments encompass the development and enhancement of infrastructure, procurement and maintenance of military equipment, as well as the expansion of personnel of the National Armed Forces, with total defence expenditure projected to reach 5% of GDP by 2028.
- The government debt level is projected to near 50% of GDP by the conclusion of the projection horizon. The upward trajectory of public debt will remain primarily driven by growth in budgetary expenditure, while the rising effective interest rate on the government's debt portfolio will further elevate debt servicing costs.
Macroeconomic fundamentals: Latvijas Banka's forecasts
|
2024 |
2025 |
2026 |
2027 |
|
|
Economic activity (annual changes; %; at constant prices; seasonally adjusted data) |
||||
|
GDP |
–0.4 |
1.2 |
2.8 |
3.2 |
|
Private consumption |
0.3 |
1.4 |
3.2 |
3.4 |
|
Government consumption |
7.5 |
3.1 |
0.6 |
1.5 |
|
Investment |
–6.8 |
0.1 |
5.4 |
4.9 |
|
Exports |
–1.6 |
2.2 |
2.4 |
2.9 |
|
Imports |
–2.4 |
3.5 |
3.1 |
3.1 |
|
HICP inflation (annual changes; %) |
||||
|
Inflation |
1.3 |
3.4 |
2.1 |
2.8 |
|
Core inflation (excluding food and energy prices) |
3.7 |
3.2 |
2.4 |
2.4 |
|
Labour market |
||||
|
Unemployment (% of the economically active population; seasonally adjusted data) |
6.9 |
6.9 |
6.7 |
6.5 |
|
Nominal gross wage (annual changes; %) |
9.7 |
6.0 |
6.3 |
6.3 |
|
External sector |
||||
|
Current account balance (% of GDP) |
–2.1 |
–3.2 |
–3.9 |
–4.0 |
|
Government finances (% of GDP) |
||||
|
General government debt |
46.8 |
47.9 |
48.2 |
49.9 |
|
Budget surplus/deficit |
–1.8 |
–3.2 |
–2.8 |
–2.9 |
The forecasts assume that throughout the projection horizon, trade tariffs between the US, the EU, China, and other global partners will remain unchanged from those established following the US announcement on 12 May. Specifically, the US maintains a 10% import duty on goods originating from the EU, while preserving previously granted exemptions – such as those for semiconductors, wood, and pharmaceutical products – and the EU refrains from enacting retaliatory measures. With respect to China, the US is expected to maintain the current reduced tariffs – namely, the 34% additional tariffs – throughout the entire projection horizon. The trade policy uncertainty index is gradually declining to the average level of 2018, reflecting a return to the degree of uncertainty that prevailed during the first term of Donald Trump's presidency.
The cut-off date for the information used in the forecast is 21 May 2025, and 14 May for the information used in some technical assumptions.