The Bank of Latvia has published its latest September 2023 macroeconomic forecasts, which have been drawn up amid persistently high uncertainty. Compared with the June forecast, this year’s GDP growth is expected to be lower (0.6%), while annual inflation will be higher (9.0%). No growth no party.

Inflation is currently declining in the euro area and Latvia. However, the world’s major central banks have emphasized that it will remain above the target level over a longer period:

• the euro area inflation forecasts for 2023 and 2024 have been revised up in September, and only those for 2025 have been revised down;
• to ensure the return of inflation to its 2% target in the medium term, the Governing Council of the ECB continued to raise its key interest rates.

The lower GDP forecast is believed to depend solely on the financing conditions observed in the euro area and the subsequent demand reduction as a result of monetary tightening. Therefore, the focus should be on the competitiveness of the supply side, whose enhancement would raise production with lower prices.

On the other hand, the persistently high inflation has adverse effects on purchasing power and consumption:

• activity of several sectors, such as manufacturing and agriculture, fell from unusually high levels;
• commercial banks point to tighter credit standards and weaker demand for credit;
• the outlook for foreign demand and export opportunities deteriorated slightly;
• natural processes (heat, storms, rainfall, bark beetle damage) have adverse effects on the quality and price of timber and grain – two important commodity groups in exports.

The most recent inflation data point to a stronger-than-projected rise in the prices of energy, services, and industrial goods. Thus, the inflation forecast for 2023 has been revised up to 9.0%. At the same time, the core inflation is expected to remain elevated due to the strong wage growth affecting both demand and costs in the price-setting process.

The current steep wage rise that exceeds inflation only misleadingly alleviates the financial position of households. In fact, firms have the capacity to raise the wages of their employees rapidly for an extended period of time only if their productivity also increases buoyantly. Therefore, the rapid wage growth only impairs competitiveness and, ultimately, everyone’s purchasing power.

Therefore, concerns persist about the adverse effects of the increase in labor costs on Latvia’s competitiveness and thus the return to sluggish economic growth. Weaknesses lie in both labor shortages and firms’ investment opportunities hampered by barriers stemming from lending.