The Eurozone economy appears to be recovering rapidly approaching pre-pandemic levels. Central banks continue to view the rise in inflation as transitory despite supply bottlenecks in the face of growing demand. In recent months, accommodative monetary policies have continued, maintaining extremely favorable financing conditions for businesses, households, and the public sector. The Bank of Latvia has published the latest macroeconomic forecasts for September 2021, including gross domestic product and inflation forecasts. Latvia’s GDP growth estimates for 2021 have been revised upwards to 5.3%, while those for 2022 are down to 5.1% (from 3.3% and 6.5% respectively in the forecasts of June). Meanwhile, CPI forecasts have been revised upwards to 2.8% in 2021 and 4.0% in 2022, from 2.0% and 2.9% respectively. Inflation is here to stay.

The Latvian economy appears to have recovered faster than expected, with GDP growth reaching pre-crisis levels as early as the second quarter of 2021. However, activity in the sectors most affected by the restrictions such as hotel, food, entertainment, and transport remains significantly below pre-crisis levels. Towards the end of this year and early 2022, however, economic growth could slow temporarily due to a surge in new infections and slower-than-expected progress with vaccinations. Latvijas Banka has revised down the GDP growth forecast for 2022 to 5.1%. Private consumption will be supported by the savings accumulated during the pandemic, while exports will benefit from growing external demand. Estimates on public investment suggest a strong rebound in construction due to a significant increase in commissioned projects, thus increasing the risks of overheating in the sector. The main challenges faced by the industry are capacity shortages and rising costs.

Meanwhile, the GDP growth forecast for 2023 at 3.8% suggests a return to a sustainable pace of long-term growth. However, one of the biggest challenges to sustaining investment and innovation-driven economic growth would be to boost credit by removing both supply and demand constraints, including lowering relatively high lending rates. In addition, the government should strengthen its support for reducing labor market tensions and developing human capital in Latvia.

The global economic recovery and rebound in demand, as well as supply-side constraints associated with the pandemic, are reflected in a temporary increase in consumer price inflation after a short period of deflation. Inflation is expected to peak around the end of this year when the annual increase in consumer prices could exceed 5%. Inflationary pressures stem largely from rising energy prices and the direct effect on fuel, heating, gas, and electricity prices, all of which increased in the second half of 2021.

Good news comes from the labor market compared to August estimates, with unemployment falling despite the expiry of the allowances provided by the government and with steady growth in wages. The trend in service prices is moderate overall, but further acceleration is likely due to both pent-up demand and cost factors. The global shortage of shipping containers and transport costs are having an upward effect on the prices of industrial goods. Thus, the inflation forecasts for 2021 and 2022 have been revised upwards, respectively to 2.8% and 4.0%. Solid economic growth and sustainable wage increases will result in a gradual rise in inflation. However, with the pressure on global commodity prices easing, analysts forecast inflation to fall below 3% in 2023. Hope here is the last to die.

Thanks to a more positive economic outlook, the general government deficit (6.7% of GDP in 2021) is estimated to be lower than the previous forecast. Public spending is expected to grow in the coming years, both for the use of the available fiscal space and for the rescheduling of some investments and health care in 2022-23. This increases the projected short-term government deficit compared to the June forecast, while the medium-term budget balance still shows improvement. Public investments are expected to grow strongly, with the negative effect of national co-financing on the budget balance offset by the positive effect of investments on economic growth. According to Latvijas Banka estimates, public debt will remain below 50% of GDP over the medium term. Provided that economic growth remains solid and in the absence of new restrictions related to Covid-19, no further government measures would be needed to stimulate domestic demand. The available funds should be invested in strengthening labor productivity and economic growth, and the extraordinary income should be used to finally address structural priorities.