Latvijas Banka has published its latest December 2023 macroeconomic forecasts, which have been drawn up amid persistently high uncertainty. Inflation in Latvia is expected to be low (2.0%) in 2024; however, the growth of gross domestic product (GDP) will remain weak (2.0%). Ashes keep burning underneath.

According to the latest projections for the euro area, inflation is expected to decline gradually over the next year, before approaching the 2% target in 2025. The ECB’s future interest rate decisions will be based on the inflation outlook, including the dynamics of underlying inflation and the strength of monetary policy transmission.

At the same time, the Governing Council decided to advance the normalization of the Euro system’s balance sheet, intending to reduce the pandemic emergency purchase program (PEPP) portfolio by 7.5 billion euros per month on average over the second half of the year.

In this scenario, prices have decreased in the last months of this year mainly due to the sharp fall in global energy prices. In Latvia, this is reflected in lower heat energy and fuel prices, which also reduce the pressure on the prices of other goods and services. The inflation estimate for 2023 stands at 9.0%.

Inflation is projected to stand at around 2% over the next three years (2.0%, 2.3% and 1.8%, respectively). The government’s decisions on raising indirect tax rates and on limiting the increase in electricity distribution tariffs are among the factors affecting inflation. However, the assumptions about lower estimated global prices of natural gas, oil, and food have affected both the downward revision of inflation forecasts and the passthrough of global prices to core inflation.

Core inflation will remain persistently higher (3%–5%) than headline inflation throughout the entire projection period due to the robust wage growth.

In the medium term, economic activity will spur the demand for labor. Owing to this demand, wage growth will remain persistently high (above 7%) amid the labor shortage. Such long-lasting sharp wage increases that exceed productivity growth reduce the cost competitiveness and increase the risk of a weaker performance of exports.

The GDP projection period can be divided into two groups.

• An initial period of weak activity (the end of 2023 and the first half of 2024. The causes are related to the weaker external demand, particularly in Estonia and Lithuania. Additionally, the wood industry, the largest subsector of manufacturing in Latvia, is weakening further, and its price competitiveness in export markets has worsened. The increase in private consumption will resume only gradually.
• The situation might improve in the second half of 2024 as the already growing domestic demand will also be accompanied by more rapid export growth. The GDP growth is expected to increase by 3.6% in 2025 and by 3.8% in 2026. Investment financed from own funds of businesses and investment co-financed by the EU funds provides the possibility to increase production capacity, which will allow the strengthening of the external demand and supplement the export portfolio with higher value-added products. The role of the growth leader will be retained by investment with a significant increase in public sector demand, supported by the sizeable Rail Baltica project as well as by the planned investments in the field of internal and external security.

The budget for 2024 envisages priorities in the areas significant for Latvia such as security, health, and education. However, additional spending and weaker economic activity are reflected in a higher government budget deficit and government debt. Although public investment is supposed to strengthen the resilience to geopolitical threats, an expansionary fiscal policy will increase the inflationary pressure and weaken the price competitiveness of the economy.