Latvijas Banka has published its latest June 2023 macroeconomic forecasts drawn up amid persistently high uncertainty. Latvia’s inflation projections for 2023 and 2024 have been revised downwards to 8.5% and 2.4% respectively. For 2025, inflation has been revised slightly upwards – to 3.0%. The GDP growth forecast for 2023 has been revised upwards to 1.2%, while downwards to 3.1% in 2024. The growth forecast for 2025 is 3.5%. The more inflation, the more uncertainty.
Major global central banks, in response to the high inflation, continued raising interest rates. Inflation in the euro area is proving to be more persistent than previously expected despite falling energy prices and easing supply chain bottlenecks. With global energy and food prices decreasing, it is expected that headline inflation in the euro area will continue on a downward path. However, core inflation will be more persistent in combination with increasing labor costs and stronger demand in the services sector.
In the light of inflation outlook continuing to be too high for too long, the Governing Council of the ECB has decided to continue raising interest rates by 25 basis points in May and June respectively.
Annual inflation in Latvia continues decreasing on a monthly basis, i.e. from inflation rates exceeding 20% early this year to 12.3% in May, and it is expected to decline to single-digit levels in the second half of 2023.
Electricity prices and the administratively regulated heat energy and water supply tariffs also decrease in Latvia along with a drop in global energy prices. Lower natural gas tariffs for households also reflect growing competition in Latvia’s natural gas market. Higher tariffs on electricity transmission and distribution services will take effect as of July, but they leave Latvijas Banka’s outlook unchanged – apparently, they were already included in the previous forecasts as pending.
A tight labor market, which increases the wage negotiation power of employees, is reflected in steeper wage growth. Low unemployment entails an advantage for employees to request wage growth to maintain their purchasing power. While a lower energy cost burden enables businesses to increase the remuneration of sought-after employees: wages already edged up by 12% in the first quarter, reflecting a rise in the minimum wage and partly compensating the impact of inflation.
However, the tight labor market increases the risk that inflation will remain higher and growth lower. The second-round inflation risks intensify: if employees request higher wages to compensate for inflation on the basis of high inflation expectations and businesses offset the sharply increasing labor costs with price rises, inflation may remain higher for an extended period of time. And such a wage-price spiral would significantly harm competitiveness and the economy as a whole.
Currently, inflation expectations are decreasing, and government support is expected to be more targeted to avoid fueling inflation. The wage growth incorporated in the forecast baseline scenario justifies an upward revision of the core inflation forecast for this year to 8.2.
Uncertainty is prevailing in the region and the rising borrowing costs will weigh on investment growth. The role of EU funds is increasing amid uncertainty. But the implementation of projects has experienced delays so far. Additionally, demand forecasts in the main trade partners, particularly in Estonia and Lithuania, also hamper Latvia’s economic growth.