Macroeconomic forecasts | December 2024

Lowering interest rates

According to the latest ECB projections, both inflation and economic growth in the euro area are expected to be slightly lower than previously forecasted. Inflation in the euro area will be 2.4% this year, approaching the 2% target set by the Governing Council of the ECB in 2025.

The disinflation process in the euro area is progressing as expected, which allows the Governing Council of the ECB to continue lowering the key ECB interest rates. On 12 December, the Governing Council of the ECB lowered the key interest rates by 25 basis points. The interest rate on the deposit facility rate was decreased to 3.00%, the interest rate on the main refinancing operations to 3.15%, and the interest rate on the marginal lending facility to 3.40%.

The future decisions on the euro interest rates will continue to be based on the assessment of the inflation outlook, including in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

Developments in Latvia's economy. Inflation

The inflation data correspond to Latvijas Banka's forecast in October, with the outlook for the year 2024 remaining at 1.3%.

While inflation is projected to stay below 2% in the next two years (1.4% in 2025 and 1.5% in 2026), it could reach 2.1% in 2027. Global prices for energy resources and food are expected to increase somewhat in the medium term. Among the inflation-raising factors are also the government decisions to increase excise taxes, gradually implementing the national ETS2 scheme for fuel and gas. However, the expected more moderate increase in wages will mitigate the price rise.

Labour market forecast

The labour market remains resilient, but wage growth is expected to moderate.

• As a result of moderately paced economic growth, the wage increase is expected to be somewhat slower. In 2025, it will also be influenced by constraints on the growth of the public sector wage bill. However, as wages outpace inflation, the purchasing power of the population is expected to increase.
• The labour market will remain resilient. Unemployment will be low throughout the projection horizon, decreasing to 6.3% in 2027. This will be driven by improved employment expectations, the gradual recovery of the external environment, and the continued economic recovery.
• The Cabinet of Ministers has adopted a decision on the procedure for setting the minimum wage. It stipulates that the minimum wage will be fixed at 46% of the average monthly gross salary for the last 12 months. However, given that the minimum wage amount for the medium term has already been determined and incorporated into the draft law "On the State Budget for 2025 and the Budget Framework for 2025, 2026, and 2027", and is not currently being changed, the new methodology has not influenced the wage forecast prepared by Latvijas Banka.

GDP growth forecast

• In 2024, the downward revision of GDP growth, projected at only 0.1%, is primarily attributed to weak past performance, while the future outlook remains largely unchanged.
• Although consumer sentiment and financial well-being are improving, private consumption is still weak as households are opting to replenish their savings depleted by inflation.
• Government consumption remains a stable pillar of the economy; however, it cannot maintain growth for an extended period.
• The prolonged delays in implementing projects funded by the European Union (EU) are further weakening the already low overall investment levels.
• In the coming years, the situation could improve as domestic demand strengthens, supported by faster export growth. Thus, GDP is expected to grow by 2.1% in 2025, 3.0% in 2026, and 3.3% in 2027.
• The Economic Climate Indicator, which reflects changes in business and consumer sentiment, also points to economic recovery. Within the business cycle, the industrial and services sectors, as well as consumer sentiment, are currently in the upward phase.
• With the implementation of projects funded by the Recovery and Resilience Facility being continuously postponed but not extended, investments are expected to surge by mid-2026. Development investments will also drive transformation in the manufacturing industry, eventually enhancing the export portfolio with higher value-added products.
• In the short term, export growth is expected to be weak due to reduced external demand. This adds to the concerns about the competitiveness of Latvian companies. In the medium term, however, demand is expected to recover, supported by a more accommodative monetary policy and a still expansive fiscal policy. Meanwhile, challenges in Germany's economy, the election results in the United States, and the potential protectionist policy, as well as the growing instability in the neighbouring regions of the EU, have increased global uncertainty.
• The current account deficit will increase in the medium term, reaching 5% of GDP in 2027. It is affected by both declining export competitiveness and expanding imports, including those of construction services and goods for the Rail Baltica project, as well as increasing military supplies.
• The forecasts do not include assumptions about changes in international trade tariffs and their potential impact.

Budget deficit predict

Fiscal policy will remain supportive, encouraging consumption and investment.

• Consumption will be driven by the tax reform and the government's recent decisions on additional expenditures, primarily aimed at increasing wages for interior sector employees and teachers.
• Within the stream of public investments, as the projection horizon approaches its end, the significance of the Rail Baltica project will continue to grow, considering the government's decision to prioritise the construction of the main route, which will require substantial funds.
• The budget deficit forecast has been marginally revised since October, and is still expected to exceed 3% of GDP in the coming years. The situation is expected to improve only towards the end of the period, with the budget deficit projected to stand at 3.4% of GDP in 2025, 3.0% in 2026, and 2.6% in 2027. The debt forecast has been slightly increased since October – mainly due to weak economic growth. With the projection horizon coming to an end, the public debt will exceed 50% of GDP, and debt sustainability is assessed as posing a moderate risk.

Macroeconomic fundamentals: Latvijas Banka's forecasts

The cut-off date for the information used in the forecast is 27 November 2024, and 20 November for the information used in some technical assumptions.