Forecasts of Latvijas Banka

Interest rates continue to decrease

Monetary policy tightening has helped reduce inflation in the euro area and Latvia, allowing the Governing Council of the European Central Bank (ECB) to continue lowering the key ECB interest rates.

On 12 September, the Governing Council of the ECB decided to review the current degree of monetary policy restriction and to lower the key euro interest rate – the deposit facility rate – by 25 basis points. In addition, as announced on 13 March 2024 following the operational framework review, the spread between the interest rate on the main refinancing operations and the deposit facility rate was set at 15 basis points.

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

Inflation in Latvia is low; however, growth in service prices remains resilient

The inflation forecast for the next two years has also been revised down to 1.5% for 2025 and to 1.6% for 2026, from 2.1% and 1.8% in the June forecast respectively. Energy price movements are expected to lower inflation. Meanwhile, the impact of domestic factors on price developments will persist for a longer period. Risks to the inflation forecast are maintained by the geopolitical uncertainty that does not allow the exclusion of significant energy and commodity price fluctuations in global markets.

Weakening labour demand in Latvia can be viewed as short-lived. A minor increase in unemployment and the planned cap on growth of the public sector remuneration fund will hinder average wage growth in the short term, while the impact of limited labour supply will prevail in the medium term.

Wage growth still exceeds the rise in labour productivity, thus weakening competitiveness. Latvia's export share in the external market will be affected not only by the ability to adapt to structural shifts in the external market, but increasingly also by the dynamics of relative costs. The challenges of competitiveness will replace the previously dominating impact of the weak external market on Latvia's export.

GDP forecast

Due to lower levels of private consumption and investment, the GDP forecast for 2025 has been revised downwards from 3.3% to 2.6% compared to the published 2024 June forecast. Despite the surge in real wages, private consumption is currently contained by the restoration of savings following a period of high inflation. The build-up of savings is also motivated by the pessimistic sentiment of consumers. Meanwhile, investments are hindered by delays in implementing projects related to the use of European Union (ES) funds, declining profitability across several sectors, and caution among lenders. The issue of new loans could be further stimulated by a more significant fall in interest rates.

The October outlook for economic growth in 2026 has become more modest compared to June: 3.0% (the June forecast – 3.8%). Economic growth will be supported by the components of private consumption, investments, and export. Nevertheless, their increase is estimated to be slower than projected in the June forecast, with weaker competitiveness playing a more significant role.

The budget deficit will exceed 3% of GDP, and government debt will grow further

However, lower GDP in the medium-term (a significant impact of data revision and lower growth estimates) makes the budget deficit-to-GDP ratio less attractive than projected in June. Owing to these factors, the government debt is also projected to be higher than last year. In light of the need to borrow, the government debt level will be approaching 50% of GDP in the coming years.