The good news is that inflation is backing away. Not so good news – although Latvia’s economy has been more resilient than expected, future outlooks have become worse, as reported by Swedbank Chief Economist in Latvia Liva Zorgenfreija.
The increase of interest rates of central banks will leave an impact on the global economy. Latvia’s economy, for example, will experience it the most on the side of exports, which is slowly becoming the weakest point of the economy’s engine. Latvia’s GDP will increase by a mere 0.6% this year and 2.1% next year. Average inflation will be at 9.5% this year. By the end of the year, however, it may be as low as 3%.
The global economy has so far taken the living expenses crisis and growing interest rates rather well. The economy’s resilience so far has served as a reason to improve global, European and US growth outlooks for 2023. The situation in the world shows the inflation is backing away, which may indicate that interest rate reduction may be just around the corner. But let’s not celebrate too early. While prices in the volatile energy resource market are going down,
the ongoing trends with service prices, for example, are preventing central banks, especially in Europe, to relax. The objective of policies employed by central banks is maintaining inflation stable and low for long, which is possible only when there is a stable and low price rice in less variable inflation components like services. In the current situation it is clear it is only possible by dampening demand or, in other words, raising interest rates while they severely curb economic development. This is why Swedbank predicts interest rates to go up even more – ECB’s overnight deposit rates will go up from 3% to 3.75%. EURIBOR will also increase. Healthier inflation next year and weak economic growth rates will force central banks reduce interest rates.
The events that shook the global banking sector in March are often described as “the first breach” in the wall of economy. The instability has calmed down, it seems. However, the consequences from the global banking sector’s tremours, the interest rate increase and its direct effect on businesses and residents have yet to be seen. The negative impact on the economy is already seen through the lending channel –
lending conditions in Europe and the US are becoming tighter, and loans are becoming more expensive and less accessible.
High interest rates, emptying residents’ savings – this in combination with the rise in protectionism and global challenges present the biggest problems. In 2024 in the US and Europe economists predict weak growth – 0.5% and 0.7% respectively. Additionally, the risks of the interest rate increase period could culminate not only in slower growth, but even a recession, is quite high in the world.
Inflation is slowly backing away, but will prices go down?
Similarly to the rest of the world, inflation in Latvia is rapidly going down. Prices are significantly higher when compared with the year prior. However, the registered growth showed a significant slowdown in March. The reasons, on the one hand, are purely technical. Last year the price level showed a rapid growth – because the period with which we compare it to had a higher price level, because the growth rate is mathematically lower. The price rise was slowed not only in statisticians’ estimates. Prices of goods imported to Latvia continue going down because the pressure from global prices has gone down significantly – energy resource prices are down, supply chains have recovered, global food prices have recovered from the previous peak.
This is a positive background to expect a price drop for consumer prices in Latvia.
The price drop observed in recent months shows that prices have dropped for food products like milk and butter. The most notable examples include prices going down for fuel, electricity, gas and heating. We expect prices on utilities could prove friendlier to residents’ wallets this year than they were last year. Nevertheless, prices will not return to their pre-war levels. On top of that, the difference will not be as great as listed in dynamics in the gas and electricity market – because residents and businesses were safeguarded from an even more severe price leap by various support measures from the state.
The price curve continues going up, even if it is not as quick as it was before. Businesses’ wish to earn more is also mentioned as one of the reasons for high inflation in Latvia. Considering the very stable financial situation of various businesses last year, there is a great deal of truth to this – it is clear they have succeeded in transferring raw material price burden onto the consumer. Surveys among businesses about sale prices show that they may increase even further in the coming months. However, the portion of businesses that see an option to increase prices is very rapidly going down.
One of the sectors in which prices continue going up is the service sector. Service prices reflect, though with a delay, both the energy resource price rise and the general increase of living costs. The most important cost component in this sector are wages, which will increase rapidly this year and next year – by 9% and 8% respectively. This means that, unless we see a large-scale crisis, it is unlikely we can expect a drop in service prices.
Consumption – unexpected engine pushing the economy. Businesses can afford to raise prices because there are people who continue buying products. Consumers’ resilience is rather surprising. Prices have increased more rapidly than wages in the past year – we cannot afford as much as we could in the past.
Do consumers use their savings? An impressive amount of money has been saved on various deposit accounts since the start of Covid-19 pandemic. This amount continues growing, but “devil is in the details”.
An average Swedbank client has around EUR 350 left at the end of the month.
This is very far away from the security pillow suggested, which is equal to 3 to 6 monthly wage amounts. Wages are paid on different dates. This is why it is important to observe the minimal balance at the end of the month. The overall picture here is even sadder – looking at clients based on their end of the month balance, an average client has only EUR 100 left “before pay day”. It is possible residents have savings in other banks, or a sock. However, results do not suggest any impressive wealth of Latvian residents.
Then who maintains consumption? Using the method of elimination – this honour falls on wealthy residents. If we look at deposits in Swedbank, those who own approximately 80% of the total deposit volume are residents who have more than EUR 10 000 on their account. Results of Eurostat EU-SILC survey shows that 20% (of all) wealthiest households per household member spend three times more than 20% of poor households.
This means the wealthy are responsible for a disproportionately large portion of consumption. While less wealthy people pick cheaper products, limit their expenses, the wealthy have the money and will to steer general consumption.
We do not expect a rapid economic growth. Last year it was 2.8% higher in Latvia when compared with the year prior. This result is rather good when compared with the rest of Baltic states. A technical recession was observed – for two consecutive quarters, when the economy was down. This year Swedbank predicts a slight growth of the country’s GDP – by 0.6%.
Next year’s growth is not expected to be as rapid in Latvia – only 2.1% of this year’s GDP.
Consumption will be based on
a significant drop in inflation in the second half of the year and continued growth of wages.
The labour market will remain strong – this year the average unemployment level will be 6.8% and next year it will drop to 6.6%. All of this implies the average consumer’s purchasing power will improve. We expect a rise in EU fund investments in the second half of the year. At the same time, investments in the private sector will slow down high interest rates and uncertainty about the future.
For exports the story is even sadder. Exports of services finally recovered from the pandemic and started showing good growth rates. However, exports of goods, which was the driving force behind Latvia’s growth since the start of the Covid-19 pandemic, has become very exhausted. The processing sector reports the number of orders is low. As previously mentioned, economic development in countries that are Latvia’s trade partners is not expected to be very rapid.
This means that the biggest obstacle that limits exporters’ development will be the lack of demand. The situation is the most complicated in export markets together with rapid wage rise suggests there may be problems with competition. Until now they remained as “concerns” only, and export markets remained strong for the most part.
There is only one cure to help prevent loss of competition – investments. Businesses did not suffer much from higher living expenses – many have financial reserves to put into use, said Zorgenfreija.
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