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Inflation to fall, purchasing power to rise slightly
With energy and commodity prices falling and services exports continuing to expand strongly, Luminor Bank is upgrading its 2023 GDP growth forecast. While last autumn we expected a 0.5% drop in gross domestic product (GDP), now we expect a 0.6% increase, according to the latest Baltic and Latvian Economic Outlook by Luminor Bank economist Pēteris Strautiņš. The 2024 growth forecast has been revised down from 4.6% to 3.7%, and the price surge of the past year and a half is expected to be followed by a temporary period of falling prices or deflation.
Lower inflation this year will help people to spend more money on non‑essential purchases. There are signs that the use of EU funds is finally picking up, but investment remains a major source of uncertainty about the performance of the economy this year. Export growth will be modest after a very successful 2022, with services exports offsetting an expected fall in the distribution of real goods outside Latvia.
EU funds are the hope for this year, rising purchasing power for the next
This is the year to accelerate the use of EU funds: growth is generally weak, raw material prices have fallen. The prolonged stagnation in the Latvian housing market has created good conditions for investment in this area: potential demand is strong, household debt is low.
Although real wages declined in 2022, lifting restrictions boosted consumption growth. Purchasing power is likely to improve slightly this year, but it will still be lower than in 2021, families will try to increase savings, so we are not counting on a big increase in consumption. The picture is very different in 2024 and beyond, when expected wage growth will combine with low inflation or even deflation.
Inflation will fall, prices might too
Although annual inflation exceeded 20% in January and February this year, it could turn negative by the end of the year, while average annual inflation is expected to be in the range of 7‑8%. The fall in the cost of maintaining a home started at the end of last year and has been joined this year by a number of important food products. Prices in these commodity categories, which are highly dependent on prices of materials, will continue to fall until the end of the year, and very likely into next year. Price declines are also likely for some durables goods, such as household appliances. Price increases will continue in most categories of the consumer basket, driven primarily by services, the cost of which is determined by wage levels. However, the impact of the two big items, housing costs and food, will be decisive. The average price level is expected to fall by around 1% in 2024.
A contrasting export scene
Several export sectors performed very well last year. Exports of high value‑added services grew by a third to more than 800 million, while exports of transport services increased by a fifth compared to 2021. Real growth in services exports (+20%) last year was the fastest since 1996, while goods exports (+5.6%) were similar to the average of the previous decade.
In 2023, the performance of export sectors is expected to be very uneven. The outlook for the so‑called "white collar" sectors, namely, IT, communications, financial and business services, is very good. Transport and tourism will continue to be affected by sanctions and high regional risk perceptions. A full recovery in these sectors is likely only in 2024. The most challenging situation will be in the export of goods, as prices for a number of important products will no longer increase or even decrease. The crisis is already a reality in wood processing, especially in sawmills. It is caused by the downturn in important housing markets (USA, China, etc.), the end of which is not yet in sight. The outlook is better for the engineering sectors: metalworking, mechanical engineering, electronics. The expected recovery in goods exports in 2024 is one of the main reasons for the anticipated acceleration in growth.
Stable labour market
Despite slower GDP growth, the labour market has been very stable over the past year, with the average number of people in employment rising by 22,000 or 2.6%. The ability to continue employment growth will increasingly depend on immigration, as demographic trends are unfavourable. The share of jobseekers fell from 7.6% in 2021 to 6.9% last year. This indicator is expected to change little over the next two years. The risk of rising unemployment this year is fuelled by the fact that the industries affected by the difficulties in export markets, primarily wood processing, are highly concentrated geographically, especially in the East of Vidzeme, the central part of Kurzeme and elsewhere in Latvia, so opportunities to find other jobs in these regions may be very limited.
Read the Baltic and Latvian Economic Outlooks here.