OREANDA-NEWS. September 23, 2013. In its regular meeting today, the Bank of Latvia Council discussed the latest macroeconomic trends in Latvia as well as the future directions of macroeconomic policy. The main conclusions are related to the development of inflation and gross domestic product (GDP) as well as the lending dynamic in the country.

Inflation
The latest economic developments, low inflation and estimates regarding the developments in the coming period point to limited risks to price stability in the medium term. The inflation indicators of the last few months have consistently shown a lower rise in prices than expected in the first half of the year and in August, Latvia even returned to a short lived year-on-year deflation.

First, the rise in salaries continues to match increased productivity: the rate of increase in cost per unit of labour, according to seasonally adjusted data, even registered a year-on-year drop at the beginning of the year.

Second, the rise in oil prices resulting from the unstable geopolitical situation in the Middle East, is compensated by a drop in the prices of main groups of agricultural goods where the only exception is the price of milk. The predictions of grain harvest for 2013/2014 are higher globally than a year ago. As a result, following a gradual reduction in export restrictions, grain prices in the global markets are dropping. That means a drop in prices in the market of the European Union, including Latvia.

Third, the predicted development of the sales price of natural gas points to an unchanged or even slightly downward trend. At the same time, the previously observed drop in natural gas prices continues to impact the drop in thermal energy tariffs in ever more regional towns in Latvia. The latest drops have been approved for Cesis and Jurmala as of October of this year.

The overall dynamic of natural gas prices and related thermal energy tariffs for this heating season is expected to be more favourable: the tariffs will be lower than last winter if the 9-month average mazout price continues to drop at least for the next couple of months.

That has a favourable impact on the overall inflation level.

Finally, I would like to briefly comment the possible effect on prices in the context of euro changeover planned for next year. Looking at the mass media, one may get the impression that rounding the prices up before the changeover is so widely spread that it will definitely bring up the overall inflation indicators in the country. That is a misguided view. For every occasion of price rounding before the changeover, which has merited loud publicity in the media, there are a number of goods and services whose prices are not changing with the euro changeover, but these instances simply do not make it to the media. Prices are not being changed for the absolute majority of goods. Instances of rounding, on the other hand, are observed for goods and services that are not in the group of most frequently purchased. Thus they have a relatively small impact on the overall inflation indicators.

According to statistics, goods and services that leave the greatest impact on the overall price level are foodstuffs (particularly meat, bread and dairy products), electrical energy and gas as well as the operational costs of transportation. In this product group, there have been hardly any instances of the upward rounding of prices. As a result, practically no impact of this rounding has been observed on the overall inflation. And even if the upward rounding of prices were to become more widespread in the last months of the year, its overall impact on the annual inflation will be under 0.1 or maybe 0.2 percentage points.

In view of the above, we can conclude that the hitherto quoted prediction for the average annual inflation level: it will not exceed 0.7%. Moreover, the latest data allow us to expect that the annual inflation indicators at the end of the year will be even slightly lower.

On GDP
The latest economic data on overall economic development point to trends that match our previous predictions. Thus there is no reason to review our GDP growth predictions, which we had at 4.1% for this year.

To take a brief look at the branches: the latest manufacturing data point to a better situation than previously expected. Given the problems of "Liepajas metalurgs", we predicted that they will have a negative effect on the entire manufacturing branch and also forecast a drop in manufacturing production in the second quarter of this year.

The actual data have turned out to be better, posting a smaller than expected drop in value added. The situation in metal manufacturing matches expectations, i.e. it shows a substantial drop in volumes, but this negative effect is compensated to a great extent by better growth in other sub-branches of manufacturing – first and foremost, as regards the production of other means of transportation, i.e. ships.

At the same time, growth could be slightly lower than planned in other branches of the economy. First of all, agriculture this year will be affected by the grain harvest, which apparently will be smaller this year than last year. Price conditions are also not as favourable for Latvian farmers as last year, because good harvests are expected this year also in Asia and Europe. Second, the drop in cargoes on railways and in harbours will continue to have a negative impact on the overall indicators for the entire transport branch and the increase in cargoes in road transport will compensate it only in part. So the better than expected results in some branches of the economy will be counteracted by slightly lower growth rates in other ones.

The growth of private consumption, consistent so far, may increase even more by the end of the year, because we expect that a part of the population may want to spend the cash currency at their disposal. Surveys point to such likelihood. Yet we have taken this effect into account when making our predictions, so there is no reason to change them now.

On the development of lending

The total bank loan portfolio unfortunately keeps decreasing and the rate of the decrease has speeded up over the past few months. It is true that to a great extent this has been a result of one-off transactions related to the reclassification of loans, however, even if they are excluded we have to admit that lending in Latvia is currently relatively slow and banks are taking a wait-and-see attitude.

The total domestic loans granted to non-financial institutions was by 6.7% lower than a year ago and the total loans granted to households by 7.8% lower. At the same time, the deposit of disposable finances of banks keeps increasing, with the total exceeding 600 million lats a night. And this is going on despite the fact that the Bank of Latvia reward for these deposits does not exceed 0.075%. If this situation persists, the overall lending rate could become positive no sooner than the beginning of 2015.

On the resolutions of the Bank of Latvia Council

To recapitulate, inflation in Latvia continues to post lower rates than previously predicted. The overall economic development is stable and presents no risks for price stability in the medium term. At the same time, lending to the economy is weaker than planned. With this in view, the Bank of Latvia Council at its regular meeting today resolved to reduce the Bank of Latvia refinancing and lending facility rates:

to reduce the Bank of Latvia refinancing rate from 2.00% to 1.50% per annum;

to reduce the interest rates on the marginal lending facility:

from 2.5% to 2.0% per annum if the credit institution has used the facility for no more than 5 working days within the previous 30 day period;

from 4.75% to 3.50% per annum if the credit institution has used the facility for 6 to 10 working days;

from 7% to 5% per annum if the credit institution has used the facility for more than 10 working days.

The deposit facility rate and the reserve requirement remain unchanged.

The changes will take effect on 24 September.