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Friday, September 14, 2007

No Change in Latvian Interest Rates

Latvia's central bank, unsurprisingly, left the benchmark refinancing rate at 6 percent today. According to the press release:

The Bank of Latvia Council maintains that substantial risks of economic overheating are still in place and in some sectors even becoming stronger, including an upsurge in inflation rate. At the same time, there are certain trends signalling that consistent implementation of the economic stabilisation measures is likely to result in a gradual further "cooling" of the economy in the upcoming periods, with the so-far buoyant pace of growth slowing down. The anti-inflation or economic stabilisation plan is producing first results and requires further action.

The bank called on the government to continue and intensify its efforts to achieve a budget surplus.

"The efforts to implement other measures under the plan and, in some areas, to render sustainable previous achievements should continue. In the area of fiscal policy, immediate activities should focus on a budget with a surplus in the amount of 1% of GDP instead of the currently projected balanced budget position for the current year and a considerably larger budget surplus (2%) than the projected 0.2% of GDP for the next year. An urgent action is needed to address the measures under the anti-inflation plan related to enhancing export competitiveness and labour market problems. Step by step, this will lead to both adjustments in the country's external imbalances reflected in the current account deficit and internal instability or inflation rate."

Basically the absence of any change in the interest rate is hardly surprising given that Latvia's currency is pegged to the euro, and that most internal credit expansion is driven by non-Lat denominated loans the power of the central bank to influence the situation is extremely limited.

Higher than capacity economic growth, high inflation and a widening current account deficit all prompted Standard & Poor's and Fitch to cut the sovereign debt credit rating to BBB+ earlier this year, and only yesterday Moody's changed the rating outlook for Latvia and Estonia from positive to stable.

Annual inflation was up again in August to 10.1 percent, a 10-year high, from 9.5 percent in July as domestic demand, fueled by rising wages and loans, continued to grow.

Central bank Governor Ilmars Rimsevics said at a press conference in Riga today that inflation isn't expected to slow in the coming months and he ``hopes'' to see a decline in the rate next year. Inflation is being driven by advances in core inflation, Rimsevics said.

Interestingly Rimsevics stated that Latvia should consider importing skilled labor to fill job shortages: ``Urgent action is needed'' to address labor market shortages and competitiveness of the country's exporters.

Economic growth has been driven by a domestic demand boom which has sucked in large quantities of imports, leading to a negative dynamic on the trade balance and widening the current account deficit, which was 25.7 percent of GDP in the first quarter.

The economy is showing signs of slowing (although not very strong ones, see here) according top Rimsevics statement at the press conference. Real-estate prices have stabilized and the current-account gap is expected to have reduced to "only" 21 percent of GDP in the second quarter.

Latvia has the somewhat unusual twin distinction of leading the European Union in economic growth and in the size of its current account deficit.

The economy grew 11 percent in the second quarter, the ninth consecutive three-month period in which gross domestic product expanded more than 10 percent.

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