Latvia’s central bank, Latvijas Banka, has revised its GDP and inflation forecasts. In the light of the latest global economic developments, including the implications of the second wave of the COVID-19 pandemic and a stronger-than-expected economic recovery in 3Q20, Latvijas Banka's growth forecast for 2020 has remained unchanged, whereas in 2021 the economic recovery is expected to be weaker than projected in September. According to Latvijas Banka's December forecasts, Latvia's GDP is expected to decline by 4.7% in 2020 and to increase by 2.8% in 2021 (in September, GDP was projected to fall by 4.7% in 2020 and rise by 5.1% in 2021).
Meanwhile, the inflation forecast was revised slightly downwards to 0.1% for 2020 and to 1.1% for 2021 as compared to the September projections of 0.2% and 1.4% respectively.
According to the assessment of Latvijas Banka's economists, the outlook for global and euro area economic growth is still subject to the evolution of the COVID-19 pandemic, which currently is concerning. Nevertheless, the positive vaccine trial results and the take-up of vaccines, which has already started in some countries, give reason for more optimism. Meanwhile, uncertainty remains high as the Brexit trade deal between the EU and the UK is still under negotiation and the trade tensions with the US continue despite the outcome of the US presidential election.
The world leading central banks, including the ECB, have implemented monetary policy to ensure very favourable financing conditions in the financial markets. Moreover, they stand ready to provide additional monetary policy support to the economy as needed.
The gradual economic recovery in 2021 and 2022 is based on the assumption that medical solutions will become available at the beginning of the next year, thus allowing for a broad resolution of the health crisis and a gradual relaxation of restrictions both in Latvia and worldwide. Moreover, the Next Generation EU package is expected to be made available in mid-2021. Thus, in 2022 the economic growth rate is expected to accelerate and reach 5.3%.
A slowdown in economic activity and in wage growth also affects price dynamics. Therefore, the inflation forecast was revised slightly downwards to 0.1% for 2020 and 1.1% for 2021. The forecast for 2021 also takes into account retention of the reduced VAT rate on the fruit and vegetables typical of Latvia. News about successful COVID-19 vaccine trials have strengthened demand for oil and facilitated a rise in its price. In the medium term, against the background of moderate economic and oil price recovery, inflation is expected to continue on a gradual upward trend and reach 1.6% in 2022.
Latvijas Banka has developed alternative economic growth scenarios contingent upon the evolution of the COVID-19 pandemic and the course of implementation of the medical solutions. The mild scenario is based on the assumption that the medical solutions will be rolled out swiftly over 2021. According to this scenario, restrictions might be lifted earlier and normal conditions for economic development might return sooner than predicted in other scenarios. Meanwhile, according to the severe scenario, the implementation of the medical solutions would take more time. Thus, the COVID-19 restrictions would be lifted gradually over the entire forecasting horizon, i.e. until 2023, leaving a long-lasting negative impact on GDP.
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