Eurozone Competitiveness Decline to Impact Latvia: Central Bank Warning

Latvia’s economic outlook is facing headwinds from a potential slowdown in the Eurozone, coupled with persistent domestic inflationary pressures, according to recent analysis from Latvijas Banka and corroborated by broader economic assessments. While the Latvian economy is projected to grow, the pace of expansion is tempered by external risks and internal factors that are proving more stubborn than initially anticipated.

Latvijas Banka forecasts gross domestic product (GDP) growth of 1.7% for the current year. This growth is expected to be driven by investment, increasing private consumption, and exports. However, the bank’s assessment, updated in December 2025, highlights a more nuanced picture than previously projected. The European Central Bank (ECB) anticipates slightly higher inflation and economic growth in the Eurozone than previously forecasted, but this doesn’t necessarily translate to unmitigated benefits for Latvia.

The ECB projects inflation in the Eurozone to reach 2.1% this year, declining to 1.9% in 2026. This downward trend is largely attributed to falling energy prices, a factor expected to continue influencing inflation through 2027, with the 2% medium-term target expected to be reached in 2028. In response to these developments, the Governing Council of the ECB has maintained its key euro interest rates at 2% for the deposit facility, 2.15% for the main refinancing operations, and 2.4% for the marginal lending facility, as of December 18th, 2025.

However, Latvia’s inflation picture is proving stickier. Domestic price increases are being sustained by rising wages and persistently high food prices. Latvijas Banka has revised its inflation forecast for 2025 upwards to 3.9%, exceeding previous June forecasts. Projections indicate inflation will remain in the 3–4% range over the next three years: 3.2% in 2026, 2.9% in 2027, and 3.6% in 2028.

This divergence between Eurozone and Latvian inflation rates presents a challenge for policymakers. While the ECB’s monetary policy is aimed at controlling inflation across the Eurozone, Latvia’s specific economic conditions require careful consideration. The potential for a slowdown in Eurozone growth, particularly if impacted by emerging tariff conflicts, poses a risk to Latvia’s export sector. A report from the Institute of Economics of the Latvian Academy of Sciences, published in June 2025, notes that Latvia’s membership in the EU provides a measure of stability, but sustained competitiveness will require balancing wage pressures with productivity gains.

The broader global economic environment also contributes to the uncertainty. The European Central Bank’s Financial Stability Review, published in November 2025, highlights the volatility of international markets and the potential for adverse spillovers from global tensions. Specifically, the report points to risks associated with stretched public finances in some Eurozone countries and the potential for a repricing of sovereign risk, which could impact funding costs for Latvia.

the report warns of potential losses for Eurozone non-bank financial intermediaries due to their exposure to US markets. This interconnectedness underscores the vulnerability of smaller economies like Latvia to shocks originating in larger financial systems. The report also notes that market sentiment could shift abruptly if growth prospects deteriorate or if expectations surrounding the technology sector, particularly artificial intelligence, are not met.

The International Monetary Fund (IMF) also weighed in on Latvia’s economic situation in a report released in September 2025. While specific details from the report are not available, its existence indicates ongoing international monitoring of Latvia’s economic performance and potential vulnerabilities.

S&P Global Ratings downgraded Latvia’s long-term ratings to ‘A’ in May 2024, citing the continuing impact of the war in Ukraine and wider regional geopolitical risks. This downgrade reflects a broader assessment of Latvia’s economic resilience in the face of external pressures.

Looking ahead, Latvia’s economic performance will depend on a complex interplay of factors. Managing inflationary pressures, maintaining competitiveness, and navigating the uncertainties of the global economic landscape will be crucial. The ability to balance wage growth with productivity improvements, as highlighted by the Latvian Academy of Sciences, will be particularly important. Careful policymaking and a proactive approach to mitigating risks will be essential to sustaining economic momentum in the face of ongoing geopolitical and economic challenges.