According to Latvijas Banka forecast, Latvia's gross domestic product (GDP) is expected to grow by 3.9% in 2018. The previous forecast of 4.1% was adjusted downwards to reflect somewhat stronger than previously expected decline in Latvia's financial sector activity and the decreasing optimism in the external environment, partly offset by the solid performance of Latvia's economy reported in the first quarter. Latvia's GDP growth forecast for 2019 was revised downwards from 3.2% to 3.0%.
Inflation forecast for 2018 remains unchanged at 2.9%. For 2019, it was revised upwards by 0.3 percentage point, to 2.9%, reflecting higher oil prices.
The solid growth observed in 2017 continued in the first quarter of 2018. It was supported by private investment and more active absorption of the European Union funds, as well as robustly growing household real income and further favourable impact from the major foreign trade partners.
Annual growth in 2018, however, is expected to be slightly lower than in the previous year. The beginning of the year was marked by declining optimism in the external environment as well as heightening geopolitical risks. Additional obstacles to higher growth also emerged in the domestic environment, in relation to the developments in the financial sector. While there was a continuous decline of business activities related to servicing foreign clients in 2017, the decline is likely to accelerate in 2018 as a result of the stepped up efforts to eliminating business with risky customers and de-risking of the financial sector. Moreover, several sectors are facing supply side constraints and insufficient investment in production capacity could become a growth-dampening factor.
Despite oil prices growing faster than expected, this was partly offset by the strengthening of the euro against the US dollar. Moreover, the upward pressures of higher energy prices on inflation was partly offset by the deceleration of food prices in combination with a larger-than-expected impact of the reduced value added tax on vegetables and fruit typical of Latvia. Therefore, the inflation forecast for 2018 has been left unchanged. The rise in oil prices has already passed through to fuel prices, while there is a lag in the pass-through to other items which justifies an upward revision of the inflation forecast for 2019. The gradual strengthening of the domestic inflation pressures has been in line with the expectations.
The latest forecasts will be further elaborated in June 2018 Macroeconomic Developments Report of Latvijas Banka. This Report contains comprehensive information about the development and indicators of the global and Latvian economy, with a special focus on the effect of the US trade tariff increases on the Latvian economy. Various scenarios based on the already introduced and potential tariff increases have been modelled, taking into the account also the potential retaliation by the European Union and China.