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On Resolutions Passed by the Bank of Latvia's Council

Riga 14 July, 2006


In view of the macroeconomic development trends in Latvia, the continued negative interest rates of the lats in real terms as well as the recent interest rate increases in the euro area and the US, the Bank of Latvia Council resolved today to raise the refinancing interest rate set by the Bank of Latvia by 0.5 percentage points to 4.5%. The interest rates of Lombard credit were likewise raised by 0.5 percentage points. The resolution will come into effect on 15 July, 2006.

The need to increase the Bank of Latvia refinancing or monetary policy base rate is prompted by the dynamics of the macroeconomic indicators, above all inflation, the current account and lending that point to a high and persisting domestic demand. The raising of the base interest rates by the European Central Bank accords the Bank of Latvia the opportunity - for the first time since the lats was pegged to the euro - to use the interest rate instrument in order to carry out a restrictive monetary policy.

Under the influence of both the demand and supply side factors, inflation remains high; moreover there is a risk that it will be impacted in the near future by the potential rise in fuel and administered prices, e.g., the increase in utilities and transportation costs.

The record high growth of the domestic product in the first quarter points to a significant increase in the domestic demand evidenced by a more rapid growth in those areas directed at domestic demand as well as the rest of the macroeconomic indicators - the persistently high growth in lending, the high increase in the income of both enterprises and individuals and others, serving to elevate worries about inflationary pressures originating on the demand side.

The branches directed at the external demand, on the other hand, are developing at a slower pace than before: the growth of the processing industries, external orders and exports has slowed down. External imbalance has aggravated as a result and a high current account deficit or predominance of imports over exports can be expected in the future as well.

The persistence of such high growth combined with high inflation and growing external imbalance indicate more pronounced classical characteristics of overheating of the economy.

Under such circumstances, the high pace of growth in lending and the structure of loans where mortgage loans, which stimulate demand, dominate combined with high increases in income levels hardly serve to promote the return of a state of equilibrium to the economy. The Council of the Bank of Latvia therefore supports actions directed at normalizing the pace of lending.

The improvement of the fiscal situation should be noted as a positive trend in the economy. Attempts to limit additional spending in the second half of the year, which would serve to end the year with a greater surplus than last year, would be an important step that the government could take toward lowering the inflation rate.

As of 15 July, 2006, the interest rates set by the Bank of Latvia will be as follows:
- refinancing - 4.5% per annum;
- bank deposits with the Bank of Latvia:
            - 7-day maturity - 2.0% per annum,
            - 14-day maturity - 2.25% per annum;
- Lombard loans:
            - up to 10 days - 5.5% per annum,
            - 11th through 20th day - 6.5% per annum,
            - as of 21st day - 7.5% per annum

The previous refinancing interest rate of 4% has been in effect since 12 November, 2004; the interest rates on Lombard loans and bank deposits since 16 September, 2002.

The reserve requirement for banks and branches of foreign banks has been 8% since 24 December, 2005.