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On Resolutions Passed by the Bank of Latvia's Council

Press Release of 11 May 2006

The Council of the Bank of Latvia resolved today to leave unchanged the interest on refinancing, bank deposits with the Bank of Latvia, and Lombard loans. The Council of the Bank of Latvia will carefully assess the impact of the recently adopted monetary policy decisions and follow the developments in the Latvian economy, taking the necessary measures to ensure macroeconomic stability in the country.

In determining the direction of monetary policy, the Council paid particular attention to changes in prices, factors affecting economic growth, the development of export and import and lending.

The inflation level has remained unacceptably high in the country; for the third year in a row it has been hovering above 6%. The past and future increases in the cost of electricity, natural gas and other regulated prices, the impact of increased salaries on producers’ prices, the reduced impact of competitiveness under conditions of high demand and fluctuating oil prices all play an important role. In addition to external factors whose impact can hardly be avoided, a high domestic demand resulting from both increased labour costs and the record rapid lending growth (over 300 million lats in March or 64% per annum) serves as a very vigorous inflation engine.

The inflation stimulated by domestic demand and the steep increase in wages, which is out of balance with the growth of productivity, might slow down the export of  Latvian products and consequently of transit services. In the other direction, that of import, the high domestic demand acts as a stimulant. The result is the Latvian economy’s external lack of balance - the current account deficit (the preponderance of imports over exports) this year may drop even below the hitherto undesirable level. Adverse tendencies are observed also in the real estate sector: driven by lending, the prices in this market are climbing much faster than the growth of the average income. To a great extent, the rapid growth of lending is underpinned by the very low real interest rates (interest rates minus expected inflation); the real interest on household loans in March  was 1.2%, whereas the EU average was 4.7%.

It is therefore quite obvious that dampening of the steep rise in lending is one of the preconditions to continued balanced and successful development of the Latvian economy. One of the main tasks is to achieve a substantial reduction in inflation in the near future, so that inflation is prevented from becoming a chronic disease that would have an adverse effect on Latvia’s development over the long term. The Council of the Bank of Latvia supports any actions that are directed at normalizing the pace of lending, among them the project currently under discussion at the Financial and Capital Market Commission that provides for more rigorous liquidity demands on banks.

We would like to remind you that the interest rates set by the Bank of Latvia are as follows:
- refinancing  4.0% per annum;
- on bank deposits with the  Bank of Latvia:
            - with a maturity of seven days - 2.0% per annum,
            - with a maturity of fourteen days - 2.25% per annum;
- interest rates on Lombard loans:
            - with a maturity of up to 10 days - 5.0% per annum,
            - 11th-20th day - 6.0% per annum,
            - starting with day 21st - 7.0% per annum.

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