Oil crisis impact on Latvia's economy proves stronger than expected

Rising oil prices and the resulting acceleration of inflation will affect Latvia's economy this year more severely than initially predicted, according to the latest forecasts. This implies slower economic growth, higher energy and everyday goods prices, as well as larger loan payments.

The Baltic states are particularly vulnerable in this situation due to their heavy dependence on imported energy resources. Rising inflation is already influencing monetary policy — the European Central Bank raised its key interest rates last week, leading to an increase in Euribor. Financial markets expect at least one or two more rate hikes this year, meaning borrowing costs will remain higher for both households and companies.

At the beginning of the year, inflation in the eurozone was forecast to be below 2%, but after the Middle East crisis, the projection was raised to around 3%. This situation clearly demonstrates how quickly geopolitical shocks can affect the economies of the Baltic states. In light of these factors, Bigbank has lowered Latvia's economic growth forecast and raised its inflation forecast for this year. In spring, Bigbank projected Latvia's GDP to grow by 2.4% in 2026, but the latest forecast expects slower growth of 1.5%. The Bank of Latvia also cut its GDP expectations on June 16, from 2.8% forecast last December to 2%. In both cases, the main reason for the revision is the Middle East crisis, whose impact has proven more persistent than initially anticipated.

For Latvia, the rise in energy prices is a particularly significant risk. Both electricity and heating could become more expensive, as Latvia is heavily dependent on natural gas. The greatest impact is likely to be felt in autumn when heating demand increases. Higher energy costs will also affect other product groups — rising fuel and energy prices make transport, fertilizers, and food production more expensive, which over time could lead to higher food prices. Price increases will also hit petrochemical products such as plastics and synthetic materials used in construction materials, paints, packaging, and textiles. As a result, Latvia can expect a higher overall price level. Bigbank forecasts inflation in Latvia to reach 4.8% this year, while the Bank of Latvia estimates 3.6%.

Higher inflation also means higher interest rates and therefore more expensive loan payments. More expensive loans reduce households' purchasing power, as a larger share of income must be allocated to daily expenses and loan repayments. Companies also face higher borrowing costs, which may reduce investment. This leads to slower overall economic growth. The labor market, however, remains relatively stable — Bigbank predicts that wages in Latvia will grow by 6.5% this year, while the Bank of Latvia expects 7.4%. A significant increase in unemployment is not anticipated, but wage growth does not automatically mean an improvement in living standards if prices and loan payments also rise.

Currently, one of the biggest challenges is uncertainty. Companies find it harder to plan investments when the outlook for energy prices, interest rates, and consumption is unclear. Latvia's investment climate may also be affected by recent political instability and challenges with airBaltic and Rail Baltica. These factors alone do not signal a crisis, but they increase caution.

For comparison, Estonia's economic growth forecast has also been reduced, though it remains slightly higher than Latvia's. Bigbank projects 1.7% GDP growth and 5.0% inflation for Estonia. In contrast, Lithuania's economy is performing relatively better this year, partly due to the second pension pillar reform freeing up financial resources. Bigbank forecasts 3.1% economic growth, 5.5% inflation, and 8% wage growth for Lithuania. Latvia's economic outlook is currently cautious — the baseline scenario still predicts growth, but at a slower pace than forecast at the beginning of the year.