OP Corporate Bank: Economy to grow by 2.6%, Lithuania stands out from global trend

Lithuania among the leaders

“Lithuania remains the fastest-growing economy in the region, supported by stronger domestic demand and consumption. However, we cannot expect the slowdown seen at the beginning of the year to leave no mark on overall performance. Annual growth will be somewhat lower, but it will still exceed both the regional and European averages,” said Joona Widgren, Senior Economist at OP Pohjola, while presenting the latest economic outlook.

The bank has also lowered its forecast for Lithuania’s GDP growth next year to 2.5%, compared with 2.8% projected in March. In the first quarter, Lithuania’s GDP grew by 2.6%.

According to the economist, if shipping through the Strait of Hormuz returns to normal and oil prices continue to decline, cheaper fuel and improved sentiment could provide an additional boost to economic growth.

Prices and interest rates to remain higher

Due to higher oil prices and strong consumer spending, prices in Lithuania are expected to rise faster this year than anticipated. Annual inflation is now forecast at 4.5%, compared with 3.1% projected in March. Inflation in the euro area currently stands at 3.2%, while Lithuania has traditionally experienced faster price growth.

The inflation forecast for next year remains unchanged at 2.5%.

“Inflation will remain elevated this year, even if oil prices decline. However, we can be pleased that inflation has not reached the exceptionally high levels seen four years ago. Much will depend on whether oil trade returns to normal volumes in the near future and whether prices continue to fall,” the economist noted.

Inflationary pressures have recently become more broad-based, with the prices of other goods and services increasing as a result of higher fuel costs. In response to rising inflation, the European Central Bank raised interest rates by 25 basis points last week.

“Markets still expect one to two additional rate hikes this year, but the outlook may change. Much will depend on whether an effective long-term agreement regarding the Middle East is reached,” Widgren emphasized.

Manufacturing and exports feel the impact

Export growth is expected to be more moderate this year, as the conflict in the Middle East has affected global trade and trade volumes have declined in recent months.

Although Lithuania’s manufacturing sector expanded rapidly at the end of last year and the beginning of this year, output declined after the conflict in the Middle East began.

Over the past decade, Lithuania’s manufacturing output has increased by 75%, meaning the country now produces 1.75 times more goods than it did in 2015.

During the same period, manufacturing output increased by approximately 30% in Latvia, 22% in Estonia, and 20% in Finland.

“Lithuania is the clear leader among the Baltic states. In recent years, manufacturing growth has been more than twice as fast as in Latvia and Estonia, and roughly three times faster than in Finland. This is a very strong performance by European standards,” said Leda Irzikeviciene, Country Manager of OP Corporate Bank’s Lithuanian branch.

Lithuania diverges from international trend

Lithuania has found itself in a unique position due to withdrawals from the second-pillar pension system. Globally, activity in the services sector declined significantly in March and April, as households either postponed or reduced certain expenditures because of higher fuel prices and increased uncertainty.

“In Lithuania, however, the trend has been the opposite. Consumption of both services and goods has grown strongly. This has helped offset weaker demand in foreign markets faced by export-oriented companies,” said Irzikeviciene.

Nevertheless, stronger consumption does not eliminate the heightened uncertainty. Consumer confidence has declined this year, a trend visible across all Baltic countries.

The deterioration in sentiment also does not help reduce the consumption gap that has persisted for the past four years, with consumption growing more slowly than incomes.

Estonia: growth continues, but at a slower pace

According to OP’s forecasts, Estonia’s GDP is expected to grow by 2.5% both this year and next year. In March, the bank projected faster growth of 3.2% this year and 2.8% next year.

Estonia’s GDP grew by 2.4% in the first quarter, following growth of 0.6% last year after a recession that lasted three years. Economic growth at the beginning of the year was stronger than expected, but higher energy prices are slowing the recovery.

Inflation in Estonia is expected to decline to 4.0% this year and 2.5% next year, compared with 4.8% last year.

Domestic demand continues to grow, supported by rising household consumption, higher incomes, and tax-related changes.

Latvia: government investment and consumption support growth

OP economists have lowered Latvia’s GDP growth forecast for this year to 2.0%, down from 2.8% projected in March. The forecast for next year remains unchanged at 3.0%.

Latvia’s economy grew by 2.5% in the first quarter compared with the same period a year earlier.

The inflation forecast for this year has been raised to 4.0%, while next year’s forecast has been lowered to 2.5%, compared with 3.3% inflation last year.

Economic growth in Latvia continues to be supported by domestic demand from both households and the public sector. The manufacturing sector is also performing well this year.

Higher defence spending is increasing the country’s fiscal deficit, but expansionary fiscal policy continues to support economic growth.