Latvia raises interest rates, predicts more inflation for 2005

  • 2004-11-17
  • By TBT staff
RIGA - The Bank of Latvia raised the core interest rate last week, the second time it has done so this year, though analysts said the decision was unlikely to have much effect in curbing the country's consumption binge.

The bank's council raised the refinancing rate 0.5 percentage points to 4 percent on Nov. 11, while rates for term deposits at the central bank were left unchanged. The council said it had decided to raise the refinancing rate in order to "promote smooth, long-term development of the economy and curb domestic demand."

President Ilmars Rimsevics said an assessment of the latest macroeconomic data showed that domestic demand remained very strong - still exceeding external demand - and that there were no significant signs of it slowing down.

The rate increase, however, affects only the cost of borrowing lats, the national currency. For this reason, analysts were quick to point out that consumers and businesses were likely to continue borrowing and would just shift to U.S. dollar- and euro-denominated loans.

Hansabanka liquidity manager Maris Nelsons told the Baltic News Service that the refinancing rate increase was not good news for those borrowing in lats, and that more loans would now be taken out in euros and dollars. This, in turn, would boost currency fluctuation-related risks in the economy.

"Many borrowers who take loans in euros and U.S. dollars will exchange the borrowed funds against lats because [the latter] will be the consumption currency. Thus an intervention is expected, [as] the central bank will sell lats against other currencies, which will expand the supply of lats on the market - resulting in a surplus - and trigger a drop in lat interest rates," predicted Nelsons.

Latvijas Unibanka market analysis head Andris Vilks said the rate hike would have minimal effect on lending volumes. "More impact will be felt by banks, which have no access to cheap resources form parent banks or international credit institutions," said Vilks.

Parex Bank's Normunds Vigulis explained that time has shown that the previous rate increase had not influenced the tempo of lending, and that this time around it wouldn't have the desired effect either. "The only effect will be on the breakdown of credit portfolio by currencies," he said.

Meanwhile, the Bank of Latvia said it expected inflation this year to reach 6.5 percent - 7 percent. President Rimsevics told reporters last week that, although he had previously expected the inflation to amount to 7 percent, it could ultimately end up being lower, as growing oil prices would not affect Latvia's economy as much as previously expected. He also voiced conviction that this rate increase would have more effect than the previous one in March.

"The increase of the refinancing rate by any central bank serves as a signal that [it] is concerned over growth in the rate of inflation," said Rimsevics, adding that the bank would raise rates until the inflationary pace slowed down.

The consumer price index grew 7.2 percent in October year-on-year.