Economic overview 03/2025

Baltic overview

At the moment, the economic cycle in the Baltic region remains somewhat divergent, however we expect more similarities across the Baltic states going forward. For now, Lithuania continues to lead the Baltic region in regard to the strength of economic cycle, followed by Latvia and Estonia, with Estonia being the weakest link for now. However, according to recent data, the last quarter of 2024 brought long-awaited economic growth to Estonia.

In Latvia, economic activity remains flat, but we see more signs of a cyclical rebound in the economy. One of the key sectors where we see more positive signs is retail sector, which may be benefiting from recovery in consumer purchasing power as well as cheaper borrowing costs. Data compiled by the Latvian statistics department shows that in the fourth quarter of 2024 Latvian retail sales were at the highest level since 2022 Q3. As in the case of Lithuania, this rebound is mostly driven by non-food segment, which is typically more cyclical. in 2024 Q4, Latvian non-food retail sales were 7.2% higher than a year ago, excluding the impact of prices. Interestingly, rate-sensitive categories are strongly contributing to recovery in Latvian domestic demand as in 2024 Q4 retail sales of IT and communication equipment were 16% up from 2023 Q4, while retail sale of electrical household appliances in specialised stores were up 12% year-on-year, again without the impact of change in prices. Therefore, declining borrowing costs are already filtering through Latvian economy. We also see more and more positive signals from Latvian manufacturing sector, where manufacturing output in December 2024 was 3.2% up from the same period of 2023 in real terms, i.e. excluding the impact of change in prices. One interesting aspect to highlight is that in December 2024 production output in Latvian cement industry was almost 16% above the corresponding period in 2023, which is a cautious sign of upcoming rebound in construction and real estate activity.

Lithuanian economy continues to go from strength to strength, but risks that need to be followed closely have emerged. Lithuanian economy finished 2024 with a very solid performance. In 2024, GDP grew by 2.6%, while in 2024 Q4 GDP increased by 3.6%. In terms of sectoral performance, several interesting trends have emerged recently. The level of production in Lithuanian manufacturing, which exports most of its goods, is only 1% below the post-Covid peak, which is a solid result given the weakness in German industry. We also see clear signs of a pick up in cyclical production, for example in December 2024 production output in furniture was 9% above the peak minimum production level in spring 2024. In addition to this, retail sales turnover has reached the post-Covid peak levels, supported by a rebound in food sales and non-food retail sales, with the latter reaching historical highs in December 2024. This rebound is driven by both high level of consumer optimism and growing consumer purchasing power. Lastly, we see more signs of a rebound in the real estate market, as in January 2025 number of deals to buy a flat were 3% above the 2024 January level, while number of deals to buy a flat were up 6% year-on-year. However, we do see important risks that we will follow closely going forward: In December 2024, we started to see first signs of stagnation/shallow decline in export of goods of Lithuanian origin to Germany, which means that we might be seeing first signs of impact of weakness in German economy. However, given the increased willingness of German manufacturing companies to look for contract manufacturing partners outside Germany in order to regain competitiveness, we do not see substantial risks to Lithuanian exports.

In Estonia, we see more and more signs of the bottoming out of economic cycle, i.e. Estonian economy is almost out of recession and is on the verge of economic recovery.  According to Statistics Estonia, the last quarter of 2024 brought Estonia 1.2% economic growth, which was significantly higher than the forecasted result. In total, Estonia's GDP decreased by 0.3% in 2024. Leading indicators show that multiple sectors are contributing to the bottoming out of Estonian economy: at the end of 2024 we observed significant improvement in Estonian manufacturing sentiment, while economic activity in services sector also picked up somewhat. In 2024, private consumption grew by 1.2%. Lastly, both surveys of Estonian manufacturing companies and Estonian export data show a rebound in Estonian foreign trade. Statistics Estonia data show that total exports of goods and services grew by 3.2% in 2024. Estonian export is heavily linked to the Scandinavian region, which accounts to a third of total Estonian exports. Therefore, we think that to a large extent, a rebound in Estonian exports may be attributed to a positive filter-through of a decline in borrowing rates in Scandinavian region.

Baltics: outlook for 2025

We expect that in 2025 economic cycle will strengthen in each Baltic economy. We expect Latvian GDP to grow by 2.2%, Lithuanian GDP to expand by 2.9% and Estonian GDP to grow by 2.4% in 2025. One of the main catalysts behind a potentially stronger Baltic economic cycle in the Baltic region is decline in borrowing costs which will filter through both exporting and domestic sectors of the Baltic economies. In addition to this, we continue to expect further growth of purchasing power in the Baltic region: we forecast that in Latvia and Lithuania average wages will increase by 7%, while inflation rate in Latvia and Lithuania should stand at 2.2% and 2.7% respectively in 2025. In Estonia, we expect wages to grow by 5.3% this year and an inflation rate of 3.3%. Decline in borrowing costs and ongoing recovery in purchasing power will be an important catalyst behind the stronger economic cycle in the Baltics. As always, the forecasts are not without risks, and we continue to monitor them closely. Together with tariffs, perhaps the biggest risk to monitor is the filter through of weakness in German economy onto the exports of the Baltic countries, and we may be seeing the first signs of that in Lithuania.

Global overview

The US economy in 2024: A leader in growth among Western nations. The US economy remained one of the growth leaders among Western nations in 2024, while the Eurozone struggled to escape from stagnation. US household spending continued to grow steadily throughout the year, and the labour market situation remained favourable. Towards the end of the year, positive signs began to emerge in the US manufacturing sector as well. The US GDP increased by 2.8% in 2024, almost matching the 2.9% growth seen the previous year. Meanwhile, activity and sentiment in the Eurozone remained weak. After moderate growth in the first three quarters, the region's economy once again slipped into stagnation by the year-end, with overall Eurozone GDP growth of 0.7% in 2024, up from 0.4% the previous year. The region's largest player, Germany, continued to show weak performance, with its economy shrinking for the second consecutive year. Germany’s development is hindered by relatively higher energy prices, weak demand in export markets, and its economic dependency on the automotive sector, which is undergoing a period of transformation and change.

Eurozone struggles to recover post-pandemic growth. The Eurozone’s economy has yet to regain the growth momentum lost during the pandemic. While income levels continued to rise steadily in both the US and Europe, Eurozone consumers were reluctant to spend. US households directed nearly all of their income towards consumption, continuing to support the US growth engine. In the second half of 2024, US consumers allocated only slightly over 4% of their available income to savings. By comparison, Eurozone savings amounted to about 15% in the last quarters. As household well-being continues to improve, this money could begin flowing into the economy. Moreover, lower borrowing costs could provide additional incentives for Eurozone households to spend and for businesses to invest. The improvements previously observed in credit conditions have already started to positively influence the dynamics of credit issuance and borrowing in the Eurozone.

Signs of recovery in manufacturing sectors. After a prolonged pause in Western manufacturing, signs of recovery began to emerge at the start of the new year. In January, US manufacturers’ sentiment turned optimistic for the first time since the fall of 2022, and global sentiment turned positive after a half-year hiatus. In the Eurozone, early signs of demand-side improvements were also observed, as new orders declined at a slower pace, reducing the overall negativity in the sector. The coming months will reveal how much of these improvements are due to companies' desire to rebuild inventories in response to US import tariff threats.

Fundamental changes in global economic growth unlikely to be seen this year. No significant changes in global economic growth are likely to emerge this year. According to analysts surveyed by Bloomberg, US growth forecasts have been revised upward while Eurozone growth projections have been revised downward. Although US growth is expected to slow slightly in 2025, the US is still projected to experience growth that is twice as fast as Europe, with growth above 2% compared to an average of 1% in the Eurozone.

Diverging monetary policies between the US and Eurozone. The first central bank meetings of the year highlighted the growing divergence in monetary policies between the US and the Eurozone. Over the course of last year, both the US Federal Reserve and the ECB reduced their base interest rates by 1 percentage point in multiple steps. Considering inflation acceleration since the end of last year and resilient growth, the US Federal Reserve paused its rate-cutting cycle in January. In addition to inflation making a return to the spotlight, the potentially inflationary initiatives of President Donald Trump’s new administration have led market participants to virtually abandon the scenario of low interest rates, substantially reducing expectations of further rate cuts in the US. The next rate cut in the US is not expected before summer, and investors do not foresee rates falling significantly below the 4.0% range in 2025.

ECB likely to continue rate cuts amid weak economic environment. Unlike the Federal Reserve, the ECB continued to reduce rates in January. Although inflation has started to accelerate moderately in the Eurozone since the fall, the weak economic backdrop in the region still supports further rate cuts in the Eurozone. Financial market participants expect the ECB to lower rates again in March and possibly bring the deposit rate down to around 2% by the end of the year. This suggests that significant EURIBOR rates for borrowers in the Eurozone could stabilize near these levels. While it is easier for the ECB to justify a softer monetary policy compared to the US, the ECB cannot afford to aggressively cut rates without considering the global implications. A more rapid rate reduction than the Federal Reserves could lead to a loss of attractiveness for the euro in the eyes of investors. Lower demand for the euro weakens the currency and increases the cost of Eurozone imports in dollar terms. This, in turn, could exacerbate inflation and work against the ECB's interests. Additionally, the recent rise in gas prices in Europe and persistent inflation in service prices could create discomfort within the ECB.

US tariff threats add uncertainty to global economy. The relentless tariff threats by newly elected US President Donald Trump have introduced additional uncertainty into the global economy and volatility in financial markets. The introduction of import tariffs on major US trading partners and their responses could dampen global economic growth and exert further inflationary pressure, particularly within the US. Trump has not hesitated to issue threats, and actual tariffs have so far been applied on China, Canada and Mexico. The tariffs on Canada and Mexico, which were initially delayed, went into effect on March 4. These three countries account for nearly half of the US’s trade deficit of over one trillion dollars with the rest of the world. The tariff risks also extend to Europe, with which the US has a historically large trade deficit, though at present, these risks remain at the level of threats and speculation. The European Union’s exports to the US amount to over half a trillion euros, or about a fifth of total exports outside the EU. In addition to tariff threats, European manufacturers could face risks from other countries' exporters, who may seek to redirect their products to the European market due to concerns over US tariffs.

Potential impact of President Trump's economic policies. Following President Trump's re-election, investors and economists have started drawing parallels with his first term from 2017 to 2021. During that period, Trump mainly pursued an "accelerated" approach to national finances. So far, everything points to this practice continuing. For US companies, this could mean a more favourable tax and business environment. This was one of the reasons why, despite the tariff wars during Trump's previous administration, the first term was marked by inflation in financial asset prices and mostly positive business sentiment.