National central banks, including the Bank of Latvia (LB), have one main task, which is written in the first articles of their statutes. This task is to ensure price stability in the country.
It is mentioned in Article 4 of the Statute of the Bank of Latvia: “According to the Treaty on the Functioning of the European Union, the main objective of the Bank of Latvia’s activity is to maintain price stability.” In the Statute of the ECB, Article 2: “According to Article 127(1) and Article 282(2) of the Treaty on the Functioning of the European Union, the main objective of the ECB is to maintain price stability.”
Annual inflation in February 2023 was 20.3% in Latvia, and 8.5% in the eurozone countries.
The previous, long-time president of LB Ilmars Rimševičs was once ready to talk about everything, except for his direct duties – about price stability. When the inflation rate in Latvia exceeded 16% per year in 2007, Rimševičs participated in countless public debates, where he spoke about the state budget deficit (which was close to zero), the extravagance of Kalvīš’s government, mismanagement and other things that the public likes, but did nothing that he liked the head of the central bank should do to reduce high inflation.
Since those times, in the consciousness of the Latvian masses, the monetary policy of the central bank and price stability are two different, unrelated things. In the consciousness of the Latvian masses, the government is responsible for the “high prices”. In 2007 it was Kalvītis, and in 2023 – Kariņš.
In fact, the central banks, which try to keep inflation at a certain level, are responsible for the price level, according to their own statutes. Typically, this target level is 2%. At present, inflation is significantly higher.
The main tool of central banks to stabilize prices is the base interest rate, which makes money “more expensive” or “cheaper”. If inflation is low or deflation threatens, then money must be made cheaper and base interest rates are lowered. Until quite recently, before the pandemic, economists were worried about the threat of deflation, and the ECB’s base interest rates were set at 0% until July 27, 2022. Zero percent. They have grown rapidly in just the last nine months.
Now, largely due to the management’s “smart” strategy to combat the Covid-19 pandemic, inflation in the Western world has reached unprecedented levels in this century. The ECB (like the US Federal Reserve and other central banks) is rapidly raising the base interest rate to quell the rapid rise in prices and drive inflation down to its target of 2%.
It is clear that making money “more expensive” has a negative effect not only on borrowers’ monthly payments, but also on national economies as a whole. A seemingly paradoxical situation is emerging – the prices of goods and services are rising, but the prices of the most popular form of long-term deposits in the West – shares – are falling. In Latvia, the securities market is poorly developed, so the role of long-term investments is often played by the real estate market.
Real estate prices in Latvia are relatively low. They are low not only in comparison with the cities of developed western countries, but also in comparison with many Asian and African countries that are much poorer than Latvia.
Real estate prices in Latvia are still much lower than they were at the peak of 2007. Therefore, in theory, they would still have room to grow. Even more so, considering the expected increase in salary levels in the future.
However, the real estate market in Latvia is strongly pulled down by the demographic situation. There is a small influx of people into the cities from the countryside or abroad, which has always and everywhere been the main driving force behind rising real estate prices. Precisely because large masses of people move from the countryside to the cities, real estate prices in the already mentioned Asia and Africa are not lower than in Latvia, despite much lower wages.
There is no doubt that in the foreseeable future (within 5-10 years) both the salary level and housing prices will grow in absolute numbers. Another question is whether this increase will also be relative (in relation to the overall price and wage level). In any case, these price changes will be different for different segments of the real estate market, but the evaluation of these segments is not the purpose of this article. About that another time.
This time about the fact that the increase in the ECB’s base interest rates makes money (lending) more “expensive”. Therefore, in the near future (within a year), real estate in general will not become more expensive with high reliability. At the same time, there is no reason to hope and wait for some kind of “bubble burst”, as it was in 2009.
Firstly, there was no “bubble” at all (on the contrary, prices have remained low for a long time), secondly – there is no basis for a serious, deep economic crisis, which could tear these real estate prices down. Yes, the problems of some global banks indicate certain shortcomings in the banking system, but the overall economic structure in Latvia, the EU, and the USA is relatively good.
The OECD has just increased its 2023 global economic growth forecast from 2.2% to 2.6%. The International Monetary Fund gives an even more optimistic forecast – 2.9%. This means that the world economic crisis is not expected.
In Latvia, on the other hand, GDP growth close to zero is predicted this year. This economic turmoil, combined with high interest rates, makes it possible to predict a fall in real estate prices. How big it will be is hard to say. It is unlikely that the price drop will be significant, because the prices are not very high anyway. The market is likely to be inactive and stagnant.
The market could move slowly when the ECB starts lowering the base interest rates. This will happen only when the inflation rate returns close to the target.
When will it happen? Some predict that already at the end of this year, others are more cautious, but if no cataclysms happen, then the real estate market will revive already (only) next year.
