"Growth across the Baltic States looks set to weaken further as the recession in Russia weighs on exports. But output shouldn’t collapse thanks to the strength of domestic demand," Capital Economics said in a regular review of Europe's "emerging" economies.
"All three Baltic economies slowed in the first quarter of this year. This appears to be due largely to the recession in Russia – the Baltic States have by far the largest trade ties with Russia in the region. All in all, we think this could knock 0.5-1.0%-pt off GDP growth in the Baltics this year. And a modest recovery in the rest of the euro-zone will only partially offset this."
However, domestic demand should hold up "relatively well" supported by sensible fiscal policy while low oil prices will keep inflation pressures subdued.
"We are concerned that the region’s labour markets are showing signs of overheating. Indeed, wages have been rising at a faster pace than productivity for several years. While this is unlikely to be a problem over the next year or so, it could in time erode the region’s external competitiveness and lead to a renewed build-up of external imbalances," Capital Economics warned.
All three Balic economies are now operating at close to full capacity, it concluded, predicting GDP growth in Latvia of 1.7% this year and 2.0% next year.