Latvia central bank brings rates and rules in line with eurozone

The Bank of Latvia this week brought its interest rates in line with those at the European Central Bank (ECB) ahead of joining the euro in January – but the drastic rate cut, from 1.50% down to 0.24%, left economists in the country unmoved.

Inflation in Latvia has fallen in recent months to 0.3% in the year to October 2013 – lower even than the 0.7% for the eurozone as a whole, which led the ECB to cut its main policy rate from 0.50% to 0.25% last week.

The Bank of Latvia therefore cut its rates for the third time since its entry to the eurozone was formally confirmed in July this year. The refinancing rate came down from 2.5% to 2.0% in July, and then to 1.5% in September. This week's move was also accompanied by the adoption of "several regulations for a successful and smooth euro changeover as of 1 January 2014", according to the central bank.

The main change was that the Bank of Latvia adopted procedures to bring it in line with the eurozone's Target2 clearing system. It also changed its rules on the size of "suspicious and unusual" transactions, to fall in line with regulations followed in the eurozone.

The interest rate change itself was a "non-event", according to Andris Strazds, chief Latvia economist for Nordea bank. "The commercial banks in Latvia have ample liquidity as evidenced by a liquidity ratio of 65% as at the end of September 2013," he said, meaning they do not need the Bank of Latvia's refinancing facilities. What is more, "the domestic banking sector is also largely dominated by Nordic banking groups and the local entities can easily borrow from their ‘mother banks' in Scandinavia, if there is a need".

Pēteris Strautiņš, a Latvian economist with DNB bank, said he could not remember "any occasion when Bank of Latvia decisions about its refinancing rates have affected the economy in a significant way", adding that "most lending happens in euros anyway".

He said the move was best seen as "just a technical step, as monetary policies or what is left of them are moved in line with euro area numbers before the full accession happens".

Strazds agreed, saying the central bank's move could "simply be explained by the need to equalise the main policy rates with those in the eurozone, as there are less than two months left before joining", he said.