Economic overview 07/2026

Baltic economies: better growth and lower inflation projections

LATVIA

Manufacturing

Latvian economic cycle continues to improve, however growth is more skewed to the manufacturing sector and less so to the domestic demand. Citadele bank calculations based on the date compiled by the Latvian Statistics Department indicate that Latvian manufacturing activity is strengthening. On a 3-month-average basis, output rose 5.9% y/y in May and 3.7% year-to-date, and is 3.8% higher since February. Growth was led by fabricated metals (+22.7% y/y), textiles (+42.3%, from a low base) and apparel (+21.0%), computers and electronics (+18.8%), rubber and plastics (+18.7%), chemicals (+17.2%), furniture (+11.8%) and food (+6.7%). Weakness was concentrated in beverages (-31.1%), machinery repair (-19.9%), leather (-17.9%) and mining (-9.7%). The upturn seems to be driven by the defense spending in the EU and by the fact that, despite the war in Iran, overall economic activity in the EU did not lose significant ground, i.e. die not slow substantially. 

Retail

Retail growth was more moderate and has lost momentum somewhat. Citadele bank calculations based on the date compiled by the Latvian Statistics Department indicate that in May 2026 total retail (ex-autos) rose 3.6% y/y and 4.4% year-to-date but is marginally lower (-0.8%) since February. Household equipment (+7.1%), ICT equipment (+6.3%) and online/mail-order (+5.4%) grew fastest; specialised food (-0.6%) and especially books and press (-16.4%) lagged. The post-February softening chimes with weaker consumer sentiment.

Economic sentiment

Latvian economic sentiment index (ESI) deteriorated steadily through the war in Iran, with little sign of recovery. Citadele bank calculations based on the data compiled by the EU Commission show that the Latvian ESI edged up to a peak of 100.8 in March, then fell in every subsequent month to a June low of 96.5 - down 4.1 points since February and now below the 100 long-run average. June marked the bottom rather than a rebound for the headline and for several sectors.

The main drag is a deepening consumer slump. Confidence fell from -10.1 in February to a June trough of -19.0, sliding sharply from March onwards. Since the start of the conflict in Iran, Latvian consumers became more pessimistic on the economic perspectives, major purchases and savings. This points to households turning defensive on spending - and retail confidence echoes it, easing to a June low of +0.2 as expected business activity turned negative (-0.2). This is also reflected in the latest retail data.

The relative bright spot is industry, where confidence was essentially flat (-4.0 to -4.1) but the detail improved: for example, Latvian industrial companies became more positive on order books recovered strongly (from -22.9 in February to -15.9 in June, +7.0). Construction told a similar story of improving activity beneath a flat headline: confidence hovered near -7.7, but the assessment of recent activity rose from -0.6 in February to +6.4 in June, while builders' price expectations surged from +36.3 to +46.6. Services stabilised only marginally, edging up from an April trough of +1.5 to +2.0 in June, with expected demand still subdued (down to +3.9 from +6.6 in February).

Macroeconomic forecast

For 2026 we raised Latvian GDP growth projections to 1.8% (+0.3pp vs April) and cut inflation to 4.0% (-1.1pp), reflecting the peak impact of the conflict in Iran on the economic cycle and inflation. We expect Latvian unemployment to stand at 6.5% (-0.1pp vs April), wages to grow by 6.4% (+0.2pp vs April) and housing prices to increase by 5.4% (+0.2pp vs April). Overall, we remain upbeat on the perspectives of Latvian economy for 2026 and onwards.

LITHUANIA

Manufacturing

Lithuanian economic cycle continued to push forward despite the risks associated with the war in Iran. Industry extended its growth into spring 2026, with overall production output in manufacturing reaching historically highest levels. Citadele bank calculations based on data from Lithuanian Statistics Department show that nn a three-month-average basis, total industrial output rose 5.1% year-on-year in May and 3.7% year-to-date, with manufacturing up 5.8% y/y. Growth was broad but led by higher-value, export-oriented segments: computer, electronic and optical products (+18.6% y/y), rubber and plastics (+17.6%), machinery repair and installation (+18.1%), furniture and wood products (both +6.6%) and food manufacturing (+4.1%). It can be cautiously concluded that the increase in defense spending in Lithuania and EU overall is starting to have a visible impact on the Lithuanian manufacturing sector, as computer, electronics, optical, machinery segments are the direct beneficiaries on the defense spending. 

On the other hand, data clearly shows that lower added value sectors that typically depend on cheaper labor forces are struggling, with textiles (-4.6% y/y) and leather (-8.0% y/y) reporting soft production results. Since the outbreak of the Iran war in February, industrial output is up 2.9%, with gains in non-metallic minerals (+29.3%), rubber/plastics (+11.6%), motor-vehicle parts (+9.1%) and chemicals (+5.7%). The growth in cement (non-metallic minerals) segment reflects a continuation of a sharp growth in the real estate and construction segments.

Retail

Retail sector was another major contributor to the improvement in economic cycle. Citadele bank calculations based on data from Lithuanian Statistics Department show that retail trade (ex-autos, constant prices) grew 7.5% y/y and 6.9% year-to-date in May, and is 3.7% higher since February. Non-food sales led (+14.1%), with online and mail-order the standout (+26.0%), household equipment and electronics (+14.3%) and pharmacy sales (+10.3%) also strong; food was steadier (+2.1%) and fuel broadly flat (+1.2%). Retail sectors is supported by both fundamentals (further growth in salaries, tight labor market), as well as by the pension reform. Latest data shows that 40%, or 550 ths people, exited the second pillar pension system, in total these people received 2.8 bln. EUR, i.e. 3% of Lithuanian GDP. Around 70% of his capital is kept in the bank accounts, 16% of received capital was withdrawn (most likely for consumption), 6% was used to cover existing loans and leasing obligations. These numbers are well in line with the latest dynamics in Lithuanian retail segment, as pension reform had the direct impact on growth in online retail and electronics segments were directly impacted by the reform.

Economic sentiment

Leading economic indicators suggest that the period of peak negative impact of the war in Iran on Lithuanian business cycle may be over. Citadele bank calculations based on the data compiled by the EU Commission show that Lithuanian Economic Sentiment Indicator (ESI) – a good leading indicator of the economic cycle - slipped from 103.3 in February to a trough of 101.3 in March as the Iran war hit, then rebounded to 103.0 by May before easing to 102.1 in June - 0.8 point above its March low but still 1.2 below February.  Services drove the rebound and are the clear bright spot. Confidence collapsed from +6.0 in February to -1.0 in March, then staged a full V-shaped recovery to +10.2 in May and June - 11.2 points above the March trough and 4.2 above the pre-war level, with services companies becoming increasingly upbeat on current business situation and demand expectations. Construction sentiment also recovered: confidence bottomed at -8.2 in May and rebounded to -5.4 in June, back above its February level, as the assessment of recent activity improved. Consumer confidence made a partial recovery, from an April trough of -3.1 to -1.5 in June, led by a strong bounce in views on the general economy (past 12 months from -23.9 in April to -14.0; next 12 months from -22.8 to -15.5) and easing unemployment fears (peaked at 24.8 in April, down to 20.6) - though it remains 2.2 points below February. Overall, leading indicators suggest that, at least for now, the peak adverse impact of war in Iran is behind us, with economic cycle improving from the initial shock of war in Iran.

Macroeconomic forecast

We remain upbeat on perspectives on Lithuanian economy. We expect GDP growth to reach 2.9% in 2026, with 0.8% points generated by the pension reform. Compared to the previous forecast iteration (April 2026), we upgraded Lithuanian GDP growth projections for 2026 by 0.3% points as the peak impact of war in Iran on the economy and inflation has passed. We trimmed Lithuanian inflation projections to 5.8% (-0.2% point vs April 2026), however expect overall inflation to remain relatively high due to higher minimum wage and the mentioned pension reform. We expect wages to grow by 7.5% in 2026 (+0.2% points vs April forecasts) and unemployment to stand at 6.8% (-0.1% points vs April forecasts).

ESTONIA

Manufacturing

Estonian economic cycle remains somewhat weaker than in other Baltic states. Industrial activity, in general, continues to stagnate, with no clear direction since the start of 2025, and is 13% below its post-Covid peak. Calculations of Citadele bank based on data from the Estonian Statistics Department indicate that, on a 3-month-average basis total industrial output fell 3.2% y/y in May (-1.0% year-to-date) and manufacturing was down 2.6% y/y and 1.3% lower since February. Pockets of strength were basic metals (+13.1% y/y), non-metallic minerals (+12.8%, reflecting a potential upturn in construction sector), electronics and optical products (+9.9%) and electrical equipment (+4.9%), while activity is weaker in the rest of the sectors. However, the positive note is that the economic cycle in the Scandinavian region remains strong and resilient to the conflict in Iran, which should benefit the Estonian manufacturing cycle going forward. For example, during the first 4 months of the war in Ukraine, Finnish Economic Sentiment Index (ESI) fell by 13 points, while during the first 4 months of the Iranian conflict Finnish ESI index grew by 3.4 points, reflecting the overall strength in the Finnish economy, a key export market for the Estonian businesses.

Retail

Estonian domestic demand has been showing signs of weakness, as in May Estonian retail trade reached the lowest level since December 2025, reflecting the adverse impact of the war in Iran on consumers confidence and consumers’ willingness to spend money. 

Construction

On a positive note, Estonian construction sector continues to show signs of recovery, as construction output in the first quarter of 2026 reached highest level since end of 2023. This is also reflected by a sharp growth in the cement production that was mentioned above.

Macroeconomic forecast

Overall, we expect the Estonian GDP to grow by 2.2% in 2026 and inflation to stand at 4%. Unemployment level is expected to stand at 7% in 2026, while wage growth (5.8%) should outpace the increase in prices.

Global review

The global economy weathers yet another war with remarkable resilience

The global economy began 2026 on a positive note, but spring brought new test to the resilience of the global economy and financial markets. While in the spring of 2025 the U.S. administration, led by President Donald Trump, launched a global trade war against its trading partners, by the end of February of this year the same administration had launched an actual “kinetic” war against Iran.

The conflict between the U.S. and Iran, together with the closure of the Strait of Hormuz, affected around one-fifth of global oil supply, triggering a sharp rise in oil prices. However, several factors helped ensure sufficient supplies of oil and petroleum products to support the functioning of the global economy, while limiting pressure on prices. First, Middle Eastern exporters utilized alternative pipelines to bypass the Strait of Hormuz. Second, the U.S. significantly increased its oil exports. The global oil surplus that had built up prior to the conflict quickly disappeared. On the demand side, China played a significant role. It was able to rapidly reduce its oil purchases, apparently by using its strategic reserves, adjusting oil refining operations and curbing demand. Western countries also used available oil reserves to compensate for the shortfall in the market.

Following the announcement of a ceasefire between the U.S. and Iran, oil flows through the Strait of Hormuz began to gradually resume, and oil prices fell significantly. However, risks remained skewed to the upside. The ceasefire between the two sides is extremely fragile. Moreover, sooner or later, China and Western countries will need to replenish their strategic oil reserves, creating additional demand and putting upward pressure on prices. 

Although this seems to contradict economic logic, global producer sentiment has improved since the start of the Iran-U.S. conflict and has reached its highest level in four years over the past three months. This optimism among producers was evident across all major economies — the U.S., the euro area, and China. At the same time, it remains difficult to distinguish to what extent this wave of optimism was driven by a cyclical upturn in the sector, and to what extent by concerns about potential supply disruptions related to the conflict and increased demand to build up inventories.  

During the spring, consumers in Western countries continued to spend despite a decline in their purchasing power caused by higher oil prices. Household demand remained supported by steady income growth. In addition, the U.S. labor market emerged from its hibernation, as job creation resumed in the spring. 

Financial markets also recovered relatively quickly after a brief period of weakness in the spring. By June, equity markets in both developed and emerging economies had reached new record highs. The rise in stock prices continued to be supported by investors’ strong enthusiasm for artificial intelligence, which in the second quarter also spread to relatively smaller technology companies.  Positive sentiment also quickly returned to the bond markets, despite rising government bond yields in anticipation of tighter monetary policy. 

Euro area growth loses momentum again

The global economic system has once again demonstrated its resilience to external shocks, although economic forecasts have undergone revisions in recent months. Since the start of the conflict, economists and central bankers have revised inflation forecasts for Western countries upward and growth forecasts downward. The cycle of downward revisions to GDP forecasts in the euro area is not yet over, with current projections pointing to growth roughly half as strong as expected before the conflict. According to forecasts by analysts surveyed by Bloomberg, euro area economic growth could slow to nearly 0.5% in 2026 before accelerating to 1.2% in 2027. In contrast to the euro area, the U.S. is projected to see faster growth – around 2.1% in both years.

The euro area’s economic performance in the first half of the year was relatively subdued. In the first quarter, gross domestic product (GDP) declined by 0.2% on a quarterly basis. The negative result was primarily driven by a drop in Ireland’s highly volatile economic output and a moderate 0.1% decline in GDP in France and Lithuania. Meanwhile, growth continued in remaining euro area economies, with Germany’s GDP rising by 0.3%. Annual growth in the euro area slowed to 0.3% in the first quarter from an average of 1.4% over the past year and a half, also largely due to a double-digit decline in GDP in Ireland.

By sector, the euro area’s manufacturing industry delivered relatively weaker results. Despite positive producer sentiment and a rise in production volumes over the past three months, euro area manufacturing output in April was only 0.3% higher than a year ago, while in Germany it was 1.6% lower. Retail sales have become more volatile in recent months. Nevertheless, euro area retail sales volumes, excluding the impact of price changes, were 1.6% higher in May than a year earlier.

Euro area companies reacted more negatively to rising energy prices than their peers overseas. Sentiment among euro area service providers remained pessimistic during the second quarter. Consumer sentiment also deteriorated significantly in the spring. Although business and consumer sentiment recovered in June as oil prices fell, new orders dynamics in the euro area services sector continued to weaken. Pessimism among euro area construction firms also intensified over the past three months.

Overall, thanks to its positive energy trade balance, the United States is relatively better positioned to withstand rising energy prices than Europe and Asian economies. Based on our estimated, a 10 dollar per barrel increase in oil prices reduces the euro area GDP by an average of 0.15–0.20%. In contrast, the direct impact of higher oil prices on the U.S. economy is likely to be close to zero.

ECB seeks to avoid past mistakes and returns to rate hikes

The sharp rise in oil prices was quickly reflected in global inflation figures. In May, euro area inflation reached its highest level in recent year at 3.2%, while U.S. inflation accelerated to 4.2%. However, as oil prices and consequently fuel prices fell, inflation in the euro area began to normalize in June and has already fallen to 2.8%. Excluding the volatile energy and food price categories, inflation rates in the euro area remained relatively stable. Core inflation has fluctuated within a 2.2–2.4% range for more than a year. Inflation in the euro area is expected to return close to the 2% level next year.  

The acceleration in inflation also prompted central banks to consider the need for tighter monetary policy. Fearing second-round inflation effects, the European Central Bank (ECB) raised its deposit rate in June to 2.25% from 2.0%, marking the first change in its monetary stance in a year. Euribor rates had already priced in this move well ahead of the actual rate hike, reflecting investors’ expectations of a more aggressive ECB. The 6-month Euribor has stabilized at 2.5–2.6% in recent months, compared to an average of 2.15% before the conflict with Iran. Financial markets expect the ECB to raise the deposit rate by another 25 basis points this autumn and do not rule out yet another increase next year. As a result, the 6-month Euribor could eventually stabilize close to 2.75%.

Although the U.S. Federal Reserve System (FRS) has kept its policy rate unchanged in the 3.50–3.75% range since December, half of FRS officials expect it to be higher by the end of the year. At the same time, FRS projections suggest that the pick-up in inflation will be temporary and that rates could be lowered in 2027 and 2028. Financial markets also expect the first rate hike this autumn and see the possibility of another increase next year. It also appears that the new Fed Chair, Kevin Warsh, will adhere to an orthodox monetary policy approach and will not cut rates without economic justification. For a long time, financial markets were concerned that he might make politically motivated decisions under pressure from the U.S. president.