Annual inflation in Lithuania is currently significantly higher than the euro area average. According to preliminary estimates, inflation in September 2026 stood at 3.8% in the euro area and 6.1% in Lithuania. This gap naturally raises questions: what does it tell us about the state of Lithuania’s economy, and what does it mean in the context of the euro area’s single monetary policy?
The inflation gap between Lithuania and the euro area alone is not enough to draw conclusions about the monetary policy stance. First, we need to understand the factors driving this difference.
Commentary by Tomas Reichenbachas, Principal Economist at the Monetary Policy Division of the Economics Department, Bank of Lithuania
The ECB’s monetary policy focuses on price stability across the euro area
It is important to remember the European Central Bank’s (ECB) objective. The ECB does not aim to keep inflation at exactly 2% in every euro area country at all times. Its objective is to stabilise inflation at 2% across the euro area over the medium term. When making decisions, the ECB assesses not only the current inflation rate but also the inflation outlook, underlying inflation dynamics and how monetary policy is transmitted to the economy. As Lithuania is a highly open economy and most of its exports go to other euro area countries, stability across the euro area is very important to us.
Within a single currency area, inflation rates can naturally vary between countries. These differences reflect economic structures, positions in the economic cycle and the various factors driving price changes. In one country, inflation may be driven more strongly by rising wages and service prices; in another, by changes in energy prices or taxes.
Forecasts suggest that inflation should decline
It is important to assess not only the current inflation gap but also how inflation will evolve. The Bank of Lithuania forecasts that average annual inflation will fall from around 5.1% in 2026 to 3.1% in 2027 and 2.6% in 2028. The Eurosystem also projects that euro area inflation, expected to average around 3% in 2026, will subsequently decline to 2.1% in 2028.
If these forecasts materialise, the current large inflation gap between Lithuania and the euro area will gradually narrow. This is one reason why the ECB focuses on medium-term inflation developments rather than a single month’s figure.
Country-specific and temporary factors account for a substantial share of Lithuania’s inflation
Not all of Lithuania’s current inflation is the result of excessive domestic demand. Energy prices have become one of the main drivers of price growth this year, particularly fuel prices pushed up by more expensive oil. Increases in indirect taxes—excise duties—at the beginning of the year are also adding to inflation in Lithuania. The Bank of Lithuania estimates that their impact will account for around one-fifth of this year’s average inflation.
Funds withdrawn from second-pillar pension funds have provided an additional, but considerably smaller, boost to demand. The Bank of Lithuania estimates that their impact on inflation in 2026 will amount to around 0.2 percentage points.
The key point is that the effects of both the tax changes and withdrawals from second-pillar pension funds are largely temporary. As these effects fade, inflation should decline. Adjusting for these specific factors, the inflation gap between Lithuania and the euro area would be considerably smaller.
Under normal conditions, Lithuania’s inflation may be slightly higher
There is another reason why Lithuania’s inflation should not be compared mechanically with the euro area average. Lithuania is still catching up with wealthier European countries. Our labour productivity, wages and price levels are converging with those of Western Europe, so a somewhat higher inflation rate is a natural part of this process.¹
This does not in itself mean that higher inflation should be regarded as normal over an extended period. However, if wages and living standards in Lithuania continue to approach those in Germany, the Netherlands and other wealthier euro area countries, price levels will also converge.
As labour productivity and wages rise, so do the prices of local services that cannot, or cannot easily, be provided from abroad, such as restaurants, repairs, hairdressing, healthcare and other professional services. In other words, part of Lithuania’s higher inflation may be a natural consequence of economic convergence.
However, higher inflation cannot be ignored
None of this means that higher inflation in Lithuania can simply be dismissed. It may also signal an overheating economy.
If service prices and wages continued to rise rapidly in Lithuania after energy prices had stabilised and tax effects had faded, if wage growth significantly outpaced productivity growth for a prolonged period, if lending expanded rapidly and domestic demand exceeded the economy’s capacity, this would be a clearer sign of mounting domestic inflationary pressures and differences between Lithuania’s cyclical position and that of the euro area as a whole.
Wages in Lithuania are indeed currently rising rapidly: the Bank of Lithuania forecasts wage growth of around 9.4% in 2026. Service price inflation, labour costs, lending and domestic demand therefore need to be monitored closely.
Even in such circumstances, however, monetary policy is not the only tool available. Within a single currency area, national economic policies play an important role in addressing country-specific imbalances. If Lithuania’s economy is overheating, the country can pursue a less expansionary fiscal policy and exercise greater caution when increasing permanent public expenditure. The Bank of Lithuania can also apply macroprudential measures if it identifies risks of excessive credit growth or overheating in the real estate market.
What matters most is what causes the inflation gap
When assessing inflation in Lithuania, the central question should therefore not be “Why is inflation in Lithuania different from the euro area average?” but “What exactly is driving this difference?”
How much is attributable to energy, how much to taxes and temporary boosts to demand, how much to wage and price convergence, and how much to genuinely excessive domestic demand?
Lithuania’s annual inflation rate of 6.1% is a signal that requires serious analysis. However, the inflation gap itself does not reveal its causes. Country-specific and temporary factors account for a significant share of Lithuania’s current inflation, while part of the gap may be linked to economic convergence. At the same time, it is important to monitor whether higher inflation is becoming a sign of more persistent domestic price pressures.
¹ The Bank of Lithuania’s 2024 study, “Anatomy of inflationary shock in Lithuania: causes, effects and implications”, estimates that in 2022, when Lithuania’s price level was still around 26% below the euro area average, price convergence may have contributed to inflation being around 0.5–0.9 percentage points higher. The median model estimate suggested that “equilibrium” inflation in Lithuania could have been around 2.6%, compared with 2% in the euro area. As Lithuania’s price level approaches the euro area average, this gap gradually narrows.
Read more: Bank of Lithuania
