Palomo, driving a Peugeot 208 Rally4, was locked into an early battle with championship leader Laurent Pellier and moved into the lead when his Opel Corsa rival rolled on the third stage.
The Spaniard led by as much as 24.1sec after the first loop but came under increasing pressure from Herranen, who moved up the order after winning all three of the afternoon tests in his Ford Fiesta Rally4.
Herranen - co-driven by the experienced Mikko Lukka - was able to reduce the deficit by 14.7sec and trails the leader by 22.9sec ahead of Sunday's finale.
"I enjoyed today a lot," said Palomo. "The car is amazing - everything feels perfect and I learned a lot.
"In the morning it was easier, because we had some rain in the afternoon as well as a lot of ruts and rocks. Tomorrow I will try to focus on winning the rally, but I am also thinking about the championship," he added.
Fiesta driver Justas Simâska completed the podium 23.7sec down on Herranen, with Finnish debutant Benjamin Korhola another 16.1sec behind with his similar car.
Andrea Mabellini trailed the leaders by 58sec in fifth overall despite the wipers on his Renault Clio Rally4 failing on the penultimate stage. He held a slender 1.4sec advantage over team-mate Anthony Fotia, who is only eligible to score points in ERC4.
- Full coverage from Tet Rally Liepāja is available on WRC+ All Live here, including every stage broadcast as it happens as well as key interviews, features and expert analysis from the service park.
Finland
Italy
Hungary