ECONOMIC FORECAST. Lower inflation in the second half of the year will support growth in the economy



The latest economic forecast from Eesti Pank finds that the Estonian economy is doing satisfactorily overall, though the crises have hit different sectors quite differently. The picture of the state of the economy varies a lot depending on whether the impact of inflation is taken into account in the calculation of economic growth or not. The Estonian economy measured in euros, or GDP at current prices, has grown by around 30% over the past two years, but at real values, or GDP at constant prices, the Estonian economy has been shrinking steadily for more than a year. A downturn in the economy generally causes unemployment to rise and wage growth to fall, but the labour market has been resilient so far and unemployment is close to 5% while wage growth exceeds 10%. The downturn has affected the labour market little so far, as the turnover and profits of businesses in many sectors have increased faster than their wage costs. The greatest difficulties have been faced by manufacturing and construction, where employment has fallen, while the number employed in the public sector and in private sector services has risen.

Economic growth should start to recover in the second half of the year. Private consumption has been modest in the first half of the year, as it has been falling from its unsustainably high level last year that it reached because of the use of pandemic and pension savings. Growth in consumption should pick up in future as purchasing power improves. The purchasing power of the average wage started to decline in 2021 and then to increase again last year, and it will have recovered in 2024 and will then continue to strengthen in 2025. The capacity for growth in the economy will be supported by the revitalisation of demand in the main export markets, and weaker cost pressures on export prices than before as the energy crisis fades. The position of the Estonian economy will improve over the year after declining for five quarters, and so the total volume of the economy will be 1% smaller over the year as a whole. Growth will pick up in 2024 and will reach 3% by 2025.

Inflation will continue its current downwards trajectory. It was down to close to 11% in May, which is mainly a consequence of the leap in the first half of last year. The rise in the price of the consumer basket was around 4% over the past nine months. Inflation will continue to fall and will reach 5% by the end of this year and average 9% for the year. The rise in VAT that was just agreed will give a one-off boost to inflation, which will mainly be felt in 2024. Average inflation next year will remain around 4%, and it will fall to 2.5% in 2025. Inflation will be drawn downwards by falling prices for energy and the gradual pass-through of lower prices for food commodities into retail prices, but market prices for commodities could be shaped by the progress of the war in Ukraine. Future transactions for various energy sources suggest that their price levels will remain notably lower than they were last year, but the changes to the supply channels for energy mean the risk remains of an unexpected rise in price.

Interest rates rising will be less of a hindrance to economic growth than high inflation. The European Central Bank raising interest rates in order to restrain inflation will push the cost of borrowing up for people and companies in Estonia. The additional interest costs for companies will be around 10% of profits, and for households they will be less than 2% of consumption spending. Inflation remaining high would by contrast have a much more harmful impact both on people’s purchasing power and on the economy. Recent corporate survey data do not point to financing conditions being an obstacle to growth, but rather point overwhelmingly to the decline in purchasing power reducing demand. The ability to cope with loan liabilities is also indicated by the share of bad loans remaining very small.

The general government budget deficit will widen sharply this year. Revenues will grow more slowly this year, while spending will grow faster, as both social benefits and the payroll for public sector employees have jumped up. The budget deficit was also smaller last year because high inflation boosted tax revenues, while some expenditures were not made and inflation lifts state spending after a delay. Inflation will be pushed up temporarily by the government’s changes to fiscal policy, but persistent inflation pressures will be reduced in the long term. Eesti Pank considers that the budget deficit, which has become permanent, should be reduced, as that would help tackle high inflation. Reducing the budget deficit would also help avoid future growth in the Estonian state debt and the interest paid on it. This problem will be greater in the future, as pressure to increase current expenditures in areas like social and healthcare costs and national defence will only mount over time, while the working age population is shrinking. In the long term, orderly state finances and a low debt level will support the competitiveness and capacity for growth of the Estonian economy.

Key indicators for the Eesti Pank economic forecast

GDP at current prices in billion euros36.239.441.243.4
economic growth at constant prices, %-1.0-
inflation % (CPI)
unemployment, %
average gross wage in euros1645183219742086
change in the average wage, %11.611.47.85.6
budget balance, % of GDP-0.9-3.4-1.7-1.3

The table includes the measures proposed in the Stability Programme 2023.

Read more: Estonian Economy and Monetary Policy 2023/2


Additional information:

Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: [email protected] 
Press enquiries: [email protected]