The exceptionally high inflation right now will come down in the second half of the year says Ülo Kaasik
Deputy Governor of Eesti Pank Ülo Kaasik said that the current extraordinarily high inflation in Estonia is a temporary phenomenon because financial markets expect that the rise in commodities prices will slow this year, while further growth in the Estonian economy, which is doing very well, will be notably slower.
Inflation rose in Estonia throughout the whole of last year, reaching 12.2% by December. The primary reason was the rise in prices for energy and commodities on global markets and blockages in supply chains that have also pushed inflation up elsewhere around the world. Inflation rose to 7% in December in the USA, and 5% in the euro area. “Extraordinarily high inflation like this tends to remain temporary”, said Mr Kaasik. Financial markets estimate that the prices of commodities will rise more slowly this year, and that the rate of inflation will come down in the second half of the year.
Speaking at the annual conference of the Estonian Economic Association, Mr Kaasik noted separately that it would be wise for the government to keep the total size of its energy support package smaller than the additional revenues it is earning from high energy prices through taxes, emissions quotas and the profit of state-owned energy firms. “If the energy support package becomes much larger than that, there is a danger of the government pouring fuel onto the fire of already high inflation, and so the subsidies would become counter-productive”, he said.
Inflation in Estonia has been boosted even further by the good performance of the economy. The Estonian economy measured in euros was already 14% larger than it was before the crisis in the third quarter of last year. Most sectors of the economy are doing well, and production capacity is running at its maximum. Businesses are ready to pay their employees more in all sectors. Forecasts show unemployment falling to 5.5% this year and the trend remaining downwards in the years ahead.
“The problem is though that people with the necessary skills cannot be found in the labour market for the jobs that are available, and there is equally no sign that labour has moved into more productive sectors”, noted Mr Kaasik. Strong demand for labour is keeping up the rate of wage rises, with wages rising on average by more than 8% this year and next. Mr Kaasik said that a rapid rise in the costs to business could threaten the competitiveness of Estonian companies, on which job creation and long-term wage growth depend.
Growth in the economy is expected to slow this year. This is partly because production capacity has come close to its limits, and partly because rapid inflation will slow growth this year. The rapid rise in energy prices will cause additional uncertainty. It is expected that the pandemic will have less impact than before on economic activity, but the impact in some sectors will still be considerable. Estonian exports of services for example, especially those related to tourism, have not yet recovered from the crisis.
Rapid rises in the incomes of residents of Estonia and high levels of confidence have promoted strong demand in the housing market. The capacity to borrow has been increased during the pandemic by increases in savings and the withdrawals from the second pension pillar. Prices for residential space are in some places already rising faster than the average wage, and Eesti Pank estimates that the real estate market is showing signs of overheating. The central bank follows such trends closely and is ready if necessary to tighten the conditions for issuing housing loans. “Lending growing too fast could be dangerous, as a fall later on in incomes or a rise in interest rates on loans could cause some people difficulties in repaying their loans”, warned Mr Kaasik.
The annual conference of the Estonian Economic Association was held on 20 and 21 January this year.