The high rate of inflation should abate in the second half of next year
The latest economic forecast from Eesti Pank expects that the economy will grow by 8% this year, but that growth will slow to below 3% next year. Growth is being reduced by extraordinarily high inflation, which ought to start to come down in the second half of next year. Inflation may remain high for longer in Estonia though for several local reasons.
Inflation averaged below 5% this year, but in 2022 it will approach 7%. The rapid rise in consumer prices is only temporary and is expected to slow in the second half of next year. The price of the consumer basket is being pushed up by various forms of energy and fuels, and the causes of this are largely from outside Estonia. The pass-through of energy costs into the end prices of other goods and services will fuel inflation in the coming months. High inflation will peak in the first half of next year, after which the short-term impacts on various prices should fade. Inflation may still prove higher than forecast for various reasons.
Inflation in Estonia is forecast to fall below 3% in 2023–2024. Inflation has risen throughout the euro area for similar reasons. If inflation in the euro area should start to exceed its target of 2% consistently, monetary policy can be tightened in the euro area, which will also help control inflation in Estonia. There is still the risk that inflation will stay high in Estonia for longer than expected, and the reasons for that are mainly local. Worsening labour shortages in Estonia will drive companies to raise wages in any case, but this might be given an additional impetus by a temporary rise in the cost of living. This could cause a wage-price spiral that hurts people’s purchasing power and the competitiveness of exporters, on which long-term wage growth and job creation depend.
The recovery from the crisis in Estonia has been one of the fastest in Europe, but the rapid growth seen so far is easing. Growth is being hindered by global supply problems, but the biggest hindrance to further development in most sectors is the shortage of available labour. Equally, the utilisation of existing production capacity is already at its highest ever level. This means that further growth in the economy will be harder to achieve, and the rate of growth in the economy will be reduced next year by extraordinarily high inflation.
Eesti Pank monitors carefully how fast real estate prices are rising and the loan burdens of borrowers. Limited opportunities for consumption and the savings withdrawn from the second pension pillar have increased the amount of money available to spend. Demand for products and services is strong. Interest in real estate also remains high among the public. There is not enough new real estate coming to the market to meet the current strong demand, and this is feeding the rise in real estate prices. If real estate prices continue to rise very fast and debt levels start to rise at a notably faster rate, Eesti Pank is ready to apply the brakes by tightening the requirements on issuing housing loans.
Bringing the state budget out of deficit would help to rein in high inflation. The sectors that have suffered most from the restrictions, notably tourism, leisure, and accommodation and food service, have not yet fully recovered, but the majority of branches of the economy are doing well or even very well. Rapid growth in state spending and demand stimulation are driving inflation even higher at a time when it is already high. As wages are rising fast in Estonia, the state will in any case come under pressure to raise wages in the public sector. However the government has planned to increase its fixed spending on top of this, with the biggest increases coming from a rise in pensions and an increase in the income tax exemption for pensions. Increasing spending will make it harder to bring the state budget into balance in the coming years if there are no changes on the revenue side.