High inflation in the euro area and Estonia has come down because energy prices have fallen and also because central banks tightened their monetary policy. This is a bitter medicine, but a necessary one for the economy said Governor of Eesti Pank Madis Müller as he presented the Annual Accounts of Eesti Pank for 2023 to the Riigikogu.

“Looking back on the decisions taken in the Governing Council of the European Central Bank I can clearly say that they had the intended effect and have brought us closer to our target of price stability”, he said, emphasising that inflation being sufficiently low is the cornerstone of economic growth and of people’s ability to cope with everyday finances. “It is very important that the central bank be ready to react to high inflation”, he added.

The Governing Council of the European Central Bank raised the key interest rates of the euro area on ten occasions from July 2022 by a total of 4.5 percentage points, which is the sharpest series of rises in interest rates in the history of the single currency. Inflation in the euro area also hit a record high under the combined impact of multiple crises, and it peaked at above 10% in October 2022. The data for May show that it has by now fallen to 2.6% in the euro area and 2.9% in Estonia.

The Governing Council of the European Central Bank had sufficient confidence last October that inflation in the euro area was returning to its target of consumer prices rising by 2% a year that it stopped raising interest rates. It then made the first cut in rates in June this year. “However, we have not yet reached our target”, warned Mr Müller, noting that the latest forecast from the European Central Bank is that inflation in the euro area will fall to 2% by the second half of 2025. “Interest rates will probably have to remain higher than the average for some time yet for us to get there”. The central bank will also continue to withdraw the asset purchase programmes that were launched in earlier years to support the economy.

Mr Müller underlined in his comments on the role of Eesti Pank as an economic adviser to the government that it is not sustainable to have a large and lasting gap between government revenues and government spending. The rising costs of servicing debt will leave the government less and less flexibility when deciding over other spending, and fewer options for supporting the economy if it is needed. “Eesti Pank has recommended that the domestic budget rules set in Estonia should be stricter than those generally agreed for Europe in order to keep the growth in debt under control and build up reserves when the economy is doing well”, he said. “In the long term, orderly state finances and a low debt level will support the competitiveness and capacity for growth of the Estonian economy”. Eesti Pank also believes there should be constant monitoring and discussion of competitiveness in Estonia.

Mr Müller explained in his speech that the central bank is focusing ever more attention on its work to improve resilience to crises, for which readiness plans are being reviewed and extended, and exercises have been run. The law makes Eesti Pank responsible for ensuring that the vital services of payments and cash circulation function in the event of an emergency. “Looking to the future and taking the lessons learned from Ukraine has shown how important it is for banks to set up capacity to ensure their services remain available independently of the information systems based in Estonia”, said Mr Müller. Coop Pank has been listed since last year as a provider of vital services alongside Swedbank, SEB, Luminor and LHV.

The Estonian economy remained in recession in the first quarter, but Eesti Pank is more optimistic about the second half of the year. Energy prices have fallen, purchasing power is improving, investment is increasing, labour costs are rising more slowly, and demand in the main export markets is forecast to start to recover. “This gives hope that the economy as a whole will start to improve”, said Mr Müller. There remain risks though that arise from Russian aggression and geopolitical tensions.

Additional information:
Hanna Jürgenson
Communications Specialist
Eesti Pank
Tel: 5692 0930
Press enquiries: [email protected]