The economy will grow more slowly, the Bank of Estonia said in a press release on Tuesday. Companies' and households' reduced loan burdens and increased savings do not provide any grounds to expect that a sharp downturn would begin in Estonia's private sector.

At the same time, however, the economy cannot run at full power for an extended period of time without losing competitiveness, as rising wage costs will force companies to increase prices. It is notable that companies' assessments of their own competitiveness have already begun to deteriorate.

Economic growth of 4.2 percent in the third quarter was a positive surprise, but this was boosted by a few one-off factors, the bank said.

The labor market reacts to changes in the economy with a lag. When the last economic cycle ended in 2007, for example, it was more than six month after growth began to stutter in the economy before unemployment started to rise, and wages reacted even later.

The unemployment rate indicated by surveys was 3.9 percent in the third quarter of this year, which is the lowest rate ever, but the rise in registered unemployment and the decline in unfilled vacancies indicate that demand for labor has become less intense. Businesses also confirm this.

Demand for additional labor will decline in the coming years, but wage pressures will remain. Under these circumstances, the yearly increase in the average wage will decline to 5-6 percent. Unemployment will rise as the economy cools in the next few years.

According to the central bank, more people than before will enter the labor market, but not all of them will find work. Labor market activity will be increased by the gradual rise in the retirement age, improving health as well as the general growth in wage levels, which encourages people to work.

Inflation, meanwhile, is forecast to remain modest. The main factor raising prices will be the increase in wage costs, which predominantly pushes prices upward for services.

As wages grow more slowly, however, services inflation will fade, and as growth in the prices of imported products will be restrained in the coming years and tax increases will have less of an impact than before, growth in consumer prices will fall below 2 percent.

Bank: Return to structural balance faster

Despite slower economic growth, government revenues from taxation will be higher than usual. Tax revenues will be boosted in the years to come by several important factors, as the largest ever share of the population is in employment, the unemployment rate is low even as it increases somewhat, and the growth in wages remains rapid and consequently so does consumption growth.

Budget deficits built up during the good times should be eliminated faster than planned, the Bank of Estonia said. The government's plan is to reduce the structural deficit that has deepend in recent years by only the minimum permitted amount of 0.5 percentage points of GDP per year. This means that fiscal policy will remain too loose in the years ahead.

The central bank finds that the general government budget should be returned to structural balance as soon as possible, while revenues are still higher than usual.

-

Download the ERR News app for Android and iOS now and never miss an update!