Inflation in Estonia hasn't risen notably since last August, and there is reason to believe it will slow to single-digit levels in the second half of this year, Bank of Estonia Deputy Governor Ülo Kaasik said at the recent annual conference of the Estonian Economic Association (EMS).
"Food prices will continue to rise, but energy prices and the price of oil and natural gas have come down substantially," Kaasik said at the conference according to a press release. "The Bank of Estonia expects inflation to come down and approach a more normal level in the second half of this year."
He noted that the country's real estate market has been sensibly settling as well.
The European Central Bank (ECB) has raised key interest rates in the euro area by 2.5 percentage points since last July in order to slow inflation, which rose throughout the euro area last year.
The deputy governor noted that monetary policy had reacted firmly, and that the ECB has said it will continue to raise interest rates until inflation in the euro area is convincingly approaching its target of 2 percent. Raising interest rates obviously increases costs for borrowers, but helps prevent inflation becoming entrenched for a longer period.
"There are no good ways to tackle inflation that has gotten too high, so we have to choose between bad and worse, and inflation remaining high for too long would be the most harmful outcome for people and for the economy as a whole," he said.
Falling energy prices and access to alternatives to Russian natural gas have given businesses in the euro area with greater confidence.
"This gives us hope that the euro area as a whole will manage to avoid the feared recession this year," Kaasik noted.
Commenting on the Estonian economy, he acknowledged that difficult times would continue, but noted that the outlook is better for the second half of the year.
Government spending is supporting demand in the domestic market, and companies' profits have continued to grow despite their higher costs. Thus far, the impact of Russia's ongoing war in Ukraine on Estonia's economy has primarily been felt via high inflation and a sharp drop in imports and payments. Exports have largely exceeded initial Bank of Estonia forecasts, however.
"The impact of exports on the war in Ukraine is expected to be felt more strongly this year," Kaasik said, noting that it would take time for the full impact of the sanctions imposed on Russia to be felt.
As the war continues, significant uncertainty persists regarding the economic outlook and forecast; this is true for Estonia's labor market as well, where the central bank sees higher unemployment as being mainly the consequence of Ukrainian refugees entering the country's labor market.
"We are not expecting any large wave of layoffs or massive job cuts," Kaasik said, but nonetheless acknowledged that companies are less eager to hire new employees at the moment. He highlighted that the number of people employed in the Estonian economy is currently at a near record high.
"It's difficult to forecast how the refugees will impact the market as the war continues," he added.
According to the deputy governor, however, events in Estonia's real estate market cannot be compared with what happened in the market during the COVID-19 pandemic or in the first half of last year. At that time, the market was showing some signs of bubbling that weren't sustainable in the longer term.
"The current amount of construction and the number of transactions should really be compared with the state of the market prior to the pandemic," he said.
He also noted that the economy as a whole will benefit if the real estate market calms down, adding that businesses find it easier to operate when there is more stability as well.
The significant budget deficit is a notable feature of Estonia's state finances.
"When calculating how to cover the budget deficit, we have to take into account that it's gotten more expensive to borrow and that costs are increasing," Kaasik stressed, explaining that if the debt level were to rise to, say, 35-40 percent of GDP, interest payments alone could end up accounting for 3-4 percent of total government spending a decade from now.
"Additional spending requires additional revenues as well," he added.
Editor: Aili Vahtla