Analysts: Interest rate rises cooling economy, but more efforts needed

SEB and buildings in Tallinn.
SEB and buildings in Tallinn. Source: Siim Lõvi /ERR

On Thursday, the European Central Bank raised interest rates to 2.5 percent and the trend will continue in the coming months. However, this is not enough to curb inflation, analysts say.

On Wednesday, data showed Estonia's inflation rose again instead of falling, as previously predicted. Experts said the news came as a surprise to them.

LHV analyst Kristo Aab told Thursday's "Aktuaalne kaamera" that government subsidies may be behind the hike and the timing of their implementation.

SEB's analyst Mihkel Nestor said: "Energy prices, for example, even ticked up in January. Electricity, if you look at Nord Pool, was even 30 percent cheaper and natural gas about 13 percent cheaper."

However, most consumers have fixed electricity packages that hide the effects of inflation. Rising interest rates have started to cool the economy.

Kristo Aab Source: ERR

"People are becoming very cautious about buying new homes as borrowing is expensive. Demand for borrowing is falling, which will certainly cool the economy in the long run and also make it more difficult for prices to rise," explained Nestor.

But the economy is not cooling fast enough.

"No matter how high the interest rate rise, this alone will not make a difference. But it does create an economic environment that, in the long run, will depress the economy, depress consumers, depress entrepreneurs and should then drive down demand," said Aab.

Nestor said: "However, household demand is still relatively strong in both Europe and Estonia, despite growing uncertainty about the future of the economy. As long as employment is high and wages are rising here, demand will remain strong."

Mihkel Nestor Source: ERR

Paradoxically, in order for demand to decrease, unemployment would need to rise.

"Yes, today central banks are playing a game of how to make people's lives worse, but not too bad, just to stop inflation," he added.

Aab said: "We do not know what will happen to energy prices this autumn and winter, and there is still a lot of unpredictability."

He believes if all mechanisms start working together, Estonia's inflation could fall to 5-7 percent in the second half of the year.


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Editor: Helen Wright

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