According to the Bank of Estonia, the strong labor market and the reduction in monetary policy interest rates will further contribute to the restoration of household purchasing power. However, there is still considerable uncertainty in the forecast, partly due to risks arising from geopolitical tensions.

Although the economic downturn continued in the first quarter of this year, there were increasing signs of improvement. The downward trend in the production volume of the manufacturing industry, which is highly significant for the economy and has suffered the most, has ended, and the volume of goods exports began to grow at the start of the year.

Companies' outlook on export orders and competitiveness in foreign markets has become more positive, leading the Bank of Estonia to project a more stable foundation for the growth prospects of Estonian exports, in line with the expected recovery of foreign markets from their downturn. In addition to cross-border trade, increasing domestic demand also contributes to economic growth, mainly due to the recovery of household purchasing power and the resilience of the labor market.

The Bank of Estonia also finds that many conditions have become more supportive of economic growth. Exports are being boosted by a more favorable exchange rate between the euro and Scandinavian currencies, and these markets have recovered faster than expected at the beginning of the year. The overall growth of the economy is further supported by cheaper raw materials, a decline in energy prices and a reduction in supply chain issues. The rapid increase in labor costs is calming down, allowing price growth to continue on a decelerating course.

Interest rates falling but more slowly than forecast

The restraining effect of monetary policy on economic growth is expected to ease. At its latest monetary policy meeting, the Governing Council of the European Central Bank lowered interest rates, which was already reflected in the decline of the Euribor based on market expectations. The reduction in interest rates alleviates borrowing costs for both households and businesses, stimulating the economy.

However, the decline in rapid price growth in the euro area has proven to be more sluggish than previously estimated. As a result, while further interest rate reductions are anticipated in the money markets, they are expected to occur at a slower pace than previously thought. The decrease in interest rates leaves people with loan obligations with more disposable income, creating better conditions for increased household consumption and business investments.

Uncertainty has decreased but remains significant. On one hand, the outlook for Estonia's economy has become clearer, as much of the ambiguity stemming from the crises of recent years has largely dissipated. On the other hand, uncertainty related to forecasts persists, linked to elevated geopolitical risks and the ongoing war in Ukraine.

This year, elections will be held in more than 60 countries, making it the most election-heavy year in history. According to the Bank of Estonia, this inevitably brings political uncertainty, and the potential impact of these elections on the economy, both globally and regionally, is unknown.

Supplementary budget and new taxes not included in the forecast

Estonia's fiscal policy may shape the economic outlook differently than expected. The fiscal direction known at the time of the forecast suggests that the budget deficit will remain significantly larger than the 3 percent of GDP allowed by European regulations in the coming years.

According to the Bank of Estonia, it is likely that future decisions will aim to reduce the deficit, thereby decreasing the state's financial support for the economy and its growth. This scenario's likelihood is supported by the government's approval of the current year's negative supplementary budget, which was not included in the forecast published on Friday because the final size and content of the supplementary budget had not been confirmed at the time the forecast was prepared.

For the same reason, the recent decision to introduce a vehicle tax is not included in this forecast, nor have potential future fiscal policy decisions to reduce the deficit, which are probable but unknown in scope and content, been considered. Restoring fiscal discipline is crucial to avoid accumulating debt and increasing interest payments. As economic growth is accelerating, extensive budgetary support for the economy is no longer as necessary as it once was.

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