"The global economy is moving in different directions. On the one hand, in the world's two largest economies – the U.S. and China – growth is expected to slow over the next two years, according to our forecast. In the Eurozone, growth should gradually improve next year. While it won't be rapid, there is some expectation of improved external demand in the Eurozone as a whole," said Tõnu Mertsina, chief economist for Swedbank.

Mertsina added that, according to the economic forecast, Finland's external demand is expected to return to growth next year.

"In summary, one could say that there should be more opportunities for Estonia's exports next year," Mertsina said.

ECB to continue slashing interest rates

According to Swedbank's forecast, the European Central Bank will lower interest rates two more times this year. Swedbank estimates that the deposit facility interest rate will decrease from 3.75 percent to 3.25 percent this year. By the end of next year, interest rates are expected to drop to 2 percent.

Mertsina explained that the peak of the six-month Euribor occurred last fall, meaning that the highest loan burden for borrowers was in the first quarter of this year.

"The gradual decrease in interest rates will have a slow impact on Estonia's economy. The more significant effects of the interest rate reductions are likely to be felt next year," said Mertsina.

He also mentioned that, technically speaking, Estonia's economy has emerged from recession since GDP increased by 0.2 percent in the last quarter. However, the economy was in a 1.4 percent decline in the first half of the year. Swedbank expects economic growth to improve in the second half of the year.

Signs of improvement but confidence still weak

"Estonia's overall economic confidence is similar to that of Finland. However, if we look at household confidence, it remains very weak. This affects general economic activity, slowing it down, as well as consumption," said Mertsina.

He noted that while the decline in the export of goods and services is subsiding, the situation in retail trade is worse – the decline has not slowed.

Swedbank's card payment data indicates that private consumption is weak. "Since private consumption accounts for nearly half of Estonia's economy, any change in it has a significant impact," Mertsina pointed out.

The planned new tax increases and government spending cuts are expected to reduce economic growth in 2025-2026, according to the forecast.

"Due to the impact of the tax changes, we estimate that next year's GDP growth will be over 1 percentage point slower. The GDP for the year after next is expected to be about 0.5 percentage point slower," Mertsina said.

The main factor contributing to the slowdown in economic growth is private consumption. "Next year, net wages are expected to decline, with tax changes negatively affecting them. This will have a considerable impact on next year's GDP, along with the government's spending cuts," Mertsina explained.

Additionally, the introduction of a new tax on businesses will further dampen economic activity the year after next, according to Mertsina.

However, it should be noted that there are positive factors alongside these tax changes, such as improving external demand and falling interest rates.

Swedbank's senior economist Liis Elmik mentioned that while the purchasing power of the average wage earner has not returned to pre-inflation levels, those earning the minimum wage and pensioners have fared better – their purchasing power has recovered, and their incomes have grown faster than the average cost of living.

Price advance to pick up slightly next year

"While this year's price increase remains below 4 percent, we expect inflation to exceed 4 percent next year. About half of this year's price increase is due to tax hikes. In 2025 and 2026, tax hikes will account for about a third of the price increase," said Elmik.

She noted that next year, transportation services, as well as alcohol and tobacco, will see the fastest price increases due to tax changes.

Wage growth is expected to slow down significantly, especially in the public sector, Elmik added.

"We also see that in the private sector, companies are facing tougher conditions, with slower revenue growth. They can no longer raise wages as quickly as in previous years," said Elmik.

As a result, Swedbank forecasts wage growth of 6-7 percent in the coming years. "This is a significant slowdown compared to 2022 and 2023, when the average wage increased by 11-12 percent annually."

Average salary's purchasing power to wane in 2025

"If we compare the rise in wages and prices over the next few years with this year, we see that this year, the purchasing power of wage earners will increase slightly – by about 2 percent – but it will not reach the levels seen before rapid inflation began. As we know, prices started to rise in the second half of 2021," Elmik said.

The economist stated that next year, prices are expected to rise more than the average net wage, resulting in a decrease in purchasing power by about 2 percent.

However, if the tax bracket (Estonia's gradual basic exemption reduction scheme – ed.) is eliminated the year after next, it will significantly boost net wages and restore the purchasing power of wage earners to the level seen at the beginning of 2021. "It will take five years in total to regain this purchasing power."

"The labor market has fared quite well so far. Unemployment has risen somewhat, reaching over 7 percent. However, compared to 2007-2009, this unemployment level is relatively low."

Swedbank believes that the worst of the unemployment situation has passed, and unemployment will gradually decrease as the economy recovers, Elmik said. "A more noticeable decline in unemployment is expected in 2026. It will decrease slowly because the economy is growing slowly. In our latest forecast, we have significantly revised the economic growth figures downward."

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