Next year, the economy is expected to grow by 2.6 percent, followed by a 2.7 percent increase in 2027, according to the Bank of Estonia.

"Recovering from the downturn caused by crises will take time, as production costs in Estonia have risen more sharply compared to the competition. Adapting to this requires improved productivity, which is a gradual process," the central bank stated.

According to the Bank of Estonia's forecast, price increases will slow to 3.8 percent in 2026 and 2.5 percent in 2027.

Higher taxes will contribute to the continued rise in food prices and service costs. Overall, tax hikes will account for about a third of the inflation rate, which is expected to accelerate to 6 percent over the course of the year. The income tax increase at the beginning of the year will reduce people's purchasing power, which in turn will limit consumption and economic recovery.

"The total disposable income of Estonians, which includes pensions, other sources of income and the relief provided by falling interest rates, will remain at a similar purchasing power level to last year. The situation could improve in 2026, as the removal of the so-called tax hump (Estonia's gradual basic exemption reduction scheme — ed.) will reduce the tax burden and significantly increase the purchasing power of the average net salary," the Bank of Estonia predicts.

According to the central bank, confidence in the near-term economic outlook is recovering in neighboring countries. The improvement in foreign market conditions will support Estonia's exports and economic growth.

However, the recovery is still overshadowed by inflation and the risk of trade barriers, according to the central bank.

"The protective tariffs imposed by the United States so far and the retaliatory measures taken in response have had little impact on Estonia's economy. However, trade conditions could deteriorate further. This would have a significant effect on Estonia, as we are a small, open economy that heavily relies on exports. If the U.S. follows through on its promise to impose a 25 percent tariff on European Union exports, it would noticeably slow Estonia's economic growth, although it should not lead to a recession," the Bank of Estonia stated.

The recovery of economic activity to a sustainable growth trajectory will take time, as adjusting to higher production costs and price levels compared to competitors is a gradual process that depends on improvements in productivity, the central bank noted.

The budget deficit is projected to reach 2.5 percent of GDP this year, 2.6 percent in 2026 and 2.2 percent in 2027.

The Bank of Estonia considers the increased spending on defense capabilities to be entirely understandable. However, it cautions that the budget deficit should not expand for reasons unrelated to additional defense expenditures. It also emphasizes that a higher debt burden means larger annual interest payments and fewer resources available for other government expenditures.

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