Bank of Estonia forecasts 2.4% economic growth in coming years
According to the Bank of Estonia's latest forecast, the economy will grow by 2.4% this year, and if the situation in the Middle East eases in the near term, growth may remain close to 2.5% over the following two years. As recently as the end of March, the central bank had projected growth of 2.8%.
The central bank estimates that strong fiscal stimulus will boost economic growth this year. Domestic demand is being driven by the elimination of the so‑called "tax wedge," which has reduced the individual income tax burden.
"The removal of the tax wedge will cause the average net monthly wage to grow in real terms — that is, adjusted for inflation — at the fastest rate in the past 19 years," the latest forecast states.
Economic growth of 2.4% this year will largely be supported by increased spending from households and the public sector, the Bank of Estonia says. At the same time, the war in the Middle East has slowed the economic recovery by increasing uncertainty, causing supply disruptions, and driving up prices and loan interest rates.
"The war has had a similar impact on foreign markets, limiting Estonia's export opportunities. Assuming the situation in the Middle East eases soon, economic growth should remain near 2.5% over the next two years."
The central bank emphasizes that sustained growth in the economy and incomes requires increases in productivity. Rising public sector spending can stimulate the economy in the short term, but lasting growth in prosperity can only be based on improvements in productivity. This requires companies to invest, modernize their operations, and move toward higher value-added production.
"Although financing conditions are currently relatively favorable, investment is being held back by uncertainty. Uncertainty about the future is heightened by the fact that sooner or later Estonia will need to reduce its persistent budget deficit. For businesses, it is risky to invest if they do not know when and what kind of tax increases or spending cuts the government plans," the Bank of Estonia notes.
According to the central bank's forecast, inflation depends largely on developments in the energy market. In May, consumer price inflation accelerated to 3.7%, reflecting the rise in energy prices associated with the war that began in the Middle East at the end of February. Without tax increases, inflation in recent months would have remained around 2%, which would have been relatively moderate.
"Unlike during the 2022 energy crisis, this time a smaller range of energy sources has become more expensive, mainly motor fuels. At the same time, gas and electricity prices have reacted more moderately, meaning the impact of energy prices on overall inflation has been smaller. However, uncertainty surrounding future price growth remains high and will depend on how the crisis in the Middle East and the broader geopolitical situation evolve," the central bank writes.
Under the Bank of Estonia's baseline scenario, inflation will be 3.4% this year and remain close to 2.5% over the following two years.
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Editor: Mirjam Mäekivi, Argo Ideon
