Private consumption will give a powerful short-term boost to economic growth

• The Estonian economy had reached its pre-crisis level at the start of this year and the recovery is one of the fastest in Europe
• The Estonian economy will grow by 5-8% this year and 4-5% next
• The growth in the economy this year will be strongly affected by how much people divert their savings into consumption
• The economic improvement in Estonia and other countries will accelerate inflation temporarily. Inflation will be 2.5-2.7% this year and 2.8-3.3% next year
• Unemployment will fall below 5% in 2022, which is close to where it was before the crisis
• The average wage will continue to rise by above 5% in the years ahead because of labour shortages
• Faster growth in the economy than expected will raise tax revenues, makes it less necessary to support the private sector, and allows the state to bring its finances under control

The latest economic forecast from Eesti Pank predicts that the removal of restrictions will be followed by rapid growth in the economy in the second half of the year, as recovery is expected in export markets, while growth in Estonia will be given a short-term boost as the savings built up during the pandemic and the funds withdrawn from the second pension pillar are directed to consumption. Very fast growth in private consumption will make economic growth volatile in the years ahead.

With the restrictions removed, the economy will return to its strong position from prior to the outbreak. The progress with vaccination has made the outlook for the economy more certain and after the setback caused by the restrictions in spring, economic growth will have a strong basis in the second half of the year. Growth in the Estonian economy will get a short-term boost not only from the improvement in foreign markets, but also from the use of the savings built up during the crisis and the funds released from the second pension pillar in the autumn. Driven mainly by growth in private consumption, growth in the economy is expected to be in the magnitude of 5-8% this year and 4-5% next year. The speed of growth this year will depend very much on how much of their savings people choose to direct into consumption. Around 1.3 billion euros will be withdrawn from the second pillar, which is about 4.5% of the size of the economy. If more savings are directed to consumption than expected, there will be a danger of overheating in the economy that will hinder its recovery to a stable path of growth.

The strong growth in the economy will revive the labour market. The desire of companies to hire additional workers has started to increase together with employment, the number of vacancies and perceived labour shortages. The economic revival and increased demand will drive employment further upwards, while unemployment will fall below 5% in 2022, which is close to where it was before the crisis. The return of labour shortages will spur spending on labour in the coming years and the average wage will continue to rise by more than 5%.

The real estate market will remain active. The involuntary saving caused by the restrictions on consumption during the pandemic have in many countries increased demand for residential property. This has been amplified in Estonia by strong growth in wages, and the prematurely withdrawn pension savings will soon be added as well. As there may be a sharp jump in demand for real estate funded by loans, Eesti Pank is ready if necessary to tighten the requirements on housing loans if there are signs that overheating in the real estate market could pose a danger to the financial sector.

To maintain stability in the economy it would be wise to consider restricting the growth in state spending during good times. The Estonian economy had surprisingly reached its pre-crisis level at the start of this year and the recovery in the Estonian economy has been one of the fastest in Europe. The faster improvement in the economy than expected means that there will be less need than was assumed before for assistance from the state, and it also means that tax revenues will be larger than was forecast. The good position of the economy allows the state to avoid living beyond its means, and to do this the better tax revenues than were expected should be used to reduce the budget deficit faster than was planned.

Inflation will rise in the short term as global demand increases. As production volumes cannot keep up with global demand, the prices of many commodities will rise in the short term, and this will be passed on after a lag to consumers. Consumer prices in Estonia will be raised by 2.5-2.7% this year and 2.8-3.3% next year because of the blockages that appeared in supply chains during the pandemic, some shortages of products, the recovery of services from their trough, and growth in labour costs. For the same reason inflation will rise temporarily throughout the euro area, but if inflation remains persistently higher in the euro area, the European Central Bank will be able to react by tightening monetary policy, which will also slow price rises in Estonia.

For further information:
Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: viljar.raask[at] eestipank.ee
Press enquiries: press[at] eestipank.ee