Prices continued to rise rapidly in September

  • Inflation is due to higher prices for food and energy and rises in excise
  • The consumer price index was 0.1% lower in September than in August because of seasonal factors

Data from Statistics Estonia show the consumer price index was up 3.7% on the year in September. Despite slowing slightly from August, inflation remained elevated because of both higher import prices and  domestic factors.

Food prices were up 7% in September and energy prices 6%, mainly because of price developments in global markets. The oil price rose to 57 dollars a barrel by the end of September, because demand for oil has recovered slightly while supply remains constrained by the agreement between OPEC members. The yearly growth in the oil price in euros has been relatively modest, because the euro has appreciated against the dollar at the same time. Around one percentage point of the inflation in the consumer basket this year has been due to rises in excise. Higher tax rates will continue to contribute to inflation of food and energy prices in the next year, but the impact of the pass-through of commodities prices should start to ease gradually.

Factors in the domestic economy have also encouraged prices to rise this year. Core inflation in manufactured goods and services, which depends mainly on domestic factors, stood at 1.3% in September. Wage growth has remained strong in Estonia, and this has induced higher production costs. Increased production volumes and a rise in the price level have together allowed companies to restore their profits again for the first time in a few years.

Inflation in the euro area remained at 1.5% in September, which is below the 2% inflation target of the European Central Bank. Inflation has been restrained by the unexpectedly low wage growth in the larger countries of the euro area  in contrast to other activity indicators of the economy. The unemployment rate has now fallen to its levels of before the crisis, and faster economic growth has also supported inflation in the euro area. Slow growth in labour costs for companies in the euro area has so far offset higher prices for other production inputs including commodities.

Inflation in Estonia and euro area

Source: Bank of Estonia

Author: Sulev Pert, Economist at Eesti Pank

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Food and dwelling expenses account for 40 pct of the household budget

According to Statistics Estonia, in 2016, a household member spent an average of 408 euros per month, which is 13 euros more than in 2015. Compulsory expenditure, i.e. unavoidable food and dwelling expenses, accounted for 40% of the household budget, remaining at the level of the previous year.

In 2016, compulsory expenditure in the household budget was on average 162 euros per month per household member. Although the compulsory expenditure increased by 5 euros compared to 2015, its share in the household budget remained at the same level.

In 2016, a household member spent the most on food and non-alcoholic beverages (95 euros per month), which accounted for 23% of the total expenditure. Compared to the previous year, expenditure on food increased by 3 euros per month. Expenditure on dwelling was on average 67 euros per month, which is 2 euros more than in 2015.

Expenditure on transport was on average 50 euros, leisure time 41 euros, housekeeping 31 euros and clothing and footwear 22 euros per month per household member. Compared to 2015, of the listed expenditures, housekeeping expenses increased the most – from 26 euros to 31 euros.

Households in urban areas spent more on dwelling than households in rural areas. Per member of an urban household, dwelling expenditure was 13 euros higher than in rural areas (71 and 58 euros per month, respectively). Compared to urban households, rural households spent more on transport – in rural areas slightly more than 14% and in urban areas 11% of the household budget. While in an urban settlement, a household member spent 48 euros per month on transport, in rural settlements 54 euros was spent per month.

By county, the largest expenditures of households were in Harju, Rapla and Tartu county (459, 447 and 427 euros per month per household member, respectively) and the smallest in Ida-Viru and Põlva county (296 and 299 euros per month per household member, respectively).

The estimates are calculated according to the data of the Household Budget Survey conducted in 2016. More than 4,400 households participated in the survey. A household is a group of persons who live at the same address and share joint financial resources and whose members consider themselves to be members of one household. In 2016, there were over 592,000 households in Estonia and the average size of a household was 2.2 persons.

Mortgage payments, real estate purchases, financial investments, expenses on major repairs or construction and other investments are not taken into account as household consumption expenditure.

For the statistical activity “Household Budget Survey”, the main representative of public interest is the Ministry of Economic Affairs and Communications, commissioned by whom Statistics Estonia collects and analyses the data necessary for performing this statistical activity.

Source: Statistics Estonia

The Estonian economy is sailing with a tailwind

  • The current rate of growth in the economy cannot be maintained for long
  • The growth in corporate investment and profits is a positive change
  • There is increased upwards pressure on labour costs
  • There is a danger of overheating in the construction sector, which may pass on into the rest of the economy

Growth in the Estonian economy was fast in the first half of 2017, and in the second quarter it reached almost 6%. Growth was given a boost by an improvement in the external environment which encouraged exports, but the biggest driver was still domestic demand. Such strong growth is a positive point in the economy, but various indicators show that the Estonian economy is exceeding its long-term sustainable level and growth will soon slow. Production capacity has for some time been used more intensively than usual by companies, and there is heavy pressure on labour costs to rise because of labour shortages, while a rise in the number of vacancies indicates even greater stresses in the labour market than in the beginning of the year. There has also been a noticeable rise in producer prices and consumer prices of late. All of this together indicates that the current rate of economic growth cannot be maintained for long.

There is however no reason to think at the moment that the economy is overheating on a broad basis, because the picture is quite different in different sectors. The acceleration in economic growth has partly been due to improved performance in oil shale production and in energy, sectors that were earlier facing difficulties, where it is more accurate to talk about a recovery in output volumes. Most sectors have seen some growth. The growth cycle has been very strong in the trade sector and there is a threat of overheating in construction, which is running at almost maximum capacity. Cyclical peaks are more noticeable in construction, because increased demand for construction services from companies, households and the general government all coincide.

Having been in the doldrums in the past few years, corporate investment increased in the first half of this year, giving hope that potential growth may pick up again, having earlier suffered. It is worth noting that in the second quarter companies were able to increase their profits despite the substantial rise in labour costs. This was possible partly because inflation has increased in foreign markets and it has been easier to raise the prices of products. Whether the growth in profits will continue depends, however, on how the productivity of companies increases in the near future. If investment continues to increase, it may be assumed that productivity will also increase.

Household spending on residential property and real estate investment has been boosted by rapid growth in incomes. Employee compensation was up by more than 8% in the second quarter, and the average gross monthly wage by 6.8%. Household consumption has been quite restrained though, as deposits have increased more than consumption has. As income tax reform will be introduced at the start of next year, it was possible that the expectation of the rise in net taxes would cause consumption spending to rise already, as household confidence about the future is very strong. This has not happened though. Behaviour indicating a preference for gradual increases in spending is positive to note, as it helps in keeping economic growth more stable.

The data that are already available for the third quarter do not indicate any significant slowing down of growth, meaning that the economy continues to operate beyond its sustainable capacity. In this case state fiscal policy should focus on the need for balance in the economy, because overheating in some sectors could pass on into the rest of the economy. High volatility in economic growth, for which Estonia has stood out in Europe, has high social costs, leads to capital and labour resources being inefficiently allocated, increases uncertainty for companies and households, and reduces the credibility and long-term growth capacity of the economy.

Source: Bank of Estonia

Inflation was at its fastest for four years in July

  • The rise in the excise on beer increased the price level by 0.4 percentage points in July
  • Inflation stood at 3.6% in July according to Statistics Estonia and half of it was due to a 6.4% rise in food prices.

Core inflation, which shows price changes for manufactured goods and services, accelerated in July to 1.8%, mainly because of higher services prices.

The rise of food commodities prices on global markets, which started in mid-2016, has been passed into Estonian consumer prices to a significant extent. Prices for dairy products have risen especially fast, as the producer prices of butter continue to set new records on the EU market. Other food prices, especially those for fruit and vegetables, have however stabilised over the past months, as commodities prices are growing somewhat more slowly. Higher excise taxes caused a 21% price increase for the beer sold in shops, which affected the consumer price index in July by 0.4 percentage points.

The inflation in most euro area countries remained low in July at 1.3%. Rapid economic growth has not started to impact prices yet, as some euro area countries are underutilising their production capacity and inflation is also being held back by the appreciation of the euro. Since April, the euro has risen 8.5% against the US dollar. The strengthening of the euro has not caused fuel prices at filling stations to change much, although the price of a barrel of crude oil on global markets has risen from 46 US dollars to 52 in two months. The rise in the exchange rate of the euro is encouraging the prices of imported manufactured goods to fall, but it also slows down the growth of euro area exports.

Eesti Pank forecasts that inflation will continue to move at a fast pace until the end of the year. Prices should increase more slowly in the first half of next year, but still faster than the euro area average.

Inflation in the euro area remains low and rapid economic growth has yet to affect prices

Inflation in Estonia and euro area
Author: Sulev Pert, Economist at Eesti Pank

GDP growth was largely based on domestic demand in the second quarter

  • The output gap is positive
  • The economy does not need any additional stimulus
  • Rising export prices are helping profits to recover and are alleviating the imbalances that have built up

Estonian GDP was up by 5.7% over the year in the second quarter, and by 1.3% over the quarter. Faster growth in export prices has helped companies to recover the profits which have been reduced in recent years by rises in labour costs. This has helped to reduce the imbalances that had built up earlier.

Corporate surveys that describe the position in the economic cycle, including assessments of labour shortages and capacity utilisation, are above the average for the economic cycle, indicating a positive output gap. It may be too early to talk of a boom yet, but it is clear that there is no need for the government to provide any additional stimulus to the economy at the present time. As the economy is growing strongly, it would be more reasonable to build up reserves against more difficult years.

The rapid growth overshadows the unexpected weakness in the contribution of the exporting sector to growth in the economy, despite an improved external environment. Value added from manufacturing grew by only 1.4% and exports grew very slowly. It is true that different sources of data give different signals, and for example the output volume index for manufacturing was up by 8% at the same time. This suggests that it is not wise to read too much into the data for only one quarter. Manufacturing companies say that capacity utilisation was down across the board in the beginning of the third quarter, falling more in branches of manufacturing which are more susceptible to labour shortages. There are not currently sufficient data to allow it to be said that the manufacturing sector cannot use its equipment because it is not able to find sufficient workers.

Among the demand components it was investment that most boosted economic growth. This is in itself a good thing, because investment is needed to increase production capacity. The growth was mainly driven by investment in transport vehicles and in construction though, which probably does not add a great deal to growth in productivity. The volume of investment in machinery and equipment grew at the same rate as GDP.

It is good to note that despite the weakness of exports and the rapid growth in investment, the contribution of net exports was close to zero. This indicates that external balance has not changed very much, and economic growth is still largely being financed by domestic sources.

A return of inflation has changed matters for businesses and is now helping them to increase their profits. Estonian companies are price takers in export markets, meaning that they generally have to accept the prices that have already been set in those markets. Low inflation has meant that it has not been possible to pass the rapid wage rises of recent years on into prices and this has eaten into profits. Export prices and the GDP deflator increased in the second quarter by 4% over a year earlier, and this helped to increase profits. The profit of the corporate sector was up by one fifth over the year, while labour costs increased at half that pace.

Increased profits will help investment to recover further in the future, and thus will also support growth in potential output. Growth in the economy may be restrained in the quarters ahead by the oil shale sector. This is because the energy and oil shale sectors have played an important role in the growth in the economy in recent quarters, but this contribution should be reduced in the third quarter. Assessments of manufacturing companies for output in the months ahead were similar in July to what they were in the second quarter, and they do not foresee that growth in output will slow markedly in the coming months.

The economy grew markedly faster in the second quarter than was predicted by the most recent Eesti Pank forecast. When it released the data for the second quarter, Statistics Estonia also revised the GDP figures for earlier periods, meaning that earlier forecasts cannot be compared with the new data. Nominal GDP in the first quarter of this year was 1.3% higher with the new data.

Author: Kaspar Oja, Economist at Eesti Pank

Source: Bank of Estonia

Economic growth in 2Q was the fastest of the last 6 years

Swedbank expected continued robust GDP growth in the second quarter, but 5.7% yoy (1.3% qoq swda) was above expectations. As inflation has picked up, GDP nominal growth accelerated to 10.2% yoy.

Statistics Estonia revised up GDP levels and growth rates of the last four years (2013-2016), whereas GDP growth in 2016 was revised to 2.1% yoy (from 1.6%).

Productivity growth has improved considerably 

Fast economic growth, whereas the number of employed and worked hours hasn’t changed substantially, has accelerated growth of labour productivity. At the same time, increase of labour costs in business sector has stabilised. This combination has enabled enterprises to raise their profits (up by 20% yoy in 1H) and improved their ability to invest.

Business and public sector investment growth is very robust 

Gross fixed capital formation increased 18% in real terms, whereas non-financial sector invested 21% and government sector even 47% more than a year ago. Government sector increased its investments primarily in buildings and structures, followed by transport equipment. This has contributed strongly to the growth in construction sector, which contributed the most to the GDP growth in 2Q. We expect that government sector will use gradually more EU funds for its investments and that the contribution of its gross fixed capital formation to the economic activity will remain robust at least in 2017-2018. Industrial sector confidence has rised to the highest level of the last 6 years and capacity utilisation is already above its long-term average – therefore we expect that improved outlook for demand brings about the need to invest more.

Mobile equipment behind the deceleration of export growth 

Despite strong foreign demand, export growth decelerated to 1% yoy in real terms, whereas export of goods decreased even slightly. Mobile equipment was primarily behind it. Weak result in export of goods limited the growth of manufacturing sector’s value added. We expect that the decrease in export of mobile equipment will continue at least in the coming months and will have strongly negative impact on Estonia’s export of goods’ total picture (the share of mobile equipment is ca 10% of total export of goods). However, export orders of other products are increasing and enterprises have become even more optimistic about export outlook of their production.

Private consumption has slowed as expected

Private consumption increased 2% in real terms in 2Q, but has decelerated to only 1.5% in 1H (4.3% in 2016). The major contribution comes from less consumption of alcoholic beverages and tobacco, which has been going on for a longer time. We expect that private consumption slows this year, despite better consumer confidence as real growth of net wages decelerates. In 2018, wage-earners’ labour income will jump again, due to a substantial increase in their nontaxable income. This is expected to accelerate the growth of private consumption again.

Estonian economic outlook is good 

Improved foreign demand will contribute to the economic growth during the next few years and investment growth is expected to remain strong. After a slowdown this year, growth of private consumption is expected to accelerate again next year. As GDP has increased already 5.2% in real terms in 1H this year, we are considering to revise up our GDP forecast for 2017 (recently published 3.5%).

Source: Swedbank

Inflation remained high in June because of rising food prices

  • Estonia stands out among the euro area countries for the general rise in food prices
  • Inflation has been reined back by external factors, primarily the lower oil price
  • The low oil price means that inflation this year will remain close to 3%

Yearly growth in consumer prices stood at 2.9% in June according to Statistics Estonia. The growth in energy prices slowed to 2.6%, and food prices, including alcohol and tobacco, were up 6.1%. Core inflation was 1.3% over the year though.

Around half of the inflation in Estonia is driven by import prices, while the other half depends on domestic factors. Global market prices for oil and industrial commodities have fallen a little in recent months, but there has been no particular change in the price level of food. External factors, primarily the low oil price, have encouraged inflation to come down. Inflation in the euro area was slowed in June to 1.3% by the fall in energy prices, but core inflation remained low despite economic activity increasing. The latest data and survey results show growth remaining fast in the euro area economy, and this should start to pass through more strongly into inflation. The price stability goal of the European Central Bank is that inflation in the euro area should rise to close to, but just below, 2%.

Estonia stands out among the euro area countries for the general rise in food prices. Food prices were up over the year by 6.1% in Estonia in June, and by 1.4% in the euro area. Prices for dairy products and fruit were up more than 10% over the year in Estonia, though the price level of vegetables and fish products has fallen in recent months. Consumption has been aided by domestic factors, primarily wage growth and increased employment, though also by favourable financing conditions for loans. Despite that, the growth in retail sales volumes has been quite modest in recent months if car sales are excluded. Inflation started to fall for industrial products in June, partly because of seasonal factors, though core inflation points to a rise in services prices. Service price inflation was high in June at 2.8%. Communications and holiday travel, two groups that account for a large share of services, saw prices fall, but this was cancelled out by the rise in prices for the other groups of services. Without those two groups, prices for services were up more than 4%.

The low oil price means that inflation this year will remain close to 3%. Around one third of inflation will be due to tax rises this year.

Source: Bank of Estonia

Author: Sulev Pert, Economist at Eesti Pank