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

Estonian inflation 3 pct in the first half of the year

Inflation accelerated to around 3% in the first half of the year in Estonia. The contribution of food and non-alcoholic beverages increased substantially in recent months. Food and non-alcoholic beverages amount to a quarter of household expenditure, on average. In June, the prices of food and non-alcoholic beverages jumped by 6.6% as dairy products, fruits and confectionery became more expensive. Higher excise taxes pushed up the prices of alcohol and tobacco.

At the same time, the contribution of energy prices has declined in recent months. In June, motor fuels were 8.5% more expensive than last year. Although the average oil price in euros was 5% cheaper than in June last year, excise taxes on fuels have increased.

The purchasing power of wage earners will grow much less this year than in the past. In 2017, the growth of the average wage in real terms is expected to slow to around 3% (the 2013-2016 average was 6.4% per year), as nominal growth of wages will be somewhat slower and prices will rise (by around 3% in 2017). The real growth of the average net wage rose by only 2.6% in the first quarter of this year. This, in turn, will limit households’ consumption. The annual growth of retail trade volumes decelerated to 1.8% during the first five months of 2017. Economic sentiment among consumers remains very strong, however. The financial situation of households is perceived as the strongest in 20 years, for example.

Source: Swedbank

The size of the economy exceeded its potential

  • Growth accelerated in the first quarter in many countries
  • GDP growth was boosted by a recovery in output in the oil shale sector
  • Investments increased substantially

The Estonian economy grew by 4.4% over the year in the first quarter, and by 0.8% over the quarter. The size of the economy exceeded its potential output volume rather than remaining below it. This indicates that companies are using their production capacity more than usually, and it is hard to find the new employees needed for activities to expand. Further growth in the economy requires increased investment and productivity growth. The danger has increased though that the balance of the economy may worsen.

Growth accelerated in the first quarter of the year in many countries, including Estonia’s neighbours. The economies in Latvia, Lithuania and Finland grew by some 1.5% in the quarter. Quarterly growth in Estonia was a little lower, as it had accelerated in the fourth quarter of last year because of the stocking up of goods subject to excise. This meant that the contribution of net product taxes to GDP growth was smaller in the first quarter. Without the negative effect of net product taxes, the Estonian economy would have grown by 4.8%.

One reason for the faster growth in the economy was that oil-producing states have exited their recession, meaning that demand stopped falling in those countries. One country this applies to is Russia. The higher oil price is reflected in the Estonian economy primarily by the oil shale sector, and mining and energy made a large contribution to economic growth in the first quarter. More detailed data show that the financial results for oil shale oil producers were notably better than a year earlier. Equally though, the rise in the oil price has given a lift to inflation, restraining growth in private consumption. Private consumption at adjusted prices was only 0.6% more in the first quarter than a year previously.

The demand component of GDP that saw the biggest growth in the first quarter was investment, which was up 16.5%. This was also reflected by indicators for the construction sector, which have strengthened steadily since the start of the year. A recovery in investment is needed to shore up the supply side of the economy. Private sector investment has declined in recent years as corporate profits have shrunk, and this has reduced the potential for growth in the economy. This means it is now not possible for the Estonian economy to attain the levels of growth seen before the crisis, and the problem of imbalance in the economy may already arise at lower GDP growth rates.

The danger of increased imbalance is indicated by estimates that companies give of labour shortages, and also by the rapid increase in the use of production capacity. In recent years, some of those indicators have been above the average of the business cycle, and some have been below, but in the past few months these statistics have pointed to the economy outstripping its potential.

In such circumstances the government needs to be careful about stimulating the economy. As there are few available resources in the economy, an additional stimulation could lead to higher prices, which would make it harder for companies to invest. Widening a positive output gap through the budget would increase imbalance and so amplify the economic cycle, possibly ending in the economy crashing. Furthermore, it is wise to build up buffers in good times against possible rainy times in the future.

Survey data from companies looking to the months ahead indicate somewhat slower growth in the industrial sector, though expectations for output are still strong and show no sign of falling. Estimates of orders for the construction sector, which is focused on the domestic market, were above the average of the first quarter in April and May.

Source: Bank of Estonia

Author: Kaspar Oja, Economist at Eesti Pank

Inflation picked up a little in May

  • The immediate impact of the higher oil price on consumer prices has eased
  • Faster GDP growth will encourage inflation this year in Estonia and in the other countries of the euro area
  • Inflation will remain high until the end of the year

The rise in the consumer price index accelerated in the figures from Statistics Estonia to 3.3% in May 2017. Energy prices were up 5.3% over the year, and food prices, including alcohol and tobacco, were up 6.2%. Core inflation slowed to 1.2% though.

The structure of inflation has changed somewhat in recent months as energy prices are not rising as fast, but the broad-based inflation for food products continued in May. Estonia is something of an exception among euro area countries for the rapid rise in prices of food products. Inflation in May also saw some individual large changes in services prices, with prices for accommodation services standing 11% higher than they were a year earlier, possibly because of the Estonian Presidency of the European Union. Among residential services it was rent and waste disposal that drove inflation, but this was offset by cheaper communications services.

The immediate impact on consumer prices of the rise in the oil price that started in early 2016 has now eased. In January the global oil price was still 80% higher than it had been a year earlier, but by the end of May the difference over the year had dropped almost to zero. Prices of motor fuels were up 11% in May in Estonia, some 5 percentage points of which was due to the rise in excise on fuel in February. The indirect consequence of the higher oil price is transmitted into a second wave of inflation in prices for natural gas and heating energy. The prices of food and industrial commodities have fallen moderately on the global market in recent months. Commodities prices are being pushed down by uncertain demand in Asian countries.

The Estonian economy has improved noticeably since the second half of last year, and that has boosted the rise in consumer prices. Corporate profits increased in the first quarter by more than labour costs did for the first time since 2014, and they were helped in this by rapidly growing domestic demand and a revival in external demand. Corporate revenues rose because of increased export volumes and higher export prices, while on the cost side, the growth in wages slowed. The improved economic circumstances allowed companies to increase their profit margins and that will lead core inflation to rise in the second half of the year.

Inflation in Estonia is likely to remain high until the end of this year, because of both demand-side and supply-side (or cost-side) inflation factors. The coming months will see additional inflation caused by a rise in excise on alcohol. The key to long-term developments in prices is the price of oil on the global market, because oil has been relatively cheap for several years now. Eesti Pank will publish a new inflation forecast on 14 June 2017.

Inflation in Estonia and euro area

See better graph on Bank of Estonia website here

Author: Sulev Pert, Economist at Eesti Pank