Mertsina: Uncertainty in external environment hampers economic recovery

TALLINN - Estonia's economy is starting to show signs of recovery: both consumer and business confidence have improved, and consumption is gaining momentum. However, according to Swedbank's chief economist Tõnu Mertsina, the recovery is still being hampered by uncertainty in the external environment and high energy prices, keeping the economy on a more cautious course.

According to Mertsina's analysis, economic confidence in Estonia has significantly improved over the past few years. Households and businesses are looking to the future more optimistically, which is particularly reflected in the rise of consumer confidence at the beginning of the year. This, in turn, is supported by positive expectations regarding their financial situation, aided by both tax policy changes and income growth. Improved confidence is a prerequisite for an increase in consumption and investment.

Retail sales volumes grew by about eight percent in January compared to the previous year, with part of this growth coming from increased fuel sales, but signs of improvement are also visible in other trade sectors. Swedbank's card payment data confirms the gradual strengthening of private consumption. However, some sectors, such as vehicle sales, remain modest. The annual growth is mainly due to a low comparison base, as sales fell sharply last year due to a new tax.

The growth in industrial production volume continued at the beginning of the year, increasing by nearly six percent, including about three percent in the manufacturing industry. The growth was driven by the wood industry and the production of metal products and refined oil products. However, more modest production in the food industry is holding back the overall picture. In the energy sector, the colder winter increased heat production, but electricity generation continued to be lower.

The labor market is also showing signs of improvement. The unemployment rate fell to 6.5 percent in January, which, adjusted for seasonality, is the lowest level since 2023. Although the economic recovery reaches the labor market with a certain delay, the decrease in unemployment indicates an improvement in the situation for businesses, which should in turn support economic growth.

However, the beginning of the year brought a faster-than-expected price increase. In January and February, consumer prices grew by an average of 3.4 percent, with the greatest price pressure coming from food, where prices rose by nearly six percent. A significant contribution to inflation also came from more expensive energy and healthcare services. Although a slowdown in inflation has been forecast, developments in energy prices could affect this picture. Despite the faster-than-expected inflation, the elimination of the tax hump and a nearly ten percent growth in nominal wages should lead to a real increase in households' net wages and improved purchasing power, although this may happen more slowly than previously expected.

According to Swedbank's chief economist Tõnu Mertsina, the main driver of this year's economic growth is primarily domestic in origin. In addition to income growth and tax changes, the state is also significantly increasing defense and infrastructure investments, which will give the economy an additional boost. Although the economies of major trading partners are expected to improve and offer export opportunities, the external environment, along with energy prices, holds great uncertainty. However, a positive note is added by industrial companies' assessment of their improved competitiveness in foreign markets.