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Luminor forecast: Spring optimism has disappeared, Estonian economic outlook is gloomy

Прогноз Luminor: весенний оптимизм исчез, перспективы экономики Эстонии мрачные

According to Luminor's autumn economic forecast, due to low investment, cuts in public spending and higher taxes, Estonia's economic growth next year will be only one percent, which is far below our potential. The economic downturn is largely reflected in the decline in retail sales as household uncertainty continues to rise. The economic downturn is largely reflected in the decline in retail sales as household uncertainty continues to rise. Photo: Margus Ansu

According to Luminor's autumn economic forecast, due to low investment, cuts in public spending and higher taxes, Estonia's economic growth next year will be only one percent, which is far below our potential.

While the economy is finally recovering from years of decline, it is doing so more slowly than expected and with high inflation. Lower lending rates are providing less relief than expected, and the net effect is that both households and businesses remain in austerity mode.

According to Luminor Chief Economist Lenno Uusküla, the economic downturn in Estonia ended in the second quarter of this year (compared to the first quarter), and when adjusted for the number of working days, a slight increase was noticeable. "On a quarterly basis, growth can be expected in the last quarters of the year, but nevertheless, this year will end with a contraction of one percent," he said.

"Given the upcoming tax increases and the fact that the single tax-free income will not be introduced for everyone, households will continue to adhere to the austerity regime. Companies are also making plans to cut costs and raise prices next year," Uusküla said. "Although things have slowly picked up in our main export markets, the recovery will not take place in the industrial sector, which is most important to us, and therefore foreign trade volumes will remain weak next year as well."

Insufficient investment, a series of tax increases and cuts in government spending in 2025 will have a negative impact on economic growth. Therefore, Luminor forecasts one percent GDP growth next year, rather than three percent as in the spring forecast.

At the same time, Uusküla said that Estonia continues to face numerous challenges in the areas of green transition, ageing society, healthcare, education, social sphere and many other areas. In other words, long-standing problems that the current tax reforms do not take into account. "This means that key issues remain unresolved," he said.

Estonia in the "club" of more expensive countries

According to Luminor's chief economist, along with the slowdown in economic growth, the main focus was on rising prices. Compared to December 2019, prices in Estonia have increased by forty percent, which is exactly twice as much as in the eurozone as a whole.

"As a result, the consumer price level in Estonia last year was 97.9 percent of the EU average, and now there are fewer countries with higher prices than us, and more countries with lower prices," Uusküla said. "Even though we have come down from the peaks of inflation, the prospects for price growth remain high. In the summer, prices were pushed up by the high cost of electricity, and companies are much less willing to reduce prices in anticipation of a new tax increase. The increase in wage costs is also contributing to price increases."

Luminor forecasts price growth of four percent this year, one percentage point higher than expected in the spring. For 2025, Luminor raised its inflation forecast from one to five percent.

Lowering the cost of borrowing will not bring significant relief

Interest rates on loans, including the six-month Euribor on which many home loans are based, have fallen significantly this summer and are expected to continue to fall. By the end of the year, Euribor could fall to three percent.

"This is one percentage point lower than last summer. For a family with a €100,000 home loan, this means a €50 reduction in monthly payments," says Uusküla. "At the same time, inflation has eaten away all the wage increases of recent years. Since prices are also continuing to rise, the interest rate cut will not bring as much relief as previously expected."

Salary and unemployment

Although the average salary in Estonia exceeded the magic mark of 2,000 euros for the first time in history in the second quarter of this year, salary growth has slowed significantly over the past year and is very unevenly distributed across industries. Luminor predicts nominal salary growth of seven percent this year.

"In the future, we will probably see wage growth continue, but not at such a high rate. In particular, we see wage growth in the service sector. In the manufacturing industry, wage growth is only possible if new export markets open up or the number of workers is reduced," says Luminor's chief economist.

The unemployment rate in Estonia remained moderately low, but today we have reached a situation where unemployment, which was lower than in the eurozone, is above the eurozone average – at the end of the second quarter, the unemployment rate was 7.6 percent.

"The last time the unemployment rate was higher than the eurozone average was in early 2012, when we were recovering from 20 percent unemployment during the previous major crisis. The recession has deepened again, and the unemployment rate has also exceeded the eurozone average," Uusküla said. "The unemployment figures are largely due to the inclusion of Ukrainian war refugees in the overall labor market statistics, but some increase in unemployment is also observed among local residents."

"Family budgets are under such pressure that the income of one family member is not enough for a long period. The unemployment rate this year will be higher than expected, at eight percent. As a result of the slowdown in economic growth, the unemployment rate will remain high in the coming years – next year it will be eight percent, and the year after that it will fall to seven percent," Uusküla added.

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