Average inflation in euro area countries rose to 4.6% over the year. In Estonia, inflation of 7% in October was caused by a sharp rise in energy prices and blockages in the supply chain. Energy prices that soared in October include natural gas and motor fuels. The higher price of natural gas will be transferred in the coming months to the prices of heat and other goods, preventing inflation from falling. Although the price of electricity fell for the first time in a long time thanks to the government’s decision to cut distribution grid tariffs, it was still 41% higher than a year earlier. There is a serious shortage in the production of sustainable and cheaper electricity in the Baltic States and Finland, with concerns over budget to balance. Lower price levels for electricity can supposedly be expected in the spring when weather conditions allow electricity to be produced at lower prices in the Scandinavian countries.
As elsewhere, growth in Estonia is driven by demand, which is reflected in the rapid growth of private consumption. There are two factors behind this process. The first is that the easing of the pandemic has expanded consumption opportunities, for example by making it easier to move. Secondly, people have accumulated savings during lockdowns that they can now direct into consumption. These factors have been further reinforced in Estonia by early withdrawals of money from the second pension pillar.
Growth remained very rapid in the economy in the third quarter at 8.6% over the year, observed in all sectors. Second-quarter growth slowed slightly to 0.7%, adjusted seasonally and for the number of business days. There were disruptions in the production of durable goods, especially automobiles and home electronics, which caused prices to rise rapidly. Production and supply difficulties can last longer than initially thought, with repercussions on rising prices. A problem for the European economy is that production is distributed among countries and some intermediate goods are produced in Asian countries for greater efficiency, but it has become more difficult to obtain such goods.
At the same time, the growth of the economy is hampered by supply-side limitations. Growth in the industrial sector has been below average for the entire economy, and this appears to be due to problems in supply chains. Pan-European surveys of industrial enterprises show that industrial production in Estonia is mainly held back by labor shortages, while the biggest concern in Europe as a whole is access to materials. Capacity utilization in manufacturing was remarkably high in October, meaning there is now little free productive capacity to support faster growth.
And rising energy prices are slowing the rise in consumption as inflation reduces real income growth. If wage increases push prices upwards, they cause general increases in the price level keeping inflation higher for longer. The government could reduce the risk of a wage-price spiral by bringing the state budget to balance, enhancing the competitive environment for economic activity. Productivity would then boost supplies and export.