Data reported by the Bank of Estonia show that consumer prices were up over the year by 5.3% in February. The cost of electricity has been restraining inflation in the consumer basket since last spring, but the prices on the electricity exchange were twice as high in February as they were a year earlier. Electricity is nearly 5% of the consumer basket, so fluctuations of that size have a substantial impact on the aggregate indicator for inflation. Higher electricity prices added 0.8 percentage points to the yearly increase in consumer prices in February.

Food prices continued to rise in February as the increase in the prices of food commodities last year started to be passed through to consumer prices. And that’s not all. The rise in prices of services came largely from transport services. The main cause of this was the introduction of the registration tax for cars at the start of the year, as the price index records this as a fee, which is a service. Holiday travel also pushed up the cost of services, but airfares fell at the same time.

The higher registration tax for cars will remain visible throughout the year in the price index. Inflation will be pushed up further in July when VAT rises by two percentage points. The rise in excise on diesel fuel in May will also push up the general price level. Movements in the prices of energy and food commodities, on top of these known tax changes, may result in inflation being volatile throughout the year.

Growth in wages reached 8.3% in the fourth quarter of last year. Wage growth slowed in the public sector, but was faster than expected in the private sector. A weak economic climate and more people than the average looking for work usually indicate that wage pressures should be subdued, but wage growth in the private sector accelerated in the third and fourth quarters of 2024. That suggests there may be problems with the match between labour and the needs of businesses, which means that to hire workers with the skills needed, companies must increase their wage offers.

Unemployment was 7.4% in Q4 2024, which was the same as in the third quarter. The recession ended in early 2024, and GDP was up over the year by 1.2% in the fourth quarter, but demand for labour has not yet shown signs of a decisive recovery. The employment rate is at a historically high level, as fewer jobs were cut during the recession than in earlier episodes, and changes in economic activity reach the labour market after some delay.

Even though exports are increasing as foreign demand has been recovering and they have become a little more competitive, it will take time to climb out of the slump caused by the various crises, as production in Estonia has become more expensive than that in competitors, and adapting to this will need productivity improvements. Growth in the economy this year will be 1.5%, and it is expected to pick up to around 2.5% in each of the next two years.

The environment has become more complicated for the global economy, and that is also leaving an imprint on the Estonian economy. The protective tariffs imposed by the USA and the countermeasures to them have so far had little direct impact on the Estonian economy, but trade conditions may deteriorate further. This would hit Estonia hard because it is a small and open economy that is largely reliant on exports. Allegedly, the USA imposing a tariff of 25% on exports from the EU would slow growth in the Estonian economy noticeably, but would not necessarily cause a recession.

However, persisting inflation for food and services will be pushed higher by the rise in taxes. Higher taxes will in total contribute about one-third of inflation, which the Central Bank forecasts will be 6%. As income tax also rose at the start of the year, the purchasing power of wages will fall, and that will then limit consumption and growth in the economy in 2025.

Even when times are very challenging, the long-term perspective for the state finances must not be forgotten. The new governing coalition has decided to increase spending on defence and has announced tax changes that would reduce the future revenues of the state. The EU has agreed for the coming four years that a large amount of spending on defence will not be counted in the permitted national budget deficits.

Caution is needed that the exception for spending on defence is not used to increase the national deficit for reasons other than that. After all, a larger debt burden means larger interest payments each year, and limited opportunities for other government spending.