Data reported by the Bank of Estonia show that yearly consumer price inflation slowed in February to 17.6%. Inflation peaked last August at 25% and has since come down. Energy prices have fallen steadily in recent months and the market prices of gas and electricity are now back to where they were in September 2021. The price level in February was 0.6% higher than it was in the previous month as food and services put pressure on prices and eat into competitiveness.

A contraction in the economy and a fall in demand mean that many companies are no longer able to raise their prices as fast as before. Domestic inflation is being driven by rapid growth in wages.

In fact, the average gross monthly wage was 1775 euros in the fourth quarter of 2022, which was 9.2% more than in the fourth quarter of the previous year. Although the economy contracted at the end of last year, the growth in the average wage still remained strong. The purchasing power was lower over the whole of last year than it was in 2021 though.

If the economy had not contracted, high inflation would have pushed wages to rise even faster. The growth in wages is affected by and worsening the deteriorating economic climate, which makes companies less inclined to hire.

And higher consumer prices increase the upwards pressure on collectively bargained wages, especially in the public sector. The lowest rate of pay for workers in healthcare is rising by 20% for example, and wage growth is accelerating in education. The minimum wage also rose this year by 10.9%. Such wage rises also have an indirect impact on the private sector, as they shape the expectations of workers for wages in general and to some extent for their particular job. Even faster growth in wage costs starts to eat into competitiveness though.

The Estonian economy shrank by 1.3% last year. Consumption by households was smaller in the fourth quarter than a year earlier, but the main source of the decline was the exporting sector. The economy is in a weaker position than previously.

Various factors lie behind the fall in exports, including higher energy prices, reduced access to raw materials, and weaker demand in external markets.

Manufacturing has affected the economy most through the decline in wood processing and related branches. Options for importing wood have been curtailed at the same time that demand has changed in external markets. Higher interest rates are stifling development in construction, where demand has also fallen for certain products that became popular during the pandemic. Branches of manufacturing that are doing better are those related to electronics.

The key issue for further development in the economy is how tightly the competitiveness problems in the exporting sector will restrict growth as production becomes more expensive. Higher prices for commodities pushed a lot of prices up steeply in Estonia in 2022. Will their fall on global markets be followed by other prices coming quickly down? Prices remaining higher than those of competitors for a long time will make Estonia far less competitive.