MONDAY

Euro a minor villain in Estonia’s inflation drama 17 JANUARY 2011

Estonia’s inflation rate accelerated rapidly during businesses will also hoard certain goods in advance
(which in itself drives up actual prices), due to such fears.
2010 – but the drama is exaggerated by strong
Similar signs were evident, for example, in the run-up to
statistical base effects, due to a sharp downturn Estonia’s European Union accession in 2004.
during the deep recession of 2009 when GDP fell
by 14 per cent. The Estonian Ministry of Finance predicts that the
Consumer Price Index will rise by a modest 0.1-0.3 per
Last year the clearly dominant inflationary forces cent because business will round off prices upward
were higher prices for food, alcoholic beverages, during the euro transition. The ministry cites the
tobacco and energy, with only a weak upturn in experiences of other countries that have shifted to the
euro. Our assessment is also that the impact of the euro
underlying price pressures.
on Estonia’s inflation will be relatively minor, though
Euro zone accession is expected to result in minor higher than the government’s forecast. However, it will
price-hiking effects. be generally difficult for businesses to impose price
hikes, given the large output gap. The recovery in post-
Estonia has now become the third country in Central and recession domestic demand has hardly begun, and
Eastern Europe to join the euro zone. The transition from during the third quarter of last year unemployment stood
the kroon to the euro took place during the first two at 15 per cent, although it had fallen from ca 20 per cent
weeks of 2011. On New Year’s Eve this event was also early in 2010.
celebrated on some of the country’s streets and squares,
but basically the Estonians are not overwhelmingly Nor does an examination of last year’s inflation trend
positive towards euro zone membership. Only a slight indicate that any broad price pressure is building up.
majority, 52 per cent, believe that adopting the euro will Inflation and core inflation in Estonia
be good for Estonia, according to a large government- HICP year-on-year, per cent
sponsored survey in December. This also represented a 12.5 12.5
decline from November’s record level of 54 per cent. 10.0 10.0

Those who believe that this lukewarm attitude towards 7.5 7.5
the euro is rooted in the past year’s acute financial crises 5.0 5.0
in southern Europe and Ireland lack a sense of history.
2.5 2.5
For many years, people in Central and Eastern Europe
0.0 0.0
have been divided in their views of euro zone
membership. This has been the pattern in the European -2.5 -2.5
06 07 08 09 10
Commission’s Eurobarometer surveys for a long time.
However, there is still a broad consensus in favour of the Total HICP
HICP excl food, alcoholic beverages, tobacco, energy
euro among the political establishment, including both Source: Reuters EcoWin

governing and opposition political parties.

During 2010 the year-on-year inflation rate – the most
One reason why the people of Estonia are euro-sceptical common yardstick of inflation – admittedly rose from -1
is probably their concern that membership will lead to per cent in January to a full 5.4 per cent in December.
markedly higher consumer prices − a concern that may The 2010 annual average, compared to 2009, was 2.8
have been reinforced by last year’s rapid upturn in the per cent.
inflation rate. This may include popular suspicions that
companies will take the opportunity to carry out extra A very large proportion of last year’s inflation upturn can
price hikes during the transition and that households and be explained by higher food, alcoholic beverage, tobacco
and energy prices. This, in turn, was largely due to global
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Economic Insights

shock waves as well as administrative increases − The outlook for 2011 is for somewhat higher inflation in
including a value-added tax hike whose impact Estonia, using broad-based measures, but a continued
culminated in July 2010 − that were part of fiscal calm trend in the underlying inflation rate.
tightening, which will be eased this year. The core
Fading base effects as well as the fading effects of
inflation rate, after correcting the broad measure for the
administrative increases will have a restraining effect on
above-mentioned four items, increased more
the inflation rate. Offsetting this, private sector wages
moderately, from -1.5 per cent in January 2010 to 1.3 per
and salaries will rebound after the major cost adjustment
cent in December 2010.
of the past two years, but this trend will be weak because
It should also be noted that 12-month rates were driven there are still large idle resources in the economy.
upward by strong base effects. The comparative months Economic activity will also continue to strengthen
of 2009 were very weak. In the second half of 2009, gradually, although GDP growth will probably not reach
year-on-year measures showed growing deflation. Latvia its 4-5 per cent potential level. In addition, global energy
and Lithuania also show similar patterns for and food price increases appear likely to be higher than
corresponding reasons. The level is higher in Estonia previously expected − and finally, there will be certain
partly because the economic recovery has progressed euro-related effects.
further there; GDP is expected to have increased by 2.5
Our overall conclusion is that HICP inflation will end up
per cent in 2010.
at close to 4 per cent during calendar 2011, which
I. Comparision to other countries incidentally is close to the 4.2 per cent average so far
HICP, year-on-year, per cent during the 21st century. This represents a clear upward
20.0 20.0 revision from the 3 per cent we forecasted in the
17.5 17.5
15.0 15.0
November issue of SEB’s Nordic Outlook report. But the
12.5 12.5 reason is mounting external pressure from energy and
10.0 10.0 food prices in the past few months, not that Estonia’s
7.5 7.5
5.0 5.0
domestic inflation is getting out of control.
2.5 2.5
0.0 0.0 Meanwhile it is important to ensure that inflation does
-2.5 -2.5 not get stuck at 4 per cent, which is clearly higher than in
-5.0 -5.0
most EU countries and far above the ECB’s inflation
06 07 08 09 10
target for the euro zone countries of just below 2 per
Estonia Latvia
Lithuania Euro zone
cent. Otherwise there is a risk that the competitiveness
Source: Reuters EcoWin regained by Estonia over the past couple of years will
again be eroded.
We also obtain a more nuanced picture of inflation in
Estonia if, we choose to study moving 12-month It is also notable that in December, Estonia’s moving 12-
averages. Measured in this way, Estonia’s divergence month average inflation was higher than the Maastricht
from developments in the euro zone are more modest. In inflation criterion. Estonia fulfilled this criterion during
December the 12-month average in Estonia stood at 2.7 the convergence evaluations conducted by the EU and
per cent compared to 1.6 per cent in the euro zone. the ECB in the spring of 2010. The criterion stipulate s
that average inflation in the 12 months to the evaluation
II. Comparision to other countries
date may not exceed 1.5 percentage points above the
HICP, 12-month moving averages, per cent
17.5 17.5
three EU countries with the lowest inflation. In December
15.0 15.0
the average of these three lowest figures (Slovakia 0.7
12.5 12.5
per cent; Netherlands 0.9; and Lithuania, Germany,
Czech Republic 1.2) was 0.9 per cent. Adding 1.5
10.0 10.0
percentage points, the maximum was 2.4 per cent. Four
7.5 7.5
of the 17 euro zone countries (Cyprus 2.6 per cent;
5.0 5.0
Estonia 2.7; Luxembourg 2.8; and Greece 4.7) exceeded
2.5 2.5
the maximum inflation to qualify for euro zone
0.0 0.0
membership.
-2.5 -2.5
06 07 08 09 10

Estonia Lithuania Latvia Euro zone

Source: Reuters EcoWin

Mikael Johansson, Economic Research

+ 46 8 763 80 93