The year ahead: economy most impacted by external demand

Tõnis Oja
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The main impact on economic indicators in 2015 will be events on global markets, chiefly the persistently low interest rates and oil price drop. Both might serve as catalysts to the economy, but whether a growth boost will be provided, we’ll see in 12 months. 

For, let’s face it, interest rates have been low for three long years with no sign of fresh life in the economy. Rather the opposite – both in Estonia and elsewhere in Europe, economic growth has slowed; even so, instead of the rapid inflation predicted by many, we are rather seeing a deflationary price pressure – and, in Estonia, an outright deflation.

In interview to Postimees at the end of last year, Eesti Pank president Ardo Hansson said the reason why low interest rates have failed to impact the economy may be the low investments. On the one hand, this is because insecurity regarding the future, and on the other hand there’s the fact of equipment acquired earlier is yet to be used to the max.

To this, Swedbank chief economist Tõnu Mertsina added that the up-to-now monetary policy decisions can indeed have no instant effect and the changes in real economy may become evident over a longer period of time.

«Meanwhile, the low oil prices have a very strong impact on inflation, sufficient activity is nowhere to be seen in the economy, and the European Central Bank (ECB) is increasingly afraid that it may be late in taking action,» he said. «For ECB, bond purchasing would be the last measure to slow the price drop and boost economic activity.»

ECB aim

Last year, the influential Financial Times columnist Martin Wolf quoted ECB president Mario Draghi’s words dated December 4th that central bank balance sheet total ought to grow to the size it was at the beginning of 2012. As we remember, back then the central bank offered €1tn worth of short term loans to commercial banks. By now, the debt is largely written off and the balance sheet total would have to be increased (read: new money printed) by another trillion yet.

«It is hard to believe alternatives to outright purchases of sovereign bonds would secure this result,» Mr Wolf wrote in the big forecast by Financial Times.

Yesterday, Mr Draghi have a strong hint about a large-scale bond purchases in the German newspaper Handelsblatt. «The risk that we do not fulfil our mandate of price stability is higher than six months ago,» he said.

Mr Draghi added that technical preparations for a large-scale purchasing of sovereign bonds are underway. The central bank goal is seeing that inflation will not stay too low for long.

In Estonia, prices have been falling ever since June last year i.e. for over six months. Swedbank’s chief economist Mr Mertsina believes the prices will start to rise during the first half of this year already. «First and foremost, price rise is supported by the raising of excise taxes (alcohol and natural gas), and the moderate rise of food prices,» he said.

Nordea Bank chief economist Tõnu Palm thinks the prices will keep on falling during the first half of the year, the cause – in addition to the low oil and energy prices – also being the prices of foodstuff.

«There’s a lot of uncertainty right now. It’s only in the second half of the year, probably, that crude oil prices can be expected to rise slightly, and the euro to weaken,» he noted.

Mr Palm added that European gas prices react to event on oil market with a delay time. «Thus, in this sector also a fall of prices is to be expected,» said the economist.

Financial Times columnist Ed Crooks believes oil prices will continue to fall at least during the first half of the year and maybe longer, the price plunging below $50 a barrel.

That’s more or less what the Estonian exerts are saying as well. Even in the initial half of 2015, demand for oil products will remain weak while production goes up. On the other hand, the lower price of oil will have a positive effect on global growth and the demand for oil products will gradually begin to increase.

«At our current estimation, oil price ought to stay at the average of $60-70 in 2015,» said Mr Mertsina. «That said, as the global market oil price is very sensitive to changes in production/demand ratio and geopolitical risks, it is very difficult to be precise in one’s predictions.»

Mr Palm added that while, by and large, the lower energy prices have a positive effect on the Estonian economy (except for energy industry exports and investments), the effect of the other vital factor – geopolitical risks (incl. the Russia-Ukraine risk) are negative no doubt.

«In 2015, the Russian economy will continue to decline, the interests are high and the exchange rate of the rouble volatile,» he suggested. «In that regard, changes would only be enhanced by wise, forward-looking decisions.»

Domestic demand weak

Even more importantly: how will things go for Finland and Sweden, Estonia’s top foreign trade partners?

According to Mr Mertsina, the recovery of Finnish economy is a highly uphill battle and over there the domestic demand will remain weak for quite some time.

«Meanwhile, the export volume of Estonian enterprises is relatively small and the price level even lower as compared to Nordic and West-European countries, thus helping us to find markets even with the lower demand,» said the Swedbank chief economist.

«Next year, Latvia’s and Lithuanian’s import demand ought to improve. We might especially underline Lithuania where the growth of private consumption and investments will indeed slow down slightly, but will still be rather strong,» he added.

The Nordea economist Mr Palm also pointed out that the year ahead is elections year for Estonia and several states in Europe. After Greece failed to elect itself a president in the Parliament, the talk resurfaced about the reappearance of dent crisis in Europe. Greece will have its snap general elections on January 25th.

«That opens cards for the oppositional Syriza party which support is high,» said Mr Palm, adding that for financial markets the risks have clearly grown. «For Europe, the other weighty political event will be the upcoming parliamentary elections in the UK (On May 7th 2015 – edit. These both will be important milestones on the European political landscape,» underlined Mr Palm.