Aug. 14 (Bloomberg) -- Estonia's economy grew at its slowest pace in two and a half years in the second quarter, as manufacturing output ebbed and oil shipments from Russia declined.

The $15.1 billion economy grew an annual 7.3 percent, compared with 9.8 percent in the first three months of the year, the Tallinn-based statistics office said on its Web site today.

Standard & Poor's Ratings Service last month lowered Estonia's outlook to negative from stable after growth exceeded 11 percent last year, citing the increased risk of a ``hard landing.'' Banks tightened lending requirements, squeezing credit growth, easing concerns that the pace of growth was unsustainable.

``The number takes out the worst fears about overheating,'' said Mika Erkkila, a senior analyst with Nordea Bank in Helsinki in an e-mailed comment.``However, 7.3 percent is still above the long-run sustainable rate and hence it will still take a quarter or two with further slowing growth before we can conclude that we are out of the woods.''

`Soft Landing'

The central bank said the data was in line with its previous forecasts the economy will make a ``soft landing.'' Trade data also indicated the current-account deficit has stopped growing, it said in an e-mailed statement.

The finance ministry said growth should slow further in the third quarter, citing weaker business and consumer confidence. The slowdown in the second quarter was more than expected, but still ``welcome'' after prolonged growth above potential, the ministry said in an e-mailed statement.

Value-added growth slowed in manufacturing, wholesale and transport and storage, the statistics office said, citing preliminary data.

Transit of goods from Russia, mostly oil and oil products, fell 22 percent in May and 15 percent in June, according to Eesti Raudtee, Estonia's rail-freight carrier. Interfax reported on May 2 that OAO Russian Railways started repair work on the line to Estonia. The Baltic country says that activity was due to its relocation of a monument to Soviet soldiers from the center of the capital to a cemetery in April.

Credit growth declined last quarter to the slowest pace in more than two years, as banks tightened lending requirements to help stem inflation and private consumption. Manufacturing output rose 5 percent in the second quarter, the slowest since at least the start of 2006.

``Growth slowed somewhat more than we expected on the basis of lower manufacturing output and slowing lending,'' said Anne Karik-Uustalu, an analyst at Sampo Pank in Tallinn. ``Apparently the added impact came from lower rail cargo shipments'' from Russia.

Labor Shortages

Tax increases and rising labor shortages that push up wages still stoke inflation, which accelerated to a six-year high of 6.4 percent in July. Prime Minister Andrus Ansip said in May he hoped to slow inflation to levels needed for euro entry by 2010 at the earliest after the currency switch was postponed last year.

Estonia's rising trade deficit and quickening inflation, which hit a six-year peak in July, have raised concern that the economy may overheat, echoing similar worries about neighboring Latvia. Estonia's economic growth is the second-highest in the European Union, trailing only Latvia.

Standard & Poor's Ratings Service last month lowered Estonia's outlook to negative from stable, citing the increased risk of a ``hard landing.'' S&P said plans to loosen budget policy would further fuel economic growth.

``I'm still pretty concerned about overheating though we are beginning to see the impact of cooling down of the property market,'' said Lars Christensen, a senior analyst at Danske Bank A/S in Copenhagen.

To contact the reporter on this story: Ott Ummelas in Tallinn at oummelas@bloomberg.net

Last Updated: August 14, 2007 07:45 EDT