Sweden Recession is finally arriving

After impressive economic resilience, we expect this year to begin with falling GDP. We have revised our 2023 forecast higher, but the year’s 1.2 per cent decline will be clearly larger than the EU average. Important drivers are falling real incomes and a large downturn in housing construction. Looser fiscal policy may soften the downturn, but high inflation will lead to a difficult balancing act. We now expect the Riksbank to hike its key interest rate by 50 basis points to 3.00 per cent in February, before cuts begin in 2024.

Although Swedish households have faced strong headwinds, the resilience of the economy has been a continued surprise. GDP growth in the third quarter of 2022 was above trend, and Q4 also seemed to start off strong. Meanwhile, most sentiment indicators have fallen to levels normally consistent with falling GDP, and we now expect growth to turn negative. Because inventory build-up accounted for large positive contributions to growth over the past two quarters, the downturn will be abrupt. We now expect GDP to decline by only 1.2 per cent this year (1.5 per cent in our November forecast). Because the recovery has also been postponed, we have lowered our 2024 growth forecast from 1.3 per cent to 1.1 per cent. Downside risks are mainly connected to a potential collapse in residential -construction. On the upside, there is a chance that the government will finally launch more vigorous fiscal stimulus measures than the relatively cautious ones our forecast assumes.

Key data

Year-on-year percentage change

*% of labour force **% of GDP ***At year-end.
Source: Eurostat, SEB

Moderate decline in manufacturing

Industrial production and merchandise exports had already reverted to their pre-pandemic trend in early 2022. Since then, the upturn has gradually lost momentum. For example, the purchasing managers’ index (PMI) and the National Institute of Economic Research’s Economic Tendency Survey suggest that manufacturers started losing ground late last year. International demand and energy price developments will determine the depth of their downturn. High energy prices have weakened the competitiveness of the euro area, especially German manufacturers. Sweden is a net electricity exporter and uses very little natural gas, which is a potential competitive advantage (see chart below). But so far, its electricity price subsidies have been significantly smaller. If disbursements of these subsidies continue to be delayed, Swedish businesses risk being as severely affected as their counterparts elsewhere in Europe. Partly due to increased defence spending and investments in new energy production, the downturn in exports and industrial investments will be moderate compared to other recessions. We believe exports will fall by 2.0 per cent during 2023 and then grow by 4.0 per cent in 2024.

Sharply falling residential investments. Falling home prices and soaring construction costs are now putting heavy pressure on housing construction. We expect housing starts to halve from 67,000 units in 2021 to 30-35,000 this year. Residential investments will fall by a total of 30 per cent in 2023 and 2024, reducing GDP growth by about 0.7 percentage points per year. There is widespread uncertainty, and anecdotal information indicates downside risks and dramatic freezes of new projects, but some form of stimulus measures for housing construction will probably be launched if this downturn threatens to be larger than we have forecast. Lower demand for commercial premises will also contribute to falling construction investments. We expect overall capital spending in Sweden to fall by 3.1 per cent this year and by another 0.3 per cent in 2024.

Squeezed households will cut consumption Along with residential investments, household consumption will be the main driver of this year’s GDP decline. Real wages are projected to fall by a total of 11 per cent in 2022 and 2023. This is larger than the downturn in the early 1980s, when they fell by about 10 per cent over a four-year period. But the decline in real disposable incomes will be only about 4 per cent, due to tax cuts and increased subsidies. The fall in disposable incomes will be on a par with developments in the early 1980s but far milder than during the crisis of the early 1990s, when disposable incomes dropped by 10 per cent. At that time, a collapse in employment was an important driver, while the labour market looks significantly more resilient this time around.

Reduced savings are a downside risk to consumption. During the past six months, retail sales have fallen by nearly 10 per cent, while the downturn in total household consumption has been only around 3 per cent. This trend is expected to continue during the first half of 2023. Annual average consumption will fall by 1.7 per cent. So far, households have reduced their savings to maintain consumption. As savings buffers shrink, there is an increased risk of an even larger consumption downturn.

Home prices will continue to fall. Home prices had fallen by a total of 15 per cent by November (12.5 per cent seasonally adjusted), compared to their peak in February 2022. The downturn slowed late in 2022, and SEB’s Housing Price Indicator recovered somewhat in January. We expect home prices to continue falling during the first half of 2023, and we are sticking to our forecast that the overall home price downturn will reach 20 per cent. The average interest rate on a home mortgage loan with a three-month fixed interest period had risen from 1.4 per cent in late 2021 to 3.2 per cent in November 2022. Our forecast is that this interest rate will reach 4.2 per cent during the spring, which means that the average cost of a mortgage will have more than tripled. Interest expenses will increase from 2.5 per cent to an estimated 5.5 per cent of household incomes.

Rising unemployment during 2023 The Swedish labour market was unexpectedly strong during most of 2022, but late in the year indicators such as business hiring plans and new job vacancies turned downward. So far, this decline is moderate and there are many indications of continued job growth in early 2023. Because GDP is starting to fall, employment will probably also shrink this year, but after a certain time lag. During the financial crisis of 2009 and the pandemic of 2020, employment fell by more than 3 per cent. Since the next GDP downturn is now expected to be much milder, we believe that employment will fall by only a moderate 1.5 per cent. But the decline in output is now affecting labour-intensive service sectors and construction, posing a downside risk to our forecast.
Resource utilisation below normal by the end of 2023. Unemployment will climb from today’s 7.5 per cent to 8.5 per cent by end-2023 and remain at that level in 2024. Partly due to a strong upturn in labour force participation in the past few years, unemployment will be stuck at relatively high levels compared to pre-pandemic figures. Initial resource utilisation is high, but shortages according to the NIER’s Economic Tendency Survey fell from a record level in Q4 and will probably continue to below their historical averages late in 2023.

Moderate pay hikes, despite high inflation

The national wage round is now entering a crucial stage. After the labour unions launched demands for one-year pay hikes of 4.4 per cent, industrial employers responded with a proposed increase of 2 per cent, plus a one-time payment equivalent to 1 per cent in 2023. The employers’ proposal might be part of a slightly longer-term agreement. Further negotiations lie ahead, but the two sides do not seem far apart. Including a one-time pay-out of 1 per cent, pay hikes in 2023 could end up quite close to union demands, which might lead to lower pay hikes in 2024. But there is great uncertainty. We are sticking to our forecast that pay hikes will be 4.5 per cent in 2023 but have slightly lowered our forecast for 2024 to 3.2 per cent. This would mean somewhat lower pay increases than in the euro area and Germany.

Inflation will fall, but at an uncertain pace. Inflation rose to new highs in December, with CPIF (the consumer price index excluding interest rate changes) at 10.2 per cent and CPIF excluding energy at 8.4 per cent. Due to large base effects as rapid price increases in early 2022 vanish from the 12-month figures − combined with sharp electricity price declines − both metrics will probably fall in early 2023. But over the next six months, various factors will keep core inflation up. A large majority of companies in the retail sector are planning new price hikes, while producer prices for consumer goods continue to climb rapidly, partly due to a weak Swedish krona. Due to cost increases in 2022, many administratively set prices will continue to rise early in 2023: for example, fees for refuse collection and water, plus cooperative housing dues and rents.

A more favourable inflationary environment ahead. The potential for lower inflation further ahead has nevertheless improved. For example, prices of goods that are early in the production chain have begun to fall. US inflation indicators and actual inflation have both fallen sharply, which also increases the likelihood of a similar trend in Europe. Pay hikes will accelerate a bit, but this will not jeopardise the inflation target. Swedish core inflation will gradually fall to 2 per cent, and a slight decline in electricity prices suggests that CPIF inflation will end up below target in 2024. Due to rising mortgage rates, we expect total CPI to increase by an average of 3 percentage points more than CPIF in 2023.

A 50 basis point rate hike in February

Because of Sweden’s gloomy economic growth outlook, falling home prices, a weak krona and high inflation, the Riksbank’s dilemma will continue. Although inflation is now very likely to decline, monthly price increases over the next six months will remain higher than normal. The Riksbank’s February policy meeting will mark the debut of both Governor Erik Thedéen and Deputy Governor Aino Bunge, and there is little information about their views on monetary policy. Hawkish signals from the ECB and other central banks are putting pressure on the Riksbank, and especially Mr Thedéen, to show that they are taking the fight against inflation seriously. We thus believe that the Riksbank will raise its key interest rate by another 50 bps in February – thus by more than the 25 bp hike indicated at the bank’s November meeting. The Riksbank rate path is quite likely to indicate a high probability of a further hike in April. Yet we still believe that the relatively sharp GDP downturn, combined with gradually clearer signs of falling inflation, suggest that the key rate will remain flat after the February hike. Once inflation falls more clearly in 2024, we expect the Riksbank to cut its key rate by 75 bps to 2.25 per cent.

The Riksbank is likely to sell government bonds. The Executive Board has decided that bond purchases will now cease completely. Because of the short average maturity of its bond holdings, the Riksbank’s balance sheet will shrink rapidly. But over the next couple of years, it will mainly be mortgage and municipal bonds that mature, while Riksbank holdings of government bonds are rather evenly distributed over the next 10 years. In a recent speech, Deputy Governor Martin Flodén argued that the Riksbank should consider whether it should actively sell government bonds with long maturities. Such divestments would push up interest rates on longer-dated bonds, tightening monetary policy without significantly affecting household mortgages, which mainly have maturities of less than two years. Divestments might also attract foreign buyers and thereby help strengthen the krona. We believe the Riksbank is likely to start actively selling government bonds starting in the second half of 2023.

Cautious fiscal policy

Fiscal policymakers face a balancing act in terms of the need to soften the impact of the economic downturn without making it harder for monetary policymakers to fight inflation. Swedish government finances have been strong over the past year. The Swedish National Debt Office reports that in 2022 there was a surplus of SEK 164 billion, or 2.7 per cent of GDP. One reason for the size of the surplus is that the government’s promised electricity price subsidies have not yet been disbursed. Also, the Riksbank repaid a loan amounting to SEK 60bn last year. High inflation, bloated energy prices and rising employment have driven up tax revenues. The spending plans unveiled in the autumn budget were also unexpectedly small, for several reasons for this. The Tidö Agreement between the three non-socialist coalition parties and the Sweden Democrats, on which the government relies for a parliamentary majority, will take time to implement. Some political leaders are also worried about making it harder for monetary policymakers to combat inflation and repeating last autumn’s British mini-budget debacle.

Practical obstacles, but more fiscal stimulus on the way. Electricity subsidies will eventually be put in place, and additional stimulus will probably be rolled out as the economy slows. For example, we expect targeted support for those who are under the greatest financial pressure and increased central government grants to the local government sector, which has warned of growing deficits in 2023 and 2024. The next government budget (for 2024) will probably include new tax cuts. Measures to ease the downturn in construction are also possible, although the government will probably want to avoid direct subsidies. There will also be spending pressure due to high inflation in various fields with indexed payments. Even with the extra spending that we have included in our forecast, the central government budget will be in balance, while government debt will continue to fall well below the official “debt anchor”, which is 35 per cent of GDP. Such a feat is remarkable during an economic downturn, indicating that Swedish fiscal policy is rather cautious at present. We may see more fiscal stimulus measures once the downturn in inflation has come a long way, which we regard as an upside risk to our GDP forecast.