04 May 2010 10:45

Nordic Outlook: Growth increasing, but difficult post-crisis choices ahead

Economic signals are generally positive. World trade now seems poised to take off in earnest. This will especially benefit export- and manufacturing-dependent countries, such as Sweden. Central banks are continuing to prop up the economic recovery with highly expansionary policies, and fiscal belt-tightening is being postponed in most places. Damaged financial sector and household balance sheets are now healing, thanks to rising stock markets and home prices. But because of the policies being pursued, the bill for the lending excesses of the 2000s decade also remains unpaid. Rapidly rising government debts and a global banking system under continued regulatory pressures will lead to major economic policy challenges during the next couple of years.

In the OECD countries, economic growth will be about 2.5 per cent annually during 2010-2011, or somewhat above trend. The upturn in unemployment has been smaller than expected, but growth is insufficient to push down the jobless rate quickly. Euro zone growth is being hampered by the crisis in southern Europe, which is making huge austerity programmes necessary, and not only in Greece. The United States and Japan are regaining their strength, while Chinese economic tightening will counteract the risk of asset price inflation. Despite rising prices for most commodities, inflation pressure will continue to ease. The US Federal Reserve (Fed), the European Central Bank (ECB) and their peers can hold off on their key interest rate hikes in order to offset fiscal austerity measures and the impact of new credit regulations. The euro will continue to lose value against the US dollar.

Sweden has good potential to take advantage of the global recovery. Because of strong balance sheets, the country will be well prepared to deal with economic and financial reversals in Europe and elsewhere. Exports are about to bounce back after the disappointing winter months. GDP growth will be 3.0 per cent in 2010 (2.7 per cent in calendar-adjusted terms) and 2.7 per cent in 2011: in line with our previous forecast. Expansionary economic policies have contributed to an unusually fast labour market turnaround, but unemployment is falling only slowly and will remain at 8.5 per cent late in 2011. This will contribute to continued low inflation pressure in Sweden as well.

Because of positive economic growth signals and greater focus on household credit expansion, the Riksbank will raise its key interest rate in July. After that the bank will proceed rather gently, and at year-end 2011 the repo rate will stand at 2.75 per cent. Due to structural changes in the credit market, the neutral interest rate will move downward to 3.75 per cent. The krona will resume its previous appreciation, bringing the EUR/SEK exchange rate below 9.00 by late 2011. This autumn's parliamentary election will lead to a more expansionary fiscal policy, regardless of the winner. The election campaign also indicates a growing divide between Sweden's two main political blocks. If the "red-green" opposition wins and forms a new government, we expect it to pursue traditional leftist policies that rely heavily on stimulating demand. The risk of poorer economic performance in Sweden is associated with a delicate housing market situation.

"The world's economic and financial systems are still moving in a complex post-crisis environment, where the economic policy choices ahead for many countries will not be voluntary," says Robert Bergqvist, SEB's Chief Economist. "Greece is a clear example of this. To prevent secondary effects and avoid higher sovereign bond yields, credible economic plans for the future must be presented. The shape of fiscal policy will have a major impact on economic performance. There are also good reasons to carefully monitor efforts to create a new financial infrastructure. This will impact the credit situation and the cost of capital, thereby affecting growth as well as how quickly and how high central banks will hike their key interest rates. In the euro zone, the banking system accounts for about 80 per cent of all credit supply. Combined with further expected credit losses, this means the euro zone runs the greatest risk that growth will also be hampered."

"Since early 2010 we have entered a phase where gaps between the economic and financial situation of different countries are being exposed," says Håkan Frisén, SEB's Head of Economic Research and editor in chief of Nordic Outlook. "Although imbalance problems will persist, growth in 2010 and 2011 looks set to be fairly good. The recovery has gained a foothold, especially in Asia but also in the US. Growth is also speeding up in Germany and the Nordic countries, led by increasingly strong exports, but there is great uncertainty. One of our alternative scenarios assumes a positive spiral that would lead to one per cent higher global economic growth. The probability of such a scenario is about 25 per cent. We estimate the probability of another downturn and a new recession at around 15 per cent."

The euro zone countries are fighting an uphill battle. Government budget problems are increasing their risk of domestic political instability, and growth will be restrained during a long fiscal consolidation process.

"The emergency loans to Greece have shown how mutually dependent the euro zone countries actually are," says Tomas Lindström, euro zone analyst at SEB Economic Research. "Far-reaching reforms will be needed to enable the euro to regain credibility and strength. Otherwise the recovery will be jeopardised, and the risk of secondary effects in other countries will increase. Our calculations show that if a budget deficit is one per cent of GDP higher, this can push up long-term yields by 50 basis points. The 'PIIGS' countries have become less competitive in the past decade, and the need to lower cost pressure by means of internal devaluations is about 20-30 per cent," says Lindström, who believes that increased economic divergence between euro zone countries will make it difficult for the ECB to hike its key rate. While the German economy is in a relatively strong position, budget and cost adjustments will hamper southern European growth for many years.

The US economy looks set to regain its dynamism, but unemployment will fall only slowly, while different economic sectors will show different recovery rates.

"Many small businesses in the US are still struggling against strong headwinds," says economist Daniel Bergvall of SEB Economic Research. "And President Obama's plan to double US exports within five years would require a 30 per cent weakening of the dollar, which we don't believe will happen. The household savings ratio has risen and now seems likely to end up at 3-4 per cent, or lower than we previously expected. This is good for economic growth but leaves households in continued high debt." If we are to follow the Fed's yardstick for justifying a change in interest rate policy, then resource utilisation, inflation and inflation expectations must rise. No such trend is visible right now, according to Bergvall, who expects that the Fed will not hike its key rate until late 2010.

Economic growth is gradually returning in Estonia, Latvia and Lithuania, aided by a weak euro and lower interest rates. The domestic economy is still being squeezed by earlier belt-tightening and high unemployment. But here, too, there are signs of bottoming out, and private consumption may begin to increase late in 2010.

"Estonia is continuing on its path towards euro zone accession in 2011," says Mikael Johansson, Baltic and Eastern European analyst at SEB Economic Research. "The recession and fiscal austerity measures have reduced imbalances, and 2010 is likely to be the last year of pay cuts. We estimate that Estonia's economy will grow by 2 per cent this year and 5 per cent in 2011. The Latvian economy will continue to fall in 2010, then rebound by 4 per cent in 2011. Like Latvia, Lithuania is under pressure due to strained public finances in a situation where the government's position has been weakened, but we do not anticipate any immediate government crisis. We expect growth in Lithuania of 1 per cent this year, increasing to 4 per cent in 2011."

Key figures: International and Swedish economy

International economy. GDP, year-on-year changes, %2008200920102011
United States 0.4 -2.4 3.6 2.8
Euro zone 0.5 -4.0 1.5 1.8
Japan -1.2 -5.2 2.4 2.2
OECD 0.6 -3.5 2.5 2.4
China 9.6 8.7 10.5 9.0
Baltic countries -0.7 -15.7 0.1 4.2
The world (purchasing power parities, PPP) 3.0 -0.6 4.7 4.7
Swedish economy. Year-on-year changes, %2008200920102011
GDP, working day corrected -0.5 -4.7 2.7 2.7
GDP, actual -0.2 -4.9 3.0 2.7
Unemployment, % (EU definition) 6.2 8.3 8.9 8.8
Consumer Price Index (CPI) inflation 3.4 -0.3 1.2 1.9
Government net lending (% of GDP) 2.5 -0.8 -1.0 -0.6
Repo rate (December) 2.00 0.25 1.25 2.75
Exchange rate, EUR/SEK (December) 10.92 10.24 9.00 8.90


Watch the film clip at SEB Newsroom where Håkan Frisén talks about Nordic Outlook. Full Report to be picked up at: www.sebgroup.com, and SEB Newsroom.

SEB is a North European financial group serving some 400,000 corporate customers and institutions and five million private individuals. SEB offers universal banking services in Sweden, Germany and the Baltic countries - Estonia, Latvia and Lithuania. It also has local presence in the other Nordic countries, Ukraine and Russia and a global presence through its international network in major financial centres. On 31 March 2010, the Group's total assets amounted to SEK 2,285bn (~EUR 236bn) while its assets under management totalled SEK 1,382bn (~EUR 143bn). The Group has about 19,000 employees. Read more about SEB at www.sebgroup.com.

For further information, please contact:
Robert Bergqvist, +46 70 445 1404
Daniel Bergvall, +46 8 763 8594
Håkan Frisén, +46 70 763 8067
Olle Holmgren, +46 8 763 8079
Mikael Johansson, +46 8 763 8093
Tomas Lindström, +46 8 763 8028
Elisabeth Lennhede, Press & PR, +46 70 763 9916, elisabeth.lennhede@seb.se