SEB's Nordic Outlook: New playing field as both inflation and growth fall

We are close to peak key interest rates but must wait until autumn at the earliest before central banks start cutting their rates, with the US Federal Reserve (Fed) being the first. The GDP of the OECD countries will see weak growth this year and a moderate recovery in 2024. In Sweden, hard-pressed households, decreased housing construction and relatively tight fiscal policy indicate that economic growth this year will be among the weakest in the European Union. We expect inflation to show a clearer downturn after this summer. The Riksbank will hike its key rate one last time to 3.75 per cent in June and begin rate cuts next spring.

“Strong performance in the real economy has helped to keep inflation high but has also made it easier for central banks to hike their key interest rates quickly without worrying about rising unemployment and rapidly declining growth. But now the signs of a deceleration are becoming clearer, while inflation is finally starting to slow down. This will change the playing field,” says SEB’s Chief Economist Jens Magnusson.

The economic downturn will be mild
The United States and the euro area will enter a mild recession this year, followed by only a moderate recovery in 2024. GDP growth in the OECD countries will be 0.9 per cent in 2023 and 1.4 per cent next year, respectively, which is below trend for both years. We have revised our 2023 forecast upward by a couple of tenths compared to Nordic Outlook in January, after continued resilience around the turn of the year. Looking ahead, squeezed real incomes due to high inflation, rising interest rates and falling home prices will take their toll on households. Lower demand will push up unemployment this coming autumn, and businesses will face both high interest rates and tighter credit conditions. However, the reopening of the Chinese economy will provide long-awaited growth acceleration and strengthen global demand, which is otherwise weak. We expect global GDP to grow by 2.5 per cent in 2023 and 2.9 per cent in 2024.

Inflation will fall in 2023, but with only a sluggish decline in core inflation
In recent years, inflation has been driven higher by an almost perfect price storm: supply constraints and a boom in demand during the COVID-19 pandemic, followed by an increasingly tight energy situation. This put businesses in a situation where almost all their input costs rose and where, unlike before, it was also possible to pass on rising costs to the final consumer. Commodity, energy and freight prices have now fallen, and the upturns in producer prices are decelerating. This increases the likelihood that consumer goods prices will also decline, although this will be some way off because of long lead times. Total inflation will fall in 2023, but as rents and wages accelerate, core inflation will not reach the central banks’ 2 per cent target until well into 2024.

“Because of uncertainty about the extent of remaining price increases in the system, inflation risks will be on the upside until this summer, while long-term risks will instead be on the downside," says Daniel Bergvall, Head of Economic Forecasting at SEB.

Key rates soon peaking – Fed will begin cuts this autumn
Key interest rates are now close to their peak, but several central banks have one or more steps to go. The Fed will be first to make rate cuts, starting in November. The European Central Bank (ECB) will follow suit in 2024. Yet monetary policies will remain contractionary, with above-equilibrium interest rates. Banking sector turbulence in the US and Europe have demonstrated new dangers to financial stability. However, we believe that rapid intervention by regulatory authorities is enough to avoid a financial crisis. 

“But these developments remind us of the risks associated with dramatic changes like those we have seen in monetary policy over the past year. Monetary policy also has its impact after a time lag. There is a risk that central banks may have gone a little too far and too fast in their rate hiking cycles. The Fed and the ECB are continuing to hike their key rates, even though their internal forecasts have pointed to weak growth or even recession. This shows their strong, clear focus on bringing down inflation,” says Daniel Bergvall.

Sweden: Falling GDP, but hopes of a downturn in inflation
After a strong start to the year, we have revised our growth forecast for 2023 upward to -1.0 per cent, from -1.2 per cent in the January issue of Nordic Outlook. On the other hand, we have adjusted our 2024 GDP outlook 0.3 points lower, with Swedish growth reaching only 0.6 per cent − well below trend. Signals from the manufacturing sector are mixed, but weak order inflow indicates that we are facing a downturn. However, there is little risk that we will see as abrupt a decline as during the global financial crisis or early in the COVID-19 pandemic. Residential investments are expected to fall by a total of 30 per cent during 2023-2024. Anecdotal information, with signals of a halt to new projects, indicate downside risks for construction.

Squeezed households will cut consumption
Real wages in Sweden are expected to fall by more than 10 per cent over a two-year period, and households are also under pressure from rising mortgage rates. Consumption decreased in 2022 and is expected to fall by a total of 4 per cent: an almost unique decline. The downturn in home prices is continuing, and we are sticking to our forecast of a total decline of 20 per cent. The labour market will be important. So far, its slowdown has been milder than feared, but if the economic downturn is prolonged, the labour market risks weakening in a way that may create a negative spiral − with further declines in consumption and home prices. During 2023, fiscal policy is expected to be neutral or even slightly contractive, but later in the government’s term of office a fairly strong fiscal expansion including tax cuts and spending increases is likely.

“The spring budget was very cautious, given the weak economic outlook, but our impression is that the government is prepared to provide more stimulus when inflationary pressures ease, or if growth falters,” says Daniel Bergvall.

More signs that inflation will slow
According to short-term indicators, the risks to core inflation – CPIF (consumer price index with constant interest rates) excluding energy − are on the upside. Core inflation is likely to decelerate more clearly during the second half of 2023. The weak krona has contributed to high inflation, but prices in Sweden are mainly driven by the same forces as in the euro area. The trend of international commodity and input goods prices, as well as easing prices for more processed goods, indicate that a broader price slowdown is under way. In addition, grocery wholesalers have announced food price cuts that may contribute to an easing of food inflation earlier in Sweden than in the euro area. Slightly faster pay hikes than usual will put some upward pressure on prices during 2024, especially for services. But looking ahead, falling energy and input costs will increase the likelihood of lower inflation for services as well. Total CPIF inflation is expected to remain lower than CPIF excluding energy throughout our forecast period, mainly due to lower electricity prices.

Key interest rates are close to peaking, but the weak krona is concerning
The Riksbank will raise its policy rate by 25 basis points to 3.75 per cent in June. Our forecast of a major cooling in core inflation in August implies that this will be the last rate hike in this cycle. We then expect three rate cuts during 2024, starting in April, to a level of 3 per cent by year-end. The weak krona is a source of concern for the Riksbank. Several Executive Board members have emphasised that government bond sales by the Riksbank could help strengthen the krona by pushing up long-term yields and thus attracting foreign investors. We believe the Riksbank will expand its bond sales at the June meeting.

“Because the inflation downturn has been delayed, the Riksbank faces a difficult balancing act in a situation where the Swedish economy and labour market have shown resilience so far. Moderate collective wage agreements have greatly reduced the risks of a harmful wage-price spiral. Meanwhile falling real household incomes are increasing the risk that more rate hikes will lead to sharply falling consumption or even make households and companies unable to pay their loans. This must affect the Riksbank’s willingness and ability to keep hiking its key rate, and it is reasonable for us to assume that the key rate is now close to its peak,” says Jens Magnusson.

Key figures: International & Swedish economy (figures in brackets are from Nordic Outlook January 2023)