Economic recovery but higher risks, depressed key rates ... · Economic recovery but higher risks, depressed key rates and bond yields ... ravaged economic environment. Amid a fragile

Economic recovery but higher risks, depressed key rates and bond yields

Nordic countries well equipped for upturn

Nordic OutlookEconomic Research – August 2010

Nordic Outlook – August 2010 | 3

Contents

International overview 5

The United States 16

Japan 22

Asia 23

The euro zone 25

The United Kingdom 31

Eastern Europe 32

The Baltics 33

Sweden 35

Denmark 43

Norway 44

Finland 48

Economic data 49

Boxes

Downside risks have increased 7

Stable commodity prices 8

Basel III postponed 9

Moving towards Japanese yields? 12

An unusual recovery 19

Falling unemployment even with slow growth 28

Stress tests dispel uncertainty despite shortcomings 30

Why is Sweden doing so well? 36

Major Swedish GDP revisions 38

4 | Nordic Outlook – August 2010

This report was published on August 31, 2010.

Cut-off date for calculations and forecasts was August 27, 2010.

Robert Bergqvist Håkan FrisénChief Economist Head of Economic Research+ 46 8 506 230 16 + 46 8 763 80 67

Daniel Bergvall Mattias BruérEconomist Economist+46 8 763 85 94 + 46 8 763 85 06

Ann Enshagen Lavebrink Mikael JohanssonEditorial Assistant Economist+ 46 8 763 80 77 + 46 8 763 80 93

Andreas Johnson Tomas LindströmEconomist Economist+46 8 763 80 32 + 46 8 763 80 28

Gunilla Nyström Ingela HemmingGlobal Head of Personal Finance Research Global Head of Small Business Research+ 46 8 763 65 81 + 46 8 763 82 97

Susanne Eliasson Johanna WahlstenPersonal Finance Analyst Small Business Analyst+ 46 8 763 65 88 + 46 8 763 80 72

SEB Economic Research, K-A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Köbel, Klaus Schrüfer, SEB Frankfurt/M and Olle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwegian analysis.

Economic Research

International overview


Continued economic recovery but increased risks

� US growth below trend for the next year

� Strong recovery in Sweden and Germany

� Low inflation will allow extreme low-interest policies

� Dilemmas for Nordic central banks

� Japanese-style global long-term yields

In recent months the world economic outlook has dete-riorated, mainly due to clear signs of weakness in the American economy. Increased worries about a slowdown in the United States and Asia, combined with contin-ued uncertainty about the fiscal situation in southern Europe, have led to lower risk appetite in financial markets and sharply falling interest rates, among other things. The growth rate was unexpectedly strong in many countries during the second quarter, and the emergency response to the southern European crisis has been successful, but this has not sufficed to offset the negative news.

Inflation has continued downward, and inflation expec-tations have fallen. It is becoming increasingly clear that the risks of undesirably low inflation are the domi-nant problem for major central banks in the 32 member countries of the Organisation for Economic Cooperation and Development (OECD). This is creating room for continued record-low interest rates in the next couple of years.

We expect the US Federal Reserve (Fed) and the Euro-pean Central Bank (ECB) to maintain today’s record-low key interest rates throughout 2011 and to begin cautious rate hikes only in 2012. Due to low key rates in the foreseeable future and diminished growth and infla-tion expectations in the long term as well, government bond yields will remain at historically very low levels in the next couple of years.

There is a renewed focus on the potential for central banks to stimulate their economies by means of quanti-tative easing (QE). We expect that because of low long-term yields, central banks will be satisfied with keeping their balance sheets at current levels and thus not implement new QE programmes. The Basel Committee on Banking Supervision has presented a proposal which implies that tightening of financial regulations will be postponed, creating an economic stimulus effect that

will also reduce the need for unconventional monetary policies.

In our judgement, the deceleration signals in the Ameri-can economy will have consequences for the recovery dynamic in the coming year. Renewed weakness in both the labour and housing markets will block a traditional recovery dynamic. We have thus adjusted our forecast downward and expect GDP growth somewhat below trend in the US during late 2010 and early 2011. This will mean major economic strains, including persistent-ly high unemployment and continued financial stress.

At the global level, however, extremely loose monetary policy and continued good growth capacity in many parts of the world economy will contribute to decent growth in the next couple of years. Fast-growing Asian economies will remain an important driving force, although some deceleration is on the way. We believe that Chinese authorities, for example, have sufficient tools to ensure an economic soft landing.

In the OECD, differences in the underlying balance situation have become increasingly important. Germany and Sweden are among countries where the strength of the upturn has been surprising. A strong German econ-omy is not enough to keep up the momentum of the entire euro zone, though. There will thus be wide gaps within the currency area as the full effects of powerful austerity programmes are felt in southern Europe.

Global GDP growth Year-on-year percentage change

2009 2010 2011 2012

United States -2.6 2.6 2.2 2,9

Japan -5.2 2.5 1.5 1.5

Germany -4.7 3.3 2.1 1.8

China 8.7 10.0 9.0 8.0

United Kingdom -4.9 1.7 2.0 2.2

Euro zone -4.1 1.6 1.3 1.5

Nordic countries -4.4 2.5 2.4 2.4

Baltic countries -15.6 0.4 4.2 4.5

OECD -3.3 2.2 2.0 2.3

Emerging markets 2.4 6.8 6.0 6.4

World, PPP* -0.6 4.4 3.8 4.3

World, nominal -1.3 3.7 3.1 3.6

Source: OECD, SEB * Purchasing power parities



We are sticking to the main scenario from our economic analyses of recent years: the after-effects of the deep crisis will hamper economies for a rather long period. Debt retirement in both the private and public sectors, combined with lingering weaknesses in the financial sys-tem, will mean slower growth for some time to come. Low interest rates may ease the adjustment, but their stimulus effect will be weaker than normal in today’s ravaged economic environment.

Amid a fragile economic situation, international economic policy makers face major challenges, for example in restructuring the financial system, coordi-nating global fiscal policies and rebuilding confidence in joint European institutions. Belt-tightening in southern Europe will put the political system under severe strains there, but political authority is being questioned even in leading industrial countries. In the US, for example, President Obama’s popularity has plunged and this autumn’s congressional election may lead to further restraints on the government’s ability to make and implement decisions. In Germany, Chancellor Angela Merkel’s position has weakened and her governing coalition is going through a rough patch. In the UK, a new and inexperienced coalition government is facing painful spending cuts.

Shifting the emphasis to final demand The ongoing slowdown trend in the global economy is largely due to the fading of stimulus effects from the inventory cycle and fiscal policy measures. Inventory movements have been pivotal to the recovery in the manufacturing sector. Since most merchandise invento-ries are traded across national boundaries, this means that exports take off first.

As a percentage of GDP, current pricesUS: Non-residential fixed investments

Source: US Department of Commerce

70 75 80 85 90 95 00 05 10

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

It is thus not illogical for all parts of the world economy to begin their recovery with export-led growth. The trend in net exports, when imports are also included, is another question. Early in the crisis, the effect of international trade was to ease global imbalances. Domestic demand, and thus imports, fell sharply in countries with large domestic imbalances, such as the US. In recent months, this pattern has reversed to some extent. For example, net US exports accounted for a

large negative contribution to growth in the second quarter, among other things due to stimulus measures and a stronger US dollar.

To ensure a sustainable recovery, it will now be crucial for final demand in the form of capital spending and consumption to take over when the inventory cycle ceases to serve as an economic engine. The box entitled “Recovery at a crossroads” in the November 2009 issue of Nordic Outlook discussed this take-over. One conclu-sion was that mid-2010 would be the critical period. But the outlook is mixed.

Capital spending took off in many countries early in 2010. Growth figures are high, in part because the fixed investment level was exceptionally depressed. But there are also factors that point towards a sustained recovery.

� Non-residential fixed investment is deeply de-pressed, even in a longer time perspective. Unlike normal economic expansions, the capital spending level in the OECD countries remained rather low during the boom years 2006-07.

� Balance sheets, especially in large American corpo-rations, are much stronger than normal. This will make larger self-financing of capital investments possible, facilitating the upturn while the financial system remains relatively fragile.

� Historical associations signal that capital spending growth is more dependent on the change in capac-ity utilisation than on its actual level. This indicates that a recovery in fixed investments may begin relatively soon.

One important factor that may delay an upturn is that many small businesses are still having difficulty obtain-ing loans. The credit market is performing sub-optimally in this respect, both in the US and Europe.

Per cent of disposable incomeUS: Uniform pace of debt retirement

Household debts (LHS) Household saving (RHS)Source: Federal Reserve

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

1

2

3

4

5

6

78

9

10

11

12

60

70

80

90

100

110

120

130

140

On the consumption side, the outlook is gloomier. There is still a major need for debt retirement. New US figures point to substantially higher household saving than previously reported. The adjustment process is thus occurring faster than expected. Given new labour



market disappointments and a housing sector that again seems to be on its way down, the underlying prerequi-sites for a normal American consumption recovery are missing. In the UK, southern Europe and elsewhere, consumption is also being held back by fiscal tighten-ing. In Germany and Japan, consumers are cautious despite their strong balance sheets. In Asian emerging economies, there is an impending shift towards greater emphasis on consumption, as illustrated by accelerat-ing pay increases, but this is too lengthy a process to facilitate a decisive shift to final demand as the main economic engine.

Our overall conclusion is that, in part because of sub-dued final demand, the OECD countries will move into a slower growth phase during the second half of 2010 and the first half of 2011. This means that for several quarters, growth will again end up below trend. The output gap will thus widen. At present, however, most indications are that growth will remain well above recessionary levels.

Very strong recovery in SwedenThe Nordic economies have generally shown good resil-ience against the global crisis. In Denmark, Sweden and especially Finland, GDP indeed fell sharply during 2009, but the impact on domestic demand was rather minor and the upturn in unemployment surprisingly small. Public finances are thus in relatively good shape, and central government debts are at a low level. Combined with sizeable current account surpluses, this is creating a favourable platform for recovery. The weakening of the euro is helping to ease competitiveness problems which have hampered growth in Finland and Denmark to some extent.

In Sweden, growth has been surprisingly vigorous in re-

cent months, and we expect a 4.7 per cent upturn this year. Exports have recovered strongly after their sharp decline. Expansionary fiscal policy and strong housing market have benefited domestic demand.

In the other Nordic countries, growth will be far more moderate. The Danish economy is still being hampered by the repercussions of the housing market crash. In Finland there is good potential for an export-led manufacturing upturn similar to Germany and Swe-den. So far, the upturn has been modest, but a weaker euro will contribute to an acceleration over the next few quarters. In Norway, the economy has also been held back by an appreciating currency. A strong labour market and expansionary fiscal policy have not sufficed to get domestic demand moving. Because of the very mild downturn in 2008-09, resource utilisation is also high in Norway compared to other countries, and this will dampen long-term growth potential from the supply side.

GDP growth, Nordic and Baltic countries Year-on-year percentage change

2009 2010 2011 2012

Sweden -5.1 4.7 2.9 2.3

Norway -1.4 0.7 2.1 2.1

Denmark -4.7 1.8 1.8 2.2

Finland -7.8 2.5 2.6 2.7

Nordics -4.4 2.5 2.4 2.4

Estonia -14.1 2.0 5.0 4.0

Latvia -18.0 -1.5 4.0 5.0

Lithuania -14.8 1.0 4.0 4.5

Baltics -15.6 0.4 4.2 4.5

Source: OECD, SEB

Downside risks have increasedAs earlier, our main scenario implies a relatively slug-gish global recovery, with medium-term growth being held back by fiscal tightening, continued debt adjust-ment needs and tighter financial sector rules.

Since last spring, the risk picture has changed in some respects. The crisis-ridden countries of southern Europe continue to face major challenges, but the overall picture looks less threatening. With a credible bail-out mechanism in place and after the completion of stress tests in the European banking system, risks that southern European problems might cause a global recession have receded. The International Monetary Fund (IMF) and euro zone countries have approved a second emergency loan disbursement to Greece, another sign that the structural adaptation process has begun.

Yet the deterioration in the American economy has increased the overall risks of a global recession. We now estimate the probability of such a scenario at

around 25 per cent, compared to 15 per cent in the May issue of Nordic Outlook. Conversely, the prob-ability of upside surprises has naturally diminished. Despite signs of strength in such countries as Germany, a rapid recovery in the world economy is relatively un-likely without support from a more dynamic American economy.

Index 2000=100GDP OECD countries

New crisis wave Raprid recovery

SEB's main scenario

Source: OECD, SEB

04 05 06 07 08 09 10 11 12

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

15%

25%

SEB forecast



Baltic countries slowly on the way upThe Baltic economies have now slowly begun to re-bound from the deep declines they experienced after the credit bubble burst. The three countries’ internal devaluation policy appears likely to be successful. Their competitiveness has improved, mainly via pay cuts. Also making the situation easier is that the euro, to which their currencies are pegged, has weakened and the currencies in several important competitor countries in Eastern Europe have appreciated. Their external bal-ance has improved radically, and the deflation process is coming to an end. They have also shown political firmness in implementing major fiscal belt-tightening. Estonia will join the euro zone on January 1, 2011. This has also helped restore confidence, some of which has spread to Latvia and Lithuania. But there is a degree of lingering uncertainty about the political situation in Latvia − connected among other things to this autumn’s parliamentary election − and to some extent also in Lithuania.

Looking ahead, we expect a modest growth rate of 4-5 per cent, well below the previous trend. Continued pri-vate sector adjustment needs, combined with a less ex-pansionary credit environment, will contribute to this. It will also take time to restore confidence in Baltic investment projects among long-term foreign investors. We expect Latvia and Lithuania to have an opportunity to join the euro zone in 2014.

New labour market patternsIn recent months, the differences in labour market trends between various countries have become more pronounced. In Germany and the Nordic countries, for example, the labour market situation has begun to improve, whereas the situation in the US is plagued by new disappointments.

Index = 100 januari 2008Divergent employment trends

Sweden US Germany SpainSource: Reuters EcoWin

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr08 09 10

8990919293949596979899

100101

8990919293949596979899

100101

During the economic downturn phase, the decline in employment was substantially sharper in the US than, for example, in Germany and the Nordic countries despite a milder GDP decline. In part, this followed traditional patterns coupled to such factors as how easy it is to hire and fire employees. Especially in Germany,

Stable commodity pricesCommodity prices have followed the pattern of the global recovery. A turnaround came early in 2009 and was probably initially strengthened by China’s need to fill structural stockpiles. Since last spring, commod-ity prices have tended to level off at the same time as global manufacturing has reached a more mature phase, or somewhat ahead of this.

Index, monthly date, USDHigh commodity prices

Agriculture Industrial metals EnergySource: HWWI

00 01 02 03 04 05 06 07 08 09 10

50

100

150

200

250

300

350

400

450

500

50

100

150

200

250

300

350

400

450

500

Given our scenario of continued moderate global growth, with a slight weakening in the short term, continued price hikes are also likely to be modest. In particular, a calmer growth dynamic in fast-growing Asian economies points in this direction.

Oil prices will rise somewhat from current levels. At present, reserve oil production capacity is rela-tively large. Increases in demand next year will not be large enough to change this. Saudi Arabia’s large production reserves will give it a key influence on the future price strategy of the Organisation of Petroleum Exporting Countries (OPEC). Saudi Arabia can boost production and squeeze oil prices if it turns out that global growth is slowing too quickly. Iran and Iraq also have major potential to increase the oil supply, but in the prevailing uncertain political situation, it is hardly likely that any large production changes will be implemented. We are thus assuming that Brent oil will continue to trade in the USD 70-90/barrel interval.

Agricultural commodities will level off, but there is a risk of further upturn in the short term. Extreme weather in two key wheat-producing countries, Rus-sia and Ukraine, led to a 70-80 per cent price spike in July and August. Russia has decided to halt grain exports during the rest of 2010, aimed at ensuring domestic supplies and counteracting price increases to consumers. This will pose risks of a new wave of price increases and might spread to the maize (corn) and soya markets. But in our assessment, global wheat and other grain stockpiles are large enough to avoid price shocks. This is very different from several few years ago, when low grain stockpiles led to major price hikes that affected food prices worldwide.



employment was also sustained by special economic policy programmes.

Since employment figures have already begun to increase in a number of European countries, while remaining weak in the US, it is clear that other expla-nations for these labour market trends are needed. One pattern seems to be that in countries with milder financial imbalance problems, the labour market has rebounded faster. Because the need for restructuring measures is smaller in these countries, when demand takes off again, companies can rather easily begin rehiring.

Inflation will remain lowDiscussions of inflation have shifted emphasis in recent months. As long-term bond yields have fallen and concerns about the economy have mounted, there has been a focus on worries about undesirably low inflation. Meanwhile fears that inflation will be driven by mone-tary expansion have faded. Actual inflation figures have not been especially dramatic. Rising energy and food prices have caused some upside surprises in Consumer Price Index (CPI) inflation, while core inflation has continued to fall.

For some time, our view has been that disinflationary forces caused by large output gaps will dominate the in-flation trend. The continuous downturn in core inflation over the past year has confirmed this picture. A new IMF study also shows that the level of the output gap has historically been crucial in determining inflation pres-sure. The study provides no support either for inflation being a consequence of rapid growth in individual years (speed limit inflation) or being generated by monetary expansion, without the presence of underlying condi-tions related to factors such as capacity utilisation or wage formation.

Year-on-year percentage changeCore inflation is continuing to fall

Euro zone USSource: Eurostat, BLS, SEB

98 99 00 01 02 03 04 05 06 07 08 09 10 11 120.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

forecastSEB

Our forecast is that core inflation in the OECD countries will continue downward in the coming year. Economic growth is not strong enough to generate any significant improvement in the labour market situation. The out-put gap will not close during our forecast period. Pay increases will thus be low and unit labour costs will also be pushed down by a recovery in productivity.

Year-on-year percentage changeRate of pay increases is stabilising

Euro zone USSource: ECB, BLS

98 99 00 01 02 03 04 05 06 07 08 09

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

On the other hand, we see no major risks of a danger-ous deflationary trend either. The rate of wage and sal-ary increases has stopped falling. This will reduce the risks of a deflationary spiral of falling pay and prices. At the same time, there are reasons why the disinflation-ary forces of globalisation will lose energy compared to the previous decade. The level of wages and salaries in fast-growing emerging economies seems to be rapidly on the way up, while currency appreciation and produc-tivity growth potential will help narrow previously wide gaps in the cost situation.

Basel III postponedDuring the summer, the Basel Committee for Bank-ing Supervision approved various amendments to the proposal it submitted late in 2009 for comments by interested parties. The purpose of the reform package is to strengthen the resilience of the banking sector by tightening capital and liquidity requirements, and to thwart excessive risk-taking, diminish gearing effects and reduce pro-cyclicality.

The reform package includes definitions of capital and leverage ratios, liquidity coverage ratios, net stable funding ratios and management of counterparty risk. The details will be presented later this year, and a formal decision is expected in November.

Generally speaking, the standards have been eased, while the deadline for implementing them has been extended from December 2012 to January 2018. Our conclusion is that the Committee’s decision was influ-enced by last spring’s sovereign debt crisis, combined with the picture of a sluggish global economic recov-ery with downside risks as well as a financial system that remains weakened.

All else being equal, these amendments will have a positive impact on our economic scenario. A slower adjustment process will substantially reduce risks of poorer access to capital and higher borrowing costs, which were inherent in the original proposal. Mean-while, milder capital/credit standards − both station-ary and flexible − will mean placing greater respon-sibility on interest rate policy to maintain financial stability.



Central banks will wait until 2012Increased worries about the economy, combined with falling inflation expectations, are giving central banks strong motives for continuing their extremely low inter-est rate policies. Due to the economic slowdown in the US, deflationary forces will predominate over the next couple of years. The crisis-ridden countries of southern Europe will be strongly dependent on low interest rates for a long time in order to deal successfully with imbal-ances in competitiveness and government finances.

Asymmetric risks on the growth side will also help ensure that central banks will be very cautious. The consequences of interrupting a nascent recovery by raising interest rates too early may be relatively large in a situation where room for fiscal policy manoeuvring is sharply circumscribed in many countries and the monetary policy arsenal is also relatively exhausted. We thus anticipate that the central banks in major OECD countries will not begin hiking their key interest rates until early 2012.

Per centKey interest rates

Euro zone USSource: ECB, Fed, SEB

00 02 04 06 08 10 120

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB

A long period of extreme low interest rate policy entails certain potential risks. Asset prices may once again be pumped up to unsustainable levels. Economic players may also be given an inaccurate picture of the normal cost of capital, which may lead to inefficient capital allocation. In addition, the banking system may become too dependent on liquidity supplied by central banks, with a more poorly functioning interbank market as a consequence. The postponed launch of Basel III com-plicates the situation of the central banks, eliminating instruments for controlling credit growth and asset prices that might have eased the pressure on interest rate policy.

At present, the potential problems of low interest rate policy are relatively minor in relation to the macroeco-nomic risks of raising interest rates.

Policy dilemma in Norway and SwedenThe differences in the conditions surrounding major OECD central banks and the central banks in Norway and Sweden are becoming increasingly clear. For a long time, Norges Bank has had to deal with a situation

where differences in terms of resource utilisation, the direction of fiscal policy and the state of the credit and housing markets have pointed to a substantially higher key interest rate than that of the ECB. Having begun its rate hikes as early as October 2009, Norges Bank has gradually adopted a more cautious strategy. Due to con-cern about the strong krone and the competitiveness of Norwegian manufacturers, the bank has not wanted to open up an excessive interest rate spread over the ECB’s refi rate.

The Riksbank is now beginning to face a similar dilem-ma. Resource utilisation in Sweden is admittedly lower than in Norway, but rapid economic growth is quickly changing that situation. Unemployment has fallen rap-idly, while home prices and household borrowing have continued upward as in Norway.

Per centKey interest rates

Euro zone Norway SwedenSource: ECB, Norges Bank, Riksbank, SEB

00 02 04 06 08 10 120

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB

In some respects, the Nordic central banks are playing a pioneering role when it comes to learning from the mistakes that preceded the crisis and then applying the new guidelines that are emerging from the international monetary policy discourse. What the major countries mainly perceive as problems in the distant future is starting to be fairly urgent in the Nordic countries. Minutes of Riksbank policy-making meetings show major disagreements of principle within the Executive Board, which the bank does not try to hide either.

Our scenario is that the Riksbank will hike its key inter-est rate at each monetary policy meeting until Febru-ary 2011, when the rate will reach 1.50 per cent. After that, rate hikes will be more cautious. An international slowdown, continued low spot inflation and an ever-stronger krona may be arguments for a more cautious strategy. At year-end 2011 the repo rate will be 2.25 per cent, and at the end of 2012 it will be 3.0 per cent. Our forecast is thus lower than the Riksbank’s rate path but higher than market expectations.

Norges Banks deposit rate will remain at 2.00 per cent up until the second quarter 2011. A closing output gap and rising core inflation will thereafter lead to further gradual hikes. At the end of 2011 we see the deposit rate at 2.75 per cent and at the end of 2012 at 3.75 per cent.



Different fiscal strategiesThe acute crisis in southern Europe last spring led to a change in view about fiscal policy. The main approach in earlier recommendations from the OECD and IMF, for example, has been to focus on credible medium-term programmes, but implementation could be delayed until recovery was on firmer ground. It now became obvious that many countries lacked such room for manoeuvre. Large-scale austerity packages became necessary, especially in southern Europe. In France and Germany, however, austerity measures are rather small. As a result, the total dose of austerity in the euro zone will be no more than about 1 per cent of GDP annually in 2010-12.

Recent budget figures in a number of countries have been better than expected. In Germany the deficit can probably be reduced to less than 3 per cent of GDP as early as 2011. The government had previously aimed at achieving this level only in 2013. As for the effects of the austerity packages in southern Europe, it is too ear-ly to draw any reliable conclusions. The improvements in Greece, for example, have been sufficient to per-suade the IMF and EU institutions to approve a second disbursement of emergency loans. Most of the success in stopping the bleeding has been on the expenditure side, while attempts to improve the efficiency of tax collection have yielded smaller results so far.

Given more pessimistic economic prospects, we are not likely to see further belt-tightening in the major OECD countries during the coming year. In the UK, the new government has admittedly decided to deal with its large fiscal deficits at an early stage. In the US and Japan, however, new stimulus measures are the focus of attention, although in our judgement such measures will hardly be implemented.

Net lending Per cent of GDP 2010 2011 2012

United States -10.9 -8.2 -5.9

Japan -9.8 -9.1 -8.5

United Kingdom -11.4 -9.4 -7.6

Euro zone -6.2 -5.5 -5.0

OECD -7.8 -6.7 -5.5

Source: OECD, IMF, SEB

At the global level, we expect fiscal policy to have a weakly tightening effect in the next couple of years. This means that deficits will only shrink slowly and that government debt will continue to grow. The sharp downturn in government bond yields in major countries indicates that mistrust from financial markets will not force belt-tightening either. Not even threats of down-grading by credit rating agencies are likely to change the picture. Given continued weak economic condi-tions, high private saving and supportive central banks

many countries will to a large extent postpone fiscal adjustment needs.

Low bond yieldsThe decline in long-term bond yields has been very sharp, and yields are now exceptionally low. American 10-year government bond yield has fallen from 4.0 per cent in April to 2.60 per cent, while equivalent German bonds have now declined to an exceptionally low level of 2.25 per cent.

There have been several driving forces behind this yield trend: concerns about economic growth, falling inflation expectations and “promises” of continued low key interest rates. The search for safe investments has also benefited the fixed income market, despite large and growing government debts on both sides of the Atlantic. A very rapid increase in private savings − dur-ing the economic crisis, savings in the OECD countries have risen by about 10 per cent of GDP − has offset the increased public sector borrowing requirement and helped squeeze interest rates.

The box below discusses how asymmetric downward risks both on the growth and inflation side will probably lead to long-term uncertainty about the ability of cen-tral banks to normalise monetary policy. We expect this uncertainty to help keep long-term yields depressed, especially in the coming year. German 10-year yields will bottom out at about 2.20 per cent around year-end 2010 and remain below 2.50 per cent well into next year. Only when it begins to be apparent that central banks can actually begin interest rate hikes do we be-lieve any significant upturn will occur. Long-term yields will remain depressed, however. At the end of 2012, German 10-year government bond yields will stand at 3.20 per cent and American ones at 3.50 per cent.

Per cent10-year government bond yields

US GermanySource: Reuters EcoWin, SEB

99 00 01 02 03 04 05 06 07 08 09 10 11 12

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

SEBforecast

Cautious stock market valuationsThe stock market has recently reacted negatively to signals of an American economic slowdown. Surpris-ingly strong company earnings reports have not been enough to offset this. There are both threats and opportunities ahead. The ‘simple’ phase when the stock market was driven upward by positive surprises



Moving towards Japanese yields?The key interest rates set by central banks are at exceptionally low levels. But bond yields are also historically very low, with American 10-year Treasuries yielding 2.6 per cent and equivalent German bonds 2.2 per cent. By way of comparison, a Japanese 10-year bond is at just below 1 per cent and has fluctuated between 1 and 2 per cent for the past 13 years.

Above we discussed the forces that have pushed down long-term yields to these levels. One crucial question is how long they will last, and to what extent today’s interest rates in the Western world are abnormally low or completely normal. This can be analysed in terms of normal key interest rates and the normal steepness of the yield curve.

The level of a normal key interest rate can be based on the level of the real interest rate plus inflation expectations. A proxy for the real interest rate is long-term GDP growth. Given the need to adjust imbalances, there is reason to expect lower growth potential, which will push down the real interest rate. In the medium term, inflation pressure will remain low. Given asymmetric negative risks for both growth and inflation, uncertainty will continue as to whether central banks will actually achieve their inflation targets. Inflation expectations may thus fall below inflation targets, which will also push down the normal interest rate.

Short- and long-term interest rates in US and JapanJapanese interest rate squeeze

Japan: 10-year government yield Japan: Key interest rate US: Key interest rate US: 10-year government yield

Source: Reuters EcoWin

88 90 92 94 96 98 00 02 04 06 08 100123456789

10

0123456789

10

Given exceptionally low key interest rates during the next couple of years − Japan can serve as an example

− the average key interest rate will have been very low for a rather long time. The market’s assessment of what should be viewed de facto as a normal key interest rate will probably move downward as the period of low interest rates is extended. In addition, it is reasonable to assume that new regulatory tools for dealing with such problems as pro-cyclical forces in the financial sector will make it easier for central banks to maintain low interest rates and to instead devote monetary policy energy to price stability.

Japan’s average GDP growth since the early 1990s is 1.2 per cent. Even if we assume that growth moves higher, for example close to 2 per cent, there is still reason to believe that continued imbalances justify a lower real interest rate than 2 per cent. If we also foresee that inflation expectations may become lower, for example 1 per cent, the normal key interest rate will be pushed down further. In a medium- term per-spective, the normal key interest rate might be in the 1.5-2.5 per cent interval.

Normal long-term yield is based on the level of the normal key interest rate. The historical average for the steepness of the yield curve (10-year yield minus the key interest rate) has been about 130 basis points. This applies to most countries − the US, Germany and Japan. This differential also includes an inflation risk premium. Studies of the Fed show that the inflation risk premium is about 50 basis points. A low-inflation environment may justify lowering the risk premium. If in our example we assume that this premium is halved, the differential between the key interest rate and the low-term yield will be about 100 basis points (130 minus 25 basis points).

Based on this reasoning, long-term bond yields would be at 2.5-3.0 per cent. Arguments that the market will adjust expectations of a normal key interest rate downward are relatively strong in a medium-term five-year perspective, where the elements of similarities with the Japanese situation may be clear. What may be regarded as abnormally low interest rates, viewed in a historical perspective, may be rather normal interest rates viewed in a future perspective.

in sales and improved leading indicators is over. The next phase will be characterised by a maturing mar-ket for industrial products, with major macroeco-nomic challenges, especially in the US. Companies must now deliver good profits driven by sales growth rather than cost savings, in order for share prices to continue rising.

So far the stock exchanges in the Nordic and Baltic countries have generally performed better than ex-changes elsewhere this year. There are several rea-

sons why they may continue to do so. SEB Enskilda’s company analyses indicate a 56 per cent increase in profits this year for companies listed in the Nordic countries and 17 per cent next year. Strong growth in key Nordic markets, Germany and Asia will improve the profit outlook in the next couple of years. Low company valuations also allow room for good share price increases. Shares on the Nordic exchanges are now trading at a price-earnings ratio of 10.5 (based on expected 2012 profits) − well be-



low their historical average. Worth adding is that the ratio between share prices of listed companies and their book values is 25 per cent below its 10-year average.

Stock market indices, 2010

-30 -20 -10 0 10 20 30 40 50

Latvia (OMX)

Estonia (OMX)

Lithuania (OMX)

Iceland (OMX)

Denmark

Finland

Sweden

Germany (DAX)

USA (S&P500)

U.K. (FTSE100)

Norway

Japan (Nikkei 225)

Spain (MadSE)

The yield on listed shares in the Nordic countries during the next couple of years looks set to be at almost 4 per cent, or twice the yield on 5-year go-vernment bonds. This also illustrates the exchange’s cautious valuations. But valuation analyses are not better than the forecasts that are used in the models. The assumption is that next year, profits will have rebounded above their previous record levels in 2007/2008. The uncertain macroeconomic envi-ronment raises the question of whether this pace in improved profits will continue. If investors are to focus again on fundamental valuations, a number of basic questions about future developments must be answered.

P/E ratios in Nordic exchanges

96 98 00 02 04 06 08 10 120.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Fair valuations, more stable currenciesIn the past year, the foreign exchange market has undergone a normalisation process after major tur-bulence during the most acute phase of the financial crisis. Many currencies have again reached more neutral levels, based on long-term valuation mod-els. Today the G3 currencies (EUR, USD and JPY) are close to historical average levels in trade-weighted, inflation-adjusted terms (real effective exchange

rates). In the short term, uncertainty about the global economic recovery will dominate the for-eign exchange market, but we believe that market positioning is now more neutral than for a long time, which will restrain movements in the future. We thus see various reasons why the trend towards smaller fluctuations in the foreign exchange market will continue.

The risk aversion evident in the market over the past few months has led to heavy demand for defensive currencies like the JPY and CHF. Shrinking interest rate spreads against the US and euro zone will lead to continued upward pressure on these currencies, but the Swiss central bank has not repeated its foreign exchange market interventions of last spring, despite an ever-stronger CHF. Nor do we regard this as likely in the future. In Japan, the issue of inter-vention is heating up. Our assessment is that if the USD/JPY exchange rate approaches its historical low of just under 80 (in 1995), this will be critical in determining whether the Bank of Japan intervenes in the foreign exchange market.

Overall, our forecast implies small movements in leading currencies during the coming year. The EUR/USD exchange rate may again fall below 1.20 in the next six months, driven by continued low risk ap-petite in the world economy, then rise somewhat. In the long term we expect the EUR/USD rate to be at levels around 1.20-1.30. The US economy will admittedly remain weak and continue to show ex-ternal trade imbalances, but on the other hand the euro system is facing long-lasting uncertainties and quandaries. The yen will gain some strength against the USD in the short term but will then decline as the interest rate spread between Japan and other countries widens again in the future.

Real effective exchange rates. Index 100 = average 1980-2010EUR and USD

USD EURSource: Bank of England

1980 1985 1990 1995 2000 2005 2010

70

80

90

100

110

120

130

140

70

80

90

100

110

120

130

140

The question of further quantitative easing by cen-tral banks is a source of uncertainty in the foreign exchange market. If the Fed or Bank of England were to expand their balance sheets further, it would weaken the dollar and pound, but this is not our main scenario at present.



Commodity-producer currencies with relatively high valuations are extra sensitive to the global slow-down. Yet the trend towards appreciating currencies in emerging economies will continue, driven by such factors as the search for higher returns.

Since June, when China’s central bank resumed the appreciation of the yuan against the USD, the Chinese currency has strengthened by less than 1 per cent. Worries about speculative currency inflows have contributed to this caution. In addition, the CNY has strengthened by more than 5 per cent in the past year in trade-weighted terms as a consequence of the USD recovery. However, we expect an increase in the pace of appreciation to about 5 per cent, resulting in a USD/CNY exchange rate of 6.00 by the end of 2012. This forecast is nevertheless dependent on the movements of the USD against other curren-cies; Chinese authorities are very likely to keep close track of the yuan’s movements in terms of a trade-weighted basket. Adjustments to the imbalances in real exchange rates will also occur by means of rapid wage increases in China. The ongoing internal revaluation process will thus determine the size of nominal changes in the exchange rate.

SEB EUR/SEK model

Regression ActualSource: Reuters EcoWin, SEB

07 08 09 10

9.0

9.5

10.0

10.5

11.0

11.5

12.0

9.0

9.5

10.0

10.5

11.0

11.5

12.0

The Swedish krona and the Norwegian krone have recently demonstrated great stability. Underlying economic strength and rising key interest rates have prevented the weakening that normally occurs in troubled times. Looking ahead, we expect the two currencies to continue trending higher. By year-end 2012 the EUR/NOK exchange rate will be 7.80. In the short term, however, we see reasons for a slight weakening of the krone to 8.20 per euro at the close of 2010, among other things because Norges Bank is continuing its cautious strategy of emphasising the risks of an excessively strong currency.

The strengthening of the Swedish krona also risks being halted by international worries, as well as by increased political uncertainty related to the September 19 parliamentary election. We neverthe-less expect such effects to be very short-lived, and we are sticking to our forecast that the EUR/SEK

exchange rate will reach 9.00 at the end of 2010. After that, we foresee room for a slight further ap-preciation, with the EUR/SEK rate standing at 8.75 by late 2011.

The economic policy frameworkBoth the European Union (EU) and the Group of 20 (G20) countries are continuing their efforts to improve the stability and credibility of public finances. As a reaction to the severe fiscal crisis this past spring, the European Commission presented a proposal on June 30 for strengthening economic policy coordination. Its overall purpose is to strengthen budget discipline in the EU. The proposal includes five areas:

1. Macroeconomic surveillance (warning system: score-board) 2. Stronger fiscal frameworks 3. Greater focus on debt levels 4. Wider sanctions 5. Economic policy coordination

The final point will include the launch of a new yearly process in 2011, aimed at increased fiscal policy inte-gration. The basic idea is to enable the Commission and other EU institutions to influence national decision making in a way that does not challenge the sovereignty of national parliaments on budget policy issues: by means of collaboration in the form of problem analysis, consistency tests and recommendations.

Already under way is an equivalent Mutual Assessment Process (MAP) for the G20 countries, which will be coordinated by the IMF. MAP is a key element of the G20 countries’ efforts to find a framework that will promote sustainable and balanced economic growth at global level. The G20 meeting in Seoul on November 11-12 will provide an important opportunity to gauge the level of potential coordination and the pace of reform.

The economic crises have also fuelled an intensive international debate concerning the role of central banks. This debate is being pursued within the G20 and other forums under IMF leadership. There seems to be a consensus that price stability will remain the overall goal of monetary policy, but that financial trends and risks should be integrated into goal formulation to a greater extent.

The main responsibility for financial stability will continue to lie outside of interest rate policy. This will require new instruments with a clearer macroeconomic connection. These will mainly consist of regulations and standards for the financial sector aimed at preventing systemic crises and reducing pro-cyclical elements in lending. Concrete examples are capital requirements that are both constant and variable over time, forward-looking reserves for loan losses and liquidity ratios.

The UK has taken a major step by placing its regula-tory authority under the umbrella of the central bank. Within the Bank of England, an independent Financial



Policy Committee (FPC) is now being established along-side the existing Monetary Policy Committee (MPC). The FPC will oversee economic developments and identify macro trends that may threaten economic and financial stability, then take relevant action.

Our conclusion is that the interesting reform task in the area of economic-policy is continuing, but that its ambi-tions and pace seems to have been lowered. A fragile economic situation, but also the weakened authority of political leaders in many countries, is contributing to this.

The United States


Recovery continuing, but at a slower pace

� Faster debt retirement

� New labour and housing market slump

� Sustained upturn in capital spending

� Inflation will continue to fall

� Fed will not hike its key rate until 2012

The American economic recovery is now becoming weaker, as fiscal stimulus measures fade and the growth contribution from the inventory cycle diminishes. The improvement in the labour market has slowed in recent months, and the housing market has become shaky again now that the federal tax credit for first-time home buyers has expired. GDP rose 1.6 per cent in the second quarter on an annualised basis, a clear slowdown from 3.7 per cent in the first quarter. Sharply higher imports provided a strong negative contribution to growth and inventory build-up also slowed, compared to the first quarter. Capital spending by businesses showed strong growth, however.

Yet the low Federal Reserve key interest rate is still propping up the economy. We thus believe that the recovery will continue, but at a slower pace than esti-mated in our May forecast. GDP growth will climb 2.6 per cent in 2010 and by 2.2 per cent in 2011. 2012 GDP will grow 2.9 per cent. The risk in this growth forecast is on the downside. The slowdown has opened the way for the Fed to provide further economic stimu-lus by expanding its balance sheet and postponing key rate hikes until 2012.

Quarterly percentage change, annualisedSlower GDP growth

Source: BEA, SEB

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q309 10 11 12

-5

-4

-3

-2

-1

0

1

2

3

4

5

-5

-4

-3

-2

-1

0

1

2

3

4

5

SEB forecast

Many signs of deceleration Aside from slower GDP growth and a lukewarm labour market, various indicators have weakened in recent months. Consumer confidence has fallen and is now lower than at the beginning of 2010. The ISM purchasing managers’ index for manufacturing has fallen during the past few months, while the service sector index has lev-elled off, but both indices remain well above 50, which indicates growth. Weaker optimism is also reflected in retail sales, which recovered strongly early this year but have stagnated during the past months.

IndexSmall firms are lagging behind

ISM Manufacturing (LHS) NFIB (RHS)Source: ISM, NFIB

86 88 90 92 94 96 98 00 02 04 06 08 100

5

10

15

20

25

30

30

35

40

45

50

55

60

65

There is a persistent confidence gap between large and small businesses. While the ISM, which is dominated by large companies, continues to show a rather bright picture of the situation, the National Federation of In-dependent Business (NFIB) index of small business senti-ment is at a record low. This may partly reflect the fact that small businesses are still having difficulty obtaining loans and that depressed construction companies weigh heavily in the NFIB index.

Higher saving holds back consumptionThe latest national accounts show substantially weaker consumption and higher saving than the previously reported figures. In the second quarter, the household savings ratio was 6.1 per cent, an upward revision of several percentage points. A higher level of saving indi-cates a faster pace of adjustment in household balance sheets. In the long term this will set the stage for a sustainable recovery in consumption, but over the next couple of years we believe that the need to pay down debts will cause the savings ratio to continue upward a bit, thereby holding back consumption.


The United States

Our current assessment is that the savings ratio will gradually rise to around 8 per cent during 2011, far above the average of the past 15 years. This is also consistent with our model projections, which have sig-nalled for some time that the savings ratio will rise to a level closer to the average for the past 50 years. We thus believe that overall consumption will increase by 1.5 per cent in 2010 and 2.2 per cent in 2011, a downward revision compared to our assessment in the last Nordic Outlook.

Per cent of disposable incomeUniform pace of debt retirement

Household debts (LHS) Household saving (RHS)Source: Federal Reserve

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

1

2

3

4

5

6

78

9

10

11

12

60

70

80

90

100

110

120

130

140

Housing market unsteady againDespite record-low interest rates, pushed down partly by the Fed’s mortgage bond purchases, and a subsidy in the form of a USD 8,000 federal tax credit to home buy-ers, the housing market recovery has not really taken off in earnest. In May 2010, the S&P/Case-Shiller home price index was only some 5 per cent higher than when it bottomed out one year earlier. The number of home sales and housing starts are also at historically very low levels. In July the number of housing starts was only 546,000, less than one third of the July average from 2003 to 2005. Despite the low number of homes being built, during 2010 inventory has fluctuated around eight months. In July, inventory rose to 12 months. Such a high level will help hold prices and new construction down. Because the home buyer tax credit expired at the end of April, both residential construction and the number of contracted home sales have weakened mark-edly during the past few months. Mortgage applications are at a record low. The National Association of Home Builders index of construction industry confidence has also declined.

It is difficult to foresee any immediate improvement in the housing market. We anticipate that the rapid decline in the number of sales will drive down prices during the next few months. Housing market activity will also be hampered by the slow recovery in the la-bour market, but low mortgage rates should be able to serve as a floor under the housing market. The 30-year mortgage rate has decreased from around 5 per cent in April to just below 4 per cent. Many households also

accelerated their home purchases to take advantage of the tax credit. Once this effect has faded, the number of home sales transactions will stabilise. During 2011 we thus expect slightly rising home prices.

Index 2004:1 = 100The housing market recovery decelerates

S&P Case-Shiller 20 FHFASource: OFHEO, Standard & Poor's

04 05 06 07 08 09 10

90

95

100

105

110

115

120

125

130

135

140

90

95

100

105

110

115

120

125

130

135

140

The July issue of the Fed’s Beige Book points out that the commercial real estate market remains weak. Assessments of future trends ranged from continued decline in activity to weak growth, but one bright spot is that corporate capital spending on commercial real estate appears to have stabilised.

Company capital spending a bright spotOne bright spot during the recovery this year is capital spending by businesses, which has climbed sharply in 2010. During the second quarter, the annualised in-crease was 17.6 per cent. This growth in capital spend-ing focused on machinery and software. Commercial real estate investments were stable. The sharp increase during the second quarter was partly a consequence of earlier very depressed levels. Our assessment is thus that capital spending growth will slow during the rest of the year, but in a longer perspective there are fac-tors that indicate good capital spending growth. In a historical perspective, the capital spending ratio in the business sector remains very low. Meanwhile companies are earning good profits and their balance sheets are far stronger than during any previous economic downturn.

Per centCapacity utilisation and company capital spending

Capacity utilisation (LHS) Company capital spending, annualised Q growth (RHS)

Source: BEA, Federal Reserve

70 75 80 85 90 95 00 05 10

-40

-30

-20

-10

0

10

20

30

40

67.5

70.0

72.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0


The United States

High imports weaken trade balanceDespite a sharp deterioration in public finances, in the past few years there has been a trend towards improve-ment in the US current account balance, due to sharply higher saving by both businesses and households. Recently, however, trade imbalances seem to have widened again. The improvement in the balance of trade has been replaced by rising deficits. In June the trade deficit was nearly USD 50 billion, the largest since October 2008. The much-publicised deficit with China has increased greatly in recent months and was just above USD 26 billion in June. If it does not fall during the autumn, the slow appreciation of the Chinese yuan may become a hot issue in the campaign leading up to November’s congressional elections.

Procent of GDPCurrent account and budget balance

Current account Federal budget balanceSource: BEA, US Department of the Treasury

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

Because imports rose far more rapidly than exports, foreign trade made a large negative contribution to GDP growth during the second quarter. Export growth is ex-pected to decelerate faster than import growth, which means that US economic growth seems unlikely to get any help from foreign trade in the next few quarters.

Labour market disappointmentsAfter a fairly positive trend during the spring, the labour market has now lost momentum and the most recent reports have been clearly disappointing. The recovery is moving slowly, and unemployment remains very high. From a peak of 10.1 per cent in October 2009, the jobless rate had only fallen to 9.5 per cent in July: far from the equilibrium unemployment level, which is around 5 per cent.

Total employment increased sharply during the spring, but this was primarily due to the large number of peo-ple with temporary jobs with the 2010 US Census. For example, around 410,000 people out of a total increase of 432,000 jobs in May could be explained by Census effects. Employment in the private sector is showing a substantially more subdued trend, although the number of people with jobs has now risen for seven months in a row. In the most recent three-month period, job growth has been only 50,000 people per month, far lower than the underlying increase in the labour supply. Actual unemployment has nevertheless continued to fall

slightly, because the increase in the labour force that was discernible early in 2010 was followed by a decline during the past three months.

Unemployment and private sector employment

Unemployment, per cent (LHS) Private sector employment, millions of individuals (RHS)

Source: BLS

07 08 09 10

107

108

109

110

111

112

113

114

115

116

0

1

2

3

4

5

6

7

8

9

10

Because of their weak finances, state governments can-not contribute to the labour market recovery. In July, the number of state and local government employees fell by nearly 50,000. The federal government has ap-proved a USD 26 billion aid package to ease the fiscal plight of state governments, but many of them will need to continue trimming their payrolls.

One new phenomenon during the latest American eco-nomic downturn is the scale of chronic unemployment. The share of unemployed people without a job for 27 weeks or longer is now around 45 per cent. This is the highest level recorded since such statistics began to be collected in 1948. In response to this chronic unemploy-ment, the maximum period for benefit payments has been extended.

One positive sign in the labour market is the increase in the number of hours worked during the past year. This increase indicates continued expansion in employment. Forward-looking indicators also hold out some hope of future improvements in the labour market. The employ-ment sub-index of the ISM survey clearly indicates that manufacturing employment will continue to increase. There is also job creation in the private service sector. The construction sector, however, remains depressed and its number of employees has again begun to fall in recent months. Our overall assessment is that employ-ment will continue to increase, but at a slow pace. Unemployment will continue to fall and will be just above 9 per cent at the end of 2010 and 8.5 per cent at year-end 2011.

Inflation will continue to fallThe slow labour market recovery and high unemploy-ment are holding down inflation pressure. Despite an increase in manufacturing activity, capacity utilisation remains well below normal. Unit labour costs have fall-en rapidly in recent years, and the historical association between unit labour costs and inflation is strong. Falling bank lending and the low rate of increase for M2 money


The United States

supply reinforce the picture of continued low inflation pressure.

Year-on-year percentage change

Strong connection between inflation and unit labour cost

CPI inflation Unit labour costsSource: BLS

50 55 60 65 70 75 80 85 90 95 00 05 10

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

During the last four months core inflation has been at 0.9 per cent. Such a low level has not been recorded since the 1960s. CPI inflation has fallen during 2010 and was at 1.2 per cent in July. Our forecast is that core inflation will fall a bit further, bottoming out at 0.5 per cent in mid-2011. Then core inflation will slowly climb again, ending up just above 1 per cent at the close of 2012. CPI inflation may climb somewhat in the immedi-

ate future, but we also expect it to bottom out dur-ing 2011 and then slowly rise. Altogether, we expect inflation to end up at 1.6 per cent this year and 0.8 per cent next year. In 2012, inflation will rise to 1.2 per cent.

Year-on-year percentage changeLow inflation pressure

Core inflation Headline inflationSource: US Department of Commerce, SEB

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

forecastSEB

A dilemma for the FedBecause of large US government debt, the chances of further fiscal stimulus are slim. If the recovery con-tinues to weaken, the Fed will thus be under increas-

An unusual recoveryThe National Bureau of Economic Research (NBER) is the agency that officially establishes the dates of US economic cycles. Although the agency has not yet declared that the recession is over, the general per-ception is that it ended in the summer of 2009. The recovery has thus lasted four quarters so far. On the other hand, economic developments have diverged from the “normal” cyclical pattern, which is probably the reason why the NBER is hesitant to declare that the recession is over.

Since the Second World War, annualised GDP growth has averaged 6 per cent at this point in the economic cycle, compared to 1.6 per cent during the second quarter of 2010. Looking back at more than half a century of data, two and a half years after a recession started the GDP level has averaged 8 per cent above the previous peak.

Today’s weak labour market also diverges from the historical pattern. The previous two recessions were admittedly also characterised by relatively long periods before job creation began to prevail, but the latest recession is unique in terms of its combination of depth and length. And without the support of a stronger labour market, the American economy will have a difficult time reverting to its normal recovery dynamic.

This recovery does not resemble others, due to the causes of the economic crisis. Short, shallow post-war

recessions have often been caused by excessive inven-tories and exaggerated optimism among investors. This time, the recession has instead centred on a severely wounded banking system as well as on household bal-ance sheets and debt retirement. When the dotcom (IT) bubble popped in 2001, household balance sheets experienced a shock, but an expansionary monetary policy quickly helped the housing market to soar.

Total number of employed, index=100 in the quarter preceding the beginning of the recession

An unusually sluggish recovery

Source: BLS0 5 10 15 20 25 30 35 40 45

92.5

95.0

97.5

100.0

102.5

92.5

95.0

97.5

100.0

102.51974

1981

1990

2001

Current

The NBER focuses mainly on four variables in assess-ing economic cycles: sales, employment, industrial production and income. Of these, the first two have fallen in recent months while the latter two have levelled off at slow speed. In such a situation, it is natural to be cautious in making assessments.


The United States

ing pressure to act, but the central bank has limited potential for increasing its stimulus. The federal funds rate is in the 0-0.25 per cent interval and cannot be cut further. As early as March 2009 the Fed also pledged to keep its key rate at an exceptionally low level for an “extended period”. The remaining weapon in the Fed’s arsenal is thus to expand its balance sheet by purchas-ing securities.

USD trillionThe Fed's balance sheet

Source: Federal Reserve

07 08 09 10

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

At its interest rate meeting in August, the Fed con-firmed that the US economic recovery has slowed down and outlined a new monetary policy strategy. The central bank decided that it will keep its balance sheet at the current level, instead of shrinking it over time. Its interest revenue and the principal it receives back as its existing stock of mortgage bonds matures will thus be reinvested in government securities. In itself, this decision does not signify any new stimulus, but it sends a clear signal that monetary policy has now become more dovish and that a key rate hike is very distant. The Fed has shifted from a situation where it had begun preparing for normalisation of monetary policy to one of paving the way for possible further stimulus.

If the recovery should weaken even more, the shift in Fed strategy has opened the door for further quantita-tive easing (QE), thereby pushing down market interest rates. Inflation pressure remains very low, and the risk of deflation has not disappeared, but there is reason for the Fed to hold off on QE for the time being. To begin with, interest rates are already falling due to market forces. Furthermore, inflation expectations are admittedly low, though they have not yet approached deflation levels. By purchasing government securities, the Fed also risks being criticised for monetising the US federal budget deficit. A more far-reaching ques-tion is how much stimulus effect the Fed can expect to achieve by further squeezing interest rates that are already extremely low.

Our assessment is thus that the Fed will hold off on further stimulus during the next several months but may implement such measures later this autumn if the state of the economy deteriorates substantially. Our

forecast is that the Fed’s first key interest rate hike will occur during the first quarter of 2012 and that the federal funds rate will stand at 1.25 per cent by the end of 2012.

Obama faces uphill political battlePresident Barack Obama’s public approval rating has fallen sharply. When he took office in January 2009, a Gallup poll on whether the president was doing a good job or a bad job gave him a 68-21 per cent score. Today’s polls give him 41-52. Despite the passage of historic health care and financial sector reforms, the new president has not managed to live up to people’s expectations. High unemployment and last year’s bank-ing sector bail-out have soured many voters on the Obama administration.

This decline in public confidence is so large that it is jeopardising continued Democratic control of the House of Representatives following the November 2 mid-term election. It is nothing unusual for an incumbent president’s party to lose seats in Congress, but our analysis (see chart) shows that the Democrats will only barely retain control of both houses. With a weakened president, Washington risks political paralysis until the autumn 2012 presidential election. This is occurring in a situation where both the American economy and global cooperation efforts are in great need of clear US politi-cal leadership.

Democratic control of House of Representatives in jeopardy

-60 -50 -40 -30 -20 -10

0 10

30 35 40 45 50 55 60 65 70

Democratic projected seat loss

Source: Gallup.com, SEB Number of seats gained/lost (vertical axis) Presidential approval rating, per cent (horisontal axis)

Today’s US domestic political scene is dominated by discord and by Republican attempts to stop or at least stall reforms. There is also disagreement as to whether the economy needs further stimulus, or whether belt-tightening is required. The Republicans oppose further fiscal stimulus and question the size of the positive im-pact from earlier stimulus packages. Even among Demo-crats and the general public, there are doubts about the need for further stimulus measures. The pendulum thus seems to be swinging towards support for greater austerity. Obama’s plan for another large-scale stimulus package has undergone radical cuts. The extension of unemployment benefits to 99 weeks was pushed through only with great difficulty.


The United States

Fiscal policy difficult to assessThe political situation has made it more difficult to as-sess US fiscal policy. For example, it is unclear whether the tax cuts implemented by President George W. Bush, which expire at the end of 2010, will be extended. The Republicans want to retain the tax cuts, while the administration and most Democrats only want to retain the cuts for people who earn a maximum of USD 250,000 per year. In August, the independent Congres-sional Budget Office warned that extended tax cuts for all income groups would seriously worsen the fiscal outlook, but our overall assessment of fiscal policy has not changed especially much since May. We expect federal stimulus measures to contribute 1 percentage point to 2010 growth and -0.5 points in 2011. Given our US economic forecast, the phase-out of fiscal stimulus will put the Fed under additional pressure to continue

pursuing an exceptionally accommodative policy, in-cluding zero interest rates and a possible expansion of the central bank’s balance sheet.

The budget deficit during the fiscal year 2009 ended up at just above USD 1.4 trillion, equivalent to nearly 10 per cent of GDP. The budget deficits in fiscal 2010 and 2011 will be lower than in our May forecast. The defi-cit will end up around USD 1.4 trillion this year and just below USD 1 trillion next year. In fiscal 2012 the deficit will shrink further.

Japan


Strong currency leads to policy dilemma

� Brisk exports, but strong yen an obstacle

� Continued deflation pressure

� BoJ will hike key rate only in 2012

The Japanese economy showed unexpected strength around year-end and early in 2010, but second quarter growth was a big disappointment. GDP growth was a mere 0.1 per cent, raising questions about the strength of the recovery. The GDP figure should not be over-interpreted; quarterly statistics are often erratic, and leading indicators like the Tankan Survey from the Bank of Japan (BoJ) point to continued decent growth in the near future. But there are also worrisome signs, among them that the housing and construction industry as well as retail sales seem to have lost momentum.

Exports and industrial production have bounced back after last year’s dramatic fall. Due to high growth else-where in Asia, combined with a favourable product mix in trade with the US, exports will rise by about 20 per cent this year.

Despite the weak second quarter, we foresee that consumption will continue to be sustained by govern-ment stimulus measures totalling about 7 per cent of GDP over the period 2008-2010. Private consumption will increase by nearly 2 per cent this year, the fast-est rate since 1996. We predict GDP growth of 2.5 per cent this year, the same forecast as in May.

A slight cooling in global demand, the lagging effects of yen appreciation so far this year and the phase-out of stimulus measures will lead to a deceleration late this year and in 2011. Export growth will slow to about 5 per cent in 2011, capital spending growth to about 4 per cent and consumption growth to less than 1 per cent. Overall, GDP growth will fall to 1.5 per cent in 2011 as well as 2012.

Unemployment has risen in recent months (currently 5.3 per cent), which risks blunting the consumption upturn. We expect GDP growth to be close to or just above trend during the next couple of years, which means that unemployment will move sideways.

Inflation pressure will remain very low. CPI will decline by 1.0 per cent this year and end up around zero in 2011. A lower inflation trend than in other countries is reflected in the long-term strengthening of the yen (in keeping with the theory of purchasing price parity,

PPP). The euro zone economic crisis, combined with uncertainty about the American economy, has quickly resulted in a clear appreciation of the yen. The USD/JPY exchange rate has moved from over 90 in January to just above 85 today. The yen has also strengthened against the euro: from about 130 per EUR in January 2010 to about 112 today. In spite of this, the yen is not unjustifiably expensive at present, but given our forecast that the USD/JPY will approach 80 (the yen’s highest value since 1995), official intervention in the foreign exchange market cannot be ruled out.

USD/JPY rate follows relative prices

USD/JPY, Yen per dollar (LHS) Relative prices, Japan compared to US, Jan. 2010=100 (RHS)


75 80 85 90 95 00 05 10

80

105

130

155

180

205

230

255

75

100

125

150

175

200

225

250

275

300

325

Due to the strong yen and the trend towards weaker global demand, Japanese policy makers will face new challenges. The government, also confronted by falling stock prices, will seek to have new stimulus measures outlined by late August. We expect a budget deficit equivalent to about 8 per cent of GDP this year, somewhat lower in 2011-2012. Government debt is ap-proaching 200 per cent of GDP. This difficult situation must be managed in an uncertain political landscape. The Social Democratic Party recently withdrew from the governing coalition and in June the former finance min-ister, Naoto Kan, became Japan’s fifth prime minister since 2006. The Bank of Japan will raise its key interest rate to 0.5 in 2012.

Asia


Slight deceleration in growth

� Slowdown from high level

� Balanced growth in China

� Monetary tightening needed in India

Asia’s emerging countries have shown good resilience in the face of global recession, recovering far more rapidly than the OECD countries. Good central govern-ment finances have made it possible for them to launch stimulus packages, and their export-driven economies have benefited from the global trade recovery. Howev-er, there are signs that the recovery that started during the second half of 2009 is now slowing a bit. In China, there was a welcome deceleration in economic activity during the second quarter of 2010. The latest outcomes for industrial production, exports and purchasing man-agers’ indices also indicate a slowdown in such econo-mies as Malaysia, South Korea and Taiwan. Despite this deceleration, we expect good growth in the region during both 2010 and 2011.

Year-on-year percentage changeIndustrial production

Thailand South Korea

Taiwan India


Jan May Sep Jan May Sep Jan May Sep Jan May07 08 09 10

-40

-30

-20

-10

0

10

20

30

40

50

60

-40

-30

-20

-10

0

10

20

30

40

50

60

Rapid wage increases, partly in response to an increas-ing number of strikes in various Asian countries, repre-sent a certain short-term inflationary threat. In some countries, such as India, the authorities will need to respond with continued monetary policy tightening. In a longer perspective, rising wages are a natural develop-mental step in the region that will help reduce global imbalances, both by narrowing cost differences and by shifting these economies towards a larger consumption element.

China: Slowdown but no crash landingGDP figures for the second quarter confirmed our forecast of a soft landing in China. Year-on-year growth slowed from 11.9 per cent in the first quarter to 10.3 per cent. The government’s tightening measures during the spring, including restrictions on bank lending and

regulation of home sales, seem to have had an effect. Various indicators are also showing continued decelera-tion. The purchasing managers’ index has continued to fall, in July reaching its lowest level since February 2009. Industrial production, retail sales and car sales have also decelerated. Exports have also slowed, but the rate of increase remains high; their level is nearly 40 per cent higher than in 2009.

The upturn in CPI inflation has slowed, and although core inflation has climbed in recent months it was only 2.4 per cent in June. This will probably mean that the authorities will be cautious about further tightening measures.

Year-on-year percentage changeInflation in China and India

China IndiaSource: National Bureau of Statistics of China, Ministry of Commerce and Industry, India

07 08 09 10

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

There is a continued focus on the risks of overheating in the housing market. A sharp decline in home prices would impact the real economy mainly through falling activity in the construction sector. Government-controlled Chinese banks nevertheless have sizeable reserves, and the home loan-to-value ratio is very low, providing a substantial cushion against falling home prices and reducing the risks of a broader financial crisis.

A certain slowdown in the housing market now seems to be on the way. Construction investments and the number of home sales have diminished. The rate of price increases has also cooled somewhat but remains above 10 per cent. In our assessment, the risk of a sharp decline in home prices is fairly small. Chinese authorities will try to respond to an initial price slide. Overheating is also largely a local problem. There have been major price hikes in cities like Shanghai and Shen-zhen, but in the housing market as a whole the increase is more limited. Looking a little further ahead, there is also a large underlying demand for housing.


Asia

Year-on-year percentage changeChina: Home prices

Source: National Bureau of Statistics of China

07 08 09 10

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Since China’s central bank resumed the appreciation of the yuan against the US dollar in June, the currency has strengthened very moderately: less than one per cent. Because of official concerns about speculative curren-cy inflows, appreciation is likely to continue occurring relatively slowly. A continued low-interest policy in the West will increase the risks of speculative inflows and may raise the question of introducing capital controls similar to those used in countries like Brazil. Further-more, due to the general USD upturn over the past year, China’s currency has strengthened by more than 5 per cent in trade-weighted terms, also contributing to caution in adjusting the USD/CNY exchange rate. We expect the USD/CNY rate to stand at 6.40 by mid-2011 and then continue downward to 6.00 by late 2012, but these levels will depend greatly on the performance of the USD against other currencies. The Chinese authori-ties are likely to pay close attention to the trend of the yuan in terms of a trade-weighted currency basket.

Monthly averages. Index = 100, Janaury 2005

China's effective exchange rate

Source: BIS

05 06 07 08 09 10

95

100

105

110

115

120

125

95

100

105

110

115

120

125

This increased flexibility has eased currency policy tensions with the US. In light of the yuan’s slow appreciation,and because China’s trade surplus against the US is on its way up ( in July it reached USD 28.7 billion), the issue is likely to heat up again this autumn, America’s trade deficit against China may thus influence the US stance towards Chinese currency policy.

Looking further ahead, however, other forces besides currency rates will also lead to a better trade balance. The recent increase in the number of strikes is a sign

that Chinese labour market conditions are changing. The share of younger people in the population is shrink-ing, which will eventually hamper the geographic mobil-ity in the labour force. This will help push up wages in regions where demand for labour is largest. Rising wages and disposable incomes will then help narrow cost differentials with other countries, while strength-ening domestic demand. China’s imports will thus rise.

Chinese authorities have repeatedly shown their ability to craft economic policies in such a way that growth ends up in the interval they regard as compatible with economic and social balance. This is one reason why we predict that the economy will decelerate in a controlled fashion. Our forecast is that GDP will increase by 10.0 per cent in 2010 and growth will then slow to 9.0 per cent in 2011 and 8.0 per cent in 2012.

Monetary tightening in India The Indian economy is characterised both by high growth and high inflation. In the first quarter of 2010, GDP rose by 8.6 per cent year-on-year. The upturn was mainly driven by exports and industrial production, but the rate of increase in manufacturing is decelerating from the high figures reported in late 2009 and early 2010.

Per centIndia: Inflation and key interest rate

Inflation (LHS) Key interest rate (RHS)Source: Reserve Bank of India

07 08 09 10

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

-2

0

2

4

6

8

10

12

14

The agricultural sector accounts for between 15 and 20 per cent of the overall economy. The monsoon season runs from June to September and is of key importance to agricultural production. This year’s monsoon ap-pears likely to result in a somewhat better harvest than normal. Since the 2009 season was much worse than normal, the shift in agricultural production, and the impact on GDP, will be relatively large. We expect that GDP will grow 9.0 per cent in 2010, slowing to 8.0 per cent in 2011 and 7.0 per cent in 2012.

Rising food prices have pushed up inflation. The good domestic harvest may contribute to slower price increases, but we still expect India’s central bank to express concern about the situation. Since March 2010 it has raised its key interest rate by one percentage point to 5.75 per cent. Further hikes to 6.50 per cent continuing into 2011 are expected but these hikes will not occur as frequently as they have so far. Key inter-est rate hikes help to strengthen the currency and the rupee will stand at 43.5 per USD one year from now.

The euro zone


Doing better, but increasingly divided

� Germany’s strong competitive position driving rapid growth

� Debt reduction tough on southern Europe

� Unemployment has peaked − low inflation

� ECB will not hike refi rate until 2012

The economic trend in the euro zone has been favour-able in the past few months. GDP growth was strong in the second quarter, leading indicators have continued to climb especially in Germany, while financial market worries about sovereign debt problems have eased somewhat.

The next couple of years will be characterised by big gaps within the euro zone. Germany is benefiting from very strong global competitiveness and comparatively good balances in its domestic economy. Southern European countries face continued major challenges in consolidating their central government finances and restoring their competitiveness.

Low inflation will enable the European Central Bank to keep its key rate very low to support adjustment proc-esses in southern Europe. We expect it to begin hiking the refi rate only in 2012.

Year-on-year percentage change (GDP), IFO index 2000=100IFO climbs higher

GDP, Germany (LHS) Business conditions, IFO (RHS) Expectations, IFO (RHS)

Source: Federal Statistics Office, IFO

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

75

80

85

90

95

100

105

110

115

120

-7.0

-5.0

-3.0

-1.0

1.0

3.0

5.0

Strong short-term indicatorsSecond quarter GDP figures provided upside surprises, but also illustrated increasingly obvious gaps between countries. Euro zone economic growth totalled 1.0 per cent quarter-on-quarter, and the upturn in Germany

was a full 2.2 per cent (3.7 per cent year-on-year). In France, GDP grew by 0.6 per cent and in Italy 0.4 per cent while other southern European countries lagged behind: Spanish GDP grew only 0.2 per cent, while the Greek economy shrank by 1.5 per cent.

Especially in Germany, short-term indicators also sup-port a scenario of continued strong growth. For exam-ple, order bookings in the German manufacturing sector rose by 3.2 per cent in June compared to May, and by a full 24.6 per cent year-on-year. Germany’s IFO index has continued upward at a rapid pace, and its current level indicates an upside risk to our growth forecast. The purchasing managers´ index (PMI) has also pro-vided upside surprises in most countries and is now signalling a clearer recovery. The widening gap between Germany and other parts of the euro zone is especially apparent from the OECD’s leading indicator, which has continued to climb in Germany but has turned down-ward in France and the “PIIGS” countries (Portugal, Ireland, Italy, Greece and Spain).

Composite leading indexGermany in the lead, PIIGS lagging behind

Germany France PIIGSSource: OECD

00 01 02 03 04 05 06 07 08 09 10

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

Can domestic forces take the lead?As in many other countries, exports have been the engine of the recovery. For some time, German manu-facturers have been improving their competitiveness. In the past six months they have received extra help from a weak currency. With an EUR/USD exchange rate of around 1.30, the growth stimulus in 2010 from the euro is equivalent to about 0.7 per cent of GDP. Now that the global industrial cycle is entering a more mature phase, while the American economy moves into a slowdown phase, exports will become a less important driving force. The historical association between America’s ISM


The euro zone

purchasing managers’ index and the IFO index indicates a slight deceleration in the euro zone early next year.

At present, there are mixed signals as to whether do-mestic demand can take over as a growth engine. Vari-ous indicators, among them rising capacity utilisation in manufacturing, show that we are approaching a period of stronger capital spending.

German households are an uncertainty factor a bit further ahead, despite lower unemployment and rising consumer confidence. In particular, this has been under-scored by Germany’s rather weak retail sales so far in 2010, but June sales rose by 4.7 per cent year-on-year according to revised statistics. This was stronger than expected. We anticipate that private consumption will decrease by about 0.5 per cent in Germany this year (nearly unchanged in the euro zone as a whole), speed-ing up a bit in 2011 and 2012.

Year-on-year percentage change and per centSharp increase in investments

Gross capital formation (LHS) Capacity utilisation, manufacturing (RHS)

Source: Eurostat, DG ECFIN

00 01 02 03 04 05 06 07 08 09 10

67.5

70.0

72.5

75.0

77.5

80.0

82.5

85.0

-20

-15

-10

-5

0

5

10

Euro zone growth will not bottom out until the first quarter of next year (0.2 per cent, quarter-on-quarter), two quarters after the US, then slowly recover in the course of 2011 and 2012. GDP growth will end up at 1.6 per cent this year in the euro zone as a whole − a cautious upward revision since our May forecast and well above the consensus. Growth will then remain at around 1.5 per cent in 2011 and 2012.

Year-on-year percentage changeConsumption recovers slowly

Consumer confidence (LHS) Private consumption (RHS)

Source: DG Ecfin, Eurostat, SEB

00 01 02 03 04 05 06 07 08 09 10-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

-35

-30

-25

-20

-15

-10

-5

0

5

German GDP will climb by 3.3 per cent this year, thanks to rising exports and capital spending. In the near future, the German economy will also expand relatively fast; we expect GDP to rise 2.1 per cent in 2011 and somewhat more slowly in 2012. France will grow by about 1.5 per cent a year, Italy 1-1.5 per cent. Countries with the biggest austerity programmes will continue to perform very weakly. For example, the Greek economy will shrink by about 4 per cent this year and a further 2 per cent in 2011. Spanish GDP will fall 0.5 per cent this year, then grow by some 0.5 per cent in 2011.

Percentage changeDecent growth in spite of everything

Quarter-on-quarter, annualised Year-on-year percentage change Growth indicator (Euroframe)

Source: Euroframe, Eurostat, SEB

04 05 06 07 08 09 10 11 12

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

forecastSEB

Large austerity packages During the spring and summer, various euro zone coun-tries announced fiscal austerity packages in response to the severe crisis of confidence. In the PIIGS countries, these programmes include very large doses of budget-tightening. In Greece, such cutbacks are equivalent to about 12 per cent of GDP in 2010-2012. Spain and Portugal have also pushed through major austerity pack-ages. In the core countries of the euro zone, austerity measures are far more modest. The German govern-ment plans fiscal tightening efforts totalling about EUR 80 billion until the end of 2014. This is equivalent to 3.4 per cent of GDP in all, but the annual effects will be moderate over the next couple of years. As early as January, the French government announced austerity measures amounting to EUR 11 billion (0.6 per cent of GDP), spread over several years. Further cutbacks are planned, but no formal decisions will be made before September.

The table below shows fiscal consolidation measures as a percentage of GDP. The figures for 2010 and 2011 are largely based on decisions that have already been made, while those for 2012 are largely based on esti-mates of what is reasonable. At present, these meas-ures total less than 1 per cent of euro zone GDP, and up to some 4 per cent of GDP in the PIIGS countries. Further austerity measures may follow.


The euro zone

Austerity measures announced so farPer cent of GDP 2010 2011 2012 Total

Greece 4.2 4.2 4.0 12.4

Ireland 3.7 0.0 0.0 3.7

Spain 2.3 2.3 2.0 6.6

Portugal 2.0 2.2 2.0 6.2

Italy 0.8 0.8 1.5 3.1

France 0.3 0.1 0.5 0.9

Germany 0.0 0.5 0.8 1.3

Euro zone 0.8 0.9 1.1 2.8

Source: SEB

The direct effect of these austerity programmes will be to dampen growth, especially via weaker consump-tion. But there is also a neutralising effect, since confidence in the ability of problem economies to extricate themselves from their current crisis may improve. This will benefit capital spending and con-sumption (“expansionary fiscal contraction”). A weaker euro because of the debt problem will also contribute to stronger growth.

Such indicators as data on sovereign borrowing require-ments show that the combination of austerity measures and growth recovery has already had some impact on government finances. In Germany, this is occurring mainly via increased tax revenue as the economic situation has strengthened. The federal budget deficit appears likely to drop below 3 per cent of GDP as early as 2011; last spring the government declared that its ambition was to achieve this by 2013.

Budget balance, selected countriesPer cent of GDP

2009 2010 2011 2012

Ireland -14.3 -11.7 -12.1 -10.6

Greece -13.6 -9.1 -8.6 -8.0

Spain -11.2 -9.8 -8.5 -7.0

Portugal -9.4 -8.3 -7.6 -6.1

France -7.5 -7.6 -7.1 -5.6

Belgium -6.0 -5.0 -5.0 -3.5

Italy -5.3 -5.3 -4.7 -3.2

Netherlands -5.3 -6.0 -5.0 -3.5

Austria -3.4 -4.7 -4.5 -3.0

Germany -3.3 -4.0 -3.0 -2.5

Finland -2.2 -3.5 -2.9 -2.2

Euro zone -6.3 -6.2 -5.5 -5.0

Source: European Commission, SEB

According to the European Commission, the ECB and the IMF, Greece in particular has made great progress

with its austerity package. The accumulated Greek deficit was EUR 12 billion in July, or EUR 3 billion less than the government’s own target. This means that the country will qualify for its second round of bail-out funds from the European Commission, euro zone countries and IMF. But although the pace of reform has been faster than expected during the summer, major challenges and risks remain. The market still mistrusts the ability of the PIIGS countries to tighten up their economies. This is clear from their continued high interest rate spreads against Germany. The rapid upturn in CDS spreads over the past few weeks, espe-cially for Ireland and Italy but also for the other PIIGS countries, is another sign of mistrust.

Percentage pointsYield spreads against Germany

France Greece

Ireland Italy

Portugal Spain


Oct08 09

Feb Apr Jun Aug Oct Dec10

Feb Apr Jun Aug0123456789

10

0

1

2

3

4

5

6

7

8

9

10

This mistrust may have various causes. To date, budget improvements seem to have been the result of slashing expenditures. In the long term, improving the efficien-cy of tax collection will be the most important meas-ure, and initial signals from Greece indicate certain disappointments in this regard. Angry reactions among employees and trade unions also indicate that countries face major challenges when it comes to creating con-sensus and understanding about their austerity policies. This summer, for example, Greek lorry drivers struck in protest against deregulation of the haulage trade, and public transport in both Spain and Portugal have been hard hit. So far, however, governments have responded with toughness: in Greece with emergency legislation forcing the lorry drivers back to work.

Per cent of GDPGrowing debt levels

Euro zone Germany

France Italy

Spain Ireland

Greece

Source: Eurostat, SEB

01 02 03 04 05 06 07 08 09 10 11 12

20

40

60

80

100

120

140

20

40

60

80

100

120

140

SEBforecast


The euro zone

Fundamentally, however, market mistrust is due to uncertainty as to whether the escalation of sovereign debt can be halted and whether some form of debt re-structuring is unavoidable. According to the calculations on which its bail-out programmes are based, Greek government debt will reach about 140 per cent of GDP in 2013, the highest level in the whole euro zone. Italy’s debt will end up at about 130 per cent, Portugal and Ireland just below 100 per cent and Spain just below 80 per cent.

Unemployment has peakedThe decline in German unemployment in July (20,000 fewer people without jobs) raises hopes that today’s upturn in export and industrial production will also spread to the household sector. According to national statistics, unemployment ended up at 7.6 per cent, the lowest jobless level in 20 months.

However, there are major differences in employment trends between euro zone countries. The strong Ger-man employment trend is partly due to a system of government allowances (“Kurzarbeit”) which result in a form of job-sharing. When these subsidies are phased out, there is admittedly a risk that unemployment will rebound, but the lack of large underlying imbal-ances has also benefited the German labour market. The economy can now take advantage of the upturn in international demand without needing to implement far-reaching structural changes. In various respects, Spain is the opposite of Germany. Spain faces a long period of structural adjustment, for example when it comes to cutting down the size of the construction sec-tor, reforming the labour market and streamlining the public sector.

Falling unemployment even with slow growthThe positive effect of the German government’s anti-unemployment programme can be analysed with the aid of “Okun’s Law”, which relates unemployment to GDP growth and the output gap (i.e. the difference between actual and potential GDP). According to the historical association, unemployment in the euro zone should have risen faster late in 2008 and in 2009, also remaining at a higher level in 2010-2012 (see chart). According to Okun’s Law, when the GDP gap narrows by 1 percentage point, unemployment falls by 0.5 percentage points.

Per centUnemployment has peaked

Classical Okun Unemployment NAIRUSource: Eurostat, OECD, SEB

00 01 02 03 04 05 06 07 08 09 10 11 12

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

SEBforecast

We have also analysed how the level of GDP growth compatible with constant unemployment has changed over time. One result that is evident from the table below is that this growth requirement has decreased sharply in the euro zone over the past decade. During the period 2000-2010, for example, Germany has required a GDP growth rate of only 0.8 per cent and France 1.2 per cent to keep unemployment un-changed. In Italy the figure is as low as -0.7 per cent, reflecting very special labour market mechanisms.

In Spain the level is nearly 3 per cent, among other things due to high productivity growth over the past decade. In the euro zone as a whole, GDP growth of 0.9 per cent is sufficient for unemployment to level off.

GDP growth required for unchanged unemploymentYear-on-year percentage growth

1980-10 80-90 90-00 00-10

Germany 2.5 2.6 2.6 0.8

France 2.2 3.2 2.1 1.2

Italy 1.8 0.4 2.1 -0.7

Spain 2.9 3.8 2.6 2.8

Euro zone 2.3 2.5 2.3 0.9

US 2.9 2.9 2.8 2.7

UK 2.4 3.1 1.9 2.3

Japan 2.8 4.0 3.5 1.0

Nordics 2.5 2.3 2.3 2.4

Source: IMF data, SEB estimates

In an international comparison, we can note that this required GDP growth rate in the United States, the United Kingdom and the Nordic countries has not fallen in the same way as in the euro zone and Japan. This can be explained by a higher underlying produc-tivity growth trend, as well as a more favourable trend of labour supply for demographic and other reasons.


The euro zone

Index, January 2008=100Divergent employment trends

Italy France Germany SpainSource: Deutsche Bundesbank, INE, INSEE, Istat

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr08 09 10

8990919293949596979899

100101

8990919293949596979899

100101

We expect unemployment in the euro zone as a whole, which stayed at 10 per cent in June for the fourth straight month, to peak in August and then slowly decline. Joblessness will be slightly below 10 per cent in December this year, then gradually fall to 9.0 per cent in December 2012 − a slow downturn, yet better than today’s consensus forecast of 10.1 per cent both this year and in 2011. Unemployment will continue to fall in Germany and France, level off in Italy but continue upward in Spain.

Pay squeeze in southern EuropeThe upturn in unemployment over the past few years is continuing to squeeze wages and salaries. Last year total hourly wage costs in the euro zone rose by 4 per cent, but this year and in 2011 they are unlikely to increase by more than about 1.5 per cent. The associa-tion between wages and unemployment indicates that the risks may even be on the downside.

Per centCore inflation will continue downward

Core inflation HICP inflationSource: Eurostat, SEB

01 02 03 04 05 06 07 08 09 10 11 12

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

forecastSEB

In the May issue of Nordic Outlook, we analysed the large differentials in the cost increase situation mainly between Germany and the PIIGS countries. Our conclu-sion was that the need for internal devaluations in the PIIGS countries is in the 20-30 per cent range. Some adjustments in the cost situation have now begun. Cuts in public sector pay in various countries have mainly been implemented on the basis of fiscal arguments. But in the same way as occurred in the Baltic coun-tries, for example, these measures will also lead to a

pay squeeze throughout the economy. In Germany, we discern the opposite trend. Rapidly increasing industrial production and a strong labour market have resulted in demands from IG Metall and other trade unions for higher pay increases.

Continued low inflationInflation in the euro zone, as measured by the Harmo-nised Index of Consumer Prices (HICP), rose to 1.7 per cent in July from 1.4 per cent the month before. This upturn was expected and was largely driven by tempo-rarily higher energy and food prices, which contributed about 0.7 percentage points. According to our forecast, however, the price of oil will fall towards USD 75 per barrel this autumn and winter, which means that the contribution to inflation from energy will decline. Food prices will also show a more subdued trend. HICP infla-tion will thus decelerate to 1.2 per cent by December 2010. Measured in terms of annual averages, the infla-tion rate will end up at 1.4 per cent this year, 0.8 per cent in 2011 and 1.2 per cent in 2012, in other words well below the ECB’s target.

Euro zone core inflation has been at a stable 1 per cent rate all year. As earlier, we expect underlying inflation to fall further this autumn and winter, bottoming out at 0.3 per cent in the first quarter of next year. As the output gap slowly begins to close, core inflation will cautiously climb in the course of 2011 and 2012. Meas-ured as annual averages, core inflation will end up at 0.9 per cent this year, 0.5 per cent next year and 0.9 per cent in 2012.

No ECB rate hike until 2012The ECB’s interest rate policy has been relatively simple since the central bank cut its refi rate to 1 per cent in May last year. The sharp slide in the world economy, with falling HICP and core inflation, low inflation ex-pectations and extremely restrictive credit and money supply growth, are unambiguous arguments for excep-tionally low interest rates. The ECB may also continue to provide loans on favourable terms to commercial banks in problem countries − for the time being to Greek banks. However, it cannot be ruled out that banks in other countries may also need support − and that the ECB will accept government securities as col-lateral despite poor sovereign credit ratings.

Our estimates of the optimal refi rate, using the “Taylor rule” − which can explain about 80 per cent of the vari-ation in refi rates with the help of unemployment and inflation data − indicate that the key interest rate could easily be even lower (see chart). The ECB is appar-ently making a similar assessment, since the European Overnight Index Average of interbank interest rates (EONIA) has been about 50 basis points below the refi rate since last summer.

Because of major fiscal belt-tightening and a growing mountain of debt, the countries of southern Europe are in need of exceptionally low interest rates for a long


The euro zone

period. We now expect the initial refi rate hike to be delayed until March 2012: the refi and EONIA rate will then be raised to 1.25 per cent. This hike will then be followed by another two the same year, bringing the refi rate up to 1.75 per cent in December 2012. The rate hiking cycle is roughly coniststent with what the Taylor rule recommends. In the short term, the di-lemma of divergent growth dynamics in the euro zone is not so large. German inflation pressure remains low, and the ECB also has reasons to try to get German consumers moving. In the long term, however, diver-gent growth prospects, especially between Germany and southern Europe, will lead to difficult economic and political trade-offs for the ECB.

Another difficulty is uncertainty about the global eco-nomic cycle and the sustainability of euro zone recov-ery in general. If the euro zone should suffer a double dip, in the sense that the GDP level again begins to fall

− which we estimate as having a 20 per cent probability − the game plan will change. The Taylor rule indicates that a scenario in which unemployment rises to 11 per cent and remains at that level until mid-year 2011 would have to be met by interest rate cuts of about 75 basis points.

Per centECB starts to hike in March 2012

Refi rate Taylor rule, main scenario Taylor rule, "double dip" scenario

Source: ECB, Eurostat, SEB

00 02 04 06 08 10 12

-1

0

1

2

3

4

5

-1

0

1

2

3

4

5

SEBforecast

Stress tests dispel uncertainty despite shortcomings As a result of the EU’s tests of the European banking system, which examined the financial stamina of 91 banks during 2010 and 2011, seven banks − five Span-ish, one German, one Greek − fell below the estab-lished minimum Tier 1 capital of 6 per cent. According to the hypothetical scenarios, the EU banking system would need to be capable of managing losses totalling EUR 566 billion.

Many of the 91 banks ended up close to the minimum, however. This confirms the view that there are still weaknesses in the financial system in the form of vul-nerable balance sheets, overcapacity and poor profit-ability. Euro zone banks play an especially important role in the economic recovery, since they account for some 80 per cent of the total credit supply. Meanwhile these banks have a very large need for refinancing over the next 2-3 years. Continued recapitalisation (through capital injections or earnings) is needed in order to preserve financial stability and keep borrow-ing costs down.

The tests have not escaped criticism. Their assump-tions have been described as too easy. There was no scenario in which an EU country defaults on its sover-eign debts. There was also a lack of clarity about the way German banks reported their exposure to various government securities. Of the 14 German banks that participated in the stress tests, six chose not to report details related to their holdings of government bonds and treasury bills.

The criticism is partly deserved. Nevertheless, the test fulfils a number of purposes. It took place in all coun-tries simultaneously, giving the risk picture a systemic dimension. Because it strengthened dialogue among financial institutions and regulatory authorities, it helped to increase transparency and reduce uncertain-ty. In particular, the stress tests eased the uncertainty about the status of the Spanish banking system, with all the country’s banks participating.

The United Kingdom


Emergency budget will slow economic growth

� Belt-tightening will squeeze households

� Housing market will cool off again

� Bank of England will hike rate in late 2011

Rising exports and industrial production have contrib-uted to a recovery in the battered British economy. During the second quarter of 2010, GDP grew by 1.2 per cent compared to the preceding quarter, or well above expectations. This expansion will probably slow during the second half, and over the next couple of years we foresee growth somewhat below trend. GDP will climb 1.7 per cent in 2010 and by 2.0 per cent in 2011. In 2012, GDP will increase by 2.2 per cent.

Future economic performance will be greatly affected by the emergency budget that the new coalition gov-ernment unveiled in June. This budget represents total fiscal tightening of 7-8 per cent of GDP until 2013. At least for the time being, such austerity will help the UK avoid a downgrading of its AAA credit rating. A spend-ing review will be unveiled in October, but it is already known that 80 per cent of tightening will consist of spending reductions, the remaining 20 per cent of tax increases. Cutbacks in the various departments will be around 25 per cent, but the National Health Service (NHS) has been exempted.

Tougher international regulation of financial markets (Basel III) may have a major impact on the UK’s impor-tant financial sector, but standards have been eased and in practice the implementation of Basel III has been postponed. This also postpones the risks to the British economy that poorer access to capital and higher bor-rowing costs may later imply.

Exports recovered strongly from their 2009 lows. However, looking ahead exports will be squeezed as the pound regains some of its earlier decline against the euro. Private consumption has so far held up but will show weakness because government austerity measures will restrain income growth, but if these measures are perceived as credible they may have a positive impact on consumer confidence.

The housing market now seems to be weakening, after having recovered from its nadir early in 2009. Recent transactions indicate stagnating or even falling home prices. Weak growth in disposable household income will hamper activity in the housing market ahead. We foresee that the recovery in home prices will slow dur-

ing the second half of 2010 and that prices will stagnate in 2011 and 2012.

The labour market has improved clearly since the turn of the year; in April, unemployment was 7.8 per cent. Employment increased during the first quarter. How-ever, labour market performance will be adversely affected by the expected staffing cutbacks in the public sector. The newly established Office for Budget Respon-sibility (OBR) estimates that around 600,000 people, 2 per cent of all employees, will lose their jobs. Overall, we expect unemployment to increase slightly during the coming year.

Per centHeadline and core inflation in the UK

Headline inflation Core inflationSource: ONS

07 08 09 10

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Headline inflation has fallen slightly, and core inflation declined to 2.6 per cent in July. Our forecast indicates that headline inflation will fall to 2.5 per cent by the end of 2010, resulting in 3.1 per cent inflation for the full year. This deceleration will continue during 2011 and 2012, when inflation will be 2.1 and 1.3 per cent, respectively. We expect a similar trend for core inflation. The effect of the value-added tax hike in January 2011 will be neutralised by other austerity effects. Reduced risks that inflation will again take off will enable the Bank of England to keep its key inter-est rate low and thereby continue to stimulate the economy and counteract the effects of the emergency budget. We believe the BoE will wait until the last quarter of 2011 before hiking its repo rate. In De-cember 2012 this rate will be 2.0 per cent.

We expect the pound to continue regaining some of its earlier decline against the euro. The pound is still fun-damentally undervalued, and higher UK inflation means that interest rate hikes are somewhat more imminent. We expect the EUR/GBP exchange rate to be 0.80 at year-end, then remain around the same level.

Eastern Europe


Gradual economic upturn

� Domestic demand slowly reawakening

� Improved macroeconomic balance

� Currencies once again appreciating

The economic upturn in Eastern Europe will soon broaden. In the autumn of 2009, exports and industrial production began to recover. In some places, growth has been stronger than in the West. The upturn oc-curred from a low level, however; Eastern Europe was the region hardest hit by the global credit crisis, due to its large foreign loans. The manufacturing sector is now moving into a more mature phase. Meanwhile we are seeing the first signs that household consump-tion has begun to join the recovery. Households are being sustained by stabilisation in the labour market and resumption of real wage growth. The outlook for corporate capital spending has also brightened somewhat. But we are continuing to predict a rather sluggish upturn in domestic demand. The main reasons are moderate fiscal tightening in various countries, as well as a credit situation that is only slowly thawing. Taken together, this implies decent GDP growth in the next few years, which in the most cases will reach just below potential rate.

In terms of economic fundamentals, Poland and Russia are in the best shape, except for large budget deficits.

In Poland − the only EU country with positive GDP growth last year − economic expansion will accelerate from 3.5 per cent this year to 4.5 per cent in 2012. The government’s target of trimming its budget deficit from 7.1 per cent of GDP last year to 3 per cent in 2013 − in preparation for possible euro zone accession in 2015 − appears realistic. A recently adopted four-year plan in-cludes a boost in value-added tax, a ceiling on spending increases and faster privatisations of state enterprises.

Russia’s growth accelerated during the second quarter to a year-on-year rate of 5.2 per cent. Extreme weather and fires, which have wiped out one fourth of Russia’s grain production, will hamper growth in the short term. Overall, agriculture accounts for no more than 4 per cent of GDP, but other disruptions in production will also slow expansion. We are lowering our GDP growth forecast by half a percentage point to 4.5 per cent but believe it will then rise to 5.5 per cent in 2012. The economy is benefiting from relatively high commodity prices and in 2010 continued loose fiscal policy.

Ukraine has recovered unexpectedly fast after last year’s 15 per cent GDP slide. The economy grew by 6 per cent in the first half. Steel exports and a weak currency have driven the upturn. A new loan agreement with the IMF has helped boost investor confidence but is also tied to austerity requirements and reforms. Bank lending is recovering slowly. We predict GDP growth of 4-5 per cent annually during the next couple of years.

CPI, year-on-year percentage changeDeclining inflation

Russia Ukraine PolandSource: Local statistical offices

06 07 08 09 100

5

10

15

20

25

30

35

0

5

10

15

20

25

30

35

The underlying balance situation in Eastern Europe has improved. Current account deficits are now rela-tively low in several countries; Russia, Hungary and the Baltics are showing surpluses. The large budget deficits that arose during the crisis are gradually shrinking, and this is helping to keep government debt levels relatively low. The inflation rate has fallen in recent years, in Russia to a record-low 5 per cent in July. This downturn has been driven by large resource gaps and pressure on wages. But inflation is now close to bottoming out. Poor grain harvests as well as administrative increases will boost inflation. Given our modest growth scenario, however, underlying price increases will be sedate.

Central banks can hold off on key interest rate hikes. Poland, and the Czech Republic will be the first to hike key rates in the spring of 2011. Many Eastern European currencies have weakened since May, thus tending to reverse a long-term appreciation trend. This can largely be explained by shrinking global risk appetite, but also concerns about Hungary’s loose fiscal policy. Relatively stronger growth in Eastern Europe, as well as capital flows, will lead to renewed currency appreciation this autumn. But this appreciation will not be rapid, since worries about the US economy are likely to hamper risk appetite. The forint may be under pressure again in the run-up to Hungary’s local elections this autumn.

The Baltics


Moderate growth after difficult adjustments

� Export surge − sluggish domestic upturn

� Deflation pressure will fade this year

� Greater financial stability

The three Baltic economies have once again begun to grow, sustained by strong exports. The brutal adjust-ment process following their previous severe external and internal imbalances, which led to GDP declines of around 30 per cent from peak to trough, is now ap-proaching its end. Growth will not, however, reach our previous estimate of its potential rate, about 6-7 per cent. A tighter lending environment and more cautious investment behaviour compared to the earlier boom will hold back growth. In addition, the crisis triggered new emigration trends in the labour force. We thus expect a gradual economic recovery to a growth of around 4-5 per cent over the next two years.

The European Commission’s composite business and household survey, which began rebounding in the spring of 2009, has continued upward in recent months, though at a calmer pace. Household optimism has clear-ly returned in Estonia during the past year, while still remaining at low levels in Latvia and Lithuania. One reason may be positive expectations about Estonia’s euro zone accession in 2011, but also that at an early stage the Estonian government managed to generate confidence in its fiscal policies by means of measures that prevented the budget deficit from spinning out of control.

The improvement in sentiment indicators has also be-gun to show up in GDP data. In the second quarter, Es-tonia’s GDP rose 3.5 per cent year-on-year and Lithua-nia’s by 1.3 per cent − the first positive growth rates since the fourth quarter of 2007 and the third quarter of 2008, respectively. We expect Latvia’s growth rate to turn positive no later than the fourth quarter. Outcomes have been in line with expectations: Our 2010 GDP fore-casts for Estonia (2.0 per cent) and Lithuania (1.0 per cent) are thus unchanged from the May issue of Nordic Outlook. However, for Latvia we have made an upward adjustment, from -2.8 to -1.5 per cent.

Improved competitivenessExports will remain the clearly dominant economic engine this year, although we expect the growth rate to slow due to fading positive base effects. The year-on-year rate of increase in exports, on a rolling three

month basis and in current prices, is around 30 per cent in Estonia and Latvia and nearly 40 per cent in Lithuania. Behind this upswing is greater international demand, but the Baltic countries also regained market share in 2009 (Lithuania in 2008 as well). They have im-proved their competitiveness partly due to this year’s decline in the euro, but mainly because of their internal devaluations. This is clear from real effective exchange rates; see the chart, which shows their inflation-adjust-ed exchange rate trend compared to 58 economies.

Index 100 = 2005Real effective exchange rates

Estonia Lithuania LatviaSource: BIS

00 01 02 03 04 05 06 07 08 09 10

85

90

95

100

105

110

115

120

125

130

135

85

90

95

100

105

110

115

120

125

130

135

Wages and salaries have been pushed down sharply, especially in Latvia, where the need for adjustment was also the largest. The official decline in Latvian pay levels from their peak late in 2008 has been 15 per cent so far (until the end of the first quarter), but in practice the cuts have probably been far bigger than this. Public sector salaries have been lowered by about 25 per cent. The private sector has also strengthened its competitiveness via efficiency-raising measures. There will probably be some further downward pressure on pay in yearly terms this year in all countries. After that, we expect the adjustment process to end, and we are predicting certain pay increases next year. This means, in turn, that underlying deflation pressure in consumer prices will vanish; in Estonia and Lithuania, the downturn in year-on-year HICP inflation ended last spring. However, price increases to date are largely due to administrative increases (taxes and fees) as well as higher energy costs. Inflation will resume at a moderate pace. We expect price increases to average 2-3 per cent (highest in Estonia) in 2011.

Meanwhile internal devaluations have dampened import demand and contributed to a sharp swing in current account balances. Earlier exceptionally large deficits


The Baltics

were replaced by sizeable surpluses during 2009. A shift in capital flows from foreign-owned banks also strengthened current account balances. Our assessment is that these surpluses will shrink or turn into moderate deficits in the near future as domestic demand gradu-ally strengthens.

Per cent of GDPCurrent account

Estonia Latvia LithuaniaSource: Bank of Estonia, Bank of Latvia, Bank of Lithuania

01 02 03 04 05 06 07 08 09 10

-30

-25

-20

-15

-10

-5

0

5

10

15

-30

-25

-20

-15

-10

-5

0

5

10

15

Domestic demand is still being squeezed, but there is evidence that household consumption has bottomed out. A stabilisation in the labour and housing markets has contributed to this. Looking ahead, consumption will also be sustained by rising wages and salaries. In our assessment, Estonia domestic demand will slowly begin to recover late in 2010, with a certain extra impetus for investments as the euro transition ap-proaches. In Latvia and Lithuania, domestically oriented portions of the economy will not gain momentum until early 2011.

A number of factors indicate that the recovery in do-mestic demand will be sluggish, however. GDP growth will not be strong enough to allow any significant labour market improvement; unemployment of 15-20 per cent will fall slowly in the near future. In addition, fiscal policies will remain tight in Latvia and Lithuania next year. The ongoing phase-down of private debt is also likely to continue in 2011.

Budget consolidation, but risks remainPublic sector budget consolidation has largely been completed in Estonia, while it is continuing in Latvia and Lithuania. We anticipate that Latvia will thus con-tinue to live up to the targets established by its interna-tional lenders, the IMF and the EU. We expect Latvia’s budget deficit to be somewhat below 8.5 per cent of GDP this year and 6 per cent in 2011. Lithuania’s budget deficit will shrink to 8 and 5 per cent, respectively. Public sector debt will stop growing during 2011-2012. Its levels are moderate: around 40 per cent of GDP in Lithuania and 60 per cent in Latvia. Estonia’s public sector debt is well below 10 per cent.

Certain political risks remain in Latvia and Lithuania. These countries have been led by minority governments since last spring, which could make it more difficult to push through the remaining austerity measures that

will be needed. The October parliamentary election in Latvia represents a further source of uncertainty, but in our assessment there is sufficient parliamentary support to allow the implementation of the main features of the country’s economic policy, although some proposals may be eliminated or adjusted. Because an economic recovery is on the way, political risks are generally also diminishing.

A brighter economic outlook, determined fiscal con-solidation policies and effective internal devaluation policies have helped the Baltic countries regain the confidence of financial markets. During the spring and summer, Estonia received the green light to join the euro zone in 2011. This has also contributed to greater market stability in Latvia and Lithuania. In addition, Latvia’s discussions with its creditors, the IMF and the EU, have become far less dramatic. Since February-March, the Latvian government has signalled the need to use international loans has decreased substantially.

Per centThree-month interbank rates

Estonia: TALIBOR Latvia: RIGIBOR

Lithuania: VILIBOR Euro zone: EURIBOR


Jan07

May Sep Jan08

May Sep Jan09

May Sep Jan10

May Sep0

5

10

15

20

25

30

0

5

10

15

20

25

30

In this environment, interbank rates have fallen sharply since late 2009; during the summer, three-month rates were less than one percentage point above the equiva-lent euro rates (in Latvia the margin was only 40 basis points). Fundamentally, this is an indication of greater market confidence that Latvia and Lithuania’s fixed currency pegs against the euro will also survive; this has been our main scenario all along.

As expected, in July the EU formally approved Esto-nia’s transition to the euro on January 1, 2011 without any exchange rate adjustment. Our main scenario is that Latvia and Lithuania will also become euro zone members in 2014. This is also the official target of the Latvian government and the ambition of the Lithuanian government. The budget deficit will be the trickiest of the five Maastricht criteria to fulfil. In order to adhere to this timetable, the deficit must be brought down to 3 per cent of GDP by 2012, which may prove quite tough.

Sweden


Very fast recovery

� Highest 2010 growth in the West

� Unemployment will fall rapidly this autumn

� Inflation will remain low

� Front-loaded key interest rate hikes by the Riksbank

� Expansionary fiscal policy in 2011

The Swedish economy is now growing considerably faster than comparable countries. Second quarter GDP was stronger than expected and the outlook for the rest of 2010 appears favourable. This is why we have raised our GDP forecast for 2010 and expect growth of 4.7 per cent (calendar adjusted: 4.4 per cent). Looking ahead, however, world economic deceleration will also result in slower Swedish growth. Due to high household savings and continued expansionary fiscal policy, GDP growth will remain higher than in other countries, though. We expect 2.9 per cent growth in 2011 and 2.3 per cent in 2012.

Strong recovery for GDP 2010

Quarter-on-quarter percentage change Year-on-year percentage change

Source: Statistics Sweden, SEB

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q307 08 09 10 11 12

-7-6-5-4-3-2-10123456

-7-6-5-4-3-2-10123456

forecastSEB

Reflecting this strong GDP growth, unemployment has declined in recent months. When growth slows, the labour market improvement will also enter a calmer phase, but the jobless rate will continue downward throughout our forecast period. At the end of 2012, we expect unemployment of just above 7 per cent. This is about one percentage point above the low of the pre-ceding boom period and is very close to our estimate of equilibrium unemployment.

Other statistics also indicate that total resource utilisa-tion has rebounded from crisis levels and is now at about the same level as during the mild downturn of 2001. A stronger krona, low collective pay agreements and a recovery in productivity nevertheless indicate that inflation will be low throughout our forecast pe-riod.

The situation of the Riksbank has changed to some ex-tent in recent months. The recovery is occurring faster than expected. Meanwhile Basel III regulations have been softened and postponed. We expect the Riksbank to raise its key interest rate at every monetary policy meeting this autumn. The key rate will reach 1.5 per cent in February 2011. After that, low inflation pres-sure and slower growth will help slow the pace of these hikes. There is also a risk that the krona will be exces-sively strong as a consequence of a wider short-term interest rate spread against other countries. We expect a repo rate of 2.25 per cent at the end of 2011 and 3.00 per cent at the end of 2012.

Sweden will continue to demonstrate strong public finances, and the central government budget will be close to balance as early as 2010. This will allow room for a continued expansionary fiscal policy after the September 19 election, and both governing alternatives (the incumbent non-socialist Alliance and the Red-Green opposition) have also announced more and more election promises. Regardless of which block forms a government after the election, we expect reforms equivalent to about SEK 25 billion during 2011 (0.8 per cent of GDP), primarily in the form of lower taxes for pensioners and higher state grants to the local govern-ment sector. In 2011, economic policy will be more demand- than supply-side oriented regardless of who wins the election.

Our main forecast assumes a continued Moderate Party-led Alliance government. The results of public opinion surveys vary, but it is not unlikely that the right-wing populist Sweden Democrats, who now have no seats in Parliament, will gain a kingmaker role there. In the short term, a minority government may lead to a somewhat higher risk premium in the fixed income and foreign exchange markets. Further ahead, such a parlia-mentary situation may also lead to agreements spanning the divide between the Alliance and Red-Green blocks that would help stabilise government policies. The strong position of the existing fiscal policy framework will help ensure a stable economic policy in the short and long term.


Sweden

Broad upturn in exportsThe recovery in merchandise exports began later than in many other countries, but the upturn of the past 4-5 months has been correspondingly stronger. The year-on-year change in merchandise exports is now the highest since 1994-95. The National Institute of Eco-nomic Research’s Economic Tendency Survey indicates that exports will continue to grow strongly in the near future. The average increase between 2009 and 2010 will be around 11 per cent.

The export upturn is broadly based, with large upturns especially in the sectors that fell the most during 2009, for example the automotive industry. The recovery for the metal and mining industries has also been very strong. This year’s vigorous upturn in exports is largely driven by a reversal of the international inventory draw-down during 2009. When this process gradually

fades in the course of 2010, exports will enter a calmer phase.

Strongest merchandise exports since 1995

Year-on-year percentage change (LHS) Level (RHS)


94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

100

125

150

175

200

225

250

275

-25

-20

-15

-10

-5

0

5

10

15

20

Why is Sweden doing so well?We expect Swedish growth in 2010 to be about twice the OECD average, and no other mature industrialised country seems close to Sweden’s growth rate. One explanation for this is that the downturn in 2008 and 2009 was deeper than in most other countries; the po-tential for recovery is thus larger. These large swings are due to the major role of exports in the Swedish economy (50 per cent), but the structure of the export sector has also resulted in extra large fluctuations.

This is not the most important explanation, however; even in terms of levels, output and employment have expanded more strongly in Sweden. Over the past year, for example, Sweden has regained about half the downturn in employment, whereas the euro zone job market remains depressed.

Index 100=2007Employment

Sweden Euro zoneSource: Eurostat, Statistics Sweden

Q1 Q3 Q1 Q3 Q1 Q3 Q107 08 09 10

98.5

99.0

99.5

100.0

100.5

101.0

101.5

102.0

102.5

98.5

99.0

99.5

100.0

100.5

101.0

101.5

102.0

102.5

Various factors can explain why the slump in domes-tic demand − both consumption and capital spend-ing − was more short-lived in Sweden than in other countries. Consumption has been sustained by high initial household savings and good income growth. This is largely attributable to an expansionary fiscal policy that was made possible by robust central government

finances. Another important factor is that Sweden was not hit by a housing market crisis, with large price de-clines, as was the case in a number of other countries. This preserved the strong wealth position of Swedish households, while the downturn in the residential sec-tor was milder. The housing market was stable partly because cuts in key interest rates had a larger impact on mortgage loan rates, but also because of the low level of residential construction for many years. A con-tinued rise in home prices has led to a strong wealth position, which in turn has helped stimulate consump-tion.

Short-term, per centMortgage lending rates

US, Freddie Mac 1 year United Kingdom, standard variable rate Sweden, 3-month


05 06 07 08 09 10

1

2

3

4

5

6

7

8

1

2

3

4

5

6

7

8

As a whole, the Swedish economy is thus characterised by rapid, broad growth in demand and has managed to avoid major structural crises in specific economic sectors. But at the same time, many of the factors behind this favourable trend may also be interpreted as potential future risks. The section below on consumption discusses the risks that rapid credit expansion and large home price increases may lead to problems ahead. The section on exports analyses the large international dependence of the Swedish economy.


Sweden

Gross fixed investments Percentage change, 2009 level in current prices (SEK bn)

2009 2009 2010 2011 2012

Government sector 103 7 2 -1 -1

Housing 91 -23 17 12 8

Business sector 362 -19 6 5 5

Total 555 -16 7 5 4


Room for higher consumptionPrivate consumption will be sustained by income growth averaging more than 2 per cent annually in 2010-12. Because of low inflation, real hourly wages are rising in spite of record-low nominal pay increases. Combined with rising employment, this will lead to a solid upturn in total real wages and salaries. In addition, Sweden’s expansionary fiscal policy will boost income growth by nearly one percentage point annually during 2010-2012.

Household income and consumptionYear-on-year percentage change

2009 2010 2011 2012

Consumption -0.8 2.9 2.6 2.2

Income 0.9 1.8 2.9 2.2

Savings ratio 12.6 11.6 11.8 11.8


During the economic crisis, Sweden’s household savings ratio reached record-high levels. A gradual decline in unemployment and a strong wealth position, with home prices at record levels, mean that households could now reduce their saving. We thus expect the savings ratio to fall by one percentage point this year. In 2011 and 2012, our forecast is that consumption will largely follow the trend of income, but the uncertainty risks in our consumption forecast is on the upside.

Index 2000 = 100Home prices

United Kingdom Norway US

Denmark Spain Germany

Sweden


00 01 02 03 04 05 06 07 08 09 10

75

100

125

150

175

200

225

250

75

100

125

150

175

200

225

250

Despite the appreciation of the krona, the manufactur-ing sector is relatively competitive. Sweden’s export structure is also well suited to respond to the upturn in international demand that we foresee in a longer perspective. The growth rate of Swedish exports will nevertheless slow somewhat over the next couple of years as the global market for industrial goods enters a less expansive period.

GDP, year-on-year percentage changeHigh correlation with other countries

Source: Reuters Ecowin

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

USSweden

Euro zone

Correlation:Sweden - US: 0.82Sweden - Euro zone: 0.91

But if the international economic situation should deteriorate dramatically, Sweden will inevitably be af-fected. A deep downturn in international trade, driven for example by the emergence of new problems in the financial sector, would have major consequences. The historical correlation with US and euro zone growth is high. In such crisis situations, Sweden is extra vulner-able in its role as a small open economy.

Higher resource utilisation means capital spendingBecause of the steep deceleration in manufactur-ing during 2008-2009, capacity utilisation plunged to record-low levels, with a sharp fall in capital spending as a consequence. Capacity utilisation has now rapidly rebounded and is back at levels more consistent with a normal recession.

Capital spending in the business sector began climb-ing early in 2010 from very low levels. The recovery is continuing, according to the Statistics Sweden business investment survey. The upturn is relatively broad-based, with higher activity both in manufacturing and in many domestically oriented sectors. The upturn will continue during the next couple of years, but the level of capital spending in 2012 will remain lower than before the economic crisis. Residential construction in Sweden has also rebounded sharply in recent months. As a percent-age of GDP, it has been lower than in nearly all other EU countries for some time, and it is now benefiting from rising home prices.


Sweden

Imbalances are being postponedIn a longer perspective, however, there is reason for greater concern. Due to the strong transmission mecha-nism in Swedish monetary policy, household borrowing is continuing to increase far faster than income. This diverges sharply from the pattern in other countries. Home prices have rebounded after a brief slump and have thus doubled over the past ten years. In an inter-national comparison only Spain − despite the downturn of recent years − shows a larger price increase for the decade as a whole.

There are, of course, various reassuring special features in the Swedish housing market, such as high household saving, low residential construction and fewer specu-lative elements in the housing market. Yet the gap between Sweden and other countries is sizeable. The process of de-leveraging and adjustment of home prices that is now quite typical of other countries has thus not begun in Sweden.

Per cent of disposable incomeHouseholds continuing to increase their debts

Sweden: Interest rate burden after taxes (LHS) Sweden: Debts (RHS) US: Debts (RHS)

Source: Riksbank, Federal Reserve, SEB

82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

60

80

100

120

140

160

180

3

4

5

6

7

8

9

10

11

The experiences of other countries show that a build-up of debt as rapid as in Sweden usually ends rather abruptly. This is often associated with a negative spiral in which falling home prices lead to increased sav-

Major Swedish GDP revisionsIn recent months, revisions in the Swedish GDP growth forecast have been larger than in other countries. Until the end of May 2010, the consensus forecast was around 2 per cent. Then it rose to 3.5 per cent in August, and we expect the upward trend to continue in the coming months in line with our own forecast. There are similar trends in other countries whose cyclical patterns are strongly dependent on interna-tional trade and the market for manufactured goods. For example, GDP growth in Japan was revised sharply upward during the spring, but weak second quarter GDP makes a new downswing in the consensus forecast likely. As for Germany, the strong data of recent months has not yet been fully reflected by the consen-sus forecast.

Per cent according to Consensus ForecastsGDP growth 2010

US Japan

Euro zone Sweden

Germany

Source: Consensus Economics

Jan Mar May Jul Sep Nov Jan Mar May Jul09 10

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

The change in the Swedish forecast is also partly due to revisions in the national accounts. In the May is-sue of Nordic Outlook, we predicted GDP growth of 3.0 per cent in Sweden during 2010, well above the consensus forecast at that time. In the box entitled “Large gap between GDP and labour market”, we dis-

cussed in detail the discrepancy that existed between a strong labour market, rising optimism and upside surprises for public finances, on the one hand, and GDP figures that indicated falling output throughout 2009, on the other hand.

Index Q1 2008 = 100GDP bottomed in Q1 2009, revised figure show

Source: SCB

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q208 09 10

93

94

95

96

97

98

99

100

101

93

94

95

96

97

98

99

100

101

Aug 2010

Feb 2010

When second quarter figures were published, this picture changed. The new data indicate that GDP bottomed out in the first quarter of 2009. This was far more consistent with other economic information. Technically speaking, this greatly changed the basis for the full-year 2010 forecast. In our box in May, we implicitly assumed that such a revision would be unavoidable, but we could naturally not draw the full consequences of this revision. The major adjustments in Swedish GDP forecasts for 2010 can thus be viewed as reflecting the greater dependence of a small open economy on shifts in the global economic situation, but also as showing that revisions in the statistics may be more arbitrary in small countries.


Sweden

ing, declining consumption and rising unemployment. Economic policy makers in Sweden − both in fiscal and monetary policy − face the challenge of ensuring a soft landing for credit growth and home prices, which so many countries have failed to achieve.

Expansive hiring plans in the business sector

Companies intending to boost employee numbers, net index (LHS) Employment, year-on-year percentage change (RHS)

Source: NIER, Statistics Sweden, SEB

02 03 04 05 06 07 08 09 10 11 12

-4

-3

-2

-1

0

1

2

3

4

-50

-40

-30

-20

-10

0

10

20

30

SEBforecast

Falling unemploymentSeasonally adjusted unemployment has decreased rap-idly in recent months. Although official monthly figures are often volatile, especially during the summer, most signs are that unemployment will now trend downward. Short-term indicators show that the downturn may occur quite rapidly in the near future. According to the NIER Economic Tendency Survey, for example, the percentage of companies stating that they intend to hire new employees payrolls is higher than at any time during 2007, when the number of jobs expanded by

more than 2.5 per cent.

Labour market, percentage change

2009 2010 2011 2012

Employment -2.1 0.9 1.2 0.5

Labour supply 0.2 1.0 0.5 0.3

Unemployment, % 8.3 8.5 7.9 7.6

Average hours worked -0.5 0.3 -0.4 0.0

Productivity (GDP) -2.5 3.2 2.1 2.1


Index 2003 = 100Productivity and GDP/hours


03 04 05 06 07 08 09 10 11 12

97.5

100.0

102.5

105.0

107.5

110.0

112.5

115.0

117.5

97.5

100.0

102.5

105.0

107.5

110.0

112.5

115.0

117.5

15-year trend

Productivity

SEB forecast

Statistics on new job vacancies and lay-off announce-ments do not provide quite as bright a picture of developments but still indicate that the employment upturn is continuing to gain strength. Looking a bit further ahead, the recovery in GDP nevertheless points to a moderate upturn in employment. There is major potential for productivity improvements after the large declines of recent years, and this will reduce the need for new hiring.

Low pay hikes in 2010 and 2011The 2010 wage round is now largely completed. Ac-cording to estimates by the National Mediation Office, average contractual pay increases appear likely to end up at 1.9 per cent during 2010 and 1.7 per cent in 2011. These collective agreements were largely signed during a period when there were fears that unemployment would climb far above today’s levels. Now that the la-bour market is strengthening, it is reasonable to assume that total pay increases will be somewhat higher than the agreed levels. Our forecast is that pay increases will total 2.0 per cent in 2010 and 2.3 per cent in 2011. Monthly statistics (according to the National Mediation Office) confirm a clear deceleration in the rate of wage and salary increases, even after taking into account the normal downward adjustment in preliminary figures.

Year-on-year percentage changeSlower wage and salary increases

Business sector TotalSource: National Mediation Office

01 02 03 04 05 06 07 08 09 10

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

The new collective agreements expire at the end of 2011 or early in 2012. In the next wage round, trade unions will probably try to compensate for having concluded agreements in 2010 under the influence of an excessively pessimistic picture of the economic situation and the labour market. Yet we believe that the strong support enjoyed by the Riksbank’s inflation target, along with the fact that real wages rose in 2010 and 2011 despite low nominal increases, will help keep wage formation problems from becoming too large. We thus estimate that pay increases will accelerate to about 3.5 per cent during 2012, consistent with the average in recent decades.

Core inflation to keep fallingThere are several reasons for believing that inflation will be low in the next couple of years. The krona has appreciated greatly, following its sharp decline dur-


Sweden

ing 2008-09. Prices of imported goods in Sweden rose sharply in 2009 − unlike the euro zone, for example. Now that the krona is strengthening, much of the price upturn is likely to be reversed. This effect will help ease inflation pressure during the coming year.

Year-on-year percentage changeLow inflation

CPIF CPIF excl energy and food CPISource: Statistics Sweden, SEB

08 09 10 11 12

-2

-1

0

1

2

3

4

5

-2

-1

0

1

2

3

4

5

SEB forecast

The sharp deceleration in wage inflation, combined with a recovery in productivity, will also lead to a de-cline in unit labour cost both in 2010 and 2011. We also expect international price increases on imported goods in general to be low.

Core inflation − defined as CPIF (CPI with a fixed interest rate) excluding energy and food − fell gradu-ally from nearly 3 per cent at the end of 2009 to just above 1.5 per cent in July. We expect this downturn to continue until mid-2011, when the effects of krona ap-preciation culminate. After that there will be a gradual upturn, but CPIF will remain below the Riksbank’s 2 per cent target throughout our forecast period. CPI inflation will climb gradually to just above 2 per cent in 2011 due to the Riksbank’s key rate hikes, which will boost the interest costs for home mortgages.

Rapidly climbing resource utilisation will represent an inflationary threat in a longer perspective, but the historical pattern is that inflation gains momentum only when a period of economic expansion is about to culmi-nate. That is presumably beyond our forecast horizon.

Front-loaded key rate hikesThe Riksbank now faces an ever-clearer dilemma. Very strong Swedish GDP and labour market data imply a need for major revisions in forecasts. On the other hand, the Riksbank must weigh this against downward revisions in the international picture and increasing risks of a more significant downturn, for example in the US.

In the short term, domestic factors will predomi-nate. Based on revisions of output and labour market gaps, the Riksbank will probably continue to draw the conclusion that current interest rates are too low. In addition, home prices and lending are expected to continue climbing faster than underlying factors justify.

Regardless of the election outcome, fiscal policy is also expected to remain expansionary.

In the next few months, we expect the Riksbank to carry out the interest rate hikes it has announced, rais-ing its key rate at each monetary policy meeting until February. The repo rate will thus reach 1.5 per cent in February 2011.

Indicators for capacity utilisation

Labour shortage, share of firms (LHS) Capacity utilisation, manufacturing, per cent (RHS)

Source: NIER

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

70.0

72.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0

5

10

15

20

25

30

35

40

45

After that, we expect the rate hiking cycle to shift to a slower pace. The recovery will lose momentum and meanwhile there will be increasing focus on Sweden’s low actual inflation pressure. Continued very low key interest rates in other countries will indirectly affect the Riksbank, among other things because the krona will be appreciating. Since a large majority of Swed-ish households have adjustable mortgage rates, home prices and lending are also likely to be very sensitive to higher short-term interest rates. To some extent, the housing market will also cool as a result of the new mortgage loan ceiling. The change in funding for mort-gage institutions − a shift towards longer-term funding − will also contribute to a larger increase in short-term lending rates than will be justified by repo rate hikes. The Riksbank’s estimates of a neutral key rate may also continue to be adjusted downward. Taking all factors into account, we expect the repo rate to stand at 2.25 per cent late in 2011 and 3.0 per cent late in 2012.

Basis pointsSpread vs Germany

Repo rate spread (LHS) 10 year government yield (RHS)


99 00 01 02 03 04 05 06 07 08 09 10 11 12

-0.5

-0.3

-0.1

0.1

0.3

0.5

0.7

-1.0

-0.5

0.0

0.5

1.0

1.5


Sweden

Deficits in public sector budgets Per cent of GDP

Sweden Euro zone Germany

2007 balance 3.5 -0.7 -0.2

Change since 2007 -4.5 -5.6 -3.5

GDP, change 08/09 -5.5 -3.6 -3.7

Source: Eurostat, Statistics Sweden

We expect Sweden’s central government debt to fall to 31.7 per cent of GDP in 2012: lower than before the economic crisis. This still includes more than SEK 100 billion in onward lending by the National Debt Office, mainly in the form of a loan to the Riksbank aimed at strengthening its foreign exchange reserve. If the re-serve reverted to normal size, this would reduce central government debt by nearly 3 per cent of GDP. In our calculations, we have not taken into account the incum-bent Alliance government’s declaration that it intends to carry out divestments of state-owned companies averaging SEK 25 billion (0.8 per cent of GDP) annually. The graph below shows central government debt and the effect on central government debt of a repayment of the SEK 100 billion loan to the Riksbank and sales revenue of SEK 25 billion a year 2011 and 2012.

Per cent of GDPFalling central government debt

Forecast Forecast with privatisation and loan repayment


97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

25

30

35

40

45

50

55

60

65

70

75

25

30

35

40

45

50

55

60

65

70

75

Continued fiscal expansion Unlike most other OECD countries, Sweden will pursue an expansionary fiscal policy in 2011 as well. We expect the total dose of fiscal stimulus to be equivalent to about SEK 25 billion (0.8 per cent of GDP). The shape of this stimulus will naturally depend on the election outcome, but tax cuts for pensioners totalling SEK 5-10 billion and additional billions to the local government sector will be important elements of economic policy, regardless of the election outcome.

There is further room for reforms in the years after 2011. The government’s latest estimate is a total of SEK 30-40 for the four-year parliamentary term of office as a whole (of which SEK 10 billion in 2011), beyond what had already been announced. In our assessment, this is a cautious forecast which includes safety margins

Wider spread against GermanyThe differential between Swedish and ECB key interest rates is the most important explanatory variable behind divergences in long-term yields against Germany. We expect Sweden’s repo rate at the end of 2011 to be around 100 basis points above the ECB’s refi rate. This will be reflected in a wider differential in long-term yields, but strong Swedish government finances will keep the yield spread narrower. Overall, we anticipate that the spread will widen to 30 basis points by mid-2011, from around 0 points today. Swedish bond yields will thus climb slowly from today’s very depressed lev-els. This forecast implies that the Swedish yield curve will be very flat in the future.

Normalised krona exchange rate The krona has regained most of the ground it lost dur-ing the economic crisis years. In trade-weighted TCW terms, it is now only 3-4 per cent weaker that before the crisis broke out in 2007. The EUR/SEK exchange rate is now back in the upper part of the relatively stable 9.00-9.40 interval that prevailed during 2002-07. Economic and interest rate forecasts unambiguously indicate that the krona will continue to strength against the euro. Our forecast that the EUR/SEK rate will be 9.00 at the end of 2010 remains unchanged.

Underlying fundamentals such as labour costs and cur-rent account point towards a further strengthening of the krona in a longer perspective. These fundamentals were previously difficult to see, but given the linger-ing problems of the euro zone, we expect the krona to strengthen past the 9.00 mark, reaching an exchange rate of SEK 8.75 per euro at the end of 2011. Given our EUR/USD forecast, the krona will end up at 6.89 per dollar at the end of 2011.

The risks in our forecast of a continued apprecia-tion of the krona lie mainly in a clear deterioration in risk appetite ahead. In the short term, an uncertain parliamentary situation may also lead to a temporary weakening of the currency.

Surprising public finances Our forecast for Swedish public finances has continued to improve. This is due to brighter economic prospects, but also to unexpectedly strong tax revenue. Sweden weathered the crisis without large deficits − meanwhile managing to carry out expansionary measures aimed at easing the impact of the crisis − mainly due to its strong fiscal position at the outset. In 2007, Swedish public finances showed a surplus of 3.6 per cent of GDP, while both Germany and the euro zone as a whole posted def-icits despite several years of strong economic growth. Nor was the historical pattern of greater cyclical sensi-tivity in Swedish public finances repeated in this phase. This was mainly due to a relatively moderate downturn in the labour market as well as stable private consump-tion, which kept up value-added tax revenue.


Sweden

beyond the surplus targets that are part of the existing fiscal framework.

During the election campaign, the battle for centrist voters has escalated. As a result, the two blocks have moved closer to each other, among other things be-cause the government has made its election programme more demand-oriented and toned down its emphasis on creating incentives to join the labour market. Yet there are still important differences between the two govern-ing alternatives when it comes to economic policy. An Alliance government would continue its current policy of strengthening the driving forces behind working, by enacting further earned income deductions and social insurance reforms. If the Red-Green block takes office, it will restore earlier cuts in compensation levels in the transfer payment system. The Red-Green block has also proposed tax increases of about SEK 10 billion in the form of energy, payroll and wealth taxes. This kind of more demand-oriented and perhaps more expansionary policy will lead to a somewhat greater need for interest rate hikes.

Public finances Per cent of GDP

2009 2010 2011 2012

Revenue 52.4 51.7 50.7 50.7

Expenditures 53.4 52.1 51.2 50.3

Net lending -1.0 -0.5 -0.6 0.3

General gov’t gross debt 41.7 41.3 40.1 38.2

Central gov’t debt 37.0 34.8 33.6 31.7

Central gov’t borrowing

Requirement, SEK bn 176 12 24 -7


A new minority government?In the course of 2010 the Alliance government has grad-ually increased its support in voter opinion polls and has moved ahead of the Red-Green block. The improved Swedish economy, in clear contrast to the problems of other countries, has contributed to this improvement. The Alliance government has shown that it can steer the country through an economic crisis while sticking to the existing fiscal policy framework. This has neutral-ised such traditional Social Democratic arguments as proven leadership skills and fiscal responsibility, based on the party’s earlier decades-long tenure in govern-ment. The Social Democrats’ new formal collaboration

with the Green Party and the Left Party has probably also created greater uncertainty about the Red-Green coalition’s ability to govern.

In spite of this, the election outcome is far from decided. Public opinion surveys in August have shown a very even race, though with a lead for the Alliance. Most surveys have nevertheless shown a narrower gap between the blocks than at the same point before the 2002 and 2006 parliamentary elections. In both these elections, the gaps between the blocks narrowed in the final days of the campaign. Yet at present, the most likely election outcome is that the Alliance will win more seats than the Red-Green block.

In most surveys, the right-wing populist Sweden Demo-crats have fluctuated around the 4 per cent national minimum of voter support required to win any seats at all. The party is relatively likely to make it into Parlia-ment. An Alliance government without a majority of its own would be forced to seek support from one or more other parties on various issues. Such an election outcome might create short-term concerns and lead to an extra Swedish risk premium in the fixed income in foreign exchange markets. Looking further ahead, how-ever, it is difficult to foresee any major risks to Swed-ish economy policy. The fiscal policy framework enjoys strong support, and in the long term such a parliamen-tary situation may lead to agreements across the divide between the two main blocks, which would contribute to political stability.

Denmark


Modest growth but better balance

� The labour market is stabilising

� Large foreign trade surpluses

� Budget tightening will shrink big deficit

The Danish economy is climbing at a modest pace. First quarter GDP was 0.6 per cent higher than in the fourth quarter of 2009. This third straight quarter of growth was somewhat stronger than expected. Sentiment indicators are signalling a continued gradual recovery. Both manufacturing and service sector surveys have trended upward for more than a year. After a minor slowdown last spring, the purchasing managers’ index in manufacturing has strengthened, again climbing above the expansion level of 50. The service sector indica-tor has shown a similar pattern, while expectations at construction companies remain cautious.

Exports, inventory build-up and public sector consump-tion have initially driven the economic turnaround, but private consumption has also started to rebound this year. The upturn in domestic demand will be sluggish, however. Restraining factors are tighter fiscal policy, higher savings ambitions among households and much calmer construction and housing markets than during the overheating of 3-5 years ago. Home prices have climbed weakly for three straight quarters. We expect a continued weak upturn in prices.

DKK billion, moving three month averageBig trade surpluses are back

Current account Trade balanceSource: Reuters EcoWin

04 05 06 07 08 09 10

-3-2-10123456789

-3-2-10123456789

Positive growth surprises in Sweden and Germany, and well as currency depreciation, are providing an extra impetus for exports this year. This is the main reason why we are revising our 2010 GDP forecast to 1.8 per cent, compared to 1.5 per cent in May. The 2011 growth outlook remains at 1.8 per cent. We foresee growth of 2.2 per cent in 2012.

Because of the upswing in exports, the trade and cur-rent account balances have again shown large surpluses during the past year. These will shrink somewhat as imports gradually strengthen.

After an upturn from a very low 1.7 per cent in the summer of 2008, unemployment has levelled off at 4-4.5 per cent in the past six months. We predict a slow downturn to an average of 3.5 per cent in 2012. The jobless rate can fall at least one percentage point from today’s level without triggering a surge in pay and prices. Our pay forecast is continued slow increases of slightly above 2 per cent this year and next. The deceleration in wage pressure over the past few years, combined with this year’s weakening of the Danish krone, has strengthened competitiveness. Pay growth exceeding that of competitor countries has previously been a structural problem, but the implementation of reforms aimed at creating a more flexible labour mar-ket appears to have had a favourable impact.

The inflation rate has hovered around 2 per cent, fol-lowing a brisk upturn last winter, but core inflation has trended downward to 1 per cent. Using the broad HICP measure, we expect inflation to average less than 2 per cent in 2011 and just above 2 per cent in 2012.

The public sector budget deficit looks set to end up above 5 per cent of GDP this year. Partly because of this large deficit, late in May the government presented a three-year austerity programme totalling DKK 24 billion. This package came unexpectedly early, consid-ering that the economic upturn has just begun, but the government probably wants to avoid announcing belt-tightening close to next year’s election. The measures include lower public sector investments, deceleration of automatic indexing of pensions and other transfer payments plus cancellation of certain planned tax cuts. We foresee that these measures will help shrink the budget deficit to 3 per cent in 2012.

Given robust surpluses in Denmark’s external balance, the central bank can leave its low 5 basis point spread above the ECB’s refi rate remain unchanged into next year. However, we believe that Denmark will begin interest rate normalisation one–two quarters before the ECB, which will carry out its first rate in March in 2012. Looking ahead a year or two, the spread vs the ECB will gradually widen to 20 basis points, which has historically been more normal.

Norway


More broad-based recovery

� Mainland GDP back at previous peak level

� Unexpectedly weak H1 consumption

� Norges Bank constrained by ECB

� Weaker NOK in the near term

The recovery in the Norwegian economy has been sub-par so far, but activity accelerated towards mid-year as sequential growth in mainland GDP (excluding oil, gas and shipping) picked up from 0.2 per cent in the first quarter to 0.5 per cent in the second quarter − up 1.5 per cent from the year-earlier period. Moreover, under-lying momentum was somewhat better as a sharp drop in electricity production subtracted 0.2 points from the quarterly growth rate in mainland GDP: excluding this, growth accelerated more markedly and the level surpassed the previous peak.

Meanwhile, overall GDP inched up only 0.1 per cent on the quarter in Q2 and a sub-par 0.9 per cent year-on-year, among other things due to another drop in exports of oil and gas and a substantial drag from higher net imports of ships and oil platforms.

Year-on-year percentage changeAn uneven recovery so far

Final non-oil private domestic demand (LHS) Public demand (LHS) Exports traditional goods (RHS)

Source: Statistics Norway

99 00 01 02 03 04 05 06 07 08 09

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

The 2010 forecast for growth in mainland GDP has been nudged down to 1.6 per cent because of the slow start of the year, while 2011 should see acceleration to 2.7 per cent. The downward revision is mainly due to lacklustre private consumption. However, non-oil investment shows signs of bottoming out and is likely to add to overall growth going forward. Moreover, oil companies expect markedly higher investment in 2011. Growth in overall GDP should be a modest 0.7 per cent in 2010 but somewhat stronger at 2.1 per cent in 2011.

The consumption conundrumThe turn around mid-2009 was spurred by private consumption as households reacted to sharply lower interest rates and fiscal stimuli lifting overall public demand. However, while private consumption was up more than 4 per cent from the first to the fourth quar-ter of 2009, it declined by 0.2 per cent during the first half of 2010.

The weakening has been surprising considering that fun-damentals − real income growth, still-low interest rates and some improvement in labour markets − are rather supportive. One reason might be that the considerable boost to disposable income from Norges Bank’s deep rate cuts up until June 2009 was seen by households as a one-off.

Moreover, Norwegian households’ gross debt has risen from some 150 per cent of disposable income at the start of 2004 to slightly above 190 per cent by end-2009. Part of the reason for a higher debt-to-in-come ratio than among peers reflects structural dif-ferences (such as more saving for pensions through taxes) and high public savings. In particular, assets in the Government Pension Fund Global − formerly the national petroleum fund − have increased sharply to some 145 per cent of mainland GDP as of mid-2010.

Per cent of disposable incomeHouseholds have made correction

Household saving ratio, 4Q moving average (LHS) Household savings ratio excl share dividends, 4Q mov. av. (LHS) Household gross debt (RHS)

Source: Norges Bank, Statistics Norway

90 92 94 96 98 00 02 04 06 08 10

100

125

150

175

200

225

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Nonetheless, a period of debt consolidation might be likely, but it is uncertain whether the relative level will start falling. This has happened before: gross debt fell from 148 per cent of disposable income in 1990 to 117 per cent in 1995. During that period, average annual growth in private consumption was broadly in line with that of real disposable income. It should be noted, though, that interest expenses as a share of disposable


Norway

income at the start of that period were approximately twice as high as today. So far, available data do not indicate that households have started to reduce their debts to any large extent.

However, the household savings ratio shows a sizeable correction from slightly negative at the start of 2008 to 8.4 per cent by the final quarter of 2009. The more stable savings measure which excludes share dividends shows a similar trend and is far above its long-term average.

One more factor behind the soft patch in private con-sumption was the 50 per cent spike in electricity prices over the six months to March due to unusually cold winter weather. History shows that sharp movements in such prices, whether up or down, often have a rather immediate effect on consumption. This is not surpris-ing, as electricity makes up a sizeable part of monthly household expenses. In fact, the subsequent jump in overall inflation was instrumental for the decline in real disposable income in the first quarter of the year.

Percentage change over two quartersPrivate consumption and inflation

Private consumption (LHS) Inflation, lagged 1Q (RHS)

Source: Statistics Norway

99 00 01 02 03 04 05 06 07 08 09 10

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0-3

-2

-1

0

1

2

3

4

5

6

Signs of a broadening recoveryWe expect fundamentals to reassert themselves and private consumption to re-accelerate over the re-mainder of the year. The correction in the household savings ratio has likely ended and consumption should be somewhat stronger than growth in real disposable in-come (about 2.5 per cent this year and next). In recent months, inflation pressure has eased as well, which should help consumption to recover.

In addition, the labour market shows signs of a modest improvement, but there is a discrepancy in unemploy-ment measures. The unemployment rate according to the Labour Force Survey inched up from 3.3 per cent at end-2009 to 3.5 per cent on average in May-July. How-ever, overall registered unemployment − including those in government-financed labour market schemes − de-clined to a level well below that at the end of last year. Of the two measures, the latter has tended to be more reliable in the past. In addition, employment shows tentative signs of accelerating, rising 0.5 per cent in May-July from six months earlier.

Our forecast for private consumption growth in 2010 has been cut markedly to 2.7 per cent, but growth should accelerate to 3.3 per cent in 2011. In addition, signs of the expected broadening in domestic demand are emerging, and growth in mainland GDP should acceler-ate somewhat over the second half of 2010 and in 2011.

In particular, private non-oil investments seem to have bottomed out. Residential investments, which fell by a third between mid-2007 and end-2009, show signs of stabilising and new orders for dwellings have risen. Moreover, business investments outside manufacturing saw a very marked rebound in the second quarter. Such investments tend to be very volatile, but they were up during the first half following a slump of 25 per cent from end-2007 and until the first quarter of 2010.

Other indicators also suggest an improving outlook. Firstly, Norges Bank’s latest lending survey reported rising loan demand from businesses, and lending to the sector has turned around. Secondly, producers of invest-ment goods expect rising domestic demand according to Statistics Norway’s Business Tendency Survey, and orders for such goods increased markedly in the second quarter from the year-earlier period.

Investments in the manufacturing sector dropped 23 per cent in the year to the second quarter of 2010. Manu-facturing output was up 4.3 per cent over the same pe-riod, and capacity utilisation increased somewhat. The level remains well below its long-term average, which will put a lid on future investment, although manufac-turers reported higher planned investments in the Q2 Business Tendency Survey. This suggests a slow improve-ment. Nonetheless, other business sectors will account for all of the expected pickup in investment, averaging 4.6 per cent in 2011.

The outlook has improved for oil sector investments as well. Oil companies reported surprisingly high invest-ment plans for 2011 in the second-quarter survey − 7-8 per cent higher in nominal terms than the expected level in 2010 − and orders from the sector to domestic manufacturers have shot up. We expect investments in the oil sector to be up 5.0 per cent in 2011 following a slight decline in 2010, providing stimuli to the rest of the economy, manufacturing in particular.

Core inflation to remain benignInflation has trended markedly lower so far in 2010 with the annual rate for the core CPI-ATE measure (excluding taxes and energy) slowing more than one percentage point from last December to 1.3 per cent as of July, while overall inflation dropped from 3.4 per cent in March to 1.9 per cent. Part of the slowing in headline CPI is due to a marked turn in electricity prices fol-lowing the surge until spring. In addition, the decline in import prices has accelerated, reflecting a stronger Norwegian krone. This effect is likely to continue in the near term but will wane in due time.


Norway

Year-on-year percentage changeCore inflation at a three-year low

CPI, excluding taxes and energy Core inflation, domestic goods and services Core inflation, imported consumer goods

Source: Statistics Norway, SEB

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

-5-4-3-2-1012345

-5-4-3-2-1012345

Core domestic inflation has moderated as well to slightly above 2 per cent at present. Domestic inflation-ary pressure is likely to remain muted. Wage growth is expected to moderate from 4.5 per cent in 2009 to 3.5 per cent in 2010. Productivity has staged a recovery, resulting in markedly slower growth in unit labour costs compared with the rather strong rise seen previously. Overall, we now see a slightly more benign outlook with core inflation only marginally higher by early next year, averaging 1.9 per cent in 2011 and close to Norges Bank’s 2.5 per cent medium-term target late in 2012.

Even slower interest rate hikesNorges Bank’s monetary policy meeting in August con-firmed the dovish impression left from June’s Monetary Policy Report, in which the bank once again cut its optimal rate path quite markedly: the rate path shows a 50/50 chance for a hike in the 2.00 per cent deposit rate before end-2010, while the report lowered the level in the final quarter of 2011 by almost 60 basis points to 2.74 per cent on average.

Norges Bank's rate path

Norges Bank deposit rate Optimal rate path, MPR 2/10 Optimal rate path, MPR 1/10

Source: Norges Bank

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

1

2

3

4

5

6

7

8

1

2

3

4

5

6

7

8

Domestic economic developments have been in line with Norges Bank’s expectations and suggest that the bank should continue hiking its key rate as planned. Among other things, the bank regards a gradual rise “closer to a more normal level” as warranted, in

order to guard against the risk of future financial im-balances. Taking into account our new forecasts for domestic growth and inflation and the expected soft patch in growth abroad, we now expect the deposit rate to remain at 2.00 per cent until year-end, with the next hike in the first quarter of 2011.

We see several reasons for Norges Bank to continue hiking the deposit rate gradually thereafter. The output gap is expected to be closed by early 2012 and core inflation will also start trending upward. However, the bank’s room to manoeuvre will still be constrained by monetary policy elsewhere, as it will want to avoid a markedly stronger NOK.

As the ECB and the Fed is now expected to keep their key interest rates unchanged until 2012, Norges Bank will move more slowly as well: we foresee the deposit rate ending 2011 at 2.75 per cent. Such a level implies a continued stimulative monetary policy as the real deposit rate − adjusted for core inflation − at that time will be less than ¾ percentage point according to our forecast, well below what Norges Bank regards as a “normal” level of some 2 per cent.

Tighter yield spread vs. GermanyAs indicated above, Norges Bank will continue to nor-malise its key rate at a faster pace than the ECB. Our forecast implies that the interest rate spread will be 175 basis points by the end of 2011. While this normally means that the 10-year government bond yield spread against Germany should rise, we expect it to remain unchanged or even decline somewhat from current high levels. The current low global bond yield environment makes Norwegian government bonds attractive from a yield pick-up perspective. We thus believe that the 10-year government bond yield will be unchanged at 2.95 per cent at the end of 2010, rising to 3.50 per cent by end-2011 and 3.95 per cent at the end of 2012.

Short-term krone weakeningThe Norwegian krone remains a central element of Norwegian monetary policy. Although Norges Bank has focused more on the European debt crisis in recent months, the central bank continues to express concern about the relatively strong currency. At today’s levels, the NOK is pushing down imported inflation. This is the main reason why Norges Bank would prefer − and is also forecasting − a somewhat weaker currency. We now also foresee a weaker krone, at least in the short term. The Norges Bank deposit rate will probably remain at 2 per cent until early 2011, and although expectations are set very low, we will not see hawkish surprises during the next few months.


Norway

Exchange rate EUR/NOK

EUR/NOK spot SEB regressionSource: Reuters EcoWin, SEB

02 03 04 05 06 07 08 09 10

7.0

7.5

8.0

8.5

9.0

9.5

10.0

7.0

7.5

8.0

8.5

9.0

9.5

10.0

Foreign interest in buying Norwegian equities has also cooled somewhat, although we saw a slight increase in the summer. Still, there is a risk that the global eco-nomic slowdown will reduce foreign investors’ purchas-es of Norwegian company shares and that capital will be repatriated, which would have a big impact on the NOK. Norges Bank has also announced that it will begin buying foreign currencies for the Government Pension Fund Global. This adds to the weaker flow outlook. To top it off, the NOK looks expensive in real trade-weight-ed terms. Our internal EUR/NOK model (including oil prices, interest rate spreads and risk appetite) points at an equilibrium exchange rate close to 8.60. At the end of 2010, the EUR/NOK rate will be 8.20. In a slightly longer perspective, we expect the krone to strengthen as Norges Bank continues to raise its key interest rate and the global economic outlook improves. The EUR/NOK exchange rate will be 7.90 at the end of 2011.

Finland


Strong autumn and winter

� Leading indicators climbing, GDP taking off

� Higher inflation than euro zone average

� Budget deficit below 3 per cent in 2011

The Finnish economy was very hard hit by last year’s global slowdown and early 2010 was unexpectedly weak. GDP fell by 8 per cent in 2009 − the largest de-cline in the OECD − and continued downward by 0.4 per cent in the first quarter of 2010 compared to the fourth quarter of last year. However, the downturn was largely due to the protracted dock workers’ strike, which para-lysed a large percentage of exports, hurting the paper and forest product industry in particular.

Yet leading indicators are still pointing upward. Surveys show that the service sector is leading the up-turn, but the manufacturing sector − and recently the construction industry − are also recovering. Industrial production rose 2.1 per cent month-to-month in June, equivalent to a year-on-year increase of nearly 15 per cent. Today retail sales are also rebounding, with a year-on-year increase of more than 4 per cent in June.

Exports are benefiting from substantially stronger growth in a number of important countries, especially Germany and Sweden, which each buy 10 per cent of Finnish exports. Continued strong growth in Russia and China (together accounting for 15 per cent of exports) is also having a positive impact. Altogether, exports will increase by about 6 per cent this year and in 2011.

IndexService sector leading the upturn

Construction sector Manufacturing sector

Service sector

Source: DG ECFIN

00 01 02 03 04 05 06 07 08 09 10

-70

-50

-30

-10

10

30

50

70

-70

-50

-30

-10

10

30

50

70

Capital spending will grow by 2 per cent this year, among other things due to rapidly rising capacity uti-lisation (about 80 per cent today). Households, which

cut back on consumption last year, are being stimulated by low interest rates and have already begun to spend; private consumption will climb by around 2 per cent both this year and in 2011. The household savings ratio will decline somewhat.

Altogether, GDP growth will end up at 2.5 per cent this year, 2.6 per cent in 2011 and somewhat higher in 2012 − roughly the same forecast as in May and still well above consensus. The risks in the immediate future are on the upside. Given Finland’s export structure, the economy could take off even more strongly, thus follow-ing the pattern in Sweden and Germany.

The negative labour market trend following the crisis has ended. In the second quarter, the number of job vacancies was nearly 30 per cent higher than a year earlier. Unemployment peaked at 8.9 per cent in Janu-ary and has now fallen to 8.2 per cent. We expect the jobless rate to continue downward towards 7.5 per cent in mid-2011, then to 7 per cent at the end of 2012, somewhat below the OECD’s measure of non-accelerat-ing inflation rate of unemployment (NAIRU).

Wage and price formation are affected by the labour market with a certain time lag, and last year’s upturn in unemployment and collective agreements point towards low increase in hourly wages both this year and next. In the economy as a whole, wages and salaries will climb by 2.8 per cent this year and just below 2.5 per cent in 2011. In 2012, the rate of pay increases will accelerate due to a tighter labour market situa-tion.

According to Finland’s national measure, CPI inflation has gradually climbed this year: from -0.2 per cent year-on-year in January to 1 per cent in July. This sum-mer’s value-added tax hike will result in a continued upturn this autumn and winter. CPI inflation will end up averaging 1 per cent this year, just over 2 per cent in 2011 and even higher in 2012. Eurostat’s harmonised inflation measure (HICP), which excludes interest pay-ments on loans, will be somewhat higher: HICP inflation will average 1.5 per cent this year, then climb gradually to somewhat above 2 per cent in 2011 and 2012.

Decent growth and falling unemployment will con-tribute to a moderate budget deficit of about 3.5 per cent of GDP this year and less than 3 per cent in 2011. Sovereign debt will stabilise at around 50 per cent of GDP. Finnish public finances are thus in substantially better shape than the euro zone average.

Economic data


DENMARKYearly change in per cent 2009 level, DKK bn 2009 2010 2011 2012Gross domestic product 1,660 -4.7 1.8 1.8 2.2Private consumption 817 -4.3 1.9 2.2 2.7Public consumption 492 3.4 0.8 0.3 0.5Gross fixed investment 312 -14.1 -3.5 3.0 5.5Stockbuilding (change as % of GDP) -2.4 0.7 0.0 0.0 Exports 784 -10.2 6.0 5.5 5.0Imports 727 -13.2 4.5 5.7 6.0

Unemployment (%) 3.6 4.4 4.0 3.5Consumer prices, harmonised 1.1 2.1 1.9 2.1Wage cost 3.1 2.3 2.1 3.0Current account, % of GDP 4.0 3.5 3.0 2.5Public sector financial balance, % of GDP 3.6 -5.5 -4.0 -3.0Public sector debt, % of GDP 39.0 45.0 47.0 48.0

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12Deposit rate 1.05 1.05 1.05 1.10 1.65 1.9510-year bond yield 2.21 2.30 2.55 2.95 3.15 3.3510-year spread to Germany, bp 6 10 15 15 15 15USD/DKK 5.85 6.11 5.96 5.87 5.73 5.73EUR/DKK 7.45 7.45 7.45 7.45 7.45 7.45

NORWAYYearly change in per cent 2009 level, NOK bn 2009 2010 2011 2012Gross domestic product 2,256 -1.4 0.7 2.1 2.1Gross domestic product (Mainland Norway) 1,732 -1.4 1.6 2.7 2.9Private consumption 956 0.2 2.7 3.3 3.1Public consumption 487 4.7 3.0 2.4 1.8Gross fixed investment 467 -9.1 -4.5 4.3 4.1Stockbuilding (change as % of GDP) -2.2 1.7 0.0 0.0 Exports 1,008 -4.0 -0.1 0.7 1.9Imports 638 -11.5 6.7 3.4 4.2

Unemployment (%) 3.2 3.6 3.6 3.4Consumer prices 2.1 2.4 1.6 2.4CPI-ATE 2.6 1.5 1.8 2.3Wage cost 4.5 3.5 3.7 4.0

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12Deposit rate 2.00 2.00 2.25 2.75 3.25 3.7510-year bond yield 2.97 2.95 3.00 3.50 3.75 3.9510-year spread to Germany, bp 82 75 60 70 75 75USD/NOK 6.29 6.72 6.40 6.22 6.00 6.00EUR/NOK 8.01 8.20 8.00 7.90 7.80 7.80


Nordic key economic data

SWEDENYearly change in per cent 2009 level, SEK bn 2009 2010 2011 2012Gross domestic product 3,108 -5.1 4.7 2.9 2.3Gross domestic product, working day adjusted -5.0 4.4 2.9 2.7Private consumption 1,516 -0.8 2.9 2.6 2.2Public consumption 863 1.7 1.0 0.9 0.9Gross fixed investment 555 -16.0 7.0 5.0 4.0Stockbuilding (change as % of GDP) -41 -1.4 0.7 0.2 0.2 Exports 1,507 -12.4 11.3 6.7 5.1Imports 1,294 -13.2 12.4 6.9 5.1

Unemployment, (%) 8.3 8.5 7.8 7.6Employment -2.1 0.9 1.2 0.5Industrial production -19.1 10.0 5.0 4.0Consumer prices -0.3 1.2 1.7 2.2CPIX 1.9 2.0 1.1 1.6Wage cost 3.4 2.0 2.3 3.5Household savings ratio (%) 12.6 11.6 11.8 11.8Real disposable income 0.9 1.8 2.9 2.2Trade balance, % of GDP 4.0 3.3 2.5 2.5Current account, % of GDP 7.5 6.0 5.5 5.5Central government borrowing, SEK bn 176 12 24 -7Public sector financial balance, % of GDP -1.0 -0.5 -0.6 0.3Public sector debt, % of GDP 42 41 40 38

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12Repo rate 0.50 1.25 1.50 2.25 2.75 3.003-month interest rate, STIBOR 1.03 1.78 1.85 2.65 3.15 3.4010-year bond yield 2.25 2.30 2.70 3.20 3.40 3.6010-year spread to Germany, bp 10 10 30 40 40 40USD/SEK 7.41 7.38 7.20 6.89 6.73 6.77EUR/SEK 9.43 9.00 9.00 8.75 8.75 8.80TCW 129.6 124.6 123.5 120.4 120.0 120.7

FINLANDYearly change in per cent 2009 level, EUR bn 2009 2010 2011 2012Gross domestic product 171 -7.8 2.5 2.6 2.7Private consumption 94 -1.8 2.0 2.2 2.0Public consumption 43 0.8 0.5 0.7 1.1Gross fixed investment 34 -13.4 2.0 4.0 4.3Stockbuilding (change as % of GDP) -0.9 0.3 0.1 0.0 Exports 62 -24.4 6.6 6.0 5.5Imports 57 -22.3 6.0 5.9 5.0

Unemployment (%) 8.2 8.4 7.7 7.1Consumer prices, harmonised 1.6 1.5 2.2 2.5Wage cost 3.9 2.8 2.4 2.9Current account, % of GDP 1.3 1.8 2.1 2.3Public sector financial balance, % of GDP -2.2 -3.5 -2.9 -2.2Public sector debt, % of GDP 44.0 47.1 49.7 51.9


International key economic data


EURO ZONEYearly change in per cent 2009 level, EUR bn 2009 2010 2011 2012Gross domestic product 8,979 -4.1 1.6 1.3 1.5Private consumption 5,170 -1.2 0.2 0.7 1.1Public consumption 1,975 2.7 1.5 1.4 1.6Gross fixed investment 1,773 -10.8 0.0 4.6 4.1Stockbuilding (change as % of GDP) -0.8 0.7 0.2 0.0 Exports 3,259 -13.2 7.6 4.7 4.5Imports 3,140 -11.9 6.6 6.0 5.1

Unemployment (%) 9.4 10.0 9.7 9.2Consumer prices, harmonised 0.3 1.4 0.8 1.2Household savings ratio (%) 9.6 9.5 9.3 9.0

USYearly change in per cent 2009 level, USD bn 2009 2010 2011 2012Gross domestic product 14,119 -2.6 2.6 2.2 2.9Private consumption 10,001 -1.2 1.5 2.2 2.4Public consumption 2,915 1.6 1.1 2.2 2.0Gross fixed investment 1,716 -18.3 5.4 9.7 9.0Stockbuilding (change as % of GDP) -0.6 1.4 0.1 0.0 Exports 1,578 -9.5 12.0 8.2 6.6Imports 1,965 -13.8 14.8 13.4 7.4

Unemployment (%) 9.3 9.5 9.0 7.8Consumer prices -0.3 1.6 0.8 1.2Household savings ratio (%) 5.9 6.5 7.9 7.6

LARGE INDUSTRIAL COUNTRIES Yearly change in percent 2009 2010 2011 2012GDPUnited Kingdom -4.9 1.7 2.0 2.2Japan -5.2 2.5 1.5 1.5Germany -4.7 3.3 2.1 1.8France -2.5 1.5 1.5 1.7Italy -5.1 1.0 1.1 1.5 InflationUnited Kingdom 2.2 3.1 2.1 1.3Japan -1.3 -1.0 0.0 0.3Germany 0.2 0.9 1.2 1.5France 0.1 1.6 1.7 1.9Italy 0.8 1.6 1.7 1.9 Unemployment (%)United Kingdom 7.6 7.9 8.2 7.9Japan 5.1 5.2 5.2 5.3Germany 7.5 7.8 7.2 6.9France 9.4 10.1 9.8 9.5Italy 7.8 8.4 8.1 7.8


International key economic data

EASTERN EUROPE

2009 2010 2011 2012GDP, yearly change in per centEstonia -14.1 2.0 5.0 4.0Latvia -18.0 -1.5 4.0 5.0Lithuania -14.8 1.0 4.0 4.5Poland 1.7 3.5 4.0 4.5Russia -7.9 4.5 5.0 5.5Ukraine -15.1 5.0 4.0 4.5

Inflation, yearly change in per centEstonia 0.2 2.5 3.0 2.0Latvia 3.3 -1.0 1.9 1.8Lithuania 4.2 1.0 2.0 3.0Poland 3.4 2.5 2.7 2.9Russia 11.7 7.0 7.5 8.5Ukraine 15.9 9.5 11.0 10.0

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec12Official interest ratesUS Fed funds 0.25 0.25 0.25 0.25 0.75 1.25Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50Euro zone Refi rate 1.00 1.00 1.00 1.00 1.50 1.75United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 2.00 Bond yieldsUS 10 years 2.48 2.45 2.50 3.00 3.20 3.50Japan 10 years 0.95 1.00 1.20 1.50 1.70 1.90Germany 10 years 2.15 2.20 2.40 2.80 3.00 3.20United Kingdom 10 years 2.89 2.90 3.00 3.40 3.60 3.80 Exchange ratesUSD/JPY 84 82 85 85 90 95EUR/USD 1.27 1.22 1.25 1.27 1.30 1.30EUR/JPY 107 100 106 108 117 124GBP/USD 1.55 1.49 1.47 1.55 1.63 1.67EUR/GBP 0.82 0.82 0.85 0.82 0.80 0.78

GLOBAL KEY INDICATORSYearly percentage change 2009 2010 2011 2012 GDP OECD -3.3 2.2 2.0 2.3 GDP world -0.6 4.4 3.8 4.3 CPI OECD 0.1 1.4 0.9 1.2 Export market OECD -11.5 7.7 5.7 7.8 Oil price, Brent (USD/barrel) 61.9 76.2 80.0 80.0

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Economic recovery but higher risks, depressed key rates ... · Economic recovery but higher risks, depressed key rates and bond yields ... ravaged economic environment. Amid a fragile