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Recovery becoming moreself-sustaining

Faster Nordic key rate hikes

Nordic OutlookEconomic Research – February 2011



Contents

Nordic Outlook – February 2011 | 3

International overview 5

Theme: A model for long-term equilibriumexhange rates (SEBEER) 15

The United States 16

Japan 22

Asia 23

The euro zone 26

The United Kingdom 32

Eastern Europe 33

The Baltics 34

Sweden 36

Denmark 45

Norway 46

Finland 50

Economic data 51

Boxes

Risk and opportunities in North Africa 6

“United Debt of Europe” 8

Continued high commodity prices 10

Falling private sector savings boosts GDP 17

Home price drop jeopardises recovery 18

Little risk of 1970s-style stagation 20

Obama rebounding 21

China’s twelfth ve-year plan, 2011-2015 25

ECB questioning core ination as an indicator 31

The Riksbank and macro supervisory rules 41

Fiscal policy has an expansionary bias 47



4 | Nordic Outlook – February 2011

Economic Research

This report was published on February 8, 2011.

Cut-off date for calculations and foreasts was February 3, 2011.

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 Johansson

Editorial 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, SEB Frankfurt/M and Olle Holmgren,

Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwegian analysis.



International overview


The recovery is becoming more self-sustaining Stronger momentum as the US accelerates

Ination will fall − increasing focus onresource utilisation

ECB hike in September, Fed only in 2012

The Riksbank will speed up its rate hikes

Long-term yields sideways next 6 months

Nordic currencies will keep appreciating

In recent months, the global economic outlook has

improved. US growth expectations have risen. Fiscal

policy will be more expansionary in 2011, now that

Congress has resolved important taxation issues. In

addition, the American recovery is entering a more

self-sustaining phase, despite lingering problems in

the labour and housing markets. Emerging economies,

especially in Asia, are continuing their strong expan-

sion although tighter economic policies will now lead

to a slight deceleration. In Europe, economic signals

are more mixed. In Germany and the Nordic countries,

2011 growth will be stronger than we had previously

expected. The United Kingdom is now beginning to feel

the impact of tight scal policy. In southern Europe and

Ireland, growth will be hampered by continued nancial

turmoil and necessary budget consolidation measures.

Overall, we foresee above-trend GDP growth in the 34

countries of the Organisation for Economic Cooperation

and Development (OECD). We expect GDP increases of

2.8 per cent both in 2011 and 2012, representing an

upward revision of 0.5 and 0.3 percentage points.

The world economy still faces a number of challenges.

Sovereign debts continue to grow, and acute crises inseveral euro zone countries have still not been re-

solved. Global imbalances remain large and a restruc-

turing of the nancial system is under way, yet the

world economy seems to be entering a new phase. In

the corporate sector, optimism is record-high. Strong

balance sheets, expansionary policies and large global

growth potential dominate the picture. Given a more

self-sustaining economic upturn, the focus of nancial

markets and economic policy makers is shifting towards

more traditional economic variables such as growth,

ination and the labour market.

This shift has occurred only after the American econo-my reached slightly rmer ground, yet the world that is

now taking shape has changed in many ways. The role

of the US has weakened, while China and other emerg-

ing economies have increased both their economic and

political clout. Germany’s pivotal role in Europe has

been further conrmed by the euro zone debt crisis and

its nancial consequences. The Nordic economies have

also emerged stronger from the crisis, and Swedish GDP

growth stands out in an international perspective. The

Nordic model is again a focus of international debate.

Global GDP growth Year-on-year percentage change

2009 2010 2011 2012

United States -2.6 2.9 3.6 4.0

Japan -6.3 4.0 1.6 1.6

Germany -4.7 3.6 3.1 2.5

China 9.2 10.3 9.5 8.5

United Kingdom -4.9 1.4 1.5 2.5

Euro zone -4.0 1.7 1.9 1.8

Nordic countries -4.6 2.9 3.4 2.6

Baltic countries -15.6 1.2 4.1 4.7

OECD -3.5 2.7 2.8 2.8

Emerging markets 2.6 7.1 6.5 6.5

World, PPP* -0.6 5.0 4.5 4.6

World, nominal -1.3 4.3 3.8 3.9

*Purchasing power parties

Source: OECD, SEB

In recent months, rising commodity prices have fuelled

ination worries. Our assessment is that these fears

are somewhat exaggerated. Even if commodity prices

remain high, ination will fall in the course of 2011.

Ination expectations are under control, and underlying

cost pressure is low in the US and Western Europe. This

will help keep down ination in the OECD countries dur-

ing the next couple of years, especially in the US.

In spite of this, key interest rate hikes are fast ap-

proaching. Output gaps are on their way towards

closing. Financial conditions continue to normalise,

including the beginnings of growth in the money supply.

This indicates that central banks in the major OECD

countries must soon start normalising their monetary

policies to keep ination expectations under control.

We expect the European Central Bank (ECB) to begin

hiking its key interest rate in September this year. A

relatively small output gap, combined with the ECB’s

less intensive focus on core ination compared to vari-





ous other central banks, will contribute to earlier rate

hikes. To some extent, the expansion of the European

nancial stability mechanism (ESFS/ESM) is also taking

pressure off the ECB, enabling the bank to focus to a

greater extent on its main task: ensuring price stabil-

ity. High ination gures will also help to persuade the

Bank of England (BoE) to begin key rate hikes beforethe end of 2011. Because of high unemployment and

a continued decline in core ination, the US Federal

Reserve (Fed) will hold off until April 2012 before begin-

ning its rate hikes.

The Nordic central banks will continue raising their key

interest rates. Partly due to rapidly climbing resource

utilisation, Sweden’s Riksbank will adopt a more aggres-

sive stance during 2011. We expect it to hike the repo

rate to 2.75 per cent by year-end. Norges Bank, too,

will nd it easier to raise its deposit rate in response to

Norwegian domestic conditions once the ECB and BoE

also begin hiking their key rates.

The US: Private saving now falling againAmerican economic signals have gradually become more

optimistic since worries about a double dip recession

culminated in August 2010. At rst, the Fed’s quantita-

tive easing (QE) helped restore condence. The scal

policy agreements reached in December were also

important to the 2011 growth outlook, not least by

blunting the sharp conicts that dominated Congress

last autumn. This is among the reasons why we have

revised our GDP forecast for 2011 upward from 2.2 to

3.6 per cent.

The change in our scenario is not only due to economic

stimulus policies. Changes in private sector nancial

saving are normally a reliable signal that a shift is im-

minent, mainly in capital spending. Historical experi-

ence indicates that a downward adjustment in saving

happens relatively fast once the curve has changed

direction. Our forecast assumes that the downward

adjustment in private saving will occur more slowly

than usual (see the chart). There is still a great need

for nancial consolidation, especially in the household

sector and especially due to lingering weaknesses in the

housing and labour markets. Our forecast implies that

the household savings ratio will remain at the level of

some 5-6 per cent it has now reached, which is compat-

ible with a continued draw-down in the debt ratio. Inspite of this, the saving downturn in the corporate sec-

tor is sufcient to generate signicant growth stimulus

in the form of capital spending over the next couple of

years. We thus expect GDP growth to hold up well in

2012, too, in spite of tighter economic policies.

Per cent of GDP

US: Financial saving in private sector

Normal adjustmentNO scenario

Mean (1960-95)

Source: SEB

60 65 70 75 80 85 90 95 00 05 10 15

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

Emerging Asia: Growth despitetighteningThe Asian emerging economies will continue to drive

the world economy. Accounting for nearly one fourthof global GDP, their growth is increasingly important.

Partly due to their resilience during the nancial crisis,

emerging markets are rather far ahead of the OECD

countries in the economic cycle. One expression of this

is that ination is now climbing relatively fast, mainly

due to higher food and energy prices. But core ination

has also risen in such countries as China, India and Indo-

nesia. There is a clear trend towards higher key interest

Risks and opportunities in North AfricaIn recent weeks, political unrest in North Africa has

increased global uncertainty. One reason behind theunrest is a rapid rise in food prices. This is having

an extra impact because food subsidies have been

removed in many places. Other factors, such as high

youth unemployment and widespread corruption, also

play a part.

Right now the situation is worst in Egypt, with its large

population. The country has only limited oil produc-

tion but has a pivotal security policy role as a major

US ally in the Middle East. Since 1980 Egypt has had a

peace treaty with Israel and has played a major role

as a mediator in the Israeli-Palestinian conict.

The greatest risk ahead is consequently that the

unrest will threaten to disrupt security policy stabil-

ity in the region. In nancial markets, North African

countries have been affected via rising risk premiums

and falling share prices. The crisis has also pushed upoil and wheat prices. Disruptions in vital oil shipments

through the Suez Canal would have major consequenc-

es. If the protests spread to Saudi Arabia, Kuwait and

the United Arab Emirates, there would be a big impact

on oil prices, at least in the short term.

On the other hand, experience shows that revolts and

upheavals often do not necessarily result in major

nancial consequences. Pakistan in 1999 and Thailand

in 2006 and 2010 are examples of upheavals where

economic crises were avoided. There is thus a possibil-

ity that developments in Egypt might lead to democra-

tisation and greater stability. However, no quick solu-tion seem likely, which is one reason why the current

uncertainty will continue for another while.





rates. In India, for example, the real key rate is well

into negative territory, while economic growth is nearly

9 per cent a year. Many Asian central banks seem more

and more uncomfortable with excessively accommoda-

tive monetary policies. We can thus expect continued

key interest rate hikes during 2011.

Real key rates in selected countriesPer cent

K ey rate Ination Real SEBkey rate forecast

GDP 2011 India 6.5 8.4 -1.9 8.5

Indonesia 6.5 7.0 -0.5 6.3

China 5.8 4.6 1.2 9.5

Euro zone 1.0 2.2 -1.2 1.9

Japan 0.1 0.0 0.1 1.6

United States 0.25 1.5 -1.2 3.6

Source: National statistical ofces, OECD, SEB

Because of their higher trend growth and earlier posi-

tion in the economic cycle, the differences between

nominal emerging market interest rates and those in

the OECD countries will increase this year. This may ex-

acerbate the problems connected to speculative capital

inows, including bubble tendencies in asset markets.

But to a greater extent than before, many countries

seem to accept currency appreciation as an element

of ination-ghting. One reason is that greater risks of

rising food prices might lead to social unrest.

We still foresee an Asian soft landing as the most likely

scenario. Tighter economic policies will decelerate

growth to more sustainable levels, which in the long

term are around 6 per cent. Ination will peak during

the rst half of 2011 and then decline.

Western Europe: Out of stepThe euro zone continues to be characterised by a two-

speed economy. The recovery in Germany is progress-

ing at a rapid pace. Optimism is at record-high levels,

according to the IFO sentiment index. Unemployment

has fallen to its lowest level since 1992. We expect

German GDP to climb by 3.1 per cent in 2011, a bit

less than last year’s 3.6 per cent. Meanwhile powerful

austerity programmes in southern Europe will hamper

growth in the euro zone as a whole. This year, GDP will

fall in Greece and Portugal and will be close to zero in

Spain and Ireland. In France and Italy, growth will end

up around 1½ per cent, both this year and next. Due to

structural decits in both countries, however they also

have a major need for scal austerity measures. Overall

euro zone growth will end up at 1.9 per cent this

year and 1.8 per cent in 2012, somewhat higher than

we believed in November.

During 2011, the British economy will be hampered by

scal tightening and by high ination that will under-

mine purchasing power. The weak British pound and

strong international demand will nevertheless prop up

economic growth. GDP will increase by 1.5 per cent

this year and 2.5 per cent in 2012.

Consumer confidence, net balance

Diverging levels of optimism

United Kingdom GermanySource: DG ECFIN

90 92 94 96 98 00 02 04 06 08 10

-40

-35

-30

-25

-20

-15

-10

-5

0

510

15

-40

-35

-30

-25

-20

-15

-10

-5

0

510

15

Swedish growth in a class by itself The Nordic countries are continuing their strong growth.

These countries are beneting from export sectors that

are well positioned to meet rising global demand for

investment and intermediate goods. In additional, such

fundamental factors as public nances and current ac-

count balances are in very good shape.

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

2009 2010 2011 2012

Sweden -5.3 5.7 4.7 2.6

Norway -1.4 0.1 2.7 2.5

Denmark -4.7 2.3 2.6 2.3

Finland -8.1 2.7 3.5 3.0

Nordics -4.6 2.9 3.4 2.6

Estonia -13.9 2.7 4.5 4.0

Latvia -18.0 -0.3 4.0 5.0

Lithuania -14.7 1.0 4.0 4.5

Baltics -15.6 1.2 4.1 4.7

Source: OECD, SEB

The Swedish economy is now expanding very fast. We

have revised our GDP growth forecast upward to 4.5

per cent in 2011, after an increase of no less than 5.7

per cent in 2010. Other Nordic countries will show more

modest growth gures. Danish growth will be 2.6 per

cent in 2011 and 2.2 per cent in 2012, despite a degree

of scal tightening. In Finland, too, exports are the

main driving force. GDP growth will accelerate a bit,

reaching 3.5 per cent in 2011 and 3.0 per cent in 2012,

among other things due to improved competitiveness.

In Norway, supply-side restrictions are already starting

to hamper expansion; GDP growth will thus be only 2.7

per cent in 2011 and 2.5 per cent in 2012.

Rising resource utilisation in both Sweden and Norway

has led to early key rate hikes and sharply appreciating





“United Debt of Europe”Monetary cooperation in Europe is moving into a new

phase. The temporary European Financial Stability

Facility (EFSF), which will be replaced in 2013 by

the permanent European Stability Mechanism (ESM),

serves as a supranational lender of last resort. It willplay a key role in dealing with the short- and medium-

term liquidity and renancing needs of problem coun-

tries. Also of central importance is that the EFSF/ESM

is re-establishing a clear delineation between euro

zone sovereign debt policy and monetary policy.

At their summit in late March, the European Union

heads of state and government are expected to decide

what powers the EFSF/ESM will have. We foresee the

following decisions:

1) The lending amount guaranteed by the euro zone

countries will more than double from today’s EUR 440 billion to EUR 1 trillion. That will reduce the EU’s

dependence on the advice of the International Mon-

etary Fund (IMF), but even so the IMF is still expected

to play an important role for economic policy advice.

2) The EFSF/ESM will be allowed to buy government

bonds in the secondary market. This will take over the

role the ECB has been forced to assume to stabilise

the situation. The EFSF/ESM is also expected to buy

up the approximately EUR 80 billion in government

securities now in the ECB’s balance sheet.

3) The EFSF/ESM will become a tool for long-termdebt consolidation in crisis-hit countries with solven-

cy problems; EFSF/ESM loans can be used to enable

crisis countries to repurchase outstanding bonds that

are trading today at prices sharply below face value.

EU scal policy coordination will also intensify this

year as a result of the “European semester”, a recur-

ring process in which the scal positions and policies

of EU countries will be reviewed before their national

budget process is completed. In June, the EU summit

is also expected to approve tougher standards and

sanctions for the now-toothless Stability and Growth

Pact.

This signies that euro zone government debt and

scal policies will be taking a major step towards

greater coordination. The new system represents

something of a break with the principle that previous-

ly dominated the work of the EU: that each country

should be able to pursue government debt policies

that do not adversely impact other countries (in termsof interest rate effects/credibility). However, this

seems to be the price that must be paid to ensure

the survival of the euro. It is also consistent with the

fundamental concept that the euro zone should serve

as one step in the evolution of a political union.

Increased oversight and demands on scal policy − and

clearer distinctions between different policy areas −

will have an impact on monetary policy. Government

debt problems will be referred to national govern-

ments. Since the ECB will no longer be buying govern-

ment bonds, this will increase the pressure to pursue

responsible scal policies.

The ECB can thus increasingly focus on its main

task, ensuring price stability, which will strengthen

its credibility. Our assessment is that on the margin,

this opens the door to an earlier ECB interest rate

hike. Looking ahead, conrming the ECB’s independ-

ence may also diminish the risk of rising ination ex-

pectations and long-term yields. Such a development

would be especially benecial to such debt-burdened

countries as Greece, Ireland, Portugal and Spain.

But even if the EFSF/ESM gains an enlarged mandate

and stronger nancial muscle, the underlying problemsare fundamentally national. An economy’s competi-

tiveness and scal credibility must be regained by

means of a sustainable structural policy and stable

policy frameworks. Before this is ensured, the risks of

nancial volatility will persist.

During the spring, we expect that both Greece and

Ireland will be offered “soft” debt renegotiations

in the form of lower interest rates on borrowing and

extended loan maturities. Meanwhile these countries

can implement a write-down of debts by repurchasing

some of their outstanding debt. We also believe that

Portugal and Spain will show an interest in borrow-

ing money from EFSF/ESM. These countries must be

taken care of in resolute fashion, to avoid a resur-

gence of mistrust.

currencies. This will slow export growth over the next

couple of years, although our calculations indicate that

their currencies are still undervalued against the euro.

On the other hand, competitiveness in Finland and Den-

mark will benet from the appreciation of the SEK and

NOK from their previously extremely low levels.

Gradual recovery in the BalticsThe three Baltic countries rebounded weakly last year

after their depression-like downturn in 2008-2009. In

2011 and 2012 we expect GDP growth of 4-5 per cent,

which is still above consensus. We have revised our

forecast for Estonia upward by half a percentage point

to 4.5 per cent both in 2011 as well as 2012. This

implies that Estonia will have the fastest growth in the

Baltics during both years. With its relatively high ex-

ports as a percentage of GDP, the Estonian economy is

best positioned to benet from good external demand,

especially from Sweden and Finland.

Growth will continue to be driven by strong, com-

petitive exports. Domestic demand will recover

slowly. Households and businesses are still feeling the

after-effects of internal devaluation and tough public





budget consolidation; in Latvia, budget austerity meas-

ures will continue. Unemployment will fall slowly, and

at the end of 2012 it will remain far higher than before

the crisis. Ination is being pushed up by international

energy and food price increases. Underlying price pres-

sures remain low but will climb gradually.

Big labour market differencesDuring the downturn phase in 2008-2009, labour market

trends diverged from what could be expected on the

basis of GDP developments. For example, employment

in the US fell signicantly more sharply than in Germa-

ny, Sweden and Finland despite a milder GDP decline.

In the recovery phase, this trend has become even

clearer; those countries that were mainly affected by

the crisis in the form of the international trade collapse

have coped better than countries with more profound

nancial adjustment problems. One explanation is that

the need for restructuring is smaller in these countries;

when demand takes off again, their companies can

rather easily begin to rehire. The UK is a clear excep-

tion. Despite its deep nancial crisis, the downturn in

the labour market has been comparatively mild.

Per cent

Actual unemployment vs NAIRU

US, actualUS, NAIRU

Euro zone, actualEuro zone, NAIRU

Source: OECD, SEB

92 94 96 98 00 02 04 06 08 10 12

3

4

5

6

7

8

9

10

11

3

4

5

6

7

8

9

10

11

forecastSEB

These differences in the labour market situation will

be increasingly important for ination analysis and thus

central bank action ahead. Because of the sharp upturn

in US unemployment during the crisis, the gap between

actual unemployment and established measures of

equilibrium unemployment (such as non-acceleratingination unemployment rate, NAIRU) is signicantly

larger than in Europe. On the other hand, there is a risk

that the period of high unemployment in the US will be-

come so lengthy that structural damage to the economy

will be unavoidable and that equilibrium unemployment

will end up climbing even faster than traditional esti-

mates indicate. For example, the slide in home prices

may have made it more difcult for many people to

move out of homes whose mortgage loans exceed their

market value. The geographic mobility that has been so

important to the exibility of the US labour market may

thereby have diminished.

More symmetrical ination risksIn recent years, discourse has alternated between two

extremes: worries about monetary-driven ination or

fear of deation caused by low resource utilisation

and lack of condence in the future. For some time,

our ination forecast has been below consensus, based

on our assessment that large output gaps have domi-

nated ination processes. At the same time, we have

deemed the deation risk to be relatively small, since

central banks seem to have retained credibility fortheir medium-term ination ambitions. This has been

reected, for example, in ination expectations and

wage formation. In recent months, the risk picture has

changed to some extent. Rising energy and food prices

as well as tax increases in a number of countries have

pushed up actual ination. This has also contributed to

a certain increase in ination expectations.

CPI, year-on-year percentage change

Headline inflation will fall back in the euro zone

Euro zone USSource: Eurostat, BLS, SEB

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

-2

-1

0

1

2

34

5

6

-2

-1

0

1

2

34

5

6

forecastSEB

Our forecast implies that Consumer Price Index (CPI)

ination will fall somewhat in the course of 2011.

Although commodity prices will remain at high levels,

or even continue climbing somewhat, the ination rate

will slow as the effects of the rapid price increase dur-

ing 2010 disappear from the 12-month gures. In addi-

tion, underlying price pressures remain low. Because of

the cyclical recovery in productivity, unit labour costs

are still falling. We thus expect core ination to keep

declining in 2011, especially in the US.

Year-on-year percentage change

Unit labour costs

Europe (OECD countries) USSource: OECD

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

-3

-2

-1

0

1

2

3

4

5

67

8

9

-3

-2

-1

0

1

2

3

4

5

67

8

9

In the long term, however, we foresee growing risks of a

cyclically driven acceleration in ination:

The output gap is on its way towards closing, al-

though the situation looks different, for example, in







than before. Ination will probably fall somewhat in

2011, but a little further ahead the cyclical forces of

ination will gain strength. The period when ination

threats could be dismissed by pointing to large output

gaps seems to be on its way towards ending.

Year-on-year percentage changeMoney supply

US, M2 Euro zone, M3Source: Federal Reserve

90 92 94 96 98 00 02 04 06 08 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

“Exit policy” discussion is reawakenedThe global recovery is highly dependent on how mon-

etary policies are crafted in the world’s ve largest

economies: the US, the euro zone, China, Japan and

the UK. Central banks, in turn, must take into account

developments related to scal tightening and new

macro supervisory regulation, areas that enjoy priority

in Group of 20 cooperative efforts during 2011.

Monetary policy makers also face challenges when it

comes to managing various risk factors and dilemmas.The commodity price upturn is pushing up ination,

but at the same time it is weakening the recovery and

adding to political risks in many countries. Crises of

condence in sovereign nances and banks still have a

troublingly high probability, among other things weak-

ening the effectiveness of interest rate policy.

Meanwhile the crisis policies of recent years have

opened up new issues. In order to maintain long-term

credibility, the allocation of responsibility among

different elds of policy must be made clearer. In

such a situation, ination expectations are especially

important to keep track of. Despite earlier enormousloosening of monetary policy and growing government

debts, ination expectations have remained at a rather

stable level. The trend of money supply and credit ag-

gregates is generally showing continued low growth g-

ures. These are, however, expected to increase as the

credit multiplier normalises, due to a better economic

outlook and stronger banking systems.

Given a more stable economic outlook, a more normally

functioning nancial system and a crisis mechanism

taking shape in Europe, the question of suitable “exit

policy” is becoming more topical. This issue was, in

principle, removed from the agenda nearly a year ago.

Later in 2011, we expect the ECB and the Bank of Eng-

land to begin moving cautiously towards a normalisation

of interest rates, with reference to increased ination

risks. The ECB will raise its key interest rate in Septem-

ber and then once more in December, while the BoE will

hold off until December. The Fed and the Bank of Japan

will wait until 2012 before hiking their key rates.

Per cent

Key interest rates

Euro zone US Source: 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

We expect the Fed to complete its programme of pur-

chasing USD 600 billion worth of government securities

by the end of the second quarter of 2011 in order to

ensure the functionality of the nancial market and to

preserve continued low mortgage interest rates. The

Bank of Japan will also continue its unconventional

monetary policies. In the euro zone, the EFSF will

take over the current role of the ECB in stabilising the

government securities market. The Bank of England will

remain inactive, however. Because of growing govern-

ment debts and the need for long-term funding in the

banking system, there will be very limited room for

central banks to reduce their holdings of securities dur-

ing the next couple of years.

Per cent

Key interest rates

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

00 02 04 06 08 10 120

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB

Rapidly rising resource utilisation combined with higher

home prices and household debt make it likely that

there will be relatively rapid key interest rate hikes in

Norway and Sweden. For some time, however, Norges

Bank has slowed the pace, mindful of the risks of an

excessively strong Norwegian currency. Last autumn,

Sweden’s Riksbank lowered its repo rate path after tak-ing into account the international situation.

Rapidly climbing resource utilisation − combined with

higher home prices and rapidly growing household debt





− throw a spotlight on risks to both price stability and

nancial stability. This is an argument in favour of rela-

tively fast key interest rate hikes in Norway and Swe-

den. For some time, however, Norges Bank has slowed

its pace, mindful that an excessively strong Norwegian

currency would weaken exports and push down ination

undesirably far. Last autumn, Sweden’s Riksbank alsolowered its repo rate path, among other things because

of the international situation.

Our forecast that the European Central Bank will begin

its key rate hikes as early as September 2011 will ease

the Nordic central banks’ dilemma related to excessive

currency appreciation. Our assessment is that this will

help bring about an upward revision in Norges Bank’s

deposit rate path at its monetary policy meeting in

March. We expect the bank to raise its key rate three

times during 2011, which will mean a deposit rate of

2.75 per cent at year-end. After ve additional hikes

during 2012 rate will stand at 4.00 per cent, a levelthat would be relatively close to normal.

Due to short-term upward revisions in our ination fore-

casts and a substantially changed resource utilisation

picture, we believe that Sweden’s Riksbank will raise

its key interest rate at a faster pace than previously

announced. We expect the bank to hike its repo rate

at every monetary policy meeting during 2011; the key

rate will thus be 2.75 per cent at year-end in Sweden

as well. During 2012 the hikes will continue, though at

a somewhat slower pace, bringing the repo rate up to

3.75 per cent at year-end. This means that the key rate

will be close to what can be regarded as a neutral level.

To ease the pressure on interest rate policy, additional

measures are being carried out to slow household credit

expansion. For example, in 2010 both countries imposed

a ceiling on the loan-to-value ratio for mortgages. The

two central banks have also pointed to the possibility

of accelerating their implementation of the new Basel

III international banking regulations. In a speech during

February, Riksbank Governor Stefan Ingves stated that

Sweden may either need to take extra steps or move

ahead faster than other countries on the matter of

macro supervisory regulations in particular.

Different scal strategiesGovernment debts are continuing to grow, and there

is a great need for continued scal tightening in many

countries, but these needs vary considerably between

countries. Simplifying a bit, we can distinguish four

categories of countries with different scal directions

and strategies:

1) Countries that have now approved very large scal

austerity programmes in the range of 5-10 per cent of

GDP. In most cases, this has occurred after heavy mar-

ket pressure (Greece, Ireland, Portugal, Spain, UK).

2) Countries that have relatively large decits but have

only implemented small and probably inadequate cut-

backs (France, Italy and Belgium).

3) Countries that are implementing further stimulus

measures in 2011 and are thus postponing their prob-

lems (Japan and the US).

4) Countries with strong public nances that have the

potential for expansionary scal policies (Norway, Swe-

den, many emerging economies including China).

Net lendingPer cent of GDP

2010 2011 2012 2012Gross debt

United States* 8.8 9.9 -7.4 101.5

Japan -9.4 -8.8 -7.6 230.0

United Kingdom -9.7 -8.0 -6.5 95.0

Euro zone -6.2 -4.5 -3.5 93.5

OECD -7.5 -6.0 -4.6 102.8

* Federal decit.

Source: European Commission, OECD, SEB

Partly due to the new stimulus measures in the US and

Japan, the tightening effect in the OECD now looks

likely to be only 0.25 per cent of GDP. Our previous

estimate was 1 per cent. Next year tightening measures

will be more powerful, nearly 1.5 per cent of GDP.

Continued large decits mean that problems are being

postponed and that scal tightening will hamper the

recovery for a rather long period. At the same time,

we can see that incoming budget statistics often bringupside surprises in countries that have progressed rela-

tively far in their recovery. Looking ahead, the cyclical

improvement may also prove larger than expected.

Bond yield rise will slow after reboundIn recent months, global long-term yields have re-

bounded after their dramatic downturn in April-October

2010. American and German 10-year yields have risen

by 1.5 and more than 1.0 percentage points, respec-

tively, from their lows last autumn of 2.4 and 2.1 per

cent, respectively. These upturns were driven by higher

ination expectations and a stronger growth outlook.

Recent expectations of earlier key interest rate hikes

in major OECD countries have also contributed. This is

especially true of the ECB, which has been clearest in

signalling its concern that rising commodity prices could

spread, causing a broader upturn in ination.

The yield curve has been very steep during the past

year. One year ago, the differential between 10- and

2-year US government bond yields was the widest for

at least 35 years. Given the recent upturn in long-term

yields, record levels are within reach again. A steep

yield curve is normally an indicator of improved eco-

nomic conditions; it reects a situation in which a lin-gering expansionary monetary policy is combined with

rising optimism and risk appetite. This interpretation

is more relevant today than a year ago. At that time,





comparatively high long-term yields reected − to a

greater extent than today − a fundamental uncertainty

about the sustainability of economic policies.

Per cent

10-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

6.06.5

7.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.06.5

7.0

SEBforecast

One of the most important tasks of central banks duringthe next couple of years will be to ensure that key rate

hikes do not lead to a signicant upturn in long-term

yields. Such a parallel upward shift in the yield curve

might jeopardise the recovery. To many central banks,

the reaction when the Fed began its rate hiking cycle in

1994 is still regarded as a textbook example of what to

avoid. In light of our ination forecasts and other data,

however, such a development seems rather unlikely.

Instead, well-justied key rate hikes may help improve

the credibility of central banks and stabilise ination

expectations in a somewhat longer perspective.

Government bonds: 10-year minus 2-year yieldSteep yield curves

US Germany SwedenSource: Reuters EcoWin

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

-4

-3

-2

-1

0

1

2

3

-4

-3

-2

-1

0

1

2

3

Our assessment is thus that the yield curve will

eventually become atter. This means that we believe

that international 10-year bond yields will move

upward at a moderate pace. The upward pressure on

long-term yields will be restrained, among other things,

by CPI gures that will ease ination worries ahead.

Towards the end of 2012, German long-term yields will

stand at 4.00 per cent and American ones at 4.30, an

upward adjustment of 60 and 70 basis points, respec-

tively, since our last Nordic Outlook.

The spread between German and Swedish 10-year

government bond yields has been rather stable at 15-

35 basis points in recent months, despite the Riksbank’s

key interest rate hikes. This is due, among other things,

to expectations of a limited supply of Swedish govern-

ment bonds (because of the balanced budget and pri-

vatisations of state-owned companies). Looking ahead,

we nevertheless believe that a widening gap in key

interest rates will enlarge the spread from today’s 20

or so basis points to 50 points by late 2012.

For Norwegian bonds, too, wider differentials in short-

term interest rates compared to those of the ECB will

mean upward pressure on the 10-year yield spread

against Germany. Our forecast is that Norway’s key rate

spread against the ECB will increase by 50 basis points

in the next couple of years. As a result, the 10-year

yield spread against Germany will climb towards 75

points by late 2012.

Calmer trend in Nordic stock marketsIn recent months, the correlation between the world’s

various stock markets has weakened. One new trendhas been that US stock exchanges in particular have

performed strongly, while stock markets in many de-

veloping countries have lost momentum and, in some

cases, also fallen signicantly. For example, the stock

market rallies in India and Indonesia during 2010 have

been followed by downturns of more than 10 per cent

so far this year. In China, too, stock exchange perform-

ance has been weak. The political unrest in North Africa

has reinforced the stock market downturn in emerging

economies, while the impact on US and euro zone stock

exchanges has been minor so far. Looking ahead, we

believe there will be a cautious global stock marketupturn. Because emerging economies are much further

ahead in the economic cycle, and their currencies will

continue to strengthen, leading stock exchanges in the

US and Western Europe are likely to continue doing

comparatively well.

Index 100 = juni 2007

Stock market slowdown in the EM sphere

USEuro zone

Emerging marketsSweden

Source: Reuters EcoWin, SEB

Jul

07

Nov

08

Mar Jul Nov

09

Mar Jul Nov

10

Mar Jul Nov

11

30

40

50

6070

80

90

100

110

120

30

40

50

6070

80

90

100

110

120

The Nordic stock exchanges are also entering a more

mature phase. Valuations (measured as share price/

equity) have now reached their average for the past

decade. For example, market capitalisation on the OMX

Stockholm exchange has doubled in the past two years.

In 2010, operating margins of many Nordic listed com-

panies reached historical peaks. This limits the room





for new positive surprises. For Swedish companies, and

to some extent also Norwegian ones, the strength of

the currency is also starting to become a greater chal-

lenge. This will make it harder for the OMX Stockholm

to continue outperforming exchanges in other countries

during the next couple of years.

Several factors nevertheless point towards a fairly

strong Nordic stock market trend this year. Because

of low debt, corporate transactions will increase after

several years of modest merger and acquisition volume.

Dividends will also be raised. The relationship between

interest rates and the yields on equities will also allow

room for rising share prices. We estimate that total

yield on Nordic stock exchanges will be 3.6 per cent,

which is higher than today’s yields on 10-year govern-

ment bonds in all Nordic countries but Iceland.

Continued Nordic currency appreciation

Differences in macroeconomic fundamentals, includ-ing economic growth and government nances, will

remain key driving forces in the foreign exchange mar-

ket. Short-term interest rate spreads will also grow in

importance, as the volatility of the FX market subsides.

An increasingly vigorous world economy will continue to

push up the currencies of emerging market countries. In

many cases, rising commodity prices will help improve

terms-of-trade, making more room for continued ap-

preciation. This also applies to such OECD currencies as

the AUD, CAD and NOK.

Cyclically sensitive currencies will thus appreciate,

though earlier weakening trends have been reversed in

many cases. Central banks in many emerging economies

have intervened forcefully to slow the appreciation of

their currencies. However, we believe that many coun-

tries will, to a greater extent, accept future strength-

ening of their currencies as a means of keeping ination

down. This is one way of taking the edge off rising food

prices and the related risks of social unrest.

China’s currency policy remains cautious. Since late

June 2010, when appreciation against the US dollar was

resumed, the yuan has gained about 3.5 per cent. Real

effective appreciation totalled about 5 per cent during2010. We believe that the pace of appreciation against

the USD will increase somewhat during 2011 in order

to counter ination and contribute to more balanced

economic growth. Our assessment is that the USD/CNY

exchange rate will be 6.30 at the end of 2011.

As for the trend of G4 currencies, we anticipate that

the euro will continue to strengthen against the USD

in the immediate future. Among factors supporting

the euro will be that the ECB will start its key interest

rate hikes earlier than other major central banks. We

also expect the strengthening of the EFSF/ESM stability

mechanism to help reduce the political risk premium.This has been manifested, for example, in narrowing

euro zone yield spreads. Our forecast is thus that the

EUR/USD exchange rate will continue to climb, peaking

at 1.45 during the third quarter of 2011. Next year

the USD will regain ground as the American economic

recovery progresses and as the Fed begins its key rate

hikes. Towards year-end 2012, the EUR/USD rate will

stand at 1.30: still a bit above our estimated long-term

equilibrium exchange rate (fair value) of around 1.20.

Long-term fair values according to SEBEER

Current Fair value 2010

EUR/USD 1.36 1.19

EUR/SEK 8.82 8.27

EUR/NOK 7.82 7.39

USD/SEK 6.47 6.93

USD/NOK 5.73 6.19

USD/JPY 82 120

EUR/GBP 0.84 0.71

EUR/CHF 1.29 1.44

GBP/USD 1.61 1.68

USD/CHF 0.95 1.20

Source: Reuters, SEB

The Japanese and Swiss currencies (JPY and CHF) are

among the most overvalued according to our model. As

the world economic situation stabilises and the ECB and

Fed begin their rate hikes, we expect the JPY and CHF

to fall towards levels more justied by fundamentals.

The USD/JPY rate will be 90 at the end of 2011 and 98at the end of 2012.

The Swedish and Norwegian currencies will continue

to strengthen. Rapid rate hikes by the Riksbank will

open a key rate gap against the ECB. The Norwegian

krone will also move higher due to a widening key rate

spread against the ECB. We thus expect its appreciation

to continue during 2011, and the EUR/NOK rate will

reach 7.60 at the end of this year.

The ow situation will also push up the SEK. Strong

government nances are one reason why the krona

may gain a larger weighting in the foreign exchangereserves of central banks. We believe that the EUR/

SEK exchange rate will stand at 8.50 towards the end

of 2011 and 8.40 towards the end of 2012. This is close

to our fair value estimate of about 8.30. The large cur-

rent account surplus and Sweden’s strong net external

nancial position support our forecast that the krona

may appreciate further.

On the other hand, company reports from the fourth

quarter of 2010 are showing that prots are beginning

to be affected by the strong currency.



Theme


SEBEER: A model for long-term equilibriumexchange rates

EUR/USD equilibrium at 1.20

JPY and CHF the most overvalued

NOK and SEK undervalued against theeuro

The economic literature includes many approaches to

calculating equilibrium exchange rates (fair values).Purchasing Power Parity (PPP) emphasises the associa-

tion between relative price levels in different countries

and exchange rate. Other methods focus on internal

and external balance conditions − with the situation

related to resource utilisation and ination rate, on the

one hand, and current account balance and net exter-

nal nancial position, on the other, providing the basis

for estimating equilibrium exchange rates.

In addition to these more fundamental, theoretical

approaches, there are more empirical methods based

on actual historical exchange rate trends. SEB Research

recently estimated such equilibrium rates (BehaviouralEquilibrium Exchange Rate, BEER). The variables that

proved to have the largest impact on fair values in the

model that we have named SEBEER are the following:

Relative prices: Long-term fair value is affected by

relative price levels between countries, in keeping with

the above-mentioned PPP theory. A low domestic price

level relative to other countries indicates that the cur-

rency is undervalued.

Terms-of-trade: Differences in world market price

trends between a country’s exports and imports inu-

ence fair value. A favourable trend with faster-rising

export prices strengthens a country’s fair value.

Relative productivity: Differences in productivity

growth inuence fair value. A country with higher pro-

ductivity growth than its peers can maintain a gradually

appreciating currency without seeing its competitive-

ness undermined.

Current account: In the long term, the current account

balance affects the exchange rate. A surplus leads to

greater demand for the currency, thereby strengthening

its exchange rate.

Interest-rate differentials: Differences in interest rates

generate capital ows, which inuence the exchange

rate. A country with higher interest rates receives an

inow of capital that helps strengthen its exchange rate

in the short and medium term.

The usual way of estimating fair values is to use tradi-

tional time series analysis on individual currencies. One

way of carrying the analysis further is to estimate fair

values for a panel of exchange rates simultaneously.

The number of observations − and the precision of

the estimates−

is larger, without having to extend theestimate period as far back in time. The panel approach

also makes it possible to estimate several fair values

simultaneously, so the approach is internally consistent.

Deviation from Fair Value 2010

Deviation, per cent, vs. USD

36%

22%

22%

14%

14%

8%

8%

0%

0%

-8%

JPY

CHF

CAD

DKK

NZD

EUR

AUD

SEK

NOK

GBP

OvervaluedUndervaluedSource: SEB

The chart shows selected results from our latest panel

data estimate of nominal fair values from 1980 through

2010, stating deviations from fair value against the US

dollar for the average exchange rate in 2010 (for more

details, see FX Ringside, January 2011). The hard cur-

rencies of Japan and Switzerland are the most over-

valued, while the British pound is the only currency in

the list that is undervalued against the USD. The euro

exchange rate is above its fundamental valuation; the

latest estimate indicates that EUR/USD fair value is

1.20.

The SEK and NOK were in balance against the USD in2010 (SEK 6.93 and NOK 6.19) but were fundamen-

tally undervalued against other currencies, except the

pound. Estimated EUR/SEK fair value in 2010 was 8.30

and EUR/NOK fair value was 7.39.



The United States


The US economy gears up above trend

The labour market is improving

Corporate prots will continue upward

The housing market is stumbling

The Fed will hike its key rate in April 2012

The US economic outlook has improved. A combination

of the Federal Reserve’s ultra-loose monetary policy

and a new scal stimulus has bolstered optimism. GDPgrowth in the fourth quarter of 2010 was signicantly

stronger than we expected in the last Nordic Outlook,

and there are many indications of continued good

growth gures early in 2011. Private sector nancial

saving has now started falling, which is usually an

important signal that a recovery is becoming self-

sustaining. Measured as annual averages, we foresee

GDP growth of 3.6 per cent this year and 4.0 per cent

in 2012, which is above consensus and a sharp upward

revision for 2011. Housing market reversals and poor

state government nances will nevertheless keep the

recovery a few percentage points weaker than histori-cal averages during the corresponding cyclical phase.

Employment will increase by an average of about

180,000 per month this year, despite public sector

cutbacks. Unemployment will fall but will remain at

a high 7.8 per cent at the end of our forecast period.

Large output and labour market gaps will lead to low

core ination; our ination forecasts are below consen-

sus. We thus anticipate that the Fed will hike its key

interest rate in April 2012, later than market pricing

indicates.

Index, year-on-year percentage changeComposite ISM and GDP growth

ISM Composite index (LHS) Real GDP (RHS)Source: ISM, SEB

02 03 04 05 06 07 08 09 10 11 12

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

35,0

37,5

40,0

42,5

45,0

47,5

50,0

52,5

55,0

57,5

60,0

62,5

SEBforecast

Continued strong company prot growthCapacity utilisation has risen at a brisk pace since it

bottomed out a year and a half ago, but remains at low

levels. Capital spending by businesses is now increas-

ing 10 per cent year-on-year but is still at a histori-

cally very low level as a percentage of GDP. Meanwhile

current market values relative to the replacement

costs are giving companies good incentives for invest-

ments. (Tobin’s Q has continued to climb). Add strong

corporate balance sheets and great optimism, bothin manufacturing and service sectors. Our composite

ISM purchasing managers’ index is compatible with

5 per cent GDP growth. The manufacturing ISM index

currently is close to 25-year highs. In a shorter perspec-

tive, however, weaker order bookings for capital goods

in recent months are evidence against an acceleration

in capital spending activity.

Good protability is also helping to stimulate capital

spending activity. Corporate after-tax prots are at 5.6

per cent of GDP, slightly above the historical average

but far below previous peaks. A combination of ris-

ing labour costs and higher taxes will eventually push

down prots. But 2011 will probably be another year of

double-digit prot growth. The gap between ination

and labour costs has historically been a good indicator

of which way prots are headed. This indicator points

towards an increase in prots 2-3 times higher than

GDP growth in current prices during 2011. Prots as a

percentage of GDP will continue upward.

Difference, year-on-year percentage change

Strong profit growth in 2011 as well

Headline inflation less unit labor cost inflation (LHS)Net profits after tax (RHS)

Source: BLS, BEA, SEB

90 92 94 96 98 00 02 04 06 08 10

P e r c e n t

-40-30

-20

-10

0

10

2030

40

5060

70

80

-4-3

-2

-1

0

1

23

4

56

7

8

Our overall forecast is that corporate capital spending

will grow by 13 per cent in 2011 and 15 per cent in2012. Its contribution to GDP growth will average 1.6




The United States

percentage points during our forecast period, compared

to 2.1 per cent for private consumption.

Exports will climb in rst half of 2011The weakening of the US dollar will lift exports dur-

ing the next six months, while import gures will be

kept down because an inventory build-up has alreadyoccurred. We foresee increases in exports averaging

11 per cent in 2011-12. Foreign trade will contribute

positively to GDP growth during the rst half of 2011,

followed by a shift to a negative contribution in the

second half and in 2012. The 2010 US current account

balance, which stood at -3.2 per cent of GDP in 2010, is

expected to approach -4 per cent of GDP by the end of

2012.

Consumers getting bolderA strong Christmas shopping season helped lift consump-

tion by 4.4 per cent annualised in the fourth quarter of

2010, the strongest gure since 2006. Several factors

indicate that this positive trend will persist. Extend-

ing the Bush-era tax cuts for another two years as well

as cutting the employees’ federal payroll tax in 2011

will increase room for consumption. Meanwhile the

consumer condence surveys look a bit brighter; for

example the Conference Board indicator posted a heavy

gain in January. We foresee a gradual return to normal

condence levels as the labour market and incomes

strengthen.

Looking further ahead, a stronger labour market will

also help bolster household income. Given the large

role of private consumption in GDP (71 per cent), this

is one key explanation for our brighter economic view.

Household savings adjustment has also come a long way.

According to our calculations, household savings levels

are close to the equilibrium justied by such factors as

wealth position. We are thus expecting only a marginal

additional upturn in household savings ratios during

the next couple of years. Such savings behaviour is also

compatible with a continued decline in household debt

in relation to income. The debt-to-income ratio is now

at 122 per cent, according to the latest Fed statistics,

a clear downturn from its peak (135 per cent in 2007).

The adjustment has thus progressed quite far, and the

debt service ratio has also fallen to its long-term mean.

But the debt-to-income ratio is still high. Together withfurther home price declines, this indicates that debt

retirement will continue. In the years before the home

price boom, the debt ratio was below 100 per cent.

Per cent of disposable income

Household deleveraging

Household debt-to-income ratio (LHS)Household debt service ratio (RHS)

Source: Federal Reserve, SEB

45 55 60 65 70 75 80 85 90 95 00 05 10

9.5

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

15.0

15.5

2030

4050

60

70

8090

100

110

120

130

140

Mean, debt service ratio

Overall, we foresee an increase in consumption of

3.2 per cent this year and 3 per cent next year:

more than half a percentage point below the 1994-

2007 average. Rising petrol prices pose a downside risk

for our consumption forecast, however. The upturn in

oil prices does not appear to have been driven by US

consumers, since the demand for oil-related products

is currently falling at a 2.4 per cent year-on-year rate.

Petrol has climbed from an average of USD 2.70/gal-

lon (September) to USD 3.15/gallon today. One rule of

thumb is that for every cent that petrol prices rise,

household buying power shrinks by USD 1.5 billion. In

other words, rising petrol prices are blunting the impact

of the tax cut extension. Nevertheless, we expect that

Falling private sector savings boosts GDP

The difference between total private sector income

and expenditures, as a percentage of GDP, was record-

high last year. Since then, the percentage has begun

to fall. Expenditures are again increasing faster than

income. According to the historical pattern, the pri-

vate sector balance will continue falling towards the

long-term average, making strong GDP growth likely

over the next few years.

If this adjustment continues over a four-year period

(the risk scenario in the chart), our calculations indi-

cate that GDP growth measured as annual averages

will exceed 4 per cent during the next three years.

But continued need for nancial consolidation in the

household sector as well as lingering weaknesses in

the housing and labour markets implies that the ad-

justment may take longer than this. Our main scenario

is that the adjustment will take eight years, which

is slow compared to historical experience, but still

compatible with above-trend GDP growth according to

our estimates.

Per cent of GDP

Private sector balance boosts growth

Risk scenario Main scenarioSource: SEB

60 65 70 75 80 85 90 95 00 05 10 15

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0




The United States

real disposable income will rise at an annualised rate

of 5-6 per cent in the rst quarter, compared to slightly

below 2 per cent in the fourth quarter. Some of the

boost will be saved, thus reversing the recent drop in

the savings ratio. Even so, we expect impressive con-

sumption growth in the current quarter as well.

The housing market is stumblingHousing investments as a share of GDP are at a deeply

depressed 2.2 per cent. There is thus little risk of a fur-

ther decline, but no upswing will occur until the market

catches up with the oversupply of homes. Housing

investments will grow by 2 per cent in 2011, accel-

erating to a 14 per cent rate in 2012, which will still

provide a relatively small contribution to GDP growth

(0.4 percentage points in 2012).

Per cent of GDP

Huge investment swings

Residential (LHS) Nonresidential (RHS)Source: Reuters EcoWin, SEB

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

8

9

10

11

12

13

14

15

2

3

4

5

6

7

8

9

According to the Case-Shiller index, home prices have

fallen for ve months in a row, and our assessment is

that home prices will fall by an additional 5 per cent

this year. Higher mortgage interest rates will contrib-

ute to the downturn, but their effect should not be

exaggerated: a 60 basis point increase in 30-year mort-

gage rates from their bottom level will lower prices by

about 1 per cent in a one-year time frame, according to

our estimates.

The steeper yield curve is positive for bank earnings,

which would mean a gradual easing of credit condi-

tions and increased new lending. But bad commercial

property loans will pull down the banking system, es-

pecially the regional banks. These problems have been

relegated to the future, since banks have postponed

loan maturity dates and thus avoided taking losses on

their balance sheets. Commercial property loans worth

USD 1.5 trillion will reportedly fall due in the next four

years. About half of this volume is related to loans

exceeding current property value.

The labour market is gaining strengthAccording to the Fed’s latest Beige Book, stronger

employment growth is occurring in most parts of the

United States, although the improvement is rather slow.

New unemployment benet claims have also fallen

noticeably since August, which is usually a good indica-

tor that a clear increase in employment is imminent.

A cyclical slowdown in the productivity upturn is also

helping increase the need for new hiring. We expect

productivity to rise by 1.3 per cent this year and 2 per

cent in 2012, compared to 3.5 per cent in both 2009

and 2010.

Our overall assessment is that employment will in-

crease by an average of 180,000 a month this year

and by 200,000 next year, or double the 2010 level.

Home price drop jeopardises recovery

The downward trend in home prices reversed during

the second half of 2009, which can be explained by

several factors: the Fed’s mortgage bond purchases

helped push mortgage rates to record lows, while

mortgage modication plans and temporary morato-

riums on home foreclosures reduced supply. But the

market was still too weak to sustain itself, as illustrat-

ed by the renewed price declines following the expira-tion of temporary tax credits for home purchases.

The supply of available homes is still large: 3.6 mil-

lion, or 65 per cent above the historical average.

Meanwhile the “shadow supply” is signicantly larger

than the 8 month inventory that ofcial gures indi-

cate. According to Fed estimates, the actual inventory

of available homes is around 24 months. In addition,

every fth household with a mortgage owes more

money than its home is worth, and nearly half of bank

assets are tied to the housing market. Sharper home

price declines than we are expecting in our main sce-

nario are thus the biggest risk to US economic recov-ery. Although home prices in real terms have fallen by

one third from their 2006 peak, there is quite a way

left down to the historical average.

Index 1890 = 100

Real home prices well above the mean

Source: Robert Shiller, SEB

90 00 10 20 30 40 50 60 70 80 90 00 10

50

75

100

125

150

175

200

225

50

75

100

125

150

175

200

225

-1 std dev

-23%

+1 std dev

+85% -33%

What may prevent such sharp home price declines is

that a stronger labour market will help prop up the

housing market. In addition, new support measures

will probably be launched if conditions get much

worse.




The United States

The tough public budget situation at the state and local

levels − which account for 15 per cent of all employees

− will prevent an even stronger rebound in the number

of jobs. Unemployment will fall to 8 per cent by the

end of 2012, in line with the Fed’s latest forecasts.


Diverging employment trends

Total employment State & local employmentSource: BLS, SEB

90 92 94 96 98 00 02 04 06 08 10

-6

-5

-4

-3

-2

-1

0

1

2

3

4

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Yet it will be a long time before the labour market is

back at a normal situation. Some 13.8 million Ameri-

cans, or 9 per cent of the labour force, are unem-

ployed. This can be compared to our estimate of

equilibrium unemployment, which is 5.5 per cent.

Another 11 million people are underemployed; the

jobless rate is as high as 16.1 per cent according to the

broadest measure (U6). Youth unemployment stands

at 25.7 per cent, compared to 14 per cent in 2006.

The employment-population ratio is stuck close to

its 28-year low (58.4 per cent), which means that 11

million jobs will be needed in order to reach the 2007

peak. Meanwhile, among the G7 economies the US and

Canada are the only two where GDP has reached fresh

highs.

Our conclusion is that despite faster GDP and employ-

ment growth, the labour market gap will remain large

during our forecast period. In light of this, Fed Chair-

man Ben Bernanke recently warned that it may take

4-5 years before unemployment is back at historically

normal levels.

Large output gap means low inationFor a long time, our take on ination has been that the

resource situation in the US economy is the most impor-

tant determining factor and that both the output gap

and the labour market gap are large. The trend towards

low, falling core ination will thus continue for an-

other while. Broad measures of monetary growth have

rebounded, but year-on-year rates of increase remain

far below historical averages. The credit multiplier

bottomed out a year ago, but the upturn since then has

been modest.

According to our forecasts, core ination will bottom

out at a record-low 0.5 per cent rate later this springand then gradually accelerate. Measured as annual

averages, core ination will amount to 0.7 per cent in

2011 and 1.0 per cent in 2012. But historical experi-

ence shows that core ination has never risen when

there has been such high unemployment. It is thus too

early to write off the deation risk completely, a view

that also is supported by the low wage pressure.


Private sector capital stock drops

Source: BEA, SEB

25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10

-10

-5

0

5

10

15

20

25

-10

-5

0

5

10

15

20

25

Risks of long-term supply side disruptionsOur ination and labour market analysis is based on a

relatively optimistic picture of the American economy’s

supply side in the medium term. But there are various

risks that the deep recession has harmed the economy

in a more lasting way. This might lead to a substantial

downshift in potential growth and permanent exclusion

from the labour market, for example in the form of

higher equilibrium unemployment. One alarming fact

is that in 2009, US capital stock decreased for the

rst time since the 1930s depression, indicating lower

productivity growth a bit further ahead.

Another potential threat has to do with rising long-

term unemployment. Since many jobless people were

close to the end of their benet period, unemployment

benets were extended for another 13 months just

before the end of 2010. Long-term unemployment − 6.2

million people have been out of work for at least 6

months − has both economic and social dimensions: a

Congressional Budget Ofce (CBO) study shows that one

fourth of the long-term unemployed do not return to

the labour force. Those who manage to return often do

not achieve their earlier productivity level, which is one

reason why those who return average 20 per cent lowerpay.

The continued decline in home prices is another fac-

tor that may affect the supply side of the economy.

Geographic mobility is one important reason why output

and employment recoveries have historically been so

dynamic in the US. Many households have now lost a

large percentage of their residential capital. In many

cases they are stuck in homes worth less than their

mortgages. This will probably reduce mobility and thus

slightly push up the non-accelerating ination rate of

unemployment (NAIRU).

Such supply side questions will become more acute

further along in the recovery. In some respects, these

problems may have time to correct themselves, provid-




The United States

ed that the US economy enters a more positive recovery

dynamic. Otherwise fresh economic policy thinking may

be required to avoid long-term damage.

Ratio

Government spending for each USD of revenues

Source: US Department of the Treasury, SEB

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

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

National debt approaching new heightsThe contractive economic effect of private sector debt

reduction has been offset by explosive growth in public

sector debt. Federal debt has risen from 65 per cent of

GDP in 2007 to nearly 95 per cent today. In 2010, the

budget decit was nearly USD 1.3 trillion. This year

it will exceed USD 1.5 trillion or 9.9 per cent of GDP,

due among other things to further tax cuts. This year’s

federal expenditures will total 25 per cent of 2011 GDP,

with revenue at around 15 per cent. For every dollar

that ows into the Treasury, the US government thus

spends USD 1.60-1.70. During the post-war period, this

gure has rarely exceeded USD 1.30.

Next year we expect a slight scal tightening, and the

budget decit will then fall to USD 1.2 trillion, yet pub-

lic sector debt will continue climbing during the next

couple of years. We expect the 2012 national debt to be

slightly over 100 per cent of GDP. Although credit rating

agencies are beginning to show their displeasure, we

do not believe that the consequences will be particu-

larly large during the next couple of years. The dol-

lar’s status as a reserve currency provides a degree

of freedom to increase debt without incurring higher

borrowing costs. But there is a limit, and further ahead

the politicians will be forced to make decisions that

will bolster condence in a long-term balance, not least

because more than half this public debt is in foreignhands.

US hitting debt ceiling againThis spring the risks associated with the “debt ceiling”

will be in focus. US national debt now totals USD 14.004

trillion: a mere USD 290 billion below the legal ceiling

of USD 14.294 trillion. Most indications are that the US

Little risk of 1970s-style stagationThe Fed’s decision to implement quantitative easing

has been both praised and reviled. The most criticalvoices argue that stagation − weak growth combined

with high ination, as in the 1970s − may be the

outcome. In our assessment, that risk is small; our

forecasts instead point towards continued very low

ination over the next couple of years. In addition,

the situation today is different from that of 35 years

ago in several respects:

Most measures indicate plenty of idle resources in

the economy today, which was not the case in the

1970s.

The purpose of quantitative easing is to boost ina-tion to levels consistent with price stability; in the

1970s ination was signicantly higher at the outset.

Unit labour cost (ULC) is the most important factor

in the ination process in developed countries. At

present, ULC is still falling year-on-year. But 30

years ago, wages and salaries were rising at a faster

pace than productivity justied, among other things

because the labour union movement was stronger in

those days.

Mechanical monetary policy rules such as the Taylor

rule indicate that, if anything, monetary policy is

too tight today. During the 1970s, in contrast, mon-

etary policy was too accommodative.

We can also note that upturns in commodity prices

quickly spread to core ination in the 1970s, asevidenced by the high correlation between core and

headline measures. In recent years, core ination

has trended downward and has not been affected by

commodity-driven variations in headline ination. The

trend of underlying ination thus seems to be driven to

a greater extent by such factors as resource utilisation

and long-term ination expectations.


Core inflation heading down

All items All items less food and energySource: Reuters EcoWin, SEB

70 75 80 85 90 95 00 05 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




The United States

Treasury will hit the debt ceiling in April or May. Raising

this ceiling is not exactly unusual: it has been raised

74 times since 1962, and 10 times since 2001. The last

time was a year ago. But occasionally this issue has led

to political conicts, including this time around.

When the Treasury reaches the federal debt ceiling, it

is prohibited from issuing further debt securities before

Congress has approved an increase in the ceiling. This

will apparently become an important tool in efforts to

push through other reforms; this may include taking a

closer look at the proposals of President Obama’s decit

commission. House Republicans are now reportedly also

pushing for USD 50 billion in budget cuts this year. The

pension reform issue may also come up.

Per cent of GDP, USD trillion

Debt ceiling will soon be reached

Federal debt, percent of GDP (LHS)Federal debt, trillion (RHS)

Source: US Department of the Treasury, BEA, SEB

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

4

5

6

7

8

9

10

11

1213

14

15

55

60

65

70

75

80

85

90

95Current debt ceiling

The Fed will hike its key rate in a yearIn our assessment, after the Fed completes the USD 600

billion in bond purchases it has announced, it will stop

making such purchases. What may disrupt this scenario

is if core ination approaches zero, or if economic

growth turns out to be much weaker than we believe;

in that case, further stimulus may be called for. New

estimates from the Fed indicate that quantitative eas-

ing is effective: its bond purchases in recent years will

boost ination by one percentage point and generate

3 million jobs by 2012, according to the Fed’s models.

Measures aimed at actively shrinking the Fed’s balance

sheet − reversing quantitative easing − will probablynot be launched during our forecast period. Leaving QE

in place for a few years is a cornerstone of the Fed’s

calculations.

To summarise, our assessment is that the US central

bank will hold off before making its rst interest rate

hike in April 2012 and that the federal funds rate will

stand at 1.75 at the end of our forecast period. This

implies that the Fed will hold off somewhat longer than

the market has now priced in, but normalise rates more

rapidly.

Changes in the Fed’s voting system may have an effecton the detailed formulation of US monetary policy. Each

year ve regional Fed presidents are entitled to vote,

according to a rotating timetable, with the head of the

New York Fed always included. Judging from recent

speeches, this year’s Federal Open Market Committee

is slightly more hawkish than last year, since Richard

Fisher (Dallas Fed) and Charles Plosser (Philadelphia

Fed) will vote on the FOMC while Thomas Hoenig (Kan-

sas City Fed) has left. But although interest rate hawks

get a lot of media coverage, they are a clear minor-

ity and do not set the tone of the FOMC. Instead we

believe that possible shifts in the positions of Chairman

Ben Bernanke, the New York Fed’s William Dudley and

Vice Chair Janet Yellen will be decisive.

Obama rebounding

With less than two years left until the 2012 presiden-

tial election, our assessment is that Barack Obama’s

chances of being re-elected are relatively good. His

approval rating is admittedly still rather weak; only

around 50 per cent of the population thought thepresident was doing a good job in mid-January. But

the experience of recent decades indicates that public

opinion gures can shift rapidly. Bill Clinton was in a

similar position in the spring of 1995 yet still managed

to be re-elected by a wide margin in 1996. Ronald

Reagan had very weak public approval ratings early in

1983, but won a landslide victory in the 1984 election.

George Bush, both father and son, enjoyed far better

support in the 1991 and 2003 opinion polls respec-

tively, but George H.W. lost and George W. won by

the narrowest possible margin. Early in 1979, Jimmy

Carter was roughly where Obama is today, but he

failed to be re-elected.

Our conclusion is that the economic situation in

the period leading up to the election decides the

matter. If our forecasts of decent growth and falling

unemployment prove correct, Obama is likely to be

re-elected in 2012. The economy helped both Reagan

and Clinton but sank Carter and the elder Bush.

Obama has also shown considerable willingness to

compromise and has taken various steps towards the

political centre, which appear to be smart moves.



Japan


Recovery losing momentum Clear deceleration in growth this year

Exports gaining traction, but weak domes-tic demand

Fiscal weakness requires tax reform

A sharp recovery in exports and industrial production in

the rst half of 2010 lifted Japan’s GDP by around 4 per

cent for the full year, but the fourth quarter as well as

early 2011 appear to have been weak. We predict GDPgrowth of 1.6 per cent both in 2011 and 2012.

The purchasing managers’ index in the manufacturing

industry is just above 50, and leading indicators are

faltering. Consumer condence is at its lowest level

for nearly two years, which is also reected in weak

retail sales. We expect consumption growth to average

around 1 per cent in 2011-2012.

Industrial production has risen in the past two months,

but only after it had fallen for ve straight months.

According to the Bank of Japan’s latest Tankan survey,

the competitive position of the manufacturing sectordeteriorated during the fourth quarter of 2010. Weak

order bookings indicate a continued decline in capital

spending. Residential construction remains at a low

level, but rents for ofce space have rebounded.

Index 100 = 2000

Exports are taking off again

Industrial p roduction ExportsSource: Ministry of Finance, METI

00 01 02 03 04 05 06 07 08 09 10

70

80

90

100

110

120

130

140

150

160

170

180

190

70

80

90

100

110

120

130

140

150

160

170

180

190

After a slump, exports have clearly recovered in recent

months. The negative impact of yen appreciation during

2010 (4 per cent in effective terms) is being offset by

stronger demand in China and the US. Annual export

growth will average around 5 per cent in 2011-12.

The labour market improvement last summer and early

autumn has slowed. Unemployment will remain at

around 5 per cent during the next couple of years.

Headline CPI ination has crept up to zero in recent

months, but core ination remains negative. There are

no signs that the ination rate will start climbing to any

great extent. We expect CPI ination to be weakly

positive both in 2011 and 2012.

Continued deflation pressure

CPI Core inflationSource: Statistics Bureau, Ministry of Internal Affairs and Communication

00 01 02 03 04 05 06 07 08 09 10

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.51.0

1.5

2.0

2.5

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.51.0

1.5

2.0

2.5

Government efforts to highlight public debt prob-

lems and Japan’s need for tax reform have dominated

domestic policy. The newly appointed economic and

scal policy minister, Kaoru Yosano, wants to launch

quick improvements in government nances. The issue

gained new urgency when Standard & Poors downgraded

Japanese sovereign debt to AA-. Prime Minister Naoto

Kan continues to underscore the need to reform the tax

system; high government debt and budget decits make

change vital. In December, the government approved a

cut in corporate tax to 35 per cent. It has invited the

opposition for talks on raising the sales tax from the

current 5 per cent. This would risk hurting already weak

retail sales. Making all reform efforts more difcult is

the record-low public condence in the government.

The Bank of Japan will keep its key interest rate

unchanged in the 0.00-0.10 per cent interval until the

third quarter of 2012, while retaining its credit facility

and asset purchase fund.

The government has also made clear its willingness to

intervene again in the foreign exchange market if the

yen continues to appreciate. We expect the USD/JPY

rate to stand at 90 at the end of 2011 and 98 at the

end of 2012.



Asia


Good growth but rising ination More acceptance of currency appreciation

Continued monetary tightening in China

Risk of overheating in India

GDP growth in Asian emerging countries decelerated

during the third quarter of 2010, but there are many

indications of stabilisation in the fourth quarter. Exports

and industrial production show continued good growth

in most of these economies, despite noticeable ap-preciation in many currencies. During 2011 and 2012

we expect continued strong growth, but it will slow

somewhat because rising ination and large capital

inows will force governments to keep tightening their

economic policies.

Ination pressure in the region has increased in recent

months. Rising food prices play a crucial role, since

food accounts for a very large share of CPI in develop-

ing economies. There are major risks of discontent and

protests against high food prices, not least in China. So

far, however, there are few signs of a broad ination

upturn in the region, although core ination has begun

rising in China, Indonesia and elsewhere.

Per cent

Inflation is rising in Asia

ChinaIndonesia

South KoreaMalaysia

ThailandIndia

Source: National statistical offices

07 08 09 10

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

Many Asian countries have begun taking steps to prevent

ination expectations from soaring. We expect China

to continue tightening monetary policy in 2011. India

will be forced to hike interest rates further to tackle

ination, which has taken off again. South Korea raised

its key rate in January. Indonesian ination is now well

above target and core ination has also climbed signi-

cantly. Key rate hikes are being supplemented by otheractions. For example, Indonesia and China have raised

their bank reserve requirements to slow credit expan-

sion. Steps have been taken to increase food supply,

while food price controls are being considered.

Differences in interest rates and growth outlook com-

pared to the US and Western Europe are continuing to

generate large capital ows into the region. This risks

causing macroeconomic imbalances and price bub-

bles for assets like real estate and equities, which in

turn may threaten nancial stability. To counter such

tendencies, Asian countries have intervened in foreign

exchange markets. Rising ination seems to be making

countries willing to allow more currency appreciation

than before. Rapid pay increases in many countries are

also speeding the pace of real appreciation.

China: Continued strong growthDuring the fourth quarter of 2010, GDP rose by 9.8 per

cent, which was somewhat higher than expected. For

2010 as a whole, growth ended up at 10.3 per cent. We

are revising our 2011 growth forecast slightly upward

to 9.5 per cent and expect growth of 8.5 per cent in

2012.

The purchasing managers’ index in manufacturing fell

somewhat in December but still indicates good growth.

Industrial production has stabilised at year-on-yeargrowth of around 13 per cent. Retail sales have been

strong, and in December the increase was around 19

per cent. Export growth decelerated in the second half

of 2010; in December the year-on-year rate of increase

was 18 per cent, the lowest since December 2009.


Export and import growth is slowing

Exports ImportsSource: National Bureau of Statistics

00 01 02 03 04 05 06 07 08 09 10

-50

-25

0

25

50

75

100

-50

-25

0

25

50

75

100

Import growth has also decelerated, but in the past

months the rate of increase in imports has been higher

than that of exports. We expect this trend to persist. It

reects the increasing importance of domestic con-

sumption and is shrinking China’s large trade surplus.

This surplus fell from USD 196 billion in 2009 to USD

183 billion in 2010, but the politically sensitive trade




Asia

surplus against the US remains at a high level. It was

USD 25.6 billion in November. Chinese authorities have

expressed a desire to see the surplus continue shrinking

in 2011.

Calmer housing market trend

As expected, home price increases have continued toslow. In December the year-on-year increase in the

70 largest cities of China was 6.4 per cent, or half

the growth rate of last spring. The measures that the

authorities have undertaken to cool down the market

thus seem to have had an effect. Sharply increased

construction will probably lead to a further slowdown.

A property tax has been launched on a trial basis in

Chongqing and Shanghai. According to the new ve-year

plan, more than 15 million residential units will be com-

pleted before the end of 2012. Overall, we thus believe

that home prices will level off during the latter part

of 2011.

Tightening in response to rising inationInation is continuing upward. In November, CPI ina-

tion reached 5.1 per cent, its highest level since July

2008, but in December ination slowed to 4.6 per cent.

Higher ination was mainly caused by rising food prices;

food ination reached 9.6 per cent in December. Core

ination, which excludes food and energy, also climbed

and was 1.5 per cent in November. Ination expecta-

tions rose signicantly in the fourth quarter of 2010.

The December ination rate decline is largely explained

by base effects, and we expect ination to remain high

in the next few months.

Per cent

Food prices driving up inflation

CPI Core inflation Food pricesSource: National Bureau of Statistics

05 06 07 08 09 10-5

0

5

10

15

20

25

-5

0

5

10

15

20

25

China is now tightening its monetary policy to counter

the ination upturn. On Christmas day, the central bank

raised its key interest rate by 25 basis points to 5.81

per cent − the second such hike in 2010. Several other

tightening measures have been implemented. The bank

reserve requirement was raised six times during 2010

and once again in January 2011 and now stands at 19

per cent for most banks. The new 2011 lending target

for banks has also been lowered compared to 2010.

We expect China to continue its monetary tighten-

ing during the rst half of 2011. The central bank has

communicated clearly that monetary policy needs to

be normalised. The current key interest rate of 5.81

per cent is still well below the long-term average of

7.5 per cent. For example, a deposit rate of 2.75 per

cent means that real interest on household bank sav-

ings is clearly negative. This indicates signicant room

for further rate hikes. On the other hand, excessivelyaggressive rate hikes risk worsening the problem of

speculative foreign exchange inows. Our assessment

is thus that the Chinese authorities will need to use

different tools in their tightening policy. Key interest

rate hikes will be combined with increases in reserve

requirements and stricter controls on currency inows.

We predict three additional interest rate hikes during

the rst half of 2011, bringing the key rate to around

6.5 per cent. While monetary policy is being tightened,

scal policy will be less expansionary.

China’s currency appreciation will contribute to eco-

nomic policy tightening. Since late June, when theappreciation of the yuan against the US dollar was

resumed, the yuan has strengthened by around 3.5 per

cent. Real effective appreciation totalled around 5 per

cent during 2010. Although appreciation has acceler-

ated early in 2011, China rejects the demands of other

countries for a radically faster appreciation rate, and

we expect this cautious policy to continue. However,

we expect the appreciation rate to increase somewhat

in 2011 in order to counter ination, help slow export

growth and support domestic consumption by making

imports cheaper. Our assessment is that the USD/CNY

rate will be 6.30 by the end of 2011 and 6.00 by theend of 2012. This represents an appreciation of 4-5

per cent annually.

The yuan appreciated during 2010

USD/CNY (LHS) Real exchange rate (RHS)Source: BIS, Reuters Ecowin

05 06 07 08 09 10

95

100

105

110

115

120

125

1306.50

6.75

7.00

7.25

7.50

7.75

8.00

8.25

8.50

Exchange controls clearly looseningStrict currency controls are now being loosened as part

of a long-term strategy to give the yuan a larger global

role. For example, Chinese companies will be allowed

to use yuan to start operations abroad by acquiring and

merging companies. Chinese export companies will also

be allowed to keep their foreign revenue in accounts atforeign banks. However, foreign investments in China

will remain strictly regulated, decreasing the motiva-

tion for foreign companies to hold yuan.




Asia

India: Ination accelerating againIndia’s growth remains strong, and during the third

quarter GDP rose by 8.9 per cent. Industrial production

growth is slowing, however. In November the upturn

was only 2.7 per cent year-on-year, the slowest since

May 2009. But the gures have been highly volatile in

recent months, and some observers are beginning toquestion the quality of the statistics. Other indicators

are showing continued good growth. The composite

purchasing managers’ index is just above 55, indicating

continued expansion. Leading indicators have risen at a

robust rate and provide a similar picture. A favourable

trend in the agricultural sector is also contributing to

strong growth. We expect GDP growth of 8.5 per cent

in 2011 and 7.5 per cent in 2012.

India’s high ination rate slowed in November, but

rebounded in December to 8.4 per cent. Ination is thus

far above the central bank’s medium-term target of 3

per cent.

Per cent

India: Inflation and key interest rate

Key interest rate InflationSource: Ministry of Commerce and Industry, Reserve Bank of India

05 06 07 08 09 10 11

-2

0

2

4

6

8

10

12

-2

0

2

4

6

8

10

12

As expected, the falling ination rate in November

persuaded the Reserve Bank of India to hold off on any

interest rate hike in December, but late in January it

hiked its key rate by 0.25 percentage points to 6.5 per

cent. The key rate has thus been raised 1.75 percent-

age points from its low in April 2009, but in real terms

it is well into negative territory. The ination surge inDecember surprised the central bank, and several rate

hikes will probably be needed to keep ination expecta-

tions from soaring.

Unlike other Asian countries, India is running current

account and trade decits. The trade decit has been

large for a long time. In December, however, it fell to

its lowest level in three years because exports in-

creased while imports were the lowest in 14 months.

Also worth noting are the liquidity problems in the

banking sector. A combination of strong growth, tighter

monetary policy, low seasonal central governmentexpenditures and several large companies being oated

in the stock market contributed. India’s banks have

begun competing for liquidity by raising their deposit

interest rates. For a long time, the central bank viewed

the tighter liquidity situation as a welcome strengthen-

ing of the monetary policy transmission mechanism. In

December 2010, however, the central bank made the

assessment that the liquidity situation was problematic

and took action. In addition, higher government spend-

ing is expected to contribute to better liquidity in the

next several months.

Since last autumn, the currency has stabilised againstthe US dollar after a period of appreciation. We expect

that the rupee will stand at 43 per USD by the end of

2011.

China’s twelfth ve-year plan, 2011-2015China has been using ve-year plans since the 1950s.

These plans are now called “guidelines”, reecting

the fact that are increasingly dominated by general

objectives instead of detailed quantitative targets for

different economic variables. A preliminary version of

the twelfth ve-year plan has already been unveiled,but the nal version will not be approved until March.

The main theme of the new plan is that China is aim-

ing at a strategic change in its growth model. The

focus will be on generating higher “quality” growth

rather than merely generating rapid growth. Consump-

tion will enjoy priority by means of decreased house-

hold saving, while exports and capital spending will be

less important than before. The plan is also expected

to emphasise greater equality, environmental protec-

tion and investments in strategic industries. The fol-

lowing specic areas will have high priority:

health care

infrastructure

construction of homes for low-income households

environmental protection and energy efciency

reduced carbon dioxide emissions

more equitable income distribution



The euro zone


Germany in the lead, amid widening gaps Growth nearly 2 per cent despite contin-

ued problems in southern Europe

HICP will fall, but ination risks have risen

Stability Fund will narrow ECB’s role

Re rate hikes will begin in September

Euro zone GDP growth was 1.7 per cent in 2010, higher

than last autumn’s consensus. Germany, beneting froma powerful upswing in exports and capital spending,

recorded the currency area’s highest GDP growth (3.6

per cent), and Greece the lowest (-4.1). Overall, the

recovery will continue this year. As in 2010, Germany

will be the main growth engine; leading indicators such

as the IFO index are signalling GDP growth just above

3 per cent this year, but continued weak performance

in southern Europe will widen the gap in the euro

zone. The Greek economy will shrink about 3 per cent

this year. Spain is on the brink of recession. In the euro

zone as a whole, growth will reach 1.9 per cent this

year and 1.8 per cent in 2012, somewhat higher than

we believed in November.

Percentage change

Decent growth in 2011-2012

Quarter-on-quarter, annualisedYear-on-year percentage changeGrowth 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

Italy, Portugal and Spain carried out successful sover-

eign bond issues in January, slightly easing short-term

concerns about their budget and debt problems, but

these problems are far from solved. The risk premium

is unsustainably high in several countries, which puts

pressure on European politicians to act. The temporary

European Financial Stability Facility (EFSF) will play a

central role in the future, partly because of an expand-

ed mandate.

Ination as measured by the Harmonised Index of Con-

sumer Prices (HICP) rose to 2.4 per cent in January, due

to high energy and food prices. Although it will probably

fall, ination will remain a source of concern for the

European Central Bank (ECB) as resource utilisation in

several countries moves back towards normal levels.

With the EFSF assuming a larger role in sustaining

growth in southern Europe, the ECB can focus more on

its ination-related task. We believe that the ECB will

hike its re rate to 1.25 as early as September 2011,

then raise it again in December and four times in 2012.

The re rate will be 1.5 per cent in December 2011

and 2.5 per cent in December 2012.

Large differences in growth ratesThe German economy is continuing to show strength.

Last year’s export and capital spending upturn, which

was reected among other things in a three-year high

for the IFO index, will continue in 2011. The “business

conditions” sub-index was still around 110 in Janu-

ary and the “expectations” sub-index, which provided

upside surprises late in 2010, also remains high. Given

the close co-variation between the IFO index and GDP

growth, dynamic growth seems set to continue during

early 2011. Because of an improving labour market, pri-vate consumption is also starting to climb. We predict

that German growth will end up at 3.1 per cent this

year and 2.5 per cent in 2012, above the consensus

forecast.

Composite index

Widening gap in the euro zone

Germany Southern EuropeSource: 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

Several indicators illustrate the gaps in economic

performance between different parts of the euro zone.

German order bookings are currently increasing at

about 20 per cent year-on-year and output by around

10 per cent, twice as fast as in Italy and France.

Elsewhere in southern Europe, manufacturing sector

performance is even weaker.




The euro zone

It thus appears likely that the euro zone will continue

to show wide gaps during 2011-2012. In France, GDP

growth will reach 1.7 per cent this year and 1.5 per

cent in 2012. Italy will grow by 1.3 and 1.5 per cent,

respectively. Spain, which is teetering on the brink

of recession, will grow by less than 0.5 per cent this

year and a bit above 1 per cent in 2012, but the Greekeconomy will shrink again (-2.9 per cent) for the third

year in a row and move sideways in 2012. Ireland, in

turn, will grow by 0.5 and 1.1 per cent in 2011-2012.

GDPYear-on-year percentage change

2009 2010P 2011 2012

Germany -4.7 3.6 3.1 2.5

France -2.5 1.6 1.7 1.5

Italy -5.1 1.1 1.3 1.5Spain -3.7 -0.2 0.4 1.2

Greece -2.3 -4.1 -2.9 0.0

Portugal -2.6 1.3 -1.0 1.0

Ireland -7.6 -0.7 0.5 1.1

Euro zone -4.0 1.7 1.9 1.8

Source: Eurostat, SEB

Stronger domestic demandSo far, the recovery has been driven by rising exports,

while the contribution from domestic demand has been

small. To prevent the recovery from running out of

steam when the market for manufactured goods enters

a more mature phase later this year, domestic demand

will have to take over as a growth engine. This will

also happen, though at a leisurely pace. Low interest

rates and rising capacity utilisation point towards an

acceleration in gross xed investments this year, and

we predict an annual upturn of about 4 per cent in

capital spending during 2011-2012.

Year-on-year percentage change and per cent

Accelerating capital spending

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

Private consumption will also accelerate a bit thisyear, despite conspicuous scal tightening measures

in various crisis countries. Positive signs, such as more

aggressive hiring plans, falling unemployment and rising

consumer condence indicate that consumption will

increase somewhat. In Germany, a slight acceleration in

the rate of pay increases will contribute to this. Over-

all, we believe that euro zone private consumption

will increase by 0.8 per cent this year and just above

1 per cent in 2012: a cautious rebound in consumption,

viewed in a historical perspective.

Index and year-on-year percentage change

Consumer confidence is climbing

Consumer confidence (LHS)Private consumption (RHS)

Source: DG ECFIN, Eurostat

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

Major belt-tightening in 2011-2014The euro zone’s problem countries are now carrying out

conspicuous cost-cutting measures to bring down their

budget decits. Greece unveiled its austerity package

as early as last spring (including pay cuts and a higher

retirement age in the public sector). Last autumn the

Irish government launched a package including higher

value-added taxes, lower minimum wages, 25,000

fewer public sector jobs and a new pension system,while keeping the corporate tax at a low 12.5 per cent.

The Irish budget package is expected to total about 10

per cent of GDP during the period 2011-2014. Ireland’s

political crisis has deepened in recent weeks, including

Prime Minister Brian Cowen’s resignation as head of the

Fianna Fail party. A new election will be held on Febru-

ary 25. The Green Party, Cowen’s coalition partner,

terminated collaboration in January, even though the

Greens have accepted the main features of his budget

consolidation programme. The opposition has criticised

portions of Ireland’s international loan agreement and

proposed improvements in borrowing conditions. We do

not believe the loan agreement is in danger, although

some adjustments may occur after a probable change

of government. Experience from other countries (such

as Latvia) indicates that the entire political system

normally accepts existing international agreements,

despite a domestic debate climate that can sometimes

be uncompromising.

Last autumn’s austerity budget in Portugal, including

VAT hikes and the sale of government assets, increased

that country’s total belt-tightening measures to nearly

6 per cent of 2011-2013 GDP. Spain’s tightening meas-

ures−

targeting generous severance pay for dismissedemployees and reforming the pension system − will not

be enough, according to the OECD, which also wants

various changes in the country’s tax legislation. Spanish




The euro zone

banks are sitting on dangerously large credit risks (near-

ly EUR 180 billion, according to Moody’s credit rating

agency). This has led many observers to begin speculat-

ing that Spain may also need to seek an EU bail-out.

The country’s weakest savings banks, or “cajas”, have

especially large problems and there are plans for a gov-

ernment takeover. The government has said it is willingto resort to further belt-tightening if the budget decit

does not improve as expected. We believe Spain will be

forced to launch further austerity packages during the

spring, increasing its total belt-tightening measures to

nearly 7 per cent of 2011-2014 GDP.

Per cent of GDP

Fiscal tightening, 2010-2014

PortugalIreland

ItalyGreece

Spain

Source: SEB

1

2

3

4

56

7

8

9

10

11

1

2

3

4

56

7

8

9

10

11

Total belt-tightening in Greece, Ireland, Italy, Por-

tugal and Spain will end up at 4-5 per cent of GDP

during 2011-2014. Lower public sector expenditures

will account for most austerity measures: about 3 per

cent of GDP, compared to less than 1.5 per cent of

GDP in higher taxes. One reason why aggregate belt-

tightening is not higher is that Italy, the largest country

in the group, has not yet announced any major austerity

ambitions.

Public budget balance, selected countriesPer cent of GDP

2009 2010P 2011 2012

Germany -3.0 -3.6 -2.1 -1.5

France -7.5 -6.8 -5.5 -3.5

Italy -5.3 -4.4 -3.8 -3.3

Spain -11.1 -8.9 -7.0 -6.2

Greece -15.4 -9.5 -7.6 -6.1

Portugal -9.3 -7.1 -5.7 -4.7

Ireland -14.4 -32.0 -9.1 -8.0

Euro zone -6.3 -6.2 -4.5 -3.5

Source: European Commission, SEB

In Germany, the budget situation has improved. The

public decit (according to the Maastricht denition)

reached 3.6 per cent of GDP in 2010, lower than most

observers had expected. This was mainly because the

rapid upswing in the economy led to rising company

prots and thus higher tax payments from the corporate

sector. The gradual strengthening of the labour market

also contributed to the budget improvement. As earlier,

we expect Germany to meet the Maastricht criterion of

a budget decit below 3 per cent of GDP as early as this

year; the decit will reach 2.1 per cent of GDP this year

and 1.5 per cent in 2012. In the euro zone as a whole,

the budget decit will total 4.5 per cent of GDP this

year and 3.5 per cent in 2012.

Successful bond issues, but Spain

in risk zoneMarket worries about suspended payments and about

more countries being forced to request help from the

EU and IMF refuse to go away. Long-term yield spreads

against Germany have admittedly fallen somewhat in

recent weeks, but they remain at very high levels. It

has not helped that Greece and Ireland have already

accepted loans of EUR 110 and 85 billion, respectively,

and have also unveiled tough austerity programmes.

Spread against Germany, percentage pointsYields on 10-year government bonds

FranceGreece

IrelandItaly

PortugalSpain

Source: Reuters EcoWin

Oct

08

Jan

09

Apr Jul Oct Jan

10

Apr Jul Oct Jan

11

0

1

2

3

4

5

6

7

8

9

10

0

1

2

3

4

5

6

7

8

9

10

In January 2011, Italy, Portugal and Spain managed to

nance their decits in the capital markets. Generally

speaking, these countries have found it easier to obtain

nancing for shorter maturities. This can be regarded

as a sign that the market is increasingly focusing on

long-term solvency problems. Although the bond issues

went smoothly and were oversubscribed, the calm in

nancial markets is only temporary. We expect that as

early as this spring, Portugal will be forced to throw

in the towel and ask for emergency loans from the

EU and the IMF. It cannot be ruled out that Spain willalso need help.

We thus anticipate that additional countries will need

to take further steps to regain market condence.

Larger countries such as Italy and France will probably

need to carry out belt-tightening programmes to avoid

the spread of mistrust.

Unemployment will fall slowlyEuro zone unemployment rose somewhat in 2010, from

9.9 per cent in January to 10.0 per cent at year-end.

This is the highest level in 12 years. Average unemploy-

ment did not climb more because the German labour

market resisted the upward trend. A combination of a

rapid upswing in the German economy and the govern-




The euro zone

ment’s allowance system to encourage job-sharing

helped push down unemployment from 7.3 per cent in

January to 6.7 per cent at year-end (according to the

European Commission’s harmonised measure), its lowest

level since 1992.

Unemployment, per cent

Germany's labour market has resisted the trend

Germany

France

Italien

Spain Source: E urostat

00 01 02 03 04 05 06 07 08 09 10

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

There are wide disparities in the euro zone, despite

similar allowance systems in other countries. In France,

for example, unemployment remained stable at just

below 10 per cent last year, and in Italy it rose from 8.3

per cent in January to 8.7 per cent at year-end. The

Spanish labour market is in even worse shape; early in

2007 the jobless rate was 8 per cent, in November 2010

it was a full 20.6 per cent. But last year’s strong tourist

season, with fewer dismissal notices, contributed to a

degree of stabilisation during the summer and autumn.

Employment rose by 0.4 per cent between the second

and third quarter.

Year-on-year percentage change and net index

Employment on the way up

Employment (LHS)Expected employment (RHS)

Source: Eurostat

00 01 02 03 04 05 06 07 08 09 10-40

-35

-30

-25

-20

-15

-10

-5

0

5

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Leading indicators, such as company hiring plans as

measured by the European Commission, point towards

a continued slow improvement in the labour market.

We believe that euro zone unemployment will fall

to an average of 9.8 per cent this year and 9.5 per

cent in 2012. This represents a small upward adjust-

ment compared to our November forecast. In Germany,

France and Italy, we expect a downturn in the same

range as the euro zone average, that is, around 2-3tenths of a percentage point per year. Spanish unem-

ployment will probably fall about one percentage point

a year. This means that it will remain as high as 18 per

cent in 2012.

As indicated in the chart below, the euro zone is ap-

proaching its long-term non-accelerating ination rate

of unemployment (NAIRU). At the end of 2012, we

expect the unemployment gap (the difference between

actual unemployment and NAIRU) to be about 0.5

percentage point. The jobless rate will fall faster than

assumed by “Okun’s Law”, which relates unemployment

to the output gap, partly due to temporary job-sharing

allowances. But when these allowances are phased

out, there is a risk that unemployment will rebound

somewhat, thus falling more slowly than we are now

forecasting. Growth is large enough to cause unemploy-

ment to fall, according to our estimates of what GDP

growth is normally required to keep unemployment at

a constant level (see Nordic Outlook, August 2010).

These estimates indicate that the growth requirement

has fallen somewhat during the past decade in the eurozone as a whole, from about 2.3 per cent in 1990-2000

to about 1 per cent in 2000-2010.

Per cent

Unemployment will creep downward in 2011-2012

Okun's Law Unemployment NAIRUSource: Eurostat, OECD, SEB

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

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

SEB

forecast

Continued pay squeeze in southernEuropeThe upturn in unemployment over the past few years is

continuing to squeeze wages and salaries. Total hourly

wage costs in the euro zone, which rose by 3.5 per cent

as recently as 2008, ended up at a low 1.5 per cent

increase last year. The pressure on wages in southern

Europe will continue during the next couple of years.

The need for internal devaluation in southern Europe,

i.e. restoration of competitiveness either by lowering

relative pay or improving relative productivity levels,

is in the 20-30 per cent range. Public sector pay cuts

in various countries have been justied on the basis of

scal arguments, but these measures will also lead to

a pay squeeze in the private sector. Low pay agree-

ments that extend into 2012 in various other euro zone

countries also indicate that wage and salary costs will

again increase slowly this year.

In Germany, however, some tendencies in the opposite

direction are discernible. The stronger labour market

has led to calls for higher pay, but so far no higher new




The euro zone

agreements have been concluded. The collective con-

tract for Germany’s metalworkers, which provides for

pay hikes of 2.7 per cent year-on-year, runs until March

2012. This spring the chemical industry will negotiate

new pay agreements, and considering the recovery in

this sector it is likely that these agreements will end

up somewhat higher. We expect wages and salaries toincrease by about 2.5 per cent in Germany this year and

by more than 3 per cent in 2012. In the euro zone, pay

increases will reach about 1.5 per cent this year and

about 2 per cent in 2012.

Percentage points, year-on-year percentage change

Low pay increases this year, higher in 2012

Change in unemployment, shifted 2 years forward (LHS)Change in wage and salary cost in manufacturing (RHS)

Source: Eurostat, SEB

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

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Ination back below 2 per centHigher energy and food prices drove up HICP ination

to 2.4 per cent in January. The ination rate was 2.2

per cent in December, and the average rate for the year

ended up at 1.6 per cent. Underlying ination (HICPadjusted for energy and food) totalled 1.1 per cent in

December, making the full-year gure 1.0 per cent.


Higher taxes driving up inflation in southernEurope

Southern Europe Euro zone excl. southern EuropeSource: Eurostat, SEB

01 02 03 04 05 06 07 08 09 10

-1

0

1

2

3

4

5

-1

0

1

2

3

4

5

The upturn in energy and food prices, combined with

higher value-added taxes in several countries in south-

ern Europe, drove ination higher than elsewhere

in the euro zone. Greece raised VAT in two stages,

from 19 to 23 per cent, Ireland from 21 to 22 per cent.

In Portugal, VAT was increased to 23 per cent (from

the previous 21). Further ahead, adjustment needs

in southern Europe will restrain wage increases and

domestic demand, contributing to a deceleration in

ination relative to other euro zone countries in 2011

and 2012.


HICP inflation soon below 2 per cent again

HICP inflation Core 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

HICP ination will now slow as the contribution from

energy and food prices (more than 1 percentage point

in December) fades during the second quarter. In

addition, current pay agreements as well as capacityand resource utilisation remain low in the euro zone as

a whole. Ination expectations have admittedly risen

somewhat, but are still rather restrained (“break-even

ination” is now at 1.9 per cent).

We expect HICP ination to fall gradually to 1.5 per

cent next December. Measured as annual averages,

HICP ination will reach 2.0 per cent this year and

1.4 per cent in 2012. Core ination will be relatively

stable in the 0.8-1.1 per cent range during the rest of

this year, then rise towards 1.5 per cent in late 2012.

Net balance and per centInflation expectations just below 2 per cent

Households' expected price trend, next 12 months (LHS)Break-even inflation 2012 (RHS)Source: DG ECFIN, Reuters EcoWin

02 03 04 05 06 07 08 09 10

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-20

-15

-10

-5

0

5

10

15

20

25

30

35

ECB will hike repo rate in SeptemberThe euro zone’s relatively high HICP ination at present

exceeds the ECB’s target: ination close to but not

above 2 per cent. This caused ECB President Jean-

Claude Trichet to express concern about continued

rising ination after the bank’s interest rate meeting on

January 13. The ECB’s analyses now point out that only

in late 2011 will ination again creep below 2 per cent,

but Trichet emphasised that the bank has not revised its

opinion that this trend is consistent with price stability

in a policy-relevant time horizon. He indicated, how-ever, that medium-term risk (balanced at present) may

increase if administrative prices and taxes rise faster.




The euro zone

The ECB also shares our assessment that the

macroeconomic recovery will continue in the euro

zone as a whole. Leading indicators are climbing

higher, and decent global economic growth promises

continued export success. In addition, loose monetary

policy and a better-functioning banking and nancial

sector are helping domestic demand to speed up,which will mean more balanced growth in 2011-2012.

However, at the same time credit and money supply

growth remains historically low despite its recent

upturn, which indicates that demand is still relatively

modest.

Per cent

Refi rate will be hiked in September

EONIA O/N Refi rateSource: Reuters EcoW in, SEB

08 09 10 11 12 130.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

SEB forecast

As the EU strengthens the EFSF crisis fund and expands

its mandate, the division of labour between euro zone

scal and monetary policy will become clearer. The

EFSF expansion will be a response to clearer demands

that countries with high budget decits must imple-ment forceful countermeasures in the form of budget

cutbacks and reforms.

This means that the role of the ECB in helping sustain

the economic recovery in southern Europe will diminish

and that the central bank can focus more attention on

its ination-related tasks. In light of high spot ination

and the ongoing economic recovery in the euro zone as

a whole, we thus expect the ECB to hike its key interest

rate to 1.25 per cent in September this year, then raise

it again in December and four times in 2012. The re

rate will stand at 1.5 per cent in December 2011 and

at 2.5 per cent in December 2012.

The fact that Trichet is leaving his post in November

may have some signicance to monetary policy next

year, although the change should not be exaggerated

since there are six people on the ECB’s Executive Board

and all 23 central bank presidents participate in the

monetary policy decisions. The main candidates for the

ECB presidency are Lorenzo Bini Smaghi, Mario Draghi

and Axel Weber. Bini Smaghi is already an Executive

Board member, while Draghi and Weber belong to the

ECB Governing Council. In a speech on January 19, Bini

Smaghi underscored the importance of well-founded

ination expectations and toned down core ination

and output gaps in ination analysis. He thus seemsrather concerned about current high spot ination

(which can of course pull up ination expectations) and

has less faith in in the ination-squeezing effect of low

(and difcult-to-measure) capacity and resource utilisa-

tion. Draghi is usually more cautious in his monetary

policy statements and often tries to avoid conicts

with politicians. Considering the current interplay

between scal and monetary policy in the euro zone,

this indicates that he is somewhat more dovish than

Bini Smaghi. Weber, who heads Germany’s central bank

and can certainly be regarded as the favourite for the

ECB presidency, is viewed as one of the more hawkishmembers of the ECB Governing Council. He often warns

of the risks of high spot ination and also voted against

the ECB’s decision to buy Greek government bonds

in May last year. Thus the change of ECB president in

November this year, if anything, seems likely to mean a

somewhat more hawkish euro zone central bank.

ECB questioning core ination as an indicatorIn recent weeks, leading representatives of the Euro-

pean Central Bank have begun to question core ination

as a reliable measure of ination, against the backdrop

of commodity price developments and expected price

developments for imported goods from emerging econo-

mies. To date, central banks have toned down the impact

of commodity prices on monetary policy if they have

been judged as a) temporary, b) not leading to secondary

effects on other categories of goods and c) not affecting

ination expectations.

The question that the ECB is now wondering about is

whether or not higher global/imported ination is part

of a larger trend and should therefore play a larger

role in Western monetary policy. This new problem isfundamentally connected to the expected large differ-

ences between the growth of developed economies and

developing economies. If global commodity and energy

prices rise at the pace of global economic growth −

about 4 per cent annually − the impact on the domes-

tic economy is 1.2 per cent (assuming a consumption

basket consisting of about one third imported goods).

This allows room for domestic cost pressure of around

1 per cent, if the overall ination target has been set

at about 2 per cent. It should normally be possible to

offset higher ination in other countries by means of

a depreciation of their currencies. At present, that

is not happening. The currencies of many emerging

economies are under appreciation pressure. Conse-

quently, domestic cost pressure should preferably rise

by less than 1 per cent. In the euro zone, both CPI

and underlying ination are already not only above 1

percent, but above 2 per cent. This may thus be an ar-gument for the ECB to start normalising the key rate.



The United Kingdom


High ination causes policy dilemma Fiscal headwinds will slow GDP growth

Falling home prices, unhappy consumers

No key interest rate hike until November

Severe December weather contributed to a dramatic

fourth quarter reversal in the British economy; GDP

fell by 0.5 per cent quarter-on-quarter. We believe this

downturn was temporary. Loose monetary policy and

a weak pound, combined with stronger internationaldemand, will sustain decent growth despite the large

budget-tightening programmes now being launched.

GDP will grow by 1.5 per cent this year and 2.5 per

cent in 2012. Rapid price increases − ination will peak

at 4.1 per cent this summer − are creating some cred-

ibility problems for the Bank of England, but we do not

believe interest rate hikes are imminent. The BoE will

raise its key rate in November 2011. Market pricing

indicates a hike as early as this summer.

The scal austerity package will restrain growth, and

the budget decit will shrink from nearly 10 per cent

of GDP in 2010 to 6.5 per cent in 2012. Fiscal policy

will lower GDP more than 1 percentage point per year,

our calculations show. The emphasis is on lower public

spending, but other key elements of the package are

higher VAT and employer fees. Budget consolidation will

enable the UK to keep its top credit rating even though

gross public debt will reach 95 per cent of GDP in 2012.

Fast-rising prices are undermining purchasing power and

squeezing consumption. Food prices are rising by nearly

6 per cent year-on-year and petrol prices are close to

record levels, helping explain why consumer condence

has fallen sharply from last year’s peak. But no price-wage spiral is likely: Year-on-year pay hikes are at a

historically low 2.1 per cent. The freeze in public sector

pay will also contribute to low wage pressure ahead,

and consumption will be hampered by a resumption of

the home price downturn. Home prices will fall 5 per

cent in 2011 and level off in 2012, countering the

wealth effect of rising share prices; broad British indi-

ces gained over 10 per cent last year. Consumption will

rise 1 per cent in 2011 and 2 per cent in 2012. The purchasing managers’ index in the manufactur-

ing sector rose in January to its highest level since the

survey began some 20 years ago (62.0). Meanwhileindicators in both the service and construction sectors

are weaker, and manufacturing is a mere 13 per cent

of the economy. Overall, we believe capital spending

will grow by more than 5 per cent this year and 7.5

per cent in 2012, or less than in our November fore-

cast. Austerity programmes will lead to major declines

in public sector investments. The pound is sharply

undervalued, according to our calculations. The weak

currency combined with better growth in key export

markets will lift exports.

Net balance, index

Consumers are feeling blue

Consumer confidence (LHS)PMI manufacturing (RHS)

Source: DG ECFIN, Markit, SEB

92 94 96 98 00 02 04 06 08 10

35

40

45

50

55

60

65

-40

-35

-30

-25

-20

-15

-10

-5

0

5

1015

20

Traditional measures of resource utilisation make early

interest rate hikes unlikely. Unemployment rose to 7.9

per cent in December and will stay above 8 per cent in

the next six months. At the end of 2012, it will stand at

7 per cent, compared to our 6 per cent estimated non-

accelerating ination rate of unemployment (NAIRU).

The industrial production index is 11 percentage points

below its 2007 peak, indicating that there are idle re-

sources in manufacturing as well. We estimate that the

output gap in the economy is about 4 per cent.

Various factors are pushing up spot ination. Food and

energy prices are each contributing 0.6 percentage

points and VAT hikes 0.5. The weakening of the pound in

recent years has also helped push up ination rates. We

expect ination to fall slightly below target by the end

of 2012 when these factors are neutralised. Ination

expectations have not been signicantly affected. It is

true that households have raised their expectations a

bit, but “break-even” ination remains subdued.

Despite the fact that the rate-setting committee is

split, with two votes for a hike at the January meeting,

we predict that the BoE will hold off on rate hikes until

late this year. In the course of 2012 the central bank

will hike its key rate to 2 per cent, in relative harmonywith the ECB. In that environment, the pound will

recover some lost ground. The EUR/GBP exchange rate

will stand at 0.84 by the end of 2011 and 0.78 by the

end of 2012.



Eastern Europe


Faster pace despite currency appreciation Exports continue to benet from Germany

Moderate tightening will slow growth a bit

More interest rate hikes are on the way

The recovery in Eastern Europe continues at a healthy

pace. In 2011-2012 growth will accelerate further

in most countries but will not reach unsustainable

pre-crisis levels. We are revising our forecasts a bit

upward due to stronger international demand. Russiaand Ukraine will also benet from higher commodity

prices.

This year exports will again strongly support growth.

The region is mainly beneting from the positive out-

look in Germany, which buys 20-30 per cent of Polish,

Hungarian and Czech exports, for example. Eastern

European exports are in general competitive and will

not be jeopardised by the moderate currency apprecia-

tion pressure we foresee this year. Stronger curren-

cies and the need for interest rate hikes due to rising

ination may be a dilemma for some countries, such as

the Czech Republic, but the Russian and Polish central

banks have signalled their willingness to let their cur-

rencies appreciate, within reasonable limits.

Domestic demand will gradually recover. Consump-

tion will grow, aided by rising wages and slowly falling

unemployment after last year’s turnarounds. The strict

credit environment is also starting to ease. Generally

speaking, households can tolerate the moderate scal

tightening that such countries as Poland, the Czech Re-

public and Ukraine have started to launch. But there is

some downside risk in consumption estimates if higher

energy and food prices erode purchasing power.

Public debt is relatively low or moderate, diminishing

the risk that nancial turmoil will force further belt-

tightening such as in the PIIGS countries. Hungary may

again be under pressure, however. In December its

credit rating was lowered by Moody’s due to insufcient

action to deal with a large structural budget decit.

Of the larger Eastern European economies, we expect

Russia to grow fastest. GDP will increase by 4.6 per

cent in 2011 and 5.0 per cent in 2012 − forecasts

that are above consensus. High prices for oil and other

commodities (more than half of exports) will resultin good export revenue and fuel continued growth in

domestic demand. In the past six months, bank lending

has also begun to recover. Due to recent commodity

price increases, the government will further postpone

the shift to tighter scal policy that the IMF and others

are calling for, but monetary policy will soon begin to

be tightened. The repo rate was cut from 13 per cent to

7.75 per cent during the crisis. It will now be raised to

stem ination and money supply growth. Ination will

reach nearly 9 per cent this year and then slow in 2012.

Index 100 = 2000, current prices in USD

Russia: Exports and oil prices

Exports Oil prices (Brent)Source: Federal State Statistics Service

00 01 02 03 04 05 06 07 08 09 100

100

200

300

400

500

600

700

0

100

200

300

400

500

600

700

In Poland, growth will remain broad-based, with capital

spending as an ever-stronger factor. GDP will increase

by 4.5 per cent in 2011 and 4.8 per cent in 2012.

Another challenge will be the government’s handling of

its large budget decit and debt. If the latter exceeds

the constitutional limit, this will trigger further scal

austerity measures. Meanwhile monetary policy is being

tightened. As expected, the central bank raised its key

interest rate in January, to 3.25 per cent, due to con-

cerns that energy and food price-driven ination will

spread. We expect more rate hikes in March, May and

September, with the key rate reaching 4 per cent late

in the year. Because underlying ination is calm, Polandwill eventually gain control of its price surges.

Since global risk appetite remains relatively good, we

foresee generally stronger currencies. The Polish zloty

will strengthen and the EUR/PLN exchange rate will

reach 3.60 at the end of 2011. The rouble rebounded

late in 2010 after earlier weakening due to renewed

and unexpected capital outows, a process we now

believe is over. The rouble, which is as dependent on

risk appetite as some of the other Eastern European

currencies, will continue to strengthen to 33 in Decem-

ber 2011 against its USD-EUR basket because of rising

commodity prices and higher interest rates.



Baltics


Continued recovery at a moderate pace Export boom driving growth

Gradual upturn in domestic demand

Major challenges in the labour market

External forces pushing up ination

During the past year, the Baltic countries have begun

a gradual recovery after their depression-like down-

turns in 2008-2009. Their growth continues to be

driven by dynamic exports. Since last autumn, domes-

tic demand has begun to thaw, but these upturns are

being hampered because households and businesses are

still feeling the after-effects of internal devaluations

and tough public budget austerity. Latvia will continue

tightening its scal policy this year.

Fourth quarter gures indicate that last summer’s

export-driven economic turnaround, when all three

countries moved back into positive year-on-year

growth, is gaining a more solid foothold. The European

Commission’s forward-looking sentiment survey for the

Baltics has climbed further, consistent with movementsand levels in the euro zone, though Latvia has shown

a somewhat weaker increase. For 2010 as a whole, we

predict that Estonia will show GDP growth of 2.7 per

cent, while we expect Latvia to report zero growth.

Lithuania has reported plus 1.3 per cent.

In 2011-2012 we expect Estonia’s GDP to increase

by 4.5 per cent a year. Latvia’s growth will reach

4.0 and 5.0 per cent, respectively, while Lithuanian

GDP will grow by 4.0-4.5 per cent. Our forecasts,

which remain somewhat above consensus, have been

adjusted upward by half a percentage point yearly

for Estonia but are otherwise unchanged. With ex-ports playing a large role in the economy, Estonia (with

exports of about 65 per cent of GDP in 2009, compared

to 55 per cent in Lithuania and 44 per cent in Latvia)

will enjoy relatively larger support from the improved

global outlook. Estonia has also been successful with

its budget consolidation, while Latvia and Lithuania

are still grappling with large decits. This is contribut-

ing to greater uncertainty in forecasting their growth,

especially in Latvia.

Sharp upturn in exportsThe upturn in Baltic exports is dynamic. During the

third quarter of 2010, year-on-year export growth was

15-25 per cent, led by Estonia. More recent statistics

using current prices also indicate continued export ac-

celeration in Estonia and Lithuania late last year.

These export surges are due to both improved

competitiveness and a favourable geographic

position. In the past 2-3 years, the Baltics have

regained lost market share with the help of 10-20 per

cent pay cuts, a process that we believe is now over

in the private sector. Also favouring Baltic exports is

the fact that the most important markets − Russia,

Germany, Sweden, Finland and Poland − have shown

expansive growth in the past year. Appreciating

competing currencies has also helped. The improvement

in competitiveness is now largely over, but the Baltics

continue to benet from good economic conditions in

key markets.


Exports

Estonia Latvia LithuaniaSource: Local statistical offices

04 05 06 07 08 09 10

-25

-20

-15

-10

-5

0

5

10

15

20

25

-25

-20

-15

-10

-5

0

5

10

15

20

25

Household consumption in the Baltics bottomed out last

summer, but the recovery since then has been hesitant.

Retail sales volume remains low.

Index 100 = 2005, 3-month moving average

Retail sales


04 05 06 07 08 09 10

60

70

80

90

100

110

120

130

140

150

160170

180

60

70

80

90

100

110

120

130

140

150

160170

180

Consumption growth continues to be hampered byprivate debt adjustment and high, though gradually

declining unemployment. Meanwhile households will

be helped by continued low interest rates (even after




Baltics

the ECB’s coming rate hikes, which indirectly also affect

Lithuania and Latvia). Public sector pay has been frozen

this year, but private wages and salaries are rebounding

at a moderate pace, resulting in somewhat stronger

real disposable income. Latvian households will,

however, continue to be squeezed by scal tightening.

Notably, Estonian households feel considerably greatercondence in the future than Latvians and Lithuanians

do, according to the EU’s monthly sentiment surveys.

Capital spending by companies remains weak. So far

only Lithuania has shown a year-on-year increase (+15

per cent in the third quarter of 2010), though from a

very low level. Looking ahead, rising capacity utilisation

in the manufacturing sector and continued gradual re-

cuperation in housing markets point towards a gradual

increase in capital spending.

Lending to households and businesses is still declining

year-on-year, though signs of stabilisation were discern-ible late in 2010. The demand for credit is expected to

weaken in 2011 as well.

A gradual recovery in domestic demand will lead to

higher imports. Combined with a shift in ows from

foreign-owned banks and companies, which are again

making prots, this will help turn the unusual cur-

rent account surpluses of recent years into moderate

decits.

Major challenges in the labour marketUnemployment remains high, although it fell from

peaks of around 20 per cent in the rst half of 2010to 15-18 per cent late in 2010. During the overheated

period 2006-2008, unemployment bottomed out at 4-5

per cent after having previously been around 10 per

cent. The modest upturn in domestic demand indicates

that the labour market improvement will be slow. All

three Baltic countries show structural problems such as

a poor match between labour supply and demand, high

youth unemployment and a large-scale emigration wave

during the crisis years. Labour market issues will thus

remain pivotal challenges for policy makers.

Moderate inationInation has resumed and accelerated, but this is

largely due to the international wave of higher energy

and food prices plus administrative hikes including

value-added and excise taxes. In addition, there are

large statistical base effects in the calculations, since

2009 was dominated by deation.

During 2010, for example, Estonia’s year-on-year

ination rate increased from -1 per cent in January

to 5.4 per cent in December. The change in the core

ination rate was considerably calmer, from -1.5

per cent to 1.3 per cent. There were similar trends

in Lithuania and Latvia, although year-on-year coreination in those countries is still below zero.

It is difcult to foresee any broad price pressures

emerging in the short term. We expect private sector

pay to increase at a moderate pace. The three econo-

mies are also characterised by low resource utilisation,

making it difcult for companies to make price increas-

es stick. This year the ination picture will thus

continue to be dominated by developments on thecommodity side. We are raising our ination forecasts

and expect Estonia to show 4.0 per cent ination in

2011 as a whole, while Lithuania’s price increases

will be limited to 3.5 per cent and Latvia’s to 2.5 per

cent. The ination impact of Estonia’s transition to the

euro on January 1 will probably be small, but we expect

them to be somewhat higher than the 0.1-0.3 per cent

that Estonia’s Ministry of Finance foresees as a conse-

quence of companies rounding off their prices upward.

We believe that some companies will take the opportu-

nity to raise prices for other reasons.

Year-on-year percentage changeInflation (HICP)


04 05 06 07 08 09 10

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

Stabilisation in public nancesGovernment budgets are moving in the right direc-

tion after the tough scal consolidation programmes

of recent years. During the recession, Estonia managed

to maintain the stability of its public nances, includ-

ing very low debt. We expect its 2011 decit to be 1.5

per cent of GDP. The 2011 budget includes somewhat

higher increases in expenditures than in revenue. We

expect Lithuania’s decit to shrink from about 8 per

cent of GDP in 2010 to below 6 per cent in 2011. Thiswill be achieved by freezing expenditures, but without

new cutbacks. Latvia’s budget decit will shrink from

8.5 per cent of GDP in 2010 to 5.5 per cent in 2011. To

achieve this goal, which was set in consultation with

Latvia’s international creditors, the IMF and EU, this

year the Latvian government is carrying out continued

tightening measures equivalent to 2 per cent of GDP.

Both Lithuania and Latvia are aiming at achieving

budget decits of no more than 3 per cent of GDP in

2012 so they can qualify to join the euro zone by

2014. Our view is that these targets are within reach

in budget terms, but that the Maastricht ination

criterion may turn out to be a threat, especially in

Lithuania.



Sweden


Continued strong growth Exports can tolerate a stronger krona

Resource restrictions becoming visible

Ination risks ahead

Riksbank rate hike at every 2011 meeting

Surprisingly strong public nances

The Swedish economy is continuing to grow rapidly. We

have adjusted our 2011 GDP growth forecast upwardto 4.7 per cent. This implies a slight deceleration com-

pared to the record 5.7 per cent (5.4 per cent adjusted

for the number of working days) in 2010, but growth

will still be at about the level of other peaks during

the past 20 years. Next year, growth will slow to 2.6

per cent (3.0 adjusted for working days), which is still

above the long-term trend. Looking ahead, growth will

be driven to a greater extent by domestic demand.

Capital spending will soar, while consumption will be

supported by a strong labour market and a good wealth

position. Export growth will be relatively good but will

slow down somewhat.

The labour market situation improved faster than

expected late in 2010. We now believe unemployment

will drop below seven per cent as early as this year,

falling further to 6.4 per cent at the end of 2012. At

that time, it will be close to its equilibrium level.

Continued strong GDP growth

Quarter-on-quarter percentage changeYear-on-year percentage change

Source: Statistics Sweden, SEB

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q308 09 10 11 12

-8

-6

-4

-2

0

2

4

6

8

-8

-6

-4

-2

0

2

4

6

8

SEB forecast

International price upturns on food and energy have

caused ination to climb above 2 per cent. We expect

ination to fall somewhat. Ination excluding interest

rate changes (CPIF) will stay somewhat below 2 percent during most of 2011. Accelerating wage and salary

increases in 2012 will nevertheless probably be ac-

companied by a more broad-based upturn in ination

towards the end of our forecast period.

Upward revisions in ination forecasts, in a situation

where the economy is growing rapidly and the output

gap is on its way towards closing, make it likely that

the Riksbank will hike its key rate at a faster pace

than it has announced to date, in order to achieve

more normal interest levels. The European Central Bank

will already begin its rate hikes during 2011. This will

also diminish the risk of excessively large interest ratespreads over other countries. We expect the Riksbank

to raise its repo rate at every monetary policy meet-

ing during 2011, bringing the rate to 2.75 per cent at

the end of the year. During 2012 repo rate hikes will

continue, though at a somewhat slower pace, reaching

a year-end level of 3.75 per cent.

Indicators for capacity utilisation

Riksbank, RU indicator SEB's indicator Source: Riksbank, SEB

03 04 05 06 07 08 09 10

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Robust growth and rapidly rising resource utilisation

have changed the conditions for economic policy. We

thus cannot rule out the possibility that the Riksbank

must make even more radical revisions in its strategy

of raising key interest rates at a slow pace until 2013.

Rate hikes of 50 basis points may thus be possible in

mid-2011. We are not choosing to include this in our

main scenario, since the tightening effects of mon-

etary policy are reinforced by various factors. The gap

between the key rate and short-term mortgage rates

widened in recent months as a consequence of rule

changes and higher risk premiums. In addition, the ap-

preciation of the krona has a tightening effect.

More expansive scal policy, on the other hand, may

justify additional rate hikes. We expect a continuedimprovement in central government nances, which

will help intensify the debate on the value of further




Sweden

government debt reductions. The good economic situa-

tion increases the importance of reforms to improve the

supply side of the economy. The Moderate Party’s cau-

tious scal strategy and continued emphasis on incen-

tives to work and on further earned income deductions

will probably be increasingly challenged by its Alliance

coalition partners. In a situation of declining support inpublic opinion surveys, these parties will intensify their

struggle to push through their own signature issues,

especially in tax policy. We thus expect to see broader

proposals in the eld of taxation, as well as more pro-

posals on the public spending side.

Manufacturers strong, despite the kronaExports have now almost completely regained their

2008 and 2009 decline. Condence indicators are also

pointing to continued strong growth during early 2011;

expected output and order bookings, for example, are

at their highest level of the 21st century. Combined

with a stronger international economic situation, this

is why we are adjusting our 2011 export growth fore-

cast upward. But because of continued krona apprecia-

tion and ever-higher capacity utilisation, export growth

will slow from 10.5 per cent in 2010 to 9 per cent this

year and 5 per cent in 2012.

Index 100 = 2008

Merchandise exports

Sweden GermanySource: Statistics Sweden, Deutsche Bundesbank

05 06 07 08 09 10

75

80

85

90

95

100

105

110

75

80

85

90

95

100

105

110

So far, however, there are few indications that the kro-

na exchange rate will be a major problem for Sweden’s

competitiveness, although some companies will experi-

ence squeezed margins. Our calculations also show thatthe krona remains undervalued (see the Theme article).

Historically, demand has been signicantly more impor-

tant to manufacturers’ protability than the exchange

rate, as the chart below indicates. During the past year,

protability has improved, even though the krona has

appreciated substantially from its earlier weak levels.

A strong recovery in manufacturing productivity is

among the factors that have blunted the cost impact

of the stronger krona. Companies implemented tough

efciency-raising measures during the economic crisis,

and employment in the manufacturing sector shrank by

nearly 15 per cent (100,000 people). The subsequent

recovery has occurred with a very limited increase in

employment. This is one reason why we still have a way

to go before reaching krona exchange rates that will

hamper the growth of the export industry.

Profitability and exchange rate

Manufacturing, profitability assessment (LHS)TCW, % y/y, reversed scale (RHS)

Source: NIER, Reuters EcoWin

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

-15

-10

-5

0

5

10

15

20

25-40

-30

-20

-10

0

10

20

30

40

Higher capital spending by industry

in 2011Capital spending by Swedish manufacturers was un-

changed in 2010, despite a rapid increase in production.

Low capacity utilisation at the outset limited the need

for xed investments to a greater degree than expect-

ed. Late in 2010, however, capacity utilisation climbed

rapidly and is now somewhat above its historical aver-

age, according to the National Institute of Economic

Research’s Business Tendency Survey. The Statistics

Sweden survey in October showed that companies were

planning to increase their capital spending by 10 per

cent this year.


Gross fixed investment

Total Manufacturing HousingSource: Statistics Sweden

00 01 02 03 04 05 06 07 08 09 10

-30

-20

-10

0

10

20

30

-30

-20

-10

0

10

20

30

Normally, companies have a tendency to overestimate

their capital spending needs in early surveys, but this

time around the rapid upturn in capacity utilisation,

combined with a historically low capital spending level,

indicates that the increase will instead exceed corpo-

rate plans. We are thus expecting capital spending by

manufacturers to grow by 13 per cent this year and

then continue upward at a rapid pace in 2012 as well.

Residential investments have gained back their down-

turn during the crisis. Rising home prices and a low

level of residential investments compared to other

countries make a continued upturn likely. Record-




Sweden

high increases in the number of housing starts in 2010

indicate that new construction will accelerate further

in 2011. But total residential investments will be held

down by a levelling-off of renovation, following a dou-

bling in 2010 after the government introduced a tem-

porary tax deduction for home renovations and repairs.

Altogether, capital spending will increase by nearly 10per cent this year and by 4 per cent in 2012.

Gross xed investment Percentage change, 2009 level in current prices

(SEK bn) 2009 2009 2010 2011 2012

Government sector 101 4.2 2.5 0.0 -0.5

Housing 87 -23.3 21.0 19.0 7.0

Business sector 362 -18.7 2.6 11.5 4.5

Total 550 -16.3 5.5 10.5 4.0


Continued consumption boomPrivate consumption rose by 3.5 per cent during 2010.

Partly due to a rapid recovery in auto purchases, the

upturn was on a par with the highest levels of the past

20 years. With such a strong upturn in consumption,

Sweden is diverging sharply from other industrialised

countries. The large impact of earlier interest rate

cuts, an expansionary scal policy, the labour market

recovery and strong increases in household wealth are

the most important factors behind this. Yet 2010 was

an off-year in terms of income growth: the contribu-tion from tax cuts was relatively small, while wage

and salary amounts rose moderately. Because of higher

employment and continued tax cuts, the deceleration

will be temporary. Our forecast for 2012 is based on the

assumption that Parliament approves a further stage in

the earned income deduction reform equivalent to SEK

12 billion and taking effect in January 2012.


Households savings ratio

TotalExcl collective retirement saving

Financial savings, excl collective retierment savingSource: Statistics Sweden, SEB

94 96 98 00 02 04 06 08 10 12

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

forecastSEB

Household savings rose steeply during the crisis but

fell in 2010. Our forecast implies that the savings ratio

will level off during 2011 and 2012 and that saving will

remain high in a historical perspective.

Household income and consumptionYear-on-year percentage change

2009 2010 2011 2012

Consumption -0.8 3.5 3.3 2.5

Income 1.6 0.9 2.7 2.8

Savings ratio 12.9 10.6 10.1 10.4


Lending to households will slowLooking a bit ahead, the rapid upturn in home prices

and household debt in recent years constitutes the

biggest risk in the Swedish economy. After a brief

slowdown in 2008, household borrowing has accelerated

and debt is now close to 180 per cent of disposable

income, a high level in an international comparison.

Meanwhile home prices have continued climbing in a

way that diverges sharply from trends in other coun-tries.

In the latest issues of Nordic Outlook, we have dis-

cussed these risks in detail. There are several factors

underlying current developments, for example structur-

ally low home construction, exceptionally low mortgage

interest rates and strong growth in employment and

income. Meanwhile, international experience indicates

that as a rule, a debt expansion as rapid as that occur-

ring in Sweden is followed by a signicant correction.


Households continuing to increase their debts

Interest burden after taxes (LHS) Debts (RHS)Source: Riksbank, SEB

82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

80

90

100

110

120

130

140

150

160

170

180

190

3

4

5

6

7

8

9

10

11

Short-term signals from the housing market are mixed.

During the latter part of 2010, there was a slight decel-

eration in both home prices and lending to households,

but SEB’s home price indicator remains at high levels.

A strong labour market and rising incomes are continu-

ing to drive the upturn. The most likely scenario is that

loan volume and home prices will continue to increase

this year, but that the pace will slow markedly when

rising mortgage rates and the recently enacted ceiling

on loan-to-value ratios begin to have a clearer impact.

Historically, accelerations and slowdowns in householdloans have normally coincided with shifts in monetary

policy. This has occurred even in situations where

the economic cycle and the labour market have been




Sweden

moving in opposite directions. But thus pattern is not

equally clear for home prices.

Lending to households

Year-on-year percentage change (LHS)Repo rate, per cent (RHS)

Source: Statistics Sweden, The Riksbank

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

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

6

7

8

9

10

11

12

13

14

15

16

Labour market stronger than expectedEmployment rebounded as early as the end of 2009, and

the downturn in jobs during the crisis has now largely

been regained. Over the past six months, unemploy-

ment has fallen about one percentage point. Short-term

indicators such as hiring plans in the Economic Tendency

Survey and the number of newly listed job openings at

the government employment service have also continue

to strengthen. For example, hiring plans are now higher

than they were in 2007, when employment rose at

record speed. We expect unemployment to continue

downward and to drop below 7 per cent as early as

the end of 2011.

Labour marketPercentage change

2009 2010 2011 2012

Employment -2.1 1.0 2.1 1.1

Labour supply 0.2 1.1 0.6 0.4

Unemployment, % 8.3 8.4 7.3 6.6

Average hoursworked -0.6 0.9 -0.2 -0.3

Productivity (GDP) -2.7 3.3 2.7 2.1


Unemployment is falling

Unemployment, per cent (LHS)Employment, thousands (RHS)


02 03 04 05 06 07 08 09 10 11 124300

4350

4400

4450

4500

4550

4600

4650

4700

4750

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

forecastSEB

Productivity is continuing to recover strongly, which is

normal in this cyclical phase, yet the 2012 level will

still be about 2 per cent below the long-term trend. In

this respect, current developments differ from the

1990s economic crisis. At that time, long-term

productivity capacity was hurt by a sharp upturn in

equilibrium unemployment, while productivity quicklyexceeded its previous trend level. This time around, it

looks as if there is a risk of long-term damage occurring

mainly on the productivity side.

Indicators of resource utilisation

Labour shortages, business sector (LHS)Capacity utilisation, 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

Supply restrictions approachingBecause of the rapid recovery, assessments of resource

restrictions will become crucial earlier than expected,

both in forecasting and in shaping economic policy. Such

indicators as labour shortages and capacity utilisation

have climbed rapidly and in many cases are now abovehistorical averages. Many factors indicate that equilib-

rium unemployment may have shifted upward from

the approximately 6-6.5 per cent that prevailed before

the crisis. For example, manufacturing employment fell

very sharply during 2008 and will probably bounce back

only to a limited extent. Instead, expansion is occurring

in the construction sector and in the private service

sector. This may create adjustment problems for those

who lost their jobs in industry and must look for new

jobs.


Hourly wages

Total Business sector Source: Statistics Sweden

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

If we assume that equilibrium unemployment is now

6.5-7 per cent, resource utilisation should be in balance




Sweden

as early as the end of 2011. This is not necessarily a

binding restriction on long-term growth. Over time,

equilibrium unemployment may be pushed down. This

may occur as a consequence of lasting high demand

for labour or as a consequence of structural reforms

enacted by economic policy maker. Nevertheless, the

previous picture of major resource gaps in the Swedisheconomy has radically changed in a short period.

Higher pay increases in 2012The 2010 wage round took place at a time when the

labour market outlook appeared grim. This was one

reason why collective agreements were reached at his-

torically low levels, which are now reected in the in-

coming wage and salary statistics. The rate of increases

is record-low, even taking into account that as a rule,

preliminary monthly gures are later adjusted upward.

We expect total wage and salary increases in 2011 to

be only 2.5 per cent, despite the improvement in the

labour market.


Wage expectations

Employees' organisations, 2y

Employers' organisations, 2yEmployees' organisations, 5y

Employers' organisations, 5ySource: Statistics Sweden

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

1.75

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

1.75

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

The collective agreements for white-collar employees

in industry expire in September, but there are signals

indicating that they will be extended to get back into

phase with blue-collar agreements. This implies that

coordinated wage and salary negotiations for industrial

employees will be carried out in early 2012. The wage

round will occur amid a relatively strong labour market

and a favourable prot situation: Another part of the

picture is that an accelerated rate of pay increasesin Germany might also affect Sweden. We have thus

adjusted our forecast for average pay increases in

2012 upward to nearly 4 per cent. The yearly average

will also be pushed up by the fact that the revision date

in the existing agreements is at the end of 2011. It is

notable, however, that pay expectations among labour

market parties are relatively low in a longer perspec-

tive, according to a recent Prospera survey.

Higher ination, both short-and long-term

Ination unexpectedly rose to 2.3 per cent late in 2010due to higher energy and food prices. Rising electric-

ity prices because of cold winter weather in December

were one important factor, but electricity prices have

fallen again. We thus expect CPIF (CPI without inter-

est rate changes) to drop below 2 per cent early in

2011. The upturns in petrol and food prices will not be

reversed in the same way, however. Instead we expect

food prices to continue climbing. CPIF ination will end

up close to the Riksbank target in 2011 as a whole, sig-

nicantly higher than forecasts showed only one quarterago.

Core ination (CPIF excluding food and energy) fell to

1.2 per cent in December. A combination of continued

low pay increases and a stronger krona indicates make

it likely that core ination will remain low during 2011,

but a broader upturn in ination driven by rising re-

source utilisation and higher pay is not so far away. We

expect a gradual rise in core ination during 2012,

eventually threatening to climb above the Riksbank’s

target beyond our forecast horizon.

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

Headline CPI ination will be signicantly higher than

CPIF ination, due to rapidly rising household mortgage

interest expenses. The weight of mortgage interest with

short rexing periods will probably be adjusted upward

in Statistics Sweden’s calculation model, and that will

make the impact of interest rate hikes even larger than

we had previously anticipated.

Riksbank in a hurry

Growth, labour market and ination trends will prob-ably lead to interest rate hikes being implemented at a

faster pace than the Riksbank has announced to date.

During 2011, we now expect ination to be quite close

to the Riksbank’s target, which in the short term will

make rate hikes seem less uncomfortable; forecasts had

previously indicated ination well below target. Com-

modity price increases will admittedly result in transito-

ry ination surges, but will still probably cause greater

worries about secondary effects. Experience from both

the earliest years of the 21st century and from 2007-08

indicates that central banks in Europe, and not least

the Riksbank, have reacted in such a way. Meanwhile

falling unemployment and rising capacity utilisation willlead to a shift in the Riksbank’s analysis of underlying

ination pressure.




Sweden

Changes since Jan 1, 2010

Mortgage rates up more than repo rate

Repo rate Mortgage rate, 3-month ref ixingSource: SEB

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct

10 11 12

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

The risks of excessively large divergences from the key

interest rates of other countries have also diminished. A

recent upturn in market interest rates reects, among

other things, expectations of earlier rate hikes by theECB and the US Federal Reserve. This weakens one

important justication for the Riksbank’s lowering of its

repo rate path last October.

We expect that in the February issue of its Monetary

Policy Report, the Riksbank will raise the repo rate

path in such a way that the repo rate at the end of

our forecast period will again end up at 3.8 per cent

(compared to 3.45 per cent in the latest forecast). It is

also likely that stronger global economic conditions and

higher international interest rates will help reduce the

disagreements within the Riksbank’s Executive Board.

This might in turn raise the rate path which to some

extent mirrors the Board’s average view.

We also believe that the need for interest rate hikes

will become even clearer in the course of 2011. Our

forecast is thus that the Riksbank will raise its repo

rate at every monetary policy meeting this year, and

we foresee a repo rate of 2.75 per cent at the end of

2011. After that, we believe that rate hikes will con-

tinue to 3.75 per cent at the end of 2012.The Riksbank

will thus reach a level that we believe corresponds to a

neutral interest rate after the changes that occurred in

the wake of the nancial crisis.

During the coming year, the risks in this forecast are

mainly on the upside. Given strong economic growth,

an output gap that is on its way towards closing, and

increases in household debt, it is possible that the

Riksbank will be forced to more fundamentally re-assess

its strategy of gradual normalisation of the repo rateduring a three-year period. Hikes of 50 basis points

may thus be considered on some occasions later in

2011, in order to achieve a neutral interest rate within

a reasonable period.

At present we are not choosing an aggressive repo rate

path as our main scenario, due to various factors that

help intensify the impact of key rate hikes in Sweden.

Higher risk premiums for mortgage bonds, combined

with the Swedish Financial Supervisory Authority’s new

rules for bank funding of mortgage loans have already

led to an increase in mortgage loan rates of about 50-75

The Riksbank and macro supervisory rulesAs early as the autumn of 2009, the Riksbank began to

“shout for help” from the government, the Financial

Supervisory Authority and others on the question of

alternatives to interest rate hikes in order to prevent

the emergence of mortgage loan and home price bub-

bles. The interest rate weapon is, after all, a blunt

instrument. There is a risk that interest rate hikes

aimed at inuencing household debt will having unde-

sired side-effects, for example on corporate nancing

costs, and end up in conict with the bank’s main task

of achieving its ination target.

This Swedish debate, which has intensied in the past

six months, is taking place concurrently with discus-

sions in the Group of Twenty (G20) and other interna-

tional forums regarding macroeconomic supervisory

rules. Sweden has now enacted a ceiling on the loan-

to-value ratio for home loans (October 1). But there

are more potential tools in the policy makers’ kit:

mandatory mortgage principal payments, cash reserve

requirements and/or countercyclical capital require-

ments (Basel III) for banks, limits on bank lending, less

generous interest deductions, changes in capital gains

tax deferment and stamp duty and payment protec-

tion requirements in case of unemployment, illness

and the like.

Preliminary statistics indicate that the debate in itself

and the measures implemented so far may have had

a certain cooling-off effect on the credit market, but

the question is how lasting this will be in an other-

wise favourable macro environment. The Riksbank’s

dilemma − how to ensure price stability and nancial

stability with only a single policy tool − has diminished

to some extent as ination risks have increased, due

to stronger economic growth.

The need for Swedish macro supervisory rules remains,and international proposals for tools will be present-

ed, probably late in 2011. Our assessment is that the

Financial Supervisory Authority will choose to move

forward slowly with new measures. Time is needed to

study various proposals. Changes in the tax system,

for example, should not be short-term. Instead they

should preferably be made while taking a long-term

perspective. There is, furthermore, uncertainty about

the effectiveness and the side-effects of various

measures. Introducing new rules on a broad front

while interest rates are rising may create too strong

a cooling-off effect and lead to an undesired credit

contraction and falling home prices.




Sweden

points more than the repo rate hikes. In addition, tight-

ening effects via the currency are larger than normal

when many other central banks are leaving low key

interest rates unchanged.

Yield spread to Germany will slowly

widenThe yield differential against Germany on 10-year

government bonds has been relatively stable in recent

months, despite the Riksbank’s key rate hikes. The

spread has been in the 15-35 basis point interval, or

somewhat below our earlier forecast. This is partly be-

cause expectations of ECB rate hikes have risen almost

as much as in the case of the Riksbank. In addition, the

very limited supply of Swedish government bonds has

presumably limited upward pressure on yields. Looking

ahead, we believe that a widening gap in key interest

rates will be more important than the difference in the

volume of government securities available. The spread

will thus continue to widen slowly over the next couple

of years. We expect a spread of 40 basis points at the

end of 2011 and 50 points at the end of 2012. This

means that the yield on a 10-year government bond

will climb to 4.0 per cent in December 2011 and 4.5 per

cent at the end of 2012.

Basis points

Spread vs Germany

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


05 06 07 08 09 10 11 12

-0.5

-0.4

-0.3

-0.2

-0.1

0.00.1

0.2

0.3

0.4

0.5

-1.0

-0.5

0.0

0.5

1.0

1.5

SEBforecast

Krona heading towards new heightsThe krona continued to strengthen early in 2011. Its

levels against the euro and in trade-weighted TCW

terms are the strongest since 2000. In spite of this,

we believe that the krona will continue to appreciate.

Economic growth will remain higher in Sweden than in

both Europe and the US during 2011. Meanwhile the

Riksbank will hike its key interest rate, while the rst

ECB rate hike will not occur until late this year. The key

interest rate spread is a very important explanation for

short-term exchange rate movements, according to our

models. We also expect the ow situation to benet

Sweden. Strong government nances attract investors,

including other central banks. Switzerland, for exam-

ple, recently decided to add the krona to its foreign

exchange reserve.

Exchange rates

TCW Index, 1992NOV18=100 (RHS)EUR/SEK (LHS)

USD/SEK (LHS)


96 98 00 02 04 06 08 10

110

115

120

125

130135

140

145

150

155

160

5

6

7

8

9

10

11

12

Another argument for continued appreciation is that in

a long-term perspective, the krona still seems under-

valued. Our estimate of equilibrium levels (see the

Theme article), for example, indicates that the fairvalue against the euro is SEK 8.30. Sweden continues to

report large current account surpluses and has begun to

build up a positive net external balance, which supports

the picture of an undervalued currency. We believe

that at the end of 2011, the EUR/SEK exchange rate

will stand at 8.50 and the USD/SEK rate will be 6.07.

In TCW terms, the krona will reach 114.4, its strongest

level since 1996.

Public nances will surpriseNet lending by the Swedish public sector fell by a total

of 4.5 percentage points of GDP between 2007 and2009. Last year there was some improvement, and as

early as this year we expect stronger economic condi-

tions to lead to a slight surplus. Relatively moderate

pay increases will hold down income growth to some

extent this year, which will be the most noticeable in

the local and regional government sector.

Public nancesPer cent of GDP

2009 2010 2011 2012

Revenue 52.2 51.2 49.7 49.4

Expenditures 53.2 51.0 49.0 48.4

Net lending -1.0 0.2 0.7 1.0

Gen. gov’t grossdebt 41.9 37.6 33.5 30.8

Central gov’t debt 37.2 33.7 30.2 27.5

Borrowing req.,SEK bn 176 1 -39 -48


The central government borrowing requirement im-

proved sharply between 2009 and 2010, but more than

half of this SEK 175 billion improvement is explained

by onward lending to the Riskbank in 2009 aimed atstrengthening its foreign exchange reserve. The change




Sweden

late last year was somewhat stronger than expected,

and according to preliminary gures from the National

Debt Ofce the central government borrowing require-

ment in 2010 was only SEK 1 billion.

In addition to the sale of shares in Nordea of just below

SEK 20 billions we believe that decisions Parliament has

already made will be sufcient to enable the govern-

ment to divest an additional SEK 20 billion worth of

state-owned companies this year and SEK 25 billion in

2012. Due to parliamentary resistance, however, the

government’s privatisation plans may need to be adjust-

ed in some respects. The marginal borrowing require-

ment in 2010 will be replaced by surpluses of SEK

39 billion in 2011 and SEK 48 billion in 2012. Central

government debt fell as a percentage of GDP during

2010, and we expect this gure to continue downward

to 30 per cent of GDP in 2012.

Last autumn the government’s budget bill proposed SEK13 billion worth of reforms in 2011. Reforms approved

previously plus our assumptions about further scal

stimulus in 2011 will mean that total programmes in

2011 will amount to some SEK 20-25 billion (equivalent

to about 0.7 per cent of GDP). In spite of this, scal

stimulus will be neutral this year, since temporary cri-

sis-related government grants to local governments will

meanwhile disappear. In 2012 we expect scal policy to

be weakly expansionary, with reforms equivalent to SEK

20 billion or 0.7 per cent of GDP.

Approaching a political crossroadsThe government’s reform programme for its 2010-2014

term of ofce is less extensive and more back-loaded

than its 2006-2010 programme. After the 2006 election,

the new Alliance government quickly started pushing

through reforms; today we are seeing a more caretaker-

like government. However, the strong economy will

allow the government room to spend more aggressively

on reforms than the SEK 40 billion, or a bit above 1 per

cent of GDP, it has signalled for its four-year term. A

strategy of moving cautiously at the beginning of this

term, so that it can spend more aggressively as the

2014 election approaches, may also encounter prob-

lems. For reasons of stabilisation policy, the govern-ment’s scal offensive should be launched at a rela-

tively early stage.

The government is fast approaching a scal cross-

roads between a tight budget and further reduction of

central government debt, or a commitment to tax cuts

or higher health and welfare spending. Regardless of

what the government does, it will attract criticism from

either the business community or the opposition. The

electoral success of the dominant Moderate Party hasalso led to tensions within the Alliance coalition. In the

future, the much smaller Liberal Party, Christian Demo-

crats and Center Party will demand more follow-through

on their own proposals, to avoid being marginalised;

their demands will increase the worse these parties do

in opinion polls. The focus on budget discipline during

the crisis that characterised the election campaign has

faded, and Sweden is in a better scal situation. This

may help give the smaller Alliance coalition parties a

chance to push through some of their signature issues.

We can thus expect tougher battles ahead within

the government when it comes to crafting economicpolicy. The policy positions of the coalition parties,

especially regarding taxes, have become clearer in

recent months. The Moderates are continuing to pursue

a policy of strengthening incentives for people to work

and they want to enact further earned income deduc-

tions, which the other three parties seem relatively

indifferent to. The Liberal Party has underscored the

importance of abolishing the extra 5 per cent income

tax on the afuent imposed as an austerity measure in

the 1990s, while the Center prioritises improvements

in the situation of businesses, for example by lowering

employer payroll fees. The Christian Democrats seem tobe moving towards more vigorously pursuing their sig-

nature issues in family and elder care policy. We expect

reforms in the tax area to be broader with less focus on

earned income tax credits compared to the past.




Sweden

Is there an optimal government debt level?During the crisis years 2008-2009, Sweden’s central

government debt was largely unchanged as a percent-

age of GDP. A margin upturn of 3 per cent of GDP can

be compared to the 35 per cent increase in the 1990s.

Because of improved economic conditions, central

government debt is expected to fall to 30 per centof GDP in 2012. Given the government’s assumptions

of strong growth and budget surpluses in 2013 and

2014, this debt will fall even further and in 2014 it

will reach its lowest level in 40 years: 21 per cent of

GDP. Such a trend will probably trigger an increasingly

heated debate on government debt. Is it reasonable

to prioritise further debt reductions at the expense of

urgent tax cuts or expenditure reforms?

Per cent of GDP

Falling debt

Maastricht debt DebtSource: Eurostat, Swedish National Debt Office, SEB

94 96 98 00 02 04 06 08 10 12

25

30

35

40

45

50

55

60

65

70

75

80

25

30

35

40

45

50

55

60

65

70

75

80

forecastSEB

It is difcult to nd any clear criterion for what is an

optimal level of public debt. One general principle,

however, may be that debt should be at a level that

ensures the long-term sustainability of scal policy

and enough scal manoeuvring room to soften the

impact of economic uctuations. Otherwise there are

reasons both for and against public debt. Low debt

means lower interest payments, which implies that a

larger percentage of tax revenue can be used for gov-

ernment operations or tax cuts. Meanwhile it should

be possible for macroeconomically protable invest-

ments to be nanced by borrowing. In addition, net

public debt should be taken into account by including

assets. A number of different criteria for the level of public debt may be discussed:

High debt may slow growth: IMF studies show that

growth begins to be adversely affected when debt

exceeds 90 per cent of GDP. The explanation for this

is that the interest burden of such high debt levels

forces the enactment of taxes that lead to efciency

losses. Households and businesses may also tend to

increase their saving for reasons of caution in case of

such high public debt, since there is growing uncer-

tainty about the future economic policy rules of the

game.

Risk of a snowball effect: One criterion is that a debt

increase during a recession will not lead to a situation

where scal credibility problems become acute. Ex-

perience shows that a severe crisis can lead to a rapid

debt increase, totalling 30-40 per cent of GDP. Once

central government debt moves a bit above 100 per

cent of GDP, interest payments may become so large

that a primary balance (balance minus the interest

item) is not sufcient to stabilise the debt ratio. To

avoid this, the debt level should not exceed 70-75 percent of GDP in a normal economic situation.

The Maastricht criterion: A public debt of 60 per cent

of GDP (or falling debt) is one of several targets for

the euro zone countries. This debt corresponded to

the average level in the countries affected during the

preparations for the the euro in the early 1990s. A 60

per cent level can also be derived with the help of the

decit criterion and an assumption of a 5 per cent an-

nual trend level of nominal GDP growth. Given a de-

cit of 3 per cent of GDP, the debt ratio will converge

at 60 per cent of GDP in the long term.

The need for benchmark interest rates in nancial

markets: Sovereign borrowing fulls purposes that are

not directly connected to nancing. The interest rate

on government borrowing is used as a benchmark rate

for pricing other nancial instruments. There is also a

demand for safe investments in the national currency;

Basel III rules may boost this demand. In addition,

there are reasons to maintain a government borrowing

function and a liquid market for government securi-

ties. This requires an outstanding debt portfolio of a

certain size. The downside pain threshold is difcult

to estimate but can be assumed to be between 20 and

30 per cent of GDP.

Should the government build up assets? In 2009 the

Swedish central government’s net nancial debt was

13 per cent of GDP and it is expected to decrease in

the future. A build-up of public wealth has no intrin-

sic value. Excessively high government saving may

lead to squeezing out effects. Private sector saving

and wealth accumulation can instead benet from a

certain level of government debt.

Conclusion

The international crisis shows the value of good publicnances and low government debt. Sweden’s central

government debt is low in a historical and internation-

al perspective. It is well below the levels where there

is obvious direct damage and risk to the economy.

Taking into account the strong net nancial position

of the Swedish government and the functioning of the

money market, there are hardly any reasons to push

down the central government debt from a level of

30-35 per cent of GDP. Since Sweden has a high tax

burden, internationally speaking, where certain taxes

may be strategic for competitiveness, and since infra-

structure investments have been neglected for a longtime, there are strong arguments for not prioritising

further decreases in central government debt.



Denmark


Good 2011 growth due to exports, weak krone Continued strong exports

Domestic demand still a vital force drivingGDP growth

No increase in key rate spread until 2012

Denmark’s economic recovery is continuing, and growth

is accelerating despite the three-year public budget

consolidation that has now begun. Stronger interna-

tional growth will continue to stimulate exports. We

are adjusting our GDP growth forecast upward from

2.2 to 2.6 per cent in 2011 and are also making a

slight upward revision to 2.3 per cent in 2012.

GDP growth in 2010 was 2.3 per cent, according to pre-

liminary estimates. The upturn was driven by a decent

improvement in private consumption and by a sizeable

inventory contribution. This year we expect capital

spending to provide additional support. Exports will

continue to increase at a good pace, and combined with

stronger domestic demand this will also push important

growth higher. This means that net exports will con-tinue to provide small growth contributions.

Forward-looking indicators strengthened late in 2010.

Changes in consumer condence, which is somewhat

above its historical average, have been moderate for

some time, but the purchasing managers’ index in

manufacturing advanced sharply above the 60 level to

62.8. This puts the index close to its historical highs of

65-70. The main reason is strong order bookings.

Net balance, above 50 positive

New orders push manaufacturing PMI upward

Total PMI New ordersSource: DILF

00 01 02 03 04 05 06 07 08 09 10

20

30

40

50

60

70

80

20

30

40

50

60

70

80

High order inow to companies indicates that exports inparticular will pick up renewed speed. Other indicators

signal that domestic demand is recovering at a leisurely

pace. The export sector will gain extra momentum due

to the improved growth outlook in Germany, Sweden

and Norway especially. The sector is also beneting

from favourable currency rate trends, with the Swed-

ish krona and Norwegian krone continuing to appreciate

and the euro likely to weaken again in the future. For

some years, wages and salaries have grown more in line

with those of European competitor countries instead of

faster, as previously. As a result, Denmark can now take

advantage of currency depreciation in a clearer way.

Effective exchange rate, index 100=2005

The Danish krone is weakening

Källa: Reuters EcoW in

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

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

Private consumption grew by an estimated 2 per cent

last year. A continued moderate upturn is expected. In

2010, tax cuts helped bolster household income, but in

2011-2013 income will instead be undermined by scal

austerity. Growing employment and a continued gradual

housing market improvement will provide support,

however.

The ination rate climbed from 0.5-1.0 per cent in late

2009 to 2.8 per cent in December 2010, but this was

largely due to rising energy and food prices as well as

base effects. Core ination trended in the opposite

direction during the same period, moving from above

1.5 per cent to just over 1 per cent, though with a weak

upward trend more recently. We predict a continued

slow upturn in underlying ination, but HICP ination

will end up at a relatively high 2.4 per cent average for

2011 and then fall towards 2 per cent.

Due to scal austerity and higher growth, the budget

decit will shrink from about 5 per cent of GDP in 2010

to 2.5 per cent in 2012, faster than the government’s

planned 3.5 per cent. Meanwhile the central bank will

raise its key interest rate from an extremely low level,

shadowing the ECB completely this year but hiking thekey rate somewhat faster in 2012. This means that the

unusually low 5 basis point spread will be normalised

over time towards 20 points.



Norway


Ongoing expansion Growth in mainland GDP above trend

Uncomfortably high household debt

Norges Bank hiking slightly faster

The recovery in the Norwegian economy has gathered

pace. Nonetheless, overall GDP performed a lot worse

than expected; production in the oil sector plunged in

the third quarter due to maintenance at a number of

elds. Production has snapped back, but overall GDP

was broadly unchanged last year. However, excluding

oil, gas and shipping, growth in mainland GDP acceler-

ated to 2.5 per cent year-on-year by the third quar -

ter of 2010, and anecdotal evidence suggests continued

above-trend broad-based growth.

First, consumer condence and manufacturing senti-

ment are the highest since 2007 when growth was surg-

ing. Second, contacts in Norges Bank’s regional network

saw output in late 2010 expanding at the fastest clip in

two years and expectations were lifted in the Janu-

ary update on improved prospects for construction andthe service industry. Finally, the economic policy mix

is favourable: scal policy will be broadly neutral for

growth in 2011 and key interest rates remain well below

“normal” levels.

Mainland GDP and Norges Bank's network

Mainland GDP, year-on-year percentage change (LHS)Norges Bank regional network output indicator, index (RHS)

Source: Statistics Norway, Norges Bank

03 04 05 06 07 08 09 10

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

-3

-2

-1

0

1

2

3

4

5

6

7

Growth in mainland GDP will pick up from 1.9 per

cent in 2010 to 3.1 per cent in 2011 and 3.2 per cent

in 2012. In addition, overall GDP will be lifted by mark-

edly higher oil sector investment in 2011 and should

expand 2.7 per cent but decelerate slightly in 2012.

Private consumption strong but choppyStronger private consumption has so far been the

main engine of the recovery, rising 3.5 per cent

in 2010, and should accelerate slightly in 2011. The

quarterly growth rate in consumption of goods (half the

total) gathered steam in the fourth quarter, building

on the marked acceleration of the previous quarter.

However, retail sales showed a noticeable pullback in

December but the drop should prove temporary. Part of

the pullback was due to a weather-related 20 per cent

surge in electricity prices from November to December

(up 38.3 per cent year-on-year) as measured in the

consumer price index. The negative effect on household

spending in general should carry over into early 2011 asthe heating bill that households received in January was

much, much higher.

It looks as if consumption will repeat the soft patch

of early 2010. At that time, an even sharper spike in

electricity prices was instrumental for declining private

consumption of goods over the rst four months of the

year, while the subsequent sharp drop in such prices

helped revive consumption. The same is likely to hap-

pen this time around as rather strong fundamentals

eventually reassert themselves.

Our forecast of 3.7 per cent consumption growth in2011 is above that for real disposable income, implying

a lower saving ratio. However, there is a risk that the

ratio might decline further, since its 7.5 per cent level

in the third quarter of 2010 was well above the 5 per

cent long-term average.

Household debt at elevated levelsThe high level of household debt is a potential risk

in the medium to long term. Very low interest rates

have so far not fuelled a credit boom: the year-on-

year increase in credit to households accelerated only

modestly in 2010 from 6.1 per cent in June to 6.5 per

cent at year-end. Nonetheless, credit growth is running

ahead of disposable income, which increased 5.6 per

cent year-on-year on average for the rst three quar-

ters of 2010, implying a further rise in the household

debt ratio.

The gross debt-to-income ratio steadied at 193 per

cent in 2009 after having risen sharply over the previ-

ous ten years, and looks set to surpass 200 per cent dur-

ing the current year. While structural differences and

very high public sector savings in the Government Pen-

sion Fund Global help explain a higher debt-to-income

ratio than among peers, the level looks unsustainablyhigh. Moreover, borrowing by households might show a

more marked acceleration, to the extent home prices

continue rising.




Norway


Households' gross debt

Source: Norges Bank

90 92 94 96 98 00 02 04 06 08 10 12

110

120

130

140

150

160170

180

190

200

210

110

120

130

140

150

160170

180

190

200

210

forecast

Norges

Bank's

Home prices are rising sharplyThe trend of home prices has changed noticeably. Since

their low in late 2008, seasonally adjusted existing

home prices have risen every month but two and wereup 7.6 per cent in January compared to one year ear-

lier. While the increase was not as rapid as in late 2009,

prices were up almost 14 per cent at an annual rate

over the six months to January. This level is record-

high in nominal terms. Moreover, prices are up mark-

edly relative to household disposable income: some 20

per cent above the long-term average.

The strong price surge since mid-2010 is not surprising,

since demand is running well ahead of supply. Housing

starts bottomed out in mid-2009, but new construction

has picked up only modestly and is still running well

below the ten-year average and what demographics

suggest. At the same time, the supply of existing homes

for sale has trended markedly lower and is only slightlyhigher than in 2006, when the housing market was red-

hot. Meanwhile, homebuilders reported a sharp jump in

sales of new homes in the nal quarter of 2010.

Existing home prices and housing starts

Existing home prices, year-on-year % change (LHS)Housing starts, 12 month aggregate (RHS)

Source: Statistics Norway, Norwegian Association of Real Estate Agents

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

15.0

20.0

25.0

30.0

35.0

40.0

-15

-10

-5

0

5

10

15

20

25

30

Fiscal policy has an expansionary biasNorway’s scal policy is guided by the “scal policy

rule”, stating that the structural − or cyclical-adjusted

−non-oil budget decit over time shall correspond

to the expected 4 per cent real return on the Gov-

ernment Pension Fund Global (GFPG, the sovereign

wealth fund).

The oil-adjusted decit surpassed the limit in 2009

and 2010 as the government met the cyclical down-

turn with a more expansionary scal policy, letting

automatic stabilisers work as the rule implies. How-

ever, “over-spending” was less than assumed in the

original budget proposals, due to higher revenue and

slower spending growth, which was not caused by ac-

tive budget measures. In 2011, the structural non-oil

budget decit should be in line with the rule, if not

slightly lower.

Politicians like to term any reduction relative to the 4

per cent limit as a “sounder” or tighter scal policy,

but the reality may differ. Hence, while the adjusted

non-oil budget decit was unchanged as a share of the

GPFG from 2009 to 2010, scal policy actually added

to domestic demand. Likewise, the budget proposal

for 2011 saw the adjusted decit declining from 4.7

per cent to 4.2 per cent of the GPFG, but the scal

policy effect was estimated to be only marginally

negative.

The GPFG is expected to grow faster than nominal

GDP in the next few years, implying that the scal

Non-oil budget deficit and GPFG

Government Pension Fund (LHS)Structural non-oil budget deficit, current prices (RHS)Structural non-oil budget deficit, 2001 prices (RHS)

Source: Ministry of Finance

02 04 06 08 10 12 14 16 18 20

N O K

b n

25

50

75

100

125

150

175

200

225

250

N O K

b n ( s t a r t o f y e a r )

0

1000

2000

3000

4000

5000

6000

7000

policy rule will work in an expansionary direction if

the cyclically adjusted non-oil decit is kept at − or

not too far below – 4 per cent of the Fund. Assuming a

5.5 per cent average annual growth rate in mainland

GDP (marginally less than the 2000-09 average) and

that the GPFG grows as projected by the Ministry of

Finance, the fund will increase from almost 150 per

cent of mainland GDP in the third quarter of 2010 to

about 185 per cent in 2015. In other words, the

non-oil budget decit might increase in both nominal

and real terms.

This “inhibited” expansionary effect, although notnecessarily very strong, puts Norway in quite a differ-

ent position from the multi-year tightening of scal

policy going on in much of Europe.




Norway

With growing imbalances between supply and demand,

and still-low interest rates adding to the upward pres-

sure, the strong rise in existing home prices will eventu-

ally fuel an accelerating trend in housing starts. Resi-

dential investment started to grow again in early 2010

and should rise 9-10 per cent in both 2011 and 2012.

Business investment about to reboundNorwegian manufacturing output has trended up since

mid-2009, and manufacturing condence in the nal

quarter of 2010 was at the highest level since early

2007. The indicator is well above its long-term average,

suggesting above-trend growth in production as well.

Manufacturing production and sentiment

Manufacturing prod, y/y % change, 3 m average (LHS)Manufacturing sentiment, % of labour force, 2Q earlier (RHS)

Source: Statistics Norway

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

-24

-18

-12

-6

0

6

12

18

24

30

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

The advance was fuelled by rising order backlog and

stronger production expectations (at a four-year high),

but was uneven among sectors. Producers of intermedi-

ate and consumer goods reported a further accelera-

tion in production and order ow and were the most

optimistic about the outlook. Producers of capital goods

continued to languish but reported improving domes-

tic orders, a development that should gather steam

because oil companies plans a very marked increase in

capital spending this year.

Capacity utilisation in manufacturing is still below the

long-term average. Nonetheless, manufacturers have

steadily upped their capital spending expectations,

signalling at least stabilisation if not modest growth fol-

lowing a very deep slump. Moreover, investment inten-tions among Norges Bank’s regional network continued

to recover in late 2010. Of particular importance were

the almost six-year high capital spending expectations

in the private service sector. In all, non-oil business

investment should be up 5.5 per cent in 2011 and

almost as much in 2012.

Exports languish while prices rise fastMerchandise exports excluding oil/gas and ships etc.

turned around strongly in mid-2009, but have since

disappointed. They declined a bit more than 2 per cent

in volume terms from the third to the fourth quarter of

2010, according to foreign trade statistics. The decline

was exaggerated by a very sharp drop in exports of food

(reecting problems in sh farming). However, the 2.8

per cent decline in real exports of traditional goods in

the year to the fourth quarter of 2010 was surprisingly

weak and included declining exports of machinery and

transportation equipment in addition to food, while

exports of chemical products rose sharply.

Real exports of traditional goods should nonetheless

have recorded a rather solid 5 per cent growth rate for

all of 2010. However, the trajectory is weaker going

into 2011, and while momentum should pick up, full-

year growth will likely moderate to 3.5 per cent.


Exports of traditional goods

Exports traditional goods, volumeExport prices traditional goods

Source: Statistics Norway

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

-15

-10

-5

0

5

10

15

20

-15

-10

-5

0

5

10

15

20

While exports have disappointed in volume terms, ex-

port prices were up strongly in 2010 as well, rising 8 per

cent overall and by more than 6 per cent for traditional

goods. With import prices declining slightly, Norway

enjoyed improving terms-of-trade, as was the case in

ve of the previous eight years.

Core ination to trend moderatelyhigherThe jump in CPI ination to an eight-month high of 2.8

per cent in December should prove temporary, since it

was fuelled by surging electricity prices. For all of 2010,

overall ination accelerated a bit to 2.5 per cent. How-

ever, core ination on the CPI-ATE measure − excluding

taxes and energy − slowed from 2.6 per cent in 2009 to

1.4 per cent, almost evenly split between lower domes-

tic ination and imported ination turning to disina-

tion, reecting the previous appreciation of the NOK.


Core inflation remains at low levels

CPI-ATECPI-ATE domestic goods and servicesCPI-ATE import consumer goods

Source: Statistics Norway, SEB

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

-5

-4

-3

-2

-1

0

1

2

3

4

5

-5

-4

-3

-2

-1

0

1

2

3

4

5




Norway

Ination often lags the economic cycle, but the 1.0 per

cent year-on-year rate on the CPI-ATE in the nal three

months of 2010 should mark the trough. In the near

term, core ination should creep modestly higher,

mainly driven by higher food prices. In a slightly longer

term, the effect on import prices from previous NOK

strength should wane: according to foreign trade sta-tistics, the year-on-year change in prices for imported

goods has already turned from sharply negative for

most of 2010 to unchanged in the fourth quarter. Rising

wages should start adding to ination in 2012, and by

the end of the year, ination should be broadly in line

with Norges Bank’s 2.5 per cent medium-term target.

Norges Bank to hike slightly fasterAt its January monetary policy meeting, Norges Bank

left the deposit rate unchanged at 2.00 per cent, where

it has been since the hike last May. Bringing ination up

to target and stabilising output and employment “imply

a low key policy rate”, while a strong krone might dent

ination too much. However, “guarding against the risk

of future nancial imbalances … suggests that the key

policy rate should not be kept low for too long.” The

bank did not send any signals that it is considering a de-

parture from the optimal rate path stated in its October

Monetary Policy Report, which sees a hike in June or

August and another in the autumn, lifting the deposit

rate to 2.50 cent by the end of the year. In 2012, the

rate path indicates a year-end level of 3.50 per cent.

These key interest rates are lower than domestic

fundamentals suggest: According to the October MPR,simple policy rules based on actual GDP growth and

ination or the output gap, ination and the level of

interest rates implied that the deposit rate should be ½

percentage point higher in late 2010. However, factor-

ing global interest rates into the equation suggested a

deposit rate below the actual level.

Norges Bank's deposit rate

Norges Bank's deposit rateOptimal rate path, MPR 3/10

Forecast SEB

Source: Norges Bank, SEB

00 01 02 03 04 05 06 07 08 09 10 11 120

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

Since then, global and Norwegian interest rate expecta-

tions have increased markedly. Moreover, domestic fac-

tors have moved to the upside. Firstly, growth in main-

land GDP in the year to the third quarter of 2010 was ½percentage point stronger than Norges Bank assumed,

implying an even smaller negative output gap (if any),

and reports from the bank’s network suggest continued

above-trend growth. Meanwhile, global growth and the

outlook are stronger than the bank had assumed.

Secondly, core ination has stopped surprising on the

downside relative to Norges Bank’s trajectory: on the

bank’s CPIXE measure, which excluded taxes but in-

cludes an estimated trend in energy prices, the 1.5 per

cent year-on-year rate in December was 0.2 percent-

age point higher than expected. In addition, home

prices are rising faster than Norges Bank had assumed,

suggesting a subsequent increase in household debt ac-

cumulation.

On the downside, the trade-weighted NOK is somewhat

stronger than assumed by Norges Bank. To date, the

deviation is probably not sufcient to greatly alter its

ination forecast, but any further appreciation will

be a concern. However, the price index for imported

consumer goods in the foreign trade statistics suggests

that the downward trend in imported ination might becoming to an end.

Absent any major changes in the short term, there is a

better-than-even chance that Norges Bank will revise

its optimal rate path slightly higher in the Monetary

Policy Report due March 16. Such a revision probably

hinges on ination numbers. In the medium term, SEB

has brought forward the timing of a rst hike from ECB

while the Swedish Riksbank is expected to hike rates

somewhat faster, which should allow Norges Bank to

slightly accelerate the normalisation process: hence,

we now expect it to hike the deposit rate three times

to 2.75 per cent by end-2011 (up from 2.50 per centpreviously), and we are sticking to our forecast of ve

hikes during 2012 to 4.00 per cent.

Stronger NOK and higher ratesA wider short rate spread vs the ECB over the forecast

period will support the NOK and put upside pressure on

Norway’s 10-year bond spread vs Germany. Since the

recovery started, EUR/NOK has remained above the

7.70 level as Norges Bank has been guarding against a

too strong NOK. With imported ination expected to

turn soon the bank could adopt a more relaxed attitude

to the krone, which in combination with Norges Bankresuming the rate hike cycle this summer opens up for

EUR/NOK breaking below 7.70. In addition, Norway’s

outstanding scal position will support the already posi-

tive ow outlook as we expect continued diversication

ows to alternative safe havens. Our fair value model

points to 7.40 for EUR/NOK. We target EUR/NOK at 7.60

by the end of 2011 and 7.50 by the end of 2012.

Since the previous Nordic Outlook, the 10-year spread

vs. Germany has traded within a 55-85 basis-point

range. With Norges Bank delivering three hikes this year

and the key interest rate spread widening, the spread

will move towards the higher end of that range. Withthe German bond yield expected to continue to rise, we

forecast a 10-year yield at 4.30 by the end of 2011 and

4.75 per cent by the end of 2012.



Finland


Recovery will continue Exports and domestic demand will gain

momentum in 2011

Moderate downturn in unemployment

Budget decits below euro zone ceiling

Because of strong fundamentals, the Finnish economy

has good potential for a strong recovery after its sharp

GDP decline during the economic crisis. The labour mar-

ket has proved resilient, the banking sector emergedrelatively unscathed and public sector nances are solid

enough to stimulate the economy. However, so far the

recovery has not been as strong as might have been ex-

pected, given the steep slide in 2009. GDP rose by 3.0

per cent in 2010, but we expect an acceleration to 3.5

per cent this year. In 2012, GDP will again grow by 3.0

per cent. Our forecast is above the consensus.

A robust recovery in key Nordic export markets and in

Russia, plus a favourable industrial mix, will continue to

stimulate exports. The expansive Asian market will also

gain in importance. In the third quarter of 2010, ex-

ports grew by 10 per cent year-on-year, but they remain

well below pre-crisis levels. The strong euro and moder-

ate expansion in production and exports of information

and communications technology are two explanations

for this, but during the next couple of years Finnish

exporters will benet from the weakening of the euro

against the Swedish and Norwegian currencies.

Index

Leading indicators improving

Manufacturing sector Service sector

Construction sector

Source: DG ECFIN

04 05 06 07 08 09 10

-80

-60

-40

-20

0

20

40

60

-80

-60

-40

-20

0

20

40

60

Leading indicators are showing a domestic recovery

driven by the service sector. Meanwhile construction

sector activity remains relatively weak. Consumercondence bottomed out in early 2009, and private

consumption bounced back relatively early. Although

indicators fell somewhat in late 2010, we believe that

consumption will remain comparatively good, with

growth of about 2.5 per cent a year in 2011 and 2012.

To date, the capital spending upturn has been driven

by rising residential investments. Capacity utilisation in

manufacturing has also climbed, but it remains below

80 per cent. Production bottlenecks are thus rare, and

this will limit capital spending by the manufacturing

sector in the near future.

Unemployment peaked at around 9 per cent early in

2010. The upturn was milder than might be expected,

given the large GDP downturn. This was partly due to

temporary measures such as short-term lay-offs, which

affected 2 per cent of the labour force at their height.

Although the lay-offs were reversed, unemployment fell

relatively fast and now stands at around 7.7 per cent.

Nearly half the upturn has thus been reversed. Job

vacancies are close to pre-crisis levels, indicating a con-

tinued decline in unemployment. Measured as yearly

averages, unemployment will be 7.3 per cent in 2011

and 6.9 per cent in 2012.

The 2008-2009 upturn in unemployment pushed down

the rate of pay increases. They fell from an annual

average of 4 per cent in 2009 to 2.7 per cent in the rst

three quarters of 2010. Pay rises will accelerate again

in mid-2011 but remain around 3 per cent during our

forecast period. During much of 2010, HICP ination

was around 1½ per cent, but by year-end it had risen

to 2.8 per cent, among other things driven by food and

energy prices. As an annual average, ination was 1.7

per cent in 2010. We expect it to remain close to 3

per cent for another few months and then fall; annual

average ination will be 2.3 per cent in 2011 and 2.0

per cent in 2012.

The budget consolidation of the 1990s led to a decade

of public surpluses. This created a favourable situation

of relatively low public debt when the crisis broke out.

Our assessment is that 2010 will be the worst year, with

a budget decit of 3.2 per cent of GDP. The decit will

then shrink to 2.5 per cent in 2011 and 2.2 per cent in

2012. Public debt as measured by the Maastricht crite-

rion will climb from 34 per cent of GDP in 2008 to more

than 50 per cent in 2012, partly as an effect of weak

GDP growth during the period as a whole.



Economic data


DENMARK Yearly change in per cent 2009 level,

DKK bn 2009 2010 2011 2012

Gross domestic product 1,660 -5.3 2.3 2.6 2.3

Private consumption 817 -4.3 1.9 2.3 2.5

Public consumption 492 3.1 1.2 0.0 0.5

Gross xed investment 312 -15.4 -3.0 4.0 5.5

Stockbuilding (change as % of GDP) -2.4 1.0 0.0 0.0 Exports 784 -9.7 7.0 6.6 5.5

Imports 727 -12.1 5.5 5.7 6.2

Unemployment (%) 3.6 4.2 3.7 3.5Consumer prices, harmonised 1.1 2.2 2.4 2.1

Wage cost 3.1 2.3 2.1 3.0

Current account, % of GDP 4.2 4.5 4.3 4.0

Public sector nancial balance, % of GDP 3.6 -5.1 -3.5 -2.5

Public sector debt, % of GDP 41.4 44.0 46.0 46.0

FINANCIAL FORECASTS Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Deposit rate 1.05 1.05 1.30 1.55 2.10 2.65

10-year bond yield 3.25 3.55 3.65 3.75 3.95 4.20

10-year spread to Germany, bp 3 15 15 15 15 20

USD/DKK 5.47 5.32 5.14 5.32 5.44 5.73

EUR/DKK 7.45 7.45 7.45 7.45 7.45 7.45

NORWAY

Yearly change in per cent 2009 level,

NOK bn 2009 2010 2011 2012


Gross domestic product (Mainland Norway) 1,732 -1.3 1.9 3.1 3.2

Private consumption 956 0.2 3.5 3.7 3.5


Gross xed investment 476 -7.4 -9.2 5.9 5.3

Stockbuilding (change as % of GDP) -2.6 2.9 0.0 0.0 Exports 1,008 -4.0 -1.7 1.4 2.0

Imports 638 -11.4 8.1 3.6 4.5

Unemployment (%) 3.2 3.6 3.5 3.4

Consumer prices 2.1 2.5 1.6 2.2

CPI-ATE 2.6 1.4 1.6 2.1

Wage cost 4.5 3.6 3.8 4.1


Deposit rate 2.00 2.25 2.50 2.75 3.25 4.00

10-year bond yield 3.81 4.05 4.20 4.30 4.55 4.7510-year spread to Germany, bp 60 65 70 70 75 75

USD/NOK 5.73 5.50 5.31 5.43 5.47 5.77

EUR/NOK 7.82 7.70 7.70 7.60 7.50 7.50




Nordic key economic data

SWEDEN


SEK bn 2009 2010 2011 2012


Gross domestic product, working day adjusted -5.2 5.4 4.7 3.0

Private consumption 1,527 -0.4 3.5 3.3 2.5Public consumption 858 1.7 1.7 0.9 0.9

Gross xed investment 550 -16.3 5.5 10.5 4.0

Stockbuilding (change as % of GDP) -1.4 0.7 0.2 0.2 Exports 1,495 -13.4 11.4 8.9 5.4

Imports 1,294 -13.7 12.7 8.5 5.3

Unemployment, (%) 8.3 8.4 7.3 6.6

Employment -2.1 1.0 2.1 1.1

Industrial production -19.4 10.2 9.0 4.0

Consumer prices -0.3 1.3 2.7 2.4

CPIX 1.9 2.1 1.7 1.5

Wage cost 3.4 2.0 2.3 3.9Household savings ratio (%) 12.9 10.6 10.1 10.3

Real disposable income 1.5 0.9 2.7 2.8

Trade balance, % of GDP 3.2 2.5 2.8 2.9


Central government borrowing, SEK bn 176 1 -39 -48

Public sector nancial balance, % of GDP -1.0 0.2 0.7 1.0

Public sector debt, % of GDP 41.9 37.6 33.5 30.8


Repo rate 1.25 1.75 2.25 2.75 3.25 3.75

3-month interest rate, STIBOR 2.10 2.15 2.65 3.15 3.65 4.15

10-year bond yield 3.44 3.70 3.85 4.00 4.25 4.50

10-year spread to Germany, bp 22 30 35 40 45 50

USD/SEK 6.47 6.21 5.93 6.07 6.13 6.46

EUR/SEK 8.82 8.70 8.60 8.50 8.40 8.40

TCW 120.3 117.4 115.4 115.0 114.4 115.8

FINLAND


EUR bn 2009 2010 2011 2012

Gross domestic product 171 -8.1 3.0 3.5 3.0

Private consumption 94 -1.9 2.1 2.4 2.4


Gross xed investment 33 -14.5 1.5 5.1 5.9

Stockbuilding (change as % of GDP) 0.9 0.2 0.1 0.0 Exports 64 -20.5 6.5 7.4 6.4

Imports 60 -18.1 4.3 6.0 6.2

Unemployment (%) 8.2 8.3 7.3 6.9

Consumer prices, harmonised 1.6 1.7 2.3 2.0

Wage cost 4.0 2.8 2.4 2.9


Public sector nancial balance, % of GDP -2.5 -3.2 -2.5 -2.2Public sector debt, % of GDP 43.8 47.1 49.7 51.9




International key economic data

EURO ZONE


EUR bn 2009 2010 2011 2012


Private consumption 5,170 -1.0 0.7 0.8 1.1

Public consumption 1,975 2.4 0.8 0.8 1.1Gross xed investment 1,773 -11.3 -0.6 4.2 4.1

Stockbuilding (change as % of GDP) -0.7 1.3 0.2 0.0 Exports 3,259 -13.1 9.8 6.1 5.3

Imports 3,140 -11.8 10.1 5.6 5.0

Unemployment (%) 9.5 10.0 9.8 9.5

Consumer prices, harmonised 0.3 1.6 2.0 1.4

Household savings ratio (%) 9.6 9.5 9.3 9.0

USYearly change in per cent 2009 level,

USD bn 2009 2010 2011 2012


Private consumption 10,132 -1.2 1.8 3.2 3.0

Public consumption 2,934 1.6 1.1 0.4 0.0

Gross xed investment 1,638 -18.4 3.8 10.3 14.5

Stockbuilding (change as % of GDP) -0.6 1.3 -0.4 0.0 Exports 1,690 -9.5 11.7 10.1 11.3

Imports 2,116 -13.8 12.6 5.3 10.1

Unemployment (%) 9.3 9.6 8.8 8.0Consumer prices -0.3 1.7 1.5 1.6

Household savings ratio (%) 5.9 5.8 5.6 5.8

LARGE INDUSTRIAL COUNTRIES

Yearly change in percent 2009 2010 2011 2012

GDP

United Kingdom -4.9 1.4 1.5 2.5

Japan -6.3 4.0 1.6 1.6

Germany -4.7 3.6 3.1 2.5

France -2.5 1.6 1.7 1.5Italy -5.1 1.1 1.3 1.5

Ination

United Kingdom 2.2 3.3 3.7 2.4

Japan -1.3 -0.7 0.2 0.4

Germany 0.2 1.2 1.8 1.4

France 0.1 1.7 1.8 1.5

Italy 0.8 1.6 1.7 1.4

Unemployment (%)

United Kingdom 7.7 8.0 7.8 7.4

Japan 5.1 5.1 5.1 4.9

Germany 7.5 6.9 6.4 6.1

France 9.5 9.7 9.6 9.4

Italy 7.8 8.5 8.3 8.2




International key economic data

EASTERN EUROPE

2009 2010 2011 2012

GDP, yearly change in per centEstonia -13.9 2.7 4.5 4.5

Latvia -18.0 0.0 4.0 5.0

Lithuania -14.7 1.3 4.0 4.5Poland 1.7 3.8 4.5 4.8

Russia -7.9 4.0 4.6 5.0

Ukraine -15.1 4.5 4.6 4.4

Ination, yearly change in per centEstonia 0.2 2.8 4.0 5.0

Latvia 3.3 -1.2 2.5 2.4

Lithuania 4.2 1.2 3.5 4.0

Poland 3.5 2.7 3.3 3.0

Russia 11.7 6.9 8.9 7.6

Ukraine 15.9 9.4 10.3 9.6

FINANCIAL FORECASTS

Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Ofcial interest rates

US Fed funds 0.25 0.25 0.25 0.25 0.75 1.75

Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50

Euro zone Re rate 1.00 1.00 1.25 1.50 2.00 2.50

United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 2.00

Bond yieldsUS 10 years 3.55 3.70 3.85 4.00 4.10 4.30

Japan 10 years 1.24 1.30 1.40 1.50 1.70 2.00

Germany 10 years 3.21 3.40 3.50 3.60 3.80 4.00

United Kingdom 10 years 3.78 4.00 4.15 4.30 4.40 4.60

Exchange rates

USD/JPY 82 86 87 90 94 98

EUR/USD 1.36 1.40 1.45 1.40 1.37 1.30

EUR/JPY 111 120 126 126 129 127

GBP/USD 1.61 1.61 1.69 1.67 1.69 1.67

EUR/GBP 0.84 0.87 0.86 0.84 0.81 0.78

GLOBAL KEY INDICATORS

Yearly percentage change 2009 2010 2011 2012 GDP OECD -3.5 2.7 2.8 2.8

GDP world -0,6 5.0 4.5 4.6

CPI OECD 0,1 1.5 1.5 1.4

Export market OECD -11.4 11.1 9.9 7.7

Oil price, Brent (USD/barrel) 61.9 79.8 90.0 90.0



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