Nordic Outlook Somewhat brighter growth outlook

Economic Research – November 2010 — but mounting policy challenges

 Contents

International overview 5

Theme 16

The United States 18

Japan 25

Asia 26

The euro zone 29

The United Kingdom 35

Eastern Europe 36

The Baltics 37

Sweden 39

Denmark 48

Norway 49

Finland 53

Economic data 54

Boxes

Ireland the focus of new debt worries 8

Calmer commodity price trend 10
Basel III update 15
Unusually weak recovery 19
Economy vulnerable to energy price shock 20
Long-term unemployment on the way down 20
QE will push up growth a bit 21
The market is worried about inflation 22
A plan to get the deficit under control 24
A 20 per cent probability of recession 30
Watered-down sanctions when EU Stability and
Growth Pact is revised 32
Does the krona risk becoming too strong? 44

Nordic Outlook – November 2010  |  3

 Economic Research

This report was published on November 24, 2010.

Cut-off date for calculations and forecasts was November 18, 2010.

Robert Bergqvist Håkan Frisén

Chief Economist Head of Economic Research
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Daniel Bergvall Mattias Bruér

Economist Economist
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Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist
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Andreas Johnson Tomas Lindström

Economist Economist
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Gunilla Nyström Ingela Hemming

Global Head of Personal Finance Research Global Head of Small Business Research
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Susanne Eliasson Johanna Wahlsten

Personal Finance Analyst Small Business Analyst
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SEB Economic Research, K-A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Köbel, Klaus Schrüfer, SEB Frankfurt/M and
Olle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwe-
gian analysis. Financial analyses are done in collaboration with Trading Strategy and SEB Enskilda Equi-
ties.

4   |  Nordic Outlook – November 2010

 International overview

Brighter growth outlook, but

mounting policy challenges

ƒƒ Fed’s stimulus programme will help
ƒƒ Low inflation despite challenges
ƒƒ Continued debt worries in the euro zone
ƒƒ Dilemma for Nordic central banks
During the next couple of years, we foresee no major
inflation risks in the 33 countries of the Organisation
for Economic Cooperation and Development (OECD),
despite the ultra-loose monetary policies now being
pursued. Rising commodity prices and the effects of
weaker currencies will lead to slightly higher inflation,
but deflationary forces will continue to predominate.

In recent months the world economic outlook has
become somewhat brighter. Expectations of quantita-
tive easing (QE) by the US Federal Reserve contributed
to stronger optimism, reflected among other things in
rising share prices. Meanwhile underlying economic
signals in the United States have been more reas-
suring, after major disappointments during the sum-
mer. Emerging economies have continued to perform
strongly, and worries about a hard landing in China and
elsewhere have diminished. In Europe, too, economic
signals have been positive, for example in Germany, the
United Kingdom and various Nordic countries. At the
same time, though, uncertainty about the government
financial crisis in southern Europe and Ireland has once
again increased alarmingly.
Global GDP growth
Year-on-year percentage change
2009 2010 2011 2012
United States -2.6 2.7 2.2 3.4
Japan -5.3 3.1 1.6 1.5
Germany -4.7 3.6 2.5 1.8
China 8.7 10.2 9.0 8.0
United Kingdom -5.0 1.7 2.1 2.1
Euro zone -4.0 1.6 1.7 1.5
This means there is room for central banks in major
OECD countries to hold off on hiking their key inter-
est rates for at least another year or so. In addition,
the effects of quantitative easing by the Fed and other
central banks will also help keep longer-term market
interest rates down and stimulate asset prices. Over the
next couple of years, fiscal policies in OECD countries
will not be as contractive as we previously expected,
but ongoing debt retirement − mainly in the private
sector − and lingering weaknesses in the financial sys-
tem will help blunt the effects of monetary policy.
On the whole, we regard a somewhat higher growth
forecast than previously as justified. We have raised
both our 2010 and 2011 GDP forecast by 0.3 percent-
age points, both for the OECD and emerging markets.
Our upward revision for 2012 is somewhat smaller.
A low-interest environment, growth slightly above trend
in the OECD countries and continued strong growth in
developing economies will mean a relatively favourable
environment for the stock market.
GDP, OECD countries
Index 2000 = 100
130.0 130.0
127.5 127.5
20%
125.0 125.0
122.5 122.5

Nordic countries -4.5 2.7 2.8 2.4 120.0 120.0

117.5 25% 117.5
Baltic countries -15.6 0.9 4.0 4.5
115.0 115.0
OECD -3.3 2.5 2.3 2.5 112.5 SEB forecast 112.5
Emerging markets 2.5 7.1 6.3 6.5 110.0 110.0
107.5 107.5
World, PPP* -0.6 4.7 4.1 4.5
04 05 06 07 08 09 10 11 12
World, nominal -1.3 4.0 3.4 3.8
New crisis wave SEB's main scenario
* Purchasing power parities Rapid recovery
Source: OECD, SEB

Source: OECD, SEB

In our August report, we made the assessment that
the downside risks to our main economic scenario

Nordic Outlook – November 2010  |  5

 International overview

outweighted the upside risks. This time, we foresee ing process in the financial system and household debt
somewhat more symmetrical risks. The probability of retirement is under way. In the US, a clear improve-
stronger economic performance has increased from 15 ment in the labour and housing markets will not occur
to 20 per cent, mainly due to changes in the US risk until well into next year. Only then can consumption
picture. provide genuine support to the economic recov-
ery. German consumers remain cautious and need the
Capital spending growth will be crucial encouragement of slightly higher pay increases ahead,
In the OECD countries, the slowing trend in the re- while tough austerity programmes will limit the poten-
covery that we foresee in late 2010 and early 2011 is tial for an upturn in British consumption.
partly connected to the waning strength of the inven-
tory cycle. In the US, this is reinforced by the fading Economic policy challenges at many
of federal fiscal stimulus measures. Debt retirement in levels
the household sector after the bursting of the housing While the economic outlook for the next couple of
bubble will hamper consumption during the next couple years seems a bit brighter, international economic
of years. An upswing in capital spending is therefore policy collaboration faces a variety of challenges and
vital in order to ensure a continued recovery. conflicts. Despite lofty ambitions − for example in the
Group of Twenty (G20) countries − when it comes to
In some respects, the situation looks rather hopeful.
coordinating economic policies in response to global
Capital spending has taken off in many countries during
imbalances, this autumn has been full of disappoint-
2010. Although upturn figures have been high because
ments. Progress at the recent G20 summit in Seoul,
fixed investment was deeply depressed in 2009, there
South Korea, was limited. In currency policy, for
are factors that point towards a sustained recovery:
example, tensions have escalated. The task of rebuild-
ƒƒ Non-residential fixed investment is deeply de- ing euro zone institutions is also characterised by major
pressed, even in a longer time perspective. Unlike conflicts. Meanwhile efforts are under way to reform
normal economic expansions, the capital spending the infrastructure of the financial system. International
level in the OECD countries remained rather low bodies are examining the potential for developing new
during the 2006-2007 boom. instruments to make the credit market more stable and
less pro-cyclical. Several boxes and our Theme article
ƒƒ Balance sheets, especially in large American corpo- discuss these issues later in this report.
rations, are much stronger than normal. This will
make larger self-financing of capital investments Current accounts
possible, facilitating the upturn while the financial Per cent of GDP
12.5 12.5
system remains relatively fragile.
10.0 10.0
ƒƒ Historical associations signal that capital spend-
7.5 7.5
ing growth is more dependent on the change in
5.0 5.0
capacity utilisation than on its actual level. This
2.5 2.5
indicates that a recovery in fixed investments may
0.0 0.0
begin at an earlier stage.
-2.5 -2.5
US: Non-residential fixed investments
-5.0 -5.0
As a percentage of GDP, current prices
-7.5 -7.5
14.5 14.5
99 00 01 02 03 04 05 06 07 08 09
14.0 14.0
13.5 13.5 China Euro zone Sweden
13.0 13.0 US Japan
Source: IMF
12.5 12.5
12.0 12.0
Fundamentally, the challenges are all about getting to
11.5 11.5
grips with the imbalances and systemic deficiencies
11.0 11.0
10.5 10.5
that triggered the crisis, but also easing the impact
10.0 10.0 of the somewhat uncoordinated stimulus policies
9.5 9.5 now being implemented, which themselves create new
9.0 9.0 problems.
70 75 80 85 90 95 00 05 10
Many countries face a two-dimensional challenge when
Source: US Department of Commerce
it comes to contributing to a rebalancing of the world
Although US small businesses are still suffering from economy. It is a matter of formulating fiscal, monetary
fairly restrictive credit conditions, we thus foresee and structural policies in ways that contribute to better
good capital spending growth as an important driving balance, both short- and long-term and in a national
force for economic expansion during a period when the and international perspective.
inventory cycle is losing momentum. Meanwhile a heal-

6   |  Nordic Outlook – November 2010


Internal rebalancing is a matter of phasing out pub-
lic stimulus and aid policies as soon as more private
investments and consumption can take over as growth
engines. External rebalancing, for some countries, is
a matter of such steps as reducing their dependence
on consumption-driven growth and increasing their
dependence on exports. For others, such as China, it is
the opposite: reducing dependence on exports in favour
of domestic demand.
Mounting currency-related tensions
The world economic situation, with rapid growth in
many emerging economies as well as continued dif-
ficult financial problems and a fragile recovery in large
portions of the OECD countries, requires a wide variety
of suitable political medicines. The forces driving
currency movements have been dominated by these
cyclical differences. Currencies have appreciated in
countries with strong government finances and where
the central bank has been able to withdraw part of its
monetary stimulus. In many cases, these are countries
with large commodity exports that have benefited from
high prices. Fundamentally, this is a trend that often
contributes to better global balance, since many prob-
lem countries receive a little extra help from exports,
whereas currency appreciation cools off rapidly-growing
economies.
In recent months, however, this trend has led to more
troublesome consequences, resulting in currency policy
tensions − sometimes described as “currency war”. One
basic reason for this is the ultra-loose monetary policy
being pursued in the US, the euro zone, Japan and
the UK, culminating in the Fed’s quantitative easing.
Because of the “search for returns”, surplus liquidity
migrates to countries with higher potential returns.
This increases currency appreciation pressures in
export-dependent countries, especially in Asia. These
countries have responded by resorting to currency
interventions. In recent months, various countries have
also used financial regulation, tariffs and taxes to stem
the inflow of foreign capital.
In the OECD, there is a milder version of the same
dilemma for countries that are now on the way towards
slowly tightening their monetary policies. In the pre-
vailing low-inflation environment, currency apprecia-
tion has helped squeeze inflation to levels perceived as
uncomfortable. Central banks are thus abstaining from
normalising interest rates to the extent that domestic
factors would justify. This also applies to Norway and
Sweden, for example. Among the 10 largest economies,
Australia is now the only one that has not cited cur-
rency rate trends as a reason to slow the pace of its key
interest rate hikes.
Disunity on policy conclusions
One reason why international cooperation has seized up
this autumn is differences of opinion about what is the
fundamental reason behind the imbalances in the world
International overview
economy: overly aggressive stimulus policies in low in-
terest rate countries or an excessively cautious commit-
ment to domestic driving forces in surplus economies.
Some of the drawbacks associated with extreme stimu-
lus measures have thus appeared earlier than expected.
These effects, in the form of a weaker US dollar and
rising commodity and asset prices, do not primarily af-
fect the countries that implement such measures, but
affect other parts of the world via global transmission
mechanisms.
The main targets of criticism are excessively cautious
Chinese currency policy, on the one hand, and overly
aggressive stimulus programmes in the US, on the other.
At the G20 summit in Seoul, the US tried to launch a
proposal to restrict how large a country’s current ac-
count surplus or deficit could be. A proposal to establish
such a restriction equivalent to 4 per cent of GDP was
voted down, but the IMF will continue examining similar
ideas and will report back to the next G20 summit. It is
obvious, however, that international political coopera-
tion is not strong enough at present to resolve all the
disagreements that have arisen.
Emerging economies will remain the
engine
Emerging economies, especially in Asia, will continue
to serve as the largest engine in the world economy.
During the next couple of years GDP will increase by
6-7 per cent in emerging economies, compared to OECD
growth close to the trend level: about 2½ per cent. As
a share of global GDP, Asian emerging economies have
now climbed to just below one fourth. The proportion
of global exports destined for these economies has risen
from less than 5 per cent in 1980 to nearly 15 per cent.
Asian emerging economies
As a percentage of the global economy
1980 1990 2000 2009
GDP 7.9 11.0 15.1 22.6
Exports 4.7 5.5 9.5 15.9
Imports 4.6 5.7 8.3 14.5
Accumulated
direct investments 4.4 4.9 6.0 8.3
NOTE: South Korea, Hong Kong, Singapore and Taiwan are
classified as developed and are not included here.
Sources: IMF, UNCTAD, SEB
Asian emerging economies largely managed to avoid
the downturn that affected the OECD countries during
the crisis years, then began a rapid recovery. This is
due to several factors. The role of intra-regional trade
has increased. Meanwhile improved macro policies and
greater flexibility have made these economies more
resilient in the face of global downturns. From a growth
standpoint, the potential for “decoupling” − with dif-
ferent growth paths for emerging economies and OECD
countries − has increased.
Nordic Outlook – November 2010  |  7
 International overview
Ireland the focus of new debt worries
Market worries about European sovereign debt
problems have intensified again. Rising risk premi-
ums for Ireland and Portugal have pushed up their
government bond yields to levels well above those
prevailing before the bail-out package for Greece and
the European Financial Stability Facility (EFSF) were
launched last spring.
Renewed market worries
Yield spread vs Germany, 10-year government bonds
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
Oct Jan Apr Jul Oct Jan Apr Jul Oct
08 09 10
France Ireland Portugal
Greece Italy Spain
Source: Reuters EcoWin
The banking crisis has made the situation acute in
Ireland. Costs related to saving the banking sector
will push up the Irish government budget deficit to
more than 30 per cent of GDP this year: money that
has not yet been borrowed in the market. Excluding
bank support, the deficit is more than 10 per cent of
GDP. The uncertainty surrounding Ireland’s banking
system showed to be too large for general govern-
ment austerity programmes to calm the markets.
Ireland, EU and the IMF have now agreed on a sup-
port package. The details are not yet known, but will
temporarily calm down market worries. Thereafter
though, the focus will probably shift to Portugal.
But at the same time as emerging economies have
shown increasing resilience, world economic integration
has continued to increase. This applies both to the real
economy via trade flows and direct investments and to
the financial sphere via short-term capital flows and in-
tegrated capital markets. Financial integration has been
an important prerequisite for the rapid growth trend of
the past decade. During 2010, however, its drawbacks
in the form of capital flows that lead to sharply ap-
preciating currencies and bubble tendencies in asset
markets have become apparent.
In the short term, Asian countries are trying to soften
the impact of these phenomena by using both domestic
tightening measures and capital controls. In the long
term, the best medicine is to increase the role of do-
mestic demand in growth, thereby making these econo-
mies less dependent on exports and currencies. Looking
ahead, we expect Chinese currency policy to play some
part in this. The pace of yuan appreciation will remain
cautious, however. We expect China to boost the value
8   |  Nordic Outlook – November 2010
Yet the underlying situation in Ireland and Portugal
is not as serious as in Greece. The two countries
have lower government debt and better underlying
credibility. They consequently have a good chance of
avoiding defaults or debt write-downs. IMF studies
show that markets often overreact in crises and that
the upturn in yields is not due to bad fundamentals
alone. International aid also provides political leaders
with a form of backing that enables them to imple-
ment unpopular belt-tightening measures.
Ireland and Portugal are also such small economies
that the financial aid mechanisms now in place will
be able to deal with their problems. Instead, devel-
opments in Spain will determine whether the Euro-
pean debt crisis will again dominate global financial
markets. The sovereign debt problem is smaller in
Spain than in the other PIIGS countries (Portugal,
Ireland, Italy and Greece). On the other hand, Spain
has a larger external debt burden if the private sector
is also included. Signals of renewed economic weak-
ness are also especially serious in a situation where
unemployment is around 20 per cent.
Although our main scenario is that Spain will manage
without international help, there will be continued
uncertainty ahead. Wider yield spreads between euro
zone countries will probably also persist during the
foreseeable future. The market has learned the les-
son that even in the euro zone, risks must be priced
on the basis of the conditions in each respective
country. European institutions also seem to need a
certain level of pressure from market forces in order
to muster the strength to reform the Stability Pact
and establish a credible rule system.
of the yuan by 4 per cent against the USD during the
coming year, but this is unlikely to do much to mollify
critics who accuse China of pursuing an excessively rigid
currency policy.
Nordic fundamentals are paying off
The Nordic countries are continuing to benefit from
strong economic fundamentals, especially their low
sovereign debt levels. Their export structure, both in
terms of sectors and countries, also puts them in a good
position to take advantage of the global recovery. In our
assessment, these countries will also cope well with the
appreciation of their currencies this autumn.
We are revising our Nordic growth forecasts upward.
In Sweden, GDP will increase by 5 per cent this year,
significantly faster than in other EU countries. During
the next couple of years, too, we expect GDP growth to
be above trend. In the other Nordic countries, growth
will be more subdued. Strong exports will enable the
Danish economy to continue growing by more than 2

per cent a year, despite fiscal tightening. In Finland,
the economic recovery has gained strength in recent
months. We now see prospects for GDP growth of 3 per
cent in 2011. As in Sweden, this growth will be broad-
based. The Norwegian economy will grow by more
than 2 per cent a year, but high resource utilisation
is already beginning to limit supply-side potential in
Norway.
GDP growth, Nordic and Baltic countries
Year-on-year percentage change
2009 2010 2011 2012
Sweden -5.1 5.0 3.5 2.5
Norway -1.4 0.5 2.3 2.2
Denmark -4.7 2.2 2.2 2.1
Finland -8.1 2.7 3.0 2.8
Nordics -4.5 2.7 2.8 2.4
Estonia -13.9 2.5 4.0 4.0
Latvia -18.0 -0.3 4.0 5.0
Lithuania -14.7 1.0 4.0 4.5
Baltics -15.6 0.9 4.0 4.5
Source: OECD, SEB­
Gradual recovery in the Baltic countries
After their extreme economic downturn in 2009, all
three Baltic countries showed positive year-on-year
GDP growth during the past two quarters. We continue
to predict a gradual export-led recovery. Meanwhile
domestic demand is beginning to thaw. The Baltics
have restored their competitiveness after success-
fully applying an internal devaluation policy, but the
growth of private consumption and capital spending will
be sluggish due to public sector pay freezes in 2011,
high unemployment including structural problems and
continued private debt retirement.
US: The credit channel has stabilised
Ratio, year-on-year percentage change
12 12
10 10
8 8
6 6
4 4
2 2
0 0
86 88 90 92 94 96 98 00 02 04 06 08 10
M2 money supply
Credit multiplier (M2/monetary base)
Source: Federal Reserve
Overall, we expect decent annual GDP growth of
4-5 per cent in the Baltics during the next couple of
years. Estonia is adopting the euro on January 1, 2011.
International overview
Our assessment is that Latvia and Lithuania will join the
euro zone in 2014, in keeping with their ambitions.
More symmetrical inflation risks
Rising commodity prices and the Fed’s quantitative
easing programme have contributed to growing uncer-
tainty regarding inflation trends in the OECD countries.
Inflation expectations, measured as break-even inflation
in the index-linked bond market, have also risen − espe-
cially in the US.
A mechanistic calculation indicates that a commod-
ity price upturn might push up inflation as much as 2
percentage points, but in recent decades the impact
of commodity prices at the consumer level has been
rather small. Low resource utilisation is one reason why
the impact of commodity prices is unlikely to be larger
this time around. Taken together, we have adjusted CPI
inflation upward by 3-4 tenths of a percentage point
in the US and the euro zone as a consequence of the
commodity price increase, especially via the impact of
higher oil and food prices.
Core inflation will remain low
Year-on-year percentage change
3.0 3.0
2.5 SEB 2.5
forecast
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Euro zone US
Source: Eurostat, BLS, SEB
The Fed’s expansion of its balance sheet has provided
new fuel for discussion about the risk of triggering
inflation by printing money and boosting the money
supply. Broad money supply aggregates have again
begun to grow, but still at a very slow pace. The credit
multiplier also seems to have started rising again but is
not far from its lows. Our conclusion is that monetary
measures are signalling lower deflation risk but that
there is still plenty of time for the Fed to withdraw li-
quidity if a real-term upturn should take off in earnest.
We have revised our overall inflation forecast slightly
upward and consider the risk picture more symmetrical
than before. But most indications are still that infla-
tion will remain low during the next couple of years.
Resource utilisation remains low in the OECD, leading to
historically low pay hikes. Unit labour cost is also being
pushed down by cyclical recovery in productivity.
Central bank stimulus nearing its end
In the US, the euro zone, Japan and the UK, monetary
stimulus measures remain the most important instru-
Nordic Outlook – November 2010  |  9
 International overview

ment for safeguarding economic recovery. Low underly-
ing inflation pressure and stable inflation expectations
will enable central banks to continue their zero inter-
est rate policies well into 2012.
Another option is unconventional monetary policy
aimed at keeping the entire yield curve − in nominal
and real terms − at the lowest possible level as well as
keeping inflation expectations at a suitable distance
from zero. The challenge for the central banks will be
to achieve maximum impact from their stimulus meas-
ures, on the one hand, while preserving their long-term
credibility, on the other. Their strategy for accomplish-
ing this is to emphasise their readiness to resume
stimulus measures using the relevant tools, but mean-
while to carefully avoid spelling out their timetable
for this exit strategy.

Calmer commodity price trend the relationship between supply and demand will not
Since the summer, commodity prices have gained new be as strained as in 2006-2008. This indicates that
upward momentum after a brief slump last spring. Saudi Arabia, with its large production reserves, will
Metals and agricultural commodities have climbed continue to have a major influence on prices. Saudi
to new record levels, measured in US dollars. The Arabia’s aim is to keep the price of Brent oil in the
fact that commodity prices, especially oil prices, are USD 70-90/barrel range. We believe that the price
rising so early in the OECD countries’ economic cycle of Brent will end up in the upper part of this range −
may pose a danger to their relatively fragile economic slightly above today’s level.
upturn. What is driving commodity prices?
Index, thousands
We see four main reasons for the rapid price move- 900 12
ments of recent months: 1) Less uncertainty about
the world economic trend. 2) Poor grain harvests 800 10
due to weather effects. 3) An increased element of 700 8
speculative trading (especially evident from grain
contracts). 4) The decline in the USD, which creates 600 6
upward pressure on prices, since commodities are 500 4
priced mainly in dollars and producers want compen-
400
sation for USD depreciation. The latter two factors 2

have been closely linked to the Fed’s QE2 measures. 300 0

Jan May Sep Jan May Sep Jan May Sep
High commodity prices 08 09 10
Index, monthly data, USD S&P GSCI Commodity index (LHS)
500 500 Baltic Dry (RHS)
Source: S&P, Baltic Exchange
450 450
400 400
Agricultural prices will be weather-driven for
350 350 another while. Most agriculturally related commod-
300 300 ity prices have soared rapidly this autumn, especially
250 250 cotton, but wheat prices have levelled off after their
200 200 sharp upturn in July-August due to extreme weather
150 150 in two major producer countries, Russia and Ukraine.
100 100 In the short term, there is a risk that the La Niña
50 50 weather phenomenon will affect agricultural produc-
00 01 02 03 04 05 06 07 08 09 10 tion into early next year, thereby pushing prices up
Agriculture Energy
further. But in a more long-term perspective, under-
Industrial metals lying supply and demand conditions point towards a
Source: HWWI
calmer price trend.

This autumn’s commodity rally, which has re-
cently lost some steam, is thus only partially due to
fundamental factors. We thus continue to expect a
more moderate price upturn ahead, with levelling-
off tendencies later in our forecast period. Another
indication is that this autumn, the Baltic Dry freight
index has shown a downward trend, ending its strong
correlation with commodity prices in recent years.
Oil is climbing towards USD 90. In their latest
monthly reports, the International Energy Agency
(IEA) and the Organisation of Petroleum Exporting
Countries (OPEC) both adjusted their 2011 global oil
demand forecast slightly upward. In spite of this,
Gold will continue to glitter. Gold prices reached
new nominal record highs this autumn. Here, too,
the Fed’s announcement of a new quantitative eas-
ing round contributed to a sharp price increase, but
adjusted for inflation, gold prices are nearly 30 per
cent below their peak levels in the 1980s. We expect
gold prices to remain high due to long-term uncer-
tainty about inflation or deflation, the solvency of
countries and the future currency system. World Bank
representatives have indicated that they are open to
allowing gold to regain some kind of role in a re-
formed global currency system, and this may push up
gold prices further.

10   |  Nordic Outlook – November 2010

 International overview

− for example by way of higher commodity prices and

Unit labour costs
wages. The low-return environment in the West is also
Year-on-year percentage change
9 9
triggering unwanted capital inflows that lead to unde-
8 8 sirably strong currencies and increase the risks of as-
7 7 set bubbles. The room for continued interest rate hikes
6 6
is limited by appreciation pressure. In some countries,
5 5
4 4 capital controls − now an acceptable policy tool − are
3 3 one way of protecting their currency.
2 2
1
0
1
0
Slower pace of Nordic key rate hikes
-1 -1
The differences in monetary policy conditions between
-2 -2 the major OECD countries and Sweden and Norway are
-3 -3 also becoming increasingly clear. Developments in these
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 two Nordic countries show a number of similarities with
Europe (OECD countries) US certain Asian countries. Rapid domestic credit growth
Source: OECD
and a risk of housing market bubbles justify higher inte-
rest rates. But wider key rate spreads against the major
OECD countries imply currency appreciation, among
Looking ahead, central banks will emphasise that other things resulting in slower inflation. The central
expanding their balance sheets is still part of the banks in Sweden and Norway may thus indirectly be
monetary policy arsenal. Japan is closest to expanding forced to adjust their interest rates to those in other
quantitative easing, while the probability of new QE countries in order to avoid an excessively strong cur-
rounds from the Fed or Bank of England is far smaller. rency.
We expect the European Central Bank (ECB) to limit
itself to offering liquidity and accepting government Financial conditions less expansive in Sweden
securities as collateral for borrowing from the ECB. Rebase 100 = 2003:3
103 103
Tighter conditions
Key interest rates 102 102
Per cent 101 101
7 7 100 100
99 99
6 SEB 6 98 98
forecast
97 97
5 5
96 96
4 4 95 Easier conditions 95
94 94
3 3 93 93
2 2 92 92
03 04 05 06 07 08 09 10
1 1
US Sweden Euro zone
0 0 Source: SEB
00 02 04 06 08 10 12
For a long time, the situation of Norges Bank in Norway
Euro zone US
Source: ECB, Fed, SEB
has been characterised by this dilemma. In a gentler
form, it is also beginning to be true of Sweden’s Riks-
Our assessment is that the QE programmes now in bank. In its latest Monetary Policy Report, the Riksbank
place will be carried out but that unconventional adjusted its key interest rate path downward, stating
monetary policy will then be nearing its end. New more explicit references than previously to internation-
purchases of government securities will be increasingly al uncertainty and the consequences of interest rate
controversial. Because many countries regard QE as a hikes for the krona. Looking ahead, we expect the
substitute for currency intervention, new programmes Riksbank to deliver rate hikes largely in accordance
may jeopardise G20 collaboration and coordination, with the path it has now announced. This means that
thereby escalating currency policy tensions. Meanwhile we are not significantly changing our forecast from the
the justification for new monetary stimulus is dimin- last Nordic Outlook.
ishing, since market lending conditions have actually
improved, though not normalised. Growth and inflation We expect the Riksbank to hike its key rate in Decem-
risks have become more symmetrical, which points in ber and February, thus reaching a rate of 1.50 per cent.
the same direction. After that, hikes will be less frequent, mainly due to
the risks of an excessively strong krona. By the end of
Central banks in emerging economies often face a dia- 2011, the repo rate will stand at 2.25 per cent and by
metrically opposite set of problems, compared to those the end of 2012 at 3.0 per cent. Our forecast is thus
of major OECD countries. There is a risk that domestic higher than today’s prevailing market pricing.
bottlenecks will spread, boosting inflation pressures

Nordic Outlook – November 2010  |  11

 International overview
Because of low inflation in Norway, we expect Norges
Bank to hold off until next summer before resuming
rate hikes. Towards the end of 2011 the deposit rate
will reach 2.50 per cent. We expect Norway’s output
gap to be closed by early 2012; for this reason we
expect a slightly faster pace in the bank’s rate hikes. By
late 2012 the deposit rate will stand at 3.75 per cent.
Key interest rates
Per cent
7 7
6 SEB 6
forecast
5 5
4 4
3 3
2 2
1 1
0 0
00 02 04 06 08 10 12
Euro zone Norway Sweden
Source: ECB, Norges Bank, Riksbank, SEB
Because the two central banks will carry out relatively
cautious rate hikes due to the risks of strong currencies
and low inflation, home prices will continue upward
in Norway and Sweden. This will increase the risk of
painful corrections ahead. Certain other steps are being
taken to slow the price trend, for example the recently
enacted loan-to-value ceiling on mortgages in Sweden.
Given Sweden’s strong central government finances, a
policy mix that includes faster key interest rate hikes
and a more expansionary fiscal policy would be an
alternative, but at present the Riksbank and the gov-
ernment do not seem prepared to change their division
of responsibility in Sweden’s stabilisation policy. This
is despite the fact that such an arrangement would be
well in line with international discussions concerning
today’s imbalances, but also with lessons about the
importance of not allowing lending and home prices to
expand for too long.
Different fiscal strategies
The global financial and credit crisis pushed public sec-
tor deficits and debts to unsustainable levels in many
countries. In the long term, major belt-tightening will
thus be necessary. For example, IMF calculations indi-
cate that current deficits combined with demographic
strains will require austerity measures in the range
of 6-9 per cent of GDP in order to stabilise govern-
ment debt in the G20 countries. The severe crisis in the
PIIGS countries also show that immediate measures are
needed to ease acute financial mistrust.
12   |  Nordic Outlook – November 2010
Funding requirements, PIIGS countries, 2011
EUR billion
Maturing Net Total
loans lending (% of GDP)
Greece 38.5 20.0 25.1
Ireland 4.4 22.6 16.7
Italy 279.4 75.2 22.2
Portugal 26.2 13.1 22.7
Spain 124.5 90.4 20.2
Source: Bloomberg, SEB
In the short term, the recommendations of the EU, IMF
and other bodies are also cautious − reflecting a desire
not to interrupt the fragile recovery with excessively
synchronised austerity policies. This means that coun-
tries in a position to do so are being asked to postpone
belt-tightening or even stimulate the economy.
Overall, fiscal policies appear likely to be mildly con-
tractive during the next couple of years. In some of the
PIIGS countries the dose of austerity is very large, and
it is also likely that further measures will be necessary.
Among major countries, only the UK has decided to
implement a large austerity package. In countries like
Germany and France, very modest austerity measures
are being implemented. In the US, we expect an agree-
ment to extend the Bush administration’s tax cuts to be
reached at the last minute. In spite of this, federal fis-
cal policy will have a tightening effect equivalent to
about 1 per cent of GDP. In Japan, the government has
announced new stimulus measures this autumn despite
huge government debt.
Net lending
Per cent of GDP
2010 2011 2012
United States -11.1 -9.7 -6.9
Japan -9.8 -9.1 -8.5
United Kingdom -11.4 -9.4 -7.6
Euro zone -6.2 -5.5 -5.0
OECD -7.8 -6.7 -5.5
Source: OECD, IMF, SEB
Major countries are apparently not being pressured by
financial markets to speed up their austerity measures.
Interest rates have remained depressed, despite the
large supply of government securities. This will enable
these countries to prop up their economies to a fairly
high degree during the next couple of years and
thereby postpone their adjustment burdens.
Long-term yields sideways next six
months
Globally, government bond yields fell sharply during
the first eight months of 2010. During the spring, the
accelerating crisis in the PIIGS countries drove down
 International overview

long-term yields in major OECD countries. After that, a their German equivalent at 3.40 per cent.
gloomier economic outlook in the US provided new mo-
mentum for this trend. By the end of August, the yield We expect Nordic government bond yields to climb
on 10-year German government bonds bottomed out at somewhat faster. Partly because of continued key rate
around 2.10 per cent, well below prevailing yields when hikes, the spread between Swedish 10-year bonds and
the financial crisis culminated late in 2008. German ones will widen from today’s 25 to 50 basis
points by the end of 2012. The equivalent Norwegian
With a certain time lag, American bond yields have also spread will rise from around 65 to 90 points in Decem-
fallen: from 4 per cent in April 2010 to 2.4 per cent ber 2012.
in early October. Increasingly clear signals that the
Fed was preparing new QE measures initially helped Fundamentals still controlling
give yields an extra downward push. Once the size of currencies
the stimulus programme was announced, bond yields In the past year, fundamentals have been the main driv-
bounced back upward by 40-50 basis points in both ing force in the foreign exchange market. Currencies
the US and Germany. More stable economic signals have appreciated in countries with strong govern-
in the US, combined with a normalisation of inflation ment finances and where the central bank has been
expectations, also contributed to the yield upturn. able to withdraw part of its monetary stimulus. In
The phase-out of the ECB’s liquidity measures has also many cases, these are countries with large commod-
driven yields in Germany. This has been especially true ity exports that have benefited from high prices. In
of yields on short-term bonds, but long-term yields have recent months this more or less natural trend has led to
also been affected to some extent. troublesome consequences, resulting in currency policy
tensions − sometimes described as “currency war”.
10-year government bond yield
Per cent
Looking ahead, we believe that exchange rates will
7.0 7.0
continue to be driven by growth and interest rate
6.5 6.5
SEB differentials. In this environment, the G3 currencies
6.0 forecast 6.0
(USD, EUR and JPY) and the British pound will be losers
5.5 5.5
in the immediate future. Of this group, we expect the
5.0 5.0
4.5 4.5
USD to continue to be pulled down by the Fed’s poli-
4.0 4.0
cies for another while, but we do not anticipate any
3.5 3.5
surprises. The USD is thus relatively close to bottom-
3.0 3.0 ing out. We expect the EUR/USD exchange rate to be
2.5 2.5 back above 1.40 early next year. After that, strong US
2.0 2.0 economic growth combined with lingering debt prob-
99 00 01 02 03 04 05 06 07 08 09 10 11 12 lems in the PIIGS countries will cause the EUR/USD rate
to fall again towards 1.25 or 1.30. The pound will also
US Germany
Source: Reuters EcoWin, SEB see a similar trend against the euro: further short-term
weakening, then a return to more fundamentally justi-
We do not expect bond yields to revert to their late-
fied levels of around GBP 0.80 per euro.
summer lows. Worries about a new US and global reces-
sion will gradually fade in 2011, while the upturn in Exchange rates
commodity prices will help dispel risks of deflation. Index 100 = July 2007
160 160
Yet there are reasons to expect continued low bond 150 150
yields ahead. Central banks will be pursuing very 140 140
expansionary monetary policies, and a normalisation of 130 130
key interest rates is far away in time. The Fed’s bond 120 120
110 110
purchases will also help hold down bond yields in the
100 100
US, and the Fed will also continue to be prepared to 90 90
act if an upturn in long-term yields should threaten 80 80
the economic recovery. Our forecast of a continued 70 70
decline in core inflation during much of 2011 also points 60 60
towards continued low yields. Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov
07 08 09 10
EUR SEK USD
Our conclusion is that bond yields both in the US and GBP NOK JPY
Germany will remain at today’s levels until the second Source: Reuters EcoWin

half of 2011. Only when the time for central banks to

As for the USD/JPY exchange rate, the trend towards a
hike interest rates begins to move closer will long-term
stronger yen is probably close to ending. We expect the
yields climb cautiously. By the end of 2012, 10-year
USD/JPY rate to remain in the vicinity of 80 for another
US Treasury yields will stand at 3.60 per cent and

Nordic Outlook – November 2010  |  13

 International overview

while and then gradually move towards 100 as American

Stock markets still below 2007 peaks
long-term yields slowly creep upward. Rebase 100 = 2007:7
120 120
The Riksbank’s lowering of its key interest rate path
110 110
in October contributed to a temporary reversal in
100 100
the Swedish krona appreciation trend, but we expect
90 90
this appreciation to regain its strength as the Riks-
80 80
bank delivers further key rate hikes in December and
70 70
February. We believe that because of continued good
60 60
export growth and a favourable valuation, the EUR/SEK 50 50
exchange rate will reach 9.00 during the first half of 40 40
2011 and then continue to 8.75 by the end of 2011. 30 30
Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct
The Norwegian krone has lost ground recently, since 07 08 09 10
both monetary policy and the flow outlook have wors- US Emerging markets
ened. Norges Bank has underscored its displeasure while Euro zone Sweden
Source: Reuters EcoWin, SEB
carrying out large sales of NOK on behalf of the Govern-
We see potential for a continued stock market upturn.
ment Pension Fund of Norway. In the next few months,
Low interest rates have helped boost the valuations of
the flow outlook in particular will improve. We foresee
nearly all other asset classes (commodities, bonds etc.),
a move towards an EUR/NOK rate of 8.00 by the end
but so far equities have only followed profits, without
of 2010. After that, the EUR/NOK rate will continue
any extra multiplier effect. Nordic companies also have
to 7.75 by late 2011 and 7.50 by late 2012.
relatively low valuations. Share prices of Nordic listed
Equities benefiting from low interest companies divided by carrying amount (book value) are
15 per cent below their 10-year average, according to
rates SEB Enskilda’s forecast. It is reasonable to believe that
Low interest rate policies around the world and
next year, share prices will move in such a way as to
strong balance sheets, together with decent world
bring valuations closer to the 10-year average. It should
economic growth − driven by expansive developing
be added that profits are expected to increase at a
economies − have sustained strong stock markets during
healthy pace; in 2012 an increase of about 10 per
the past year. The Fed’s QE announcement in August
cent is expected. Nordic export companies will be able
helped stock exchanges worldwide regain their upward
to continue taking advantage of increased exposure to
momentum. American share price indices have climbed
emerging markets.
more than 10 per cent since late August, but the formal
decision to launch QE2 provided no further stimulus for At the same time, there are reasons to bear in mind
the stock market; the decision was expected. various risks, included flare-ups of financial worries
in Europe. The risk of a global trade war has not been
Macroeconomic strength, combined with an advanta-
entirely averted. Another risk is that the profit growth
geous sectoral and market exposure, contributed to
expected by companies may turn out to be too high,
favourable performance on Nordic stock exchanges. In
but this is offset by a significant upside risk for company
recent weeks, share prices have moved sideways. Be-
sales growth estimates. Overall, most indications are
cause of high expectations, company earnings reports
that Nordic stock exchanges will perform strongly in
for the third quarter were not able to boost share
2011.
prices in general, despite higher profits and a surpris-
ingly strong volume trend. The appreciation of Nordic
currencies also contributed to a more subdued stock
market trend.

14   |  Nordic Outlook – November 2010


Basel III update
In November 2010, the G20 heads of state and gov-
ernment who met in Seoul gave the green light to
the implementation of Basel III, based on a proposal
by the Basel Committee on Banking Supervision.
This decision will mean a gradual phase-in of tighter
capital adequacy rules (starting in January 2013) and
new global minimum liquidity rules (starting in 2015)
by 2018. The purpose of Basel III is to strengthen the
resilience of the banking sector, prevent excessive
risk-taking and leveraging and reduce the pro-cyclical
effect of the financial system on the real economy.
In the long term, these changes will create greater
stability both in the financial system and in the real
economy. Because there will be increased competi-
tion for capital, however, it will lead to higher inter-
est rates, lower capital supply and resulting costs
to the real economy during the transitional period
2012-2018. There are strong differences of opinion
as to the magnitude of these effects, but the exten-
sion of this transition period compared to the original
December 2009 proposal will reduce such adverse
effects.
In brief, Basel III will mean that the minimum require-
ment for the core Tier 1 capital ratio will be raised
from 2 to 4.5 per cent of a bank’s risk-weighted as-
sets. The requirement for Tier 1 capital will be raised
from 4 to 6 per cent. In addition, banks must hold a
capital conservation buffer of 2.5 per cent of risk-
weighted assets. This means that banks must have
total common equity of at least 7 per cent
International overview
in order to avoid regulatory restrictions on their
operations. In addition, depending on economic and
financial circumstances, the authorities may imple-
ment a counter-cyclical capital buffer, which may
vary between 0 and 2.5 per cent. If all these capital
adequacy requirements are fully implemented, this
means that the level of core Tier 1 capital will be
raised from 2 to a maximum of 9.5 per cent and for
Tier 1 capital from 4 to 11 per cent. The situation will
also include a stricter definition of what should be
regarded as capital.
The liquidity rules are based on two measures: The
liquidity coverage ratio and the net stable fund-
ing ratio. The first measure requires a bank to hold
enough liquid assets to survive 30 days of major
funding problems. The second measure is aimed at
achieving a better balance between the maturities of
a bank’s assets and liabilities, that is, to ensure that
available stable funding will be larger than the need
for such funding. In addition to these measures, a
leverage ratio will be tested, specifying that capital
must exceed 3 per cent of the bank’s exposures.
For Nordic banks, the most significant features of
Basel III are the changes in liquidity rules. More
long-term, stable borrowing via an amended borrow-
ing structure and longer maturities will increase the
expenses of banks. This will affect interest rates for
borrowers as well as the profitability of the banking
sector.
Nordic Outlook – November 2010  |  15
Theme
Greater need for new monetary system
ƒƒ Meagre Seoul summit but progress in 2010
ƒƒ New global monetary system on agenda
This autumn the climate of cooperation among the
Group of 20 countries has deteriorated. There are
several reasons for this worrisome disunity. The need
for private and public debt retirement is hampering the
domestic growth dynamic in many countries, increasing
their dependence on exports and thus tempting them to
weaken their currencies in various ways. There is also
genuine disagreement among G20 countries about the
actual causes of their shared imbalances and systemic
problems. Many countries have weak governments, also
making it harder to implement politically demanding
belt-tightening and structural reforms.
But on some points, the G20 summit confirmed progress
made in recent international discussions, for example,
the decision to introduce new capital adequacy and
liquidity requirements for banks (Basel III). In addition,
power relationships in the International Monetary
Fund (IMF) have been modernised to give emerging
economies a greater say. The G20 also decided that
concrete country-specific economic policy action plans
should be established. This will strengthen the Mutual
Assessment Process (MAP), which will continuously
evaluate countries to establish whether they are pursu-
ing policies that adversely impact other countries.
G20’s 2011 focus under French leadership
Looking ahead, the G20 has identified a number of is-
sues that will dominate its work until the next summit
in Cannes late in 2011. Some of the key issues are:
1. The IMF, Bank for International Settlements (BIS) and
Financial Stability Board (FSB) will propose new tools to
reduce financial sector risk levels, based on a systemic
perspective, to be reported to G20 finance ministers
and central bank governors at their next meeting.
2. The IMF will examine and propose guidelines on how
to identify when a country is showing excessively large
current account surpluses or deficits. The American
proposal for quantitative restrictions on acceptable cur-
rent account surpluses or deficits (which was admittedly
rejected in Seoul) is an example of the kinds of issues
the IMF will further consider.
3. The IMF will examine the need and possible mecha-
nisms for a new international monetary system.
16   |  Nordic Outlook – November 2010
The contours of a new monetary system
The world has gone without a formal international mon-
etary system for nearly 40 years. The Bretton Woods
(BW) system was ended in 1971 after having been
operating since 1945. BW was a global fixed exchange
rate system anchored by the US dollar, and indirect by
gold. This system also resulted in the establishment of
the International Monetary Fund. The IMF was assigned
the task of focusing on balance of payments problems,
currency policy and free trade in order to promote eco-
nomic growth and trade, generate income and jobs and
stop competitive devaluations.
For four decades, the US dollar has remained the de
facto anchor in the “non-system” that followed BW.
But this question has been raised: Does the world need
a new multilateral monetary system in order to reduce
economic imbalances and return to high and stable eco-
nomic growth? The G20 has entrusted the IMF − during
France’s G20 chairmanship in 2011 − to present propos-
als on the mechanisms for a new system.
World trade volume
World Trade Monitor,
index 100 = 2000, seasonally adjusted
250 250
World trade total
Emergning economies
200 Advanced economies
200
150 150
100 100
50 50
0 0
91 93 95 97 99 01 03 05 07 09
Source: Netherlands Bureau for Economic Policy Analysis
We see four main reasons why the issue of a global
monetary system has been raised again:
1. A decade of rapid globalisation has made countries
highly economically and financially interdependent.
There is a great need for cooperation in many areas to
avoid disruptions and reduce the risk of protectionism.
2. Large differences in the cyclical position of coun-
tries and related financial and monetary policy issues
create international tensions. A new system may not
solve imbalance problems but can help ensure that

adjustments are not jeopardised by unwanted currency
policies or destabilising capital or currency movements.
3. There are worries about the USD’s future stability.
4. Weaknesses in today’s system explain why some cen-
tral banks build up excessive currency reserves.
Reserve status: Privileges, responsibilities
A country whose currency enjoys the privilege of re-
serve status has a high degree of freedom in its eco-
nomic policies. This also represents an international
confirmation of its economic and political strength. The
United States has benefited from being able to borrow
internationally in its own currency at relatively low
cost. Meanwhile US investments in other countries have
yielded good returns. One result is that today the US
has a positive annual net return of USD 160 billion even
though its debts exceed its assets by USD 2.9 trillion.
Today’s international monetary system is dominated
by the US dollar in a way that is not justified by the
size of the US economy and financial markets. The
US economy accounts for 20-25 per cent of the world
economy, while US equity and fixed income markets ac-
count for 30-35 per cent of global financial markets.
Current account
Per cent of GDP
2005 2010 2015
United States -5.9 -3.2 -3.3
Germany 5.1 6.1 3.9
Japan 3.6 3.1 1.9
Spain -7.4 -5.2 -4.3
Greece -7.3 -10.8 -4.0
Portugal -9.1 -10.0 -8.4
Ireland -3.5 -2.7 -1.2
Sweden 6.9 5.9 6.2
Norway 16.3 16.6 15.8
Denmark 4.1 3.4 2.5
Finland 3.4 1.4 1.7
Source: IMF, WEO, October 2010
Yet 60-65 per cent of world currency reserves consist of
US dollars and 85 per cent of global foreign exchange
transactions have a “dollar leg”. Over 50 per cent of
debts in the global banking system are USD-denomi-
nated. At times of instability, the dollar also assumes
the role of “safe haven” currency, confirming that it
remains the world’s dominant reserve currency.
Among reasons for the USD’s role are lack of credible
alternatives or confidence in one’s own currency. The
world has relied heavily on the US in economic, finan-
cial and political terms. Worries about the US economy
and its major adjustment needs are raising questions
about alternative reserve currencies and ways of ensur-
ing that global monetary stability will not be dependent
on one currency.
Theme
First steps taken towards a new system
The steps towards a new international monetary
system have been halting and tentative. There is an
obvious political dimension. Decisions may have major
consequences for capital flows, currency movements
and economic growth. The advantages enjoyed today by
the US (see above) would decrease. But statements by
both the US Treasury Department and the Fed indicate
American openness. The dominance of the dollar may
gradually diminish in the future as alternative solutions
emerge and as other economies − such as China − gain
additional economic and financial clout.
A new international monetary system would not be
a BW type fixed exchange rate system anchored by
one currency or gold. Fixed exchange rates are old-
fashioned and make adjustments difficult for countries
that need to undergo structural reforms. But increased
currency cooperation will impact monetary policy and
may also affect room for manoeuvre in fiscal policy.
To some extent, these steps have already been initiated
by the IMF’s Mutual Assessment Process (MAP)
China's skyrocketing currency reserve
USD billion
3000 3000
2500 2500
2000 2000
1500 1500
1000 1000
500 500
0 0
86 88 90 92 94 96 98 00 02 04 06 08 10
China Japan Russia
Source: Reuters EcoWin
The IMF’s future may include global agreements on
reasonable currency movements during periods of ad-
justment and the size of currency reserves, current
account balances and external financial positions. The
US proposal to create a ceiling/floor for a country’s cur-
rent account surplus/deficit is one element of the issues
the IMF will address. The goal is to find an objective
framework the G20 can agree on for putting pressure
on an individual country to change economic policies.
Some form of sanctions will probably be needed if the
system is to be effective.
Central banks may also agree on clearer frameworks,
greater currency cooperation and intervention aid.
But this will require active participation from govern-
ments, since currency policy is often the responsibility
of finance ministries, not central banks. The IMF would
continue to strengthen its role, both institutionally
and financially, in order to reduce the need for large
currency reserves. It could also serve as guarantor of a
new weighted reserve currency that should reasonably
include such major world currencies as the US dollar,
British pound, euro, Japanese yen and Chinese yuan.
Nordic Outlook – November 2010  |  17
The United States

The Fed gives the economy a helping hand

ƒƒ The recovery will gradually strengthen account for most of GDP declines, are close to historic
lows as a percentage of GDP, so further declines are
ƒƒ The labour market is healing but the
unlikely, and 2. primarily via a weaker dollar and rising
housing market is shaky
asset values, the Fed’s renewed quantitative easing
ƒƒ Low inflation, but deflation threat avoided package (“QE2”) will improve growth prospects.
ƒƒ The Fed will hike its key rate in mid-2012 Most cyclical sectors: not much downside
Per cent of GDP
32.5 32.5
American GDP growth averaged 1.9 per cent in the
second and third quarters, compared to an average of 30.0 30.0
4.4 per cent in the two preceding quarters. Growth
27.5 27.5
will continue to sputter for another while but will
strengthen in 2011 when employment growth picks up. 25.0 25.0
Moreover, the Federal Reserve’s stimulus measures will
22.5 22.5
help consumption and corporate capital spending to
recover, despite fiscal tightening. Meanwhile exports 20.0 20.0
are benefiting from a continued weak US dollar. GDP
growth will reach 2.7 per cent this year, 2.2 per cent 17.5 17.5
50 55 60 65 70 75 80 85 90 95 00 05 10
in 2011 and 3.4 per cent in 2012. Unemployment will
fall in 2011 but inflation will remain low. The Fed will Durable goods + business inv. + inventory inv.
Source: BEA, SEB
not hike its key interest rate until mid-2012.
GDP: "Soft patch" for a year A new wave of home price declines is the biggest risk to
6 6 continued recovery. Policy mistakes may also throw our
5 SEB forecast 5 scenario off. Our forecast assumes that the federal tax
4 4 cuts now in place will be extended at the last minute.
3 3 This will limit the tightening effect of fiscal policy to
2 2 around 1 per cent of GDP in 2011. But if the prevailing
1 1 political paralysis and deep divide between congression-
0 0 al Democrats and Republicans continues, the economy
-1 -1 may suffer serious damage as early as 2011.
-2 -2
-3 -3
Composite ISM and GDP growth
Index, year-on-year percentage change
-4 -4
62.5 6
-5 -5 SEB
60.0 5
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 forecast
57.5 4
09 10 11 12
Annualised Year-on-year 55.0 3
Source: BEA, SEB 52.5 2
50.0 Note: NBER dates 1
47.5 0
Recession risk 20 per cent 45.0 -1
According to our forecast, GDP growth will remain at 42.5 -2
around 2 per cent in the next few quarters, but such 40.0 -3
a long period of low but positive growth is historically 37.5 -4
unusual. The economy usually grows above trend (2.7 35.0 -5
per cent, according to SEB’s estimates) or is in reces- 02 03 04 05 06 07 08 09 10 11 12

sion. ISM Composite index (LHS) Real GDP (RHS)

Source: ISM, SEB

Our model projections indicate that during the next six

Manufacturing sector steaming ahead
months, the recession risk is higher than usual, yet
Although the National Federal of Independent Business
lower than a month ago: about 20 per cent. The main
(NFIB) index has climbed in the past three months, it is
reasons why there will be no new recession are: 1. the
still at a depressed level. Large companies are more
most cyclical sectors in the economy, which ordinarily

18   |  Nordic Outlook – November 2010

 The United States

optimistic: Contrary to expectations of a decline, the Higher saving is holding back

ISM purchasing managers’ index for manufacturing
consumption
rose in October. The service sector index also gained
The living standard of middle class Americans has dete-
strength. Right now our composite indicators show that
riorated in the past decade. The income of the median
GDP will increase at approximately the same rate in
household has fallen slightly in real terms. Access to
the fourth quarter as in the third. The weak dollar will
cheap loans and the accompanying inflation in asset
enable exports to help drive growth in the coming 6-9
prices nevertheless helped prop up the public mood
months, after two quarters of large negative contribu-
and sustain consumption for a long time. The financial
tions from net exports. Annual export growth will
crisis has changed the playing field. Even though a
average 12 per cent in 2010-2012, which is high in a
recovery has been under way for 15 months, household
historical perspective, but the administration’s target
confidence indicators remain depressed, especially the
last spring of doubling exports over a five-year period
Conference Board survey, which is more than 40 points
still seems distant.
below its historical average. Our consumption model,
The recovery in US industrial production is continuing which includes the above indicators, shows rather low
at a healthy pace. During the recession, 11 years of consumption growth during the next several months.
production upturn were wiped out, but after a strong Contribution to change in real GDP
surge in the past year, the industrial production index Average since Q3 2009, percentage points
is back at its 2004 level. Our forecast is that industrial 2.0 2.0
production will increase by 5.4 per cent this year, 4.1 1.5 1.5
per cent in 2011 and 5.6 per cent in 2012.
1.0 1.0
Consumers are feeling blue 0.5 0.5
Deviation from the mean, 10-year percentage change
0.0 0.0
60 20
40 15 -0.5 -0.5
10
20 -1.0 -1.0
5
0 0 -1.5 -1.5

-20 -5 Inventories Residential

-10 PCE State and local
-40 Eq and S Net exports
-15
-60 Federal
-20 Source: Reuters EcoWin, SEB
-80 -25
80 85 90 95 00 05 10 Even though the stock market has risen sharply since
Michigan (LHS)
bottoming out, enormous wealth has been wiped out:
Conference Board (LHS) on average, households have become USD 100,000
Median household income (RHS) poorer than before the crisis. This, in turn, points
Source: Michigan, Conference Board, Census Bureau, SEB

Unusually weak recovery
According to a new CNN survey, more than 70 per
cent of the American public believes that the reces-
sion is still under way. The official declaration from
the National Bureau of Economic Research (NBER),
however, is that the deepest and longest-lasting
recession of the post-war period ended in June 2009.
GDP fell more than 4 per cent and the downturn
lasted 18 months. The historical pattern is that GDP
grows at a rapid pace during the first three years of a
recovery, followed by a pause for breath in year four.
Where we are now − a bit more than one year into the
recovery − GDP is thus usually growing at close to 7
per cent year-on-year. Our calculations also indicate
that private consumption growth averages 5.8 per
cent year-on-year: three times stronger than the trend
this time.
Weak recovery in historical perspective
Averages cover 9 recession/recovery cycles from 1948
7.0 7.0
6.0 6.0

Another rule of thumb is “the deeper the recession, 5.0 5.0

the more powerful the recovery”. This explains why
4.0 4.0
the recoveries of the early 1990s and 2000s sput-
tered: the preceding recessions were unusually mild. 3.0 3.0
The same logic does not apply this time around; dur- 2.0 2.0
ing the first year of recovery, GDP growth has been
1.0 Year 1 Year 2 Year 3 Year 4 1.0
less than half the historical average, and forecasts
indicate continued sluggishness over the next few 0.0 0.0
years. Average GDP growth (YoY) 1 to 4 years into recovery
Comparable SEB forecasts in the current cycle
Comparable consensus forecasts in the current cycle
Source: BEA, NBER, Consensus Economics Inc.,SEB

Nordic Outlook – November 2010  |  19

 The United States

towards a continued slight increase in saving. Our esti- The jobless rate will be 9.5 per cent in 2011 and 8.4
mate is that the household savings ratio will continue per cent in 2012, measured as annual averages.
upward to an average of 6.3 per cent in 2012.

One source of near-term concern is that many chroni- Long-term unemployment on the way
cally unemployed people are beginning to reach the down
maximum period of unemployment benefits, 99 weeks. There are still more than 6 million chronically unem-
These payments average USD 300/week. It is a close ployed people (41.7 per cent of the total), yet the
call whether Congress will approve another extension situation looks a little better than during the summer,
of these benefits. Without another extension some one when 6.8 million (46 per cent) of those without jobs
million Americans will reach the end of their benefit belonged to this category. Falling long-term jobless-
period each month from December to April. The income ness is especially positive, since the risk of being
loss will be sizeable: USD 70 billion or 0.5 per cent of pushed out of the labour market is diminishing.
GDP. Meanwhile lower transfer payments will be offset Many of the long-term unemployed lose both their
by a gain in private wages and salaries. Our overall as- willingness and ability to work (hysterisis), and this is
sessment is that household consumption will rise by an often permanent effect of a deep recession.
1.8 per cent in 2011 and 2.8 per cent in 2012. Long-term unemployment down from peak
Per cent of total unemployment, per cent
Economy vulnerable to energy price shock 50 12
45 11
Oil prices are flirting with the USD 90 level again. One
40 10
benevolent interpretation is that the upturn is due to
35 9
stronger demand in the world economy, especially in
30 8
Asia. But there are many signs that the price increase
25 7
is connected to the Fed’s new monetary stimulus
20 6
measures. Since the American central bank began to
15 5
indicate that quantitative easing was in the pipeline,
10 4
oil prices (Brent crude) have climbed by 6 per cent.
5 3
80 85 90 95 00 05 10
Rising energy costs squeeze household income in real
terms. Their ability to absorb the upturn is limited by Long-term unemployment (LHS)
all the idle capacity at the production stage and in the Unemployment rate (RHS)
Source: BLS, SEB
labour market. Oil prices reached USD 90/barrel for
the first time in October 2007, and a few months However, the downturn in long-term unemployment is
later the US recession began. The difference is that hardly due to any underlying improvement in the la-
US unemployment was 4.7 per cent in October 2007, bour market situation. Overall joblessness has moved
while it is 9.6 per cent today. Capacity utilisation in sideways in recent months. Instead, the downturn
the manufacturing sector is below 73 per cent today seems connected to the fact that more and more of
(79 per cent three years ago), and consumer confi- the long-term unemployed are approaching the end
dence is now at 50 (95 three years ago). A number of of their benefit period. This leads many of them to
factors indicate that a new recession is not imminent, accept jobs that they had previously rejected. Another
but the American economy is more vulnerable to an effect is that people lose their motivation to remain
energy price shock today than in October 2007. official job seekers, thus dropping out of the regis-
tered labour force and not being counted in unem-
Labour market beginning to heal ployment figures.
The October employment report contained a number
of bright spots. Above all, non-farm payrolls increased Home prices
significantly faster than expected and income re- Index Jan 2006 = 100
bounded. Other parts of the report indicated a poorly 110 110

functioning labour market: 1.1 million full-time jobs 105 105

100 100
have disappeared since this past summer, labour market
95 95
participation has fallen to the lowest level for a quarter
90 90
century and the percentage of people with jobs − the
85 85
indicator that many labour market experts consider
80 80
the most important barometer of the situation − is
75 75
approaching earlier lows. Employment will continue to
70 70
climb, according to our forecasts, but weak GDP growth
65 65
over the next six months will not lay the groundwork for 06 07 08 09 10
any impressive increase in job numbers. Unemployment
will remain high this winter and then start falling again. Case-Shiller 20 Existing home sales
FHFA
Source: Reuters EcoWin, SEB

20   |  Nordic Outlook – November 2010

 The United States

Companies can still ramp up production without appre-

Housing starts at rock bottom
ciably increasing their headcount. In the third quarter, Millions, annualised
productivity rose 2.5 per cent year-on-year. The rate of 2.50 2.50
increase thus remains strong, indicating that clear job 2.25 2.25
growth will not materialise for another while. Produc-
2.00 2.00
tivity will rise 3.4 per cent this year and 1.4 per cent
1.75 1.75
in 2011, according to our forecasts.
1.50 1.50
Shaky housing market 1.25 1.25
Home prices, measured by the Case-Shiller price change 1.00 1.00
index in the 20 largest metropolitan areas, have lost 0.75 0.75
ground in recent months and are now only 4 per cent
0.50 0.50
above spring 2009 lows. In the past month, the down-
0.25 0.25
turn was broad-based, with prices falling in 19 of 20
60 65 70 75 80 85 90 95 00 05 10
metro areas. Some regions have been especially hard
Source: US Census Bureau
hit: home prices in metropolitan Las Vegas and Detroit
have fallen to 1999 and 1995 levels, respectively.
QE will push up growth a bit
The Federal Reserve has decided to buy USD 600 bil- The estimated stimulus effects vary, depending on the
lion worth of government bonds over an eight-month source. Fed calculations show that bond purchases of
period. The central bank’s balance sheet will thus con- USD 500 billion are equivalent to a 50-75 basis point
tinue to swell, reaching 20 per cent of GDP, compared interest rate cut and that the 2009 QE package low-
to 6 per cent before the crisis. Having lowered the ered long-term yields by about 50 per cent. One rule
price of money (interest rates) to an absolute mini- of thumb is that an interest rate cut of 75 bps boosts
mum, the Fed is now pumping up liquidity instead. GDP by 1.2 per cent in a two-year perspective.
The impact will probably be smaller this time around,
In theory, quantitative easing (QE) can stimulate the
as the recent upturn in long-term yields also indicates.
economy in several ways: 1) lower interest rates boost
Important monetary policy channels such as the hous-
consumption and investments in interest rate-sensitive
ing market and bank lending are still out of commis-
sectors, 2) a weaker dollar benefits foreign trade, 3)
sion. Households are continuing to retire their debts
rising stock market valuations stimulate consumption
and − at least those with a good credit history − are
and capital spending via the wealth effect, 4) home
already seeing very favourable financing conditions. As
prices climb, leading to new borrowing and consump-
long as consumer demand is being squeezed, com-
tion and 5) looser monetary policy is ordinarily ac-
panies lack incentives to accelerate capital spend-
companied by easier credit conditions and an increase
ing, despite low or even negative real interest rates.
in bank lending.
Capital shortages are not a problem at present: the
Speculation about a new monetary stimulus package balance sheets of major corporations are in very good
took off after the Fed’s meeting in Jackson Hole, Wyo- shape, and banks have more than USD 1 trillion in
ming late in August, contributing to a rally in many surplus reserves.
asset classes. For example, US stock market indices
Monetary policy has an impact, but it is weaker than
have gained some 13 per cent since summer.
usual. The Fed’s QE measures will help boost growth in
the course of 2011, thereby reducing the likelihood of
Price changes in various asset classes since
a Japanese-type deflation scenario.
Jackson Hole
Core inflation comparison
Aug 27 Nov 19 Change Year-on-year percentage change
S&P 500 1,065 1,200 12.7% 3.5 3.5
3.0 3.0
Dollar index 82.9 78.5 -5.3%
2.5 2.5
10-yr Treasury bonds (%) 2.65 2.87 +22bps
2.0 2.0
10-yr TIPS (%) 1.03 0.72 -31bps 1.5 1.5
10-yr BE (%) 1.61 2.07 +46bps 1.0 1.0

Oil, USD 78.5 83.6 6.4% 0.5 0.5

0.0 0.0
Gold, USD 1,236 1,345 8.8%
-0.5 -0.5
Corp. spread 194bps 174bps -20bps
-1.0 -1.0
Source: SEB -1.5 -1.5
Japan (1989 - 2002) US (2006 - 2010)
Source:BLS, Statistics Bureau, SEB

Nordic Outlook – November 2010  |  21

 The United States

Home prices will probably stay depressed this autumn year and 650,000 next year, measured as annual aver-
and winter. Indicators are divided: some valuation ages. By way of comparison, the historical average is
measures and indices of what households can afford 1.5 million. The large percentage of vacant units − both
(even adjusted for tighter lending conditions) show that single-family homes and rental flats − is continuing to
home prices should be rising. On the other hand, the prevent a recovery in housing construction.
large inventory of homes is pointing towards a contin- US dollar is getting cheaper
ued price squeeze; this is the indicator to which we Index, USD/EUR
have attached the most importance in recent years. 1.15 92.5
1.20 90.0
By definition, about 15 per cent of home mortgages 1.25 87.5
are problem loans, but the problems of the banking 1.30 85.0
sector are wider than this. Insufficient documenta- 1.35 82.5
tion and irregularities during foreclosure procedures 1.40 80.0
have been revealed, causing banks to announce a new 1.45 77.5
moratorium on foreclosures − providing (involuntary) 1.50 75.0
support to the housing market in the form of free hous- 1.55 72.5
ing for millions of Americans who have defaulted on 1.60 70.0
their mortgages. This stimulus totals USD 2.6 billion per 07 08 09 10
month, according to The Wall Street Journal. Most of
Dollar per euro, reversed (LHS)
this money will likely go towards other consumption. US dollar Index (RHS)
Source: Reuters EcoWin, SEB

Looking ahead, the moratorium will reduce the supply

Declining dollar having little impact
of existing homes; in recent years about one third of
sales have been foreclosures. New home sales may also
on CPI
Since early summer, the dollar decline hit 14 per cent
benefit slightly, which is positive for new construction
in trade-weighted terms before reversing some of that
and GDP. Housing starts will total 600,000 units this

The market is worried about inflation that Fed policies will drive up inflation in the long
Market reactions indicate rising concern that the Fed’s term. Inflation expectations (5Y 5Y forward BE infla-
stimulus measures will lead to inflation down the tion) show an upturn of nearly 70 bps since late August
road. Since late August − when speculation about a and approached a 10-year peak a few weeks ago.
new round of QE took off − real interest rates (TIPS) According to the market deflation risks
have fallen (-31 basis points) while nominal interest have evaporated
rates have risen somewhat (+22 basis points). Like a Per cent
mirror image, inflation expectations (break-even infla- 3.5 3.5
tion) have risen by 46 bps during the same period. In 3.0 3.0
mid-October, TIPS reached a record-low 0.36 per cent.
2.5 2.5
Nominal vs real yields 2.0 2.0
Per cent
6 6 1.5 1.5

1.0 1.0
5 5
0.5 0.5
4 4
0.0 0.0
3 3 04 05 06 07 08 09 10

2 2 5y 5y forward BE inflation
Source: Reuters EcoWin, SEB
1 1
However, alternative measures of inflation expec-
0 0 tations indicate that deflation remains a risk. One
04 05 06 07 08 09 10 Cleveland Fed yardstick that focuses on how the pub-
10-year TIPS ("real rate") lic perceives inflation looking ahead 10 years ahead
10-year Treasury bond ("nominal rate") has fallen to its lowest-ever level (1.53 per cent in
10-year break-even inflation
Source: Reuters EcoWin, SEB October).

This year’s downturn in long-term yields has an en-
tirely different dynamic than in 2008, when 10-year
Treasury bonds fell to their lowest yield in modern
times (2.07 per cent). At that time, deflation worries
drove down nominal yields; expected 10-year inflation
stood at 0 per cent according to the break-even meas-
ure. This time around, the market seems convinced
In addition, there are powerful price-lowering forces
such as continued reductions in private sector borrow-
ing and enormous quantities of idle resources in the
economy. For example, 17.1 per cent of the labour
force, or 26 million Americans, are unemployed or
underemployed. Our conclusion is that it is too early
to declare an end to the danger of deflation.

22   |  Nordic Outlook – November 2010


movement in recent weeks. Although it still has some
way to go before hitting its 2008 and 2009 lows, this
movement has created concerns in other countries.
Rapid, sharp dollar slides have led to problems before.
In the 1970s, for example, the declining dollar was one
reason why global inflation took off.
Meanwhile a new Fed study shows that a 10 per
cent decline in the dollar only drives up inflation
by 0.3 percentage points. Among the factors limiting
its impact are that foreign companies do not want to
lose US market share, but instead accept lower profit
margins. It is thus most likely that core inflation will
continue to be squeezed by factors mainly determined
in the domestic market, such as rents and services.
In line with our earlier forecasts, core inflation has
continued to fall. Core consumer prices are rising at
their slowest pace since records began; 0.6 per cent in
October. There are many indications that inflation will
fall somewhat further. In light of this, the Fed has cited
the risk of deflation as one of the main motives for its
new stimulus measures.
Unit labour cost (ULC), one of the most important driv-
ing forces in the inflation process, has fallen during four
out of the past five quarters.
Core inflation uncomfortably close to zero
Year-on-year percentage change
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
00 01 02 03 04 05 06 07 08 09
Core CPI inflation (LHS) Fed Funds (RHS)
Core PCE inflation (LHS)
Source: BLS, BEA, SEB
Our forecast is that core inflation, measured by CPI,
will fall from 0.9 per cent this year to 0.6 per cent in
2011. Prices will remain under control during the fol-
lowing year as well, but our assessment is that inflation
curves will begin to point slightly upward. Core inflation
will amount to 1 per cent in 2012.
The Fed’s favourite yardstick is core inflation as meas-
ured by the personal consumption expenditure (PCE)
deflator. According to this, core inflation will now fall
below the central bank’s comfort interval. Alterna-
tive measures of underlying price pressure do not, in
principle, indicate any price pressure at all. This is why
the Fed − as it did after the previous inflation when
the dotcom (IT) bubble burst − will stick to ultra-loose
monetary policy during the foreseeable future. It will
not hike the federal funds rate until mid-2012.
The United States
A Republican wind is blowing
The Republicans achieved strong gains in the Novem-
ber 2 mid-term elections, recapturing a majority in
the House of Representatives but not in the Senate.
The most important question now is whether the two
main parties can work together. A popular adage on
Wall Street is that “political gridlock is good”, since
it prevents the passage of new legislation affecting
the business community − something that is hardly
true this time around, since the economy faces major
structural problems. Political blockages and obstacles
to collaboration will increase the probability of a new
recession. In the short term, the single most important
compromise will be an extension of the George W. Bush
administration’s tax cuts. Other key issues are prop-
erty taxation, extending the time limits on unemploy-
ment benefits and a flare-up of protectionism. Another
certainty is a re-working of the health care reform,
which is the object of growing criticism. Looking further
ahead, the structural deficit in the federal budget can-
not be swept under the carpet.
As a rule, the electorate has always punished or re-
warded an incumbent president’s party on the basis of
how the economy is performing. We can thus assume
that Barack Obama will present pro-business and
growth-promoting proposals between now and the 2012
presidential election, but the Republicans seem deter-
7 mined to sabotage the president’s plans. For example,
SEB
forecast 6
the Republican leader in the Senate, Mitch McConnell,
has repeatedly declared that his party’s highest priority
5
is to make Obama a one-term president. There is a risk
4 that this will harm the economy.
3
The tough budget situation at the state and local
2 government level will slow GDP growth by about 0.5
1 percentage points next year. In addition, the Obama
0 administration’s two-year tax cuts will likely expire,
10 11 12 along with the 99-week limit on unemployment ben-
efits. Infrastructure projects funded by the stimulus
package have also peaked, in our assessment. Taken
together, this means that federal fiscal policy will now
have a clear tightening effect on GDP growth: about
-1 percentage points in 2011.
The federal budget deficit, which totalled more than
USD 1.4 trillion in fiscal 2009, will slowly shrink to USD
1.3 trillion in 2010 and USD 1.26 trillion in 2011. The
deficit as a percentage of GDP will gradually decline
but will remain at a high 8.4 per cent in 2011. The na-
tional debt, which stood at 84 per cent of GDP in 2009,
will exceed 100 per cent by 2012.
Nordic Outlook – November 2010  |  23
 The United States

A plan to get the deficit under control

Mandatory spending accounts for 85 per cent of
federal outlays. Getting a grip on public finances and
reversing the trend towards an escalating US national
debt will thus require a comprehensive approach.
Merely trimming discretionary spending each year will
not accomplish much.

Federal government budget balance

Per cent of GDP
5.0 5.0

2.5 2.5

0.0 0.0

-2.5 -2.5

-5.0 -5.0

-7.5 -7.5

-10.0 -10.0

-12.5 -12.5
80 85 90 95 00 05 10

Source: US Department of the Treasury, SEB

Erskine Bowles, a Democrat, and Alan Simpson, a

Republican − co-chairs of the deficit commission ap-
pointed by President Obama − surprised everyone by
unveiling their personal conclusions in mid-November.
Their proposals would lead to a reduction in the fed-
eral budget deficit from USD 1.3 trillion this year to
USD 400 billion by 2015. The proposed reforms would
also slowly begin to shrink the national debt, which
now stands at USD 13.7 trillion. It remains to be seen
whether their proposals will reach Congress for a vote
later this year, since the support of least 12 of the
other 16 deficit commission members will be needed
first.

The proposals include cutbacks in the Social Security

pension and Medicare systems, raising the retirement
age and lowering defence appropriations. The tax sys-
tem would be simplified, with one attractive feature
being that tax revenue would increase, at the same
time as both income and corporate taxes would be
cut. Lower tax rates would be offset by eliminating
other tax credits and deductions. Fiscal policy would
not be affected during 2011.

24   |  Nordic Outlook – November 2010

 Japan

Continued recovery but increased uncertainty

ƒƒ Record-strong yen hampering export firms
ƒƒ Deflation pressure is continuing
ƒƒ Bank of Japan intervention and stimulus
After a very strong start in the first quarter of 2010,
growth decelerated noticeably in the second quarter,
then took off again in the third quarter; according to
preliminary figures, GDP climbed then by an annualised
3.9 per cent. Growth figures for the first and second
quarters have been revised substantially upward.
We expect GDP to increase by 3.1 per cent in 2010.
Growth will then slow to 1.6 per cent in 2011 and 1.5
per cent in 2012.
Sharp decline for purchasing managers' index
65
60
55
have recently been strong. This is usually a sign that
corporate capital spending is about to take off.
Deflation is maintaining its grip. In September, the infla-
tion rate was -0.6 per cent, while core inflation was
-1.5 per cent for the fourth straight month. CPI will fall
by nearly 1 per cent this year. We expect 2011 inflation
to be close to zero.
The US Fed’s quantitative easing policies and the crisis
in southern Europe have contributed to a sharp rise in
the yen. Since January, the yen has gained some 15 per
cent against the euro and 10 per cent against the dollar.
This autumn the Bank of Japan intervened in an at-
tempt to counter yen appreciation. We expect the USD/
JPY rate to stand at 88 at the end of 2011.
The yen is stronger than ever against the USD
65 400 400
60
55 350 350

50 50 300 300
45 45
40 40 250 250

35 35
200 200
30 30
25 25 150 150
20 20
100 100
15 15
06 07 08 09 10 50 50
77 80 83 86 89 92 95 98 01 04 07 10
Total Order bookings
Export order bookings USD/JPY EUR/JPY
Source: Markit Source: Reuters EcoWin

Recent indicators are reflecting the fragility of the re-
covery. The purchasing managers’ index in manufactur-
ing has fallen sharply from a peak of 54.7 in May to 47.2
in October. Order bookings are at their lowest since
April 2009. Export order bookings have also fallen below
50. The slowdown is also clearly evident in hard data.
During the past three months, industrial production has
fallen back to its January level. Exports have also been
subdued in recent months. We believe this will continue
during the first half of next year. In 2011, export growth
will end up just above 4 per cent.
There are some positive signs in the domestic economy,
however. Unemployment fell slightly to 5 per cent in
September, helping to fuel private consumption. We
estimate that consumption will increase by about 2 per
cent this year. The number of housing starts has risen
for four months in a row. Aside from weak figures for
September, order bookings for the machinery industry
Economic stimulus measures are now in effect on a
broad front. This autumn, the government presented
a new fiscal stimulus programme in the form of an
extra budget equivalent to USD 55 billion, equivalent
to about 1 percent of GDP. Among other things, this
stimulus will be used to prop up regional economies and
small businesses. This means that central government
debt will keep climbing and will reach 240 per cent of
GDP by 2012.
Early in October, the BoJ lowered its key interest rate
from 0.1 per cent to the 0-0.1 per cent range. It also
unveiled an asset purchase programme equivalent
to USD 62 billion. About 80 per cent will be used for
purchases of government securities and the rest to buy
corporate bonds, commercial paper and exchange-
traded funds (ETFs). We expect this programme to have
only a limited impact, however.

Nordic Outlook – November 2010  |  25

Asia

Global economic engine despite slower growth

ƒƒ Capital inflows creating tensions ated with various problems. Capital inflows generate
appreciation pressure on Asian currencies, which could
ƒƒ Soft landing in China
make their exports less competitive. There is also a
ƒƒ Continued good growth in India heightened risk of asset price bubbles and a threat of
instability if the capital flows should reverse.

A number of countries have tried to limit these inflows

Asia’s resilience during the economic crisis has further
by means of regulation or intervention in the foreign
increased the importance of that region to the world
exchange market. This autumn, growing criticism of
economy. Asian emerging countries have moved from
US monetary policy has begun to be heard in emerging
just above a 10 per cent share of global GDP in 1990 to
economies, thereby increasing the risk of more wide-
nearly one fourth in 2010. But during the third quarter,
spread measures in these countries.
their GDP growth rate decelerated, mainly as a conse-
quence of slower expansion in exports and industrial Inflation in Asia
production. Looking ahead, we expect continued de- Year-on-year percentage change
celeration, though growth will remain higher than the 12.5 12.5
global average. 10.0 10.0

So far, the strong performance of the Asian economies 7.5 7.5

has not led to any broad inflation pressure although ris- 5.0 5.0
ing food prices are pushing up consumer prices in China, 2.5 2.5
India and elsewhere.
0.0 0.0
GDP growth decelerates -2.5 -2.5
Year-on-year percentage change
-5.0 -5.0
15.0 15.0
07 08 09 10
12.5 12.5
10.0 10.0 China Indonesia South Korea
India Malaysia Thailand
7.5 7.5 Source: Local statistical offices
5.0 5.0
2.5 2.5
0.0 0.0
China: Gradual deceleration
In China, economic growth slowed during the third
-2.5 -2.5
quarter. GDP rose by 9.6 per cent year-on-year, com-
-5.0 -5.0
pared to 10.3 per cent in the second quarter. There are
-7.5 -7.5
07 08 09 10 no signs of an economic hard landing. While it is true
that the rate of increase in exports decelerated clearly
China Indonesia South Korea
in September, neither purchasing managers’ indices,
India Malaysia Thailand
Source: Local statistical offices retail sales, industrial production nor bank lending
reflected any significant drop in activity − thereby
The main risks in Asia are connected to large-scale confirming the picture of a controlled soft landing we
capital inflows. Good global liquidity combined with described in our August report. GDP growth will reach
major differentials in interest rates and growth pros- 10.2 per cent in 2010 and decelerate to 9 per cent in
pects between Asia, on the one hand, and the United 2011. In 2012, GDP growth will be 8 per cent.
States and Western Europe on the other are the driving
forces behind this trend. During the autumn, the US The contribution of exports to growth will decrease
Federal Reserve’s quantitative easing policy and in the next couple of years, while the role of domes-
accompanying downward pressure on the dollar have tic demand will increase. There are various examples
further strengthened speculative capital flows to Asia. of China’s efforts to reduce dependence on exports
and continue its transition towards more domestically
These inflows are leading, among other things, to rising driven demand. An important element is investing in
share and property prices as well as a heavy demand for the development of China’s central and western areas,
fixed income securities. These developments are associ- which are lagging behind the more industrialised and

26   |  Nordic Outlook – November 2010


urbanised eastern part of the country. One example
is the build-up of a functioning financial system and
improvement in rural infrastructure, thereby countering
bottleneck problems in the agricultural sector. Con-
sumption in rural areas has been stimulated by provid-
ing discounts to households for purchases of capital
goods. China’s five-year plan for 2011-2015 will also
focus on strengthening domestic demand and the “qual-
ity” of growth. Central government expenditures for
health care will continue to increase, reducing the need
for households to save and thereby stimulating con-
sumption. A growth model based on domestic demand
rather than export growth will provide more stable
development with fewer imbalances, but GDP growth
will probably no longer be able to reach double-digit
figures.
Broad-based tightening
The housing market remains hyperactive, and in a
number of major cities there are clear signs of over-
heating. At the national level, home prices continue to
climb rapidly, although the rate of increase has deceler-
ated somewhat since this past summer. In September,
the year-on-year rate of increase was 9 per cent. In
some major cities, home prices have reached a level
higher than an average household can manage.
China: Slower increase in home prices
Year-on-year percentage change
25
20
15
10
5 5
0 0
-5
-10
-15
-20
07 08 09
70 cities Shenzhen
Beijing Hangzhou
Source: National Bureau of Statistics of China
This autumn, the government has implemented new
measures to cool down the housing market. It has fur-
ther restricted residential loans to households by lower-
ing the permitted loan-to-value ratio. Bank reserve
requirements have also been raised, and a property tax
will probably be introduced during 2011. The authori-
ties have also pledged to build housing units that even
low-income households can afford, in order to slow
down the long-term price increases for housing.
In our assessment, these measures are sufficient to
ensure that a sharp decline in home prices can be
avoided. We are thus sticking to our main scenario, in
which prices will level off. One reason for this is that
in a longer-term perspective, price increases have not
been alarmingly high. Since 1998, when China’s private
housing market began to develop, home prices at the
Asia
national level have risen roughly in line with disposable
per capita income.
Chinese authorities have also begun to use interest rate
policy in order to cool down the economy. In October,
the central bank raised its key rate by 25 basis points to
5.56 per cent. This was the first rate hike since Decem-
ber 2007 and a reaction to rising CPI inflation in recent
months. In October, the inflation rate reached 4.4 per
cent, which was the fastest increase since September
2008 and well above the central bank’s 3 per cent tar-
get for 2010. Rising food prices drove up inflation; core
inflation, which excludes food and energy, was 1.1 per
cent in September for the third month in a row. There is
limited room for further rate hikes as long as developed
economies keep their key interest rates at extremely
low levels, due to problems related to speculative cur-
rency flows. However, our assessment is that the central
bank’s concern about the rapid increase in the inflation
rate will result in more interest rate hikes in late 2010
and early 2011. China is also considering price controls
to contain inflation.
China: CPI, core inflation and key rate
Per cent
9 9
8 8
7 7
6 6
5 5
25 4 4
3 3
20
2 2
15 1 1
10 0 0
-1 -1
-2 -2
00 01 02 03 04 05 06 07 08 09 10
-5
-10 CPI Key rate (one year interest)
-15 Core inflation
Source: National Bureau of Statistics of China
-20
10
Cautious appreciation
Since China’s central bank resumed the appreciation
of the yuan against the US dollar in June, the currency
has appreciated by a modest 3 per cent. Communica-
tion from the bank indicates that this appreciation will
continue at a modest pace, out of concern for Chinese
export companies. But there are good arguments for
letting the currency strengthen. Such appreciation will
counteract inflationary tendencies triggered by imports
but will also help boost household purchasing power,
thereby facilitating the transition to an economy more
based on domestic demand.
We expect China to keep its promises of continued,
modest-paced yuan appreciation against the dollar. It
is likely that periods of yuan appreciation will alternate
with periods of depreciation, in order to decrease the
risk that “one-way bets” will boost speculative capital
inflows. Over the next 12 months we foresee an ap-
preciation of the yuan against the dollar of around 4
per cent and that the USD/CNY rate will then be 6.40.
Nordic Outlook – November 2010  |  27
 Asia

The relatively slow appreciation of the yuan has
become an important issue in the US; the House of Rep-
resentatives approved a bill that would allow American
companies to demand import tariffs on imports from
China to compensate for the weak yuan. Yet it is unlike-
ly that this proposal will be implemented in practice.
Both China and US have an interest in not escalating
their disagreements. And although the tone of dis-
course has occasionally been shrill, there are still signs
of a desire to reach consensus. China has expressed a
willingness to specify a target for reduction of its trade
surplus. Meanwhile, the US has chosen not to single out
China as a currency manipulator.
Cautious yuan appreciation against the USD
6.50
6.75
7.00
7.25
7.50
7.75
8.00
ber. Changes in the weightings India uses to measure
inflation have also contributed to the slowdown. In our
assessment, the inflation rate will continue to deceler-
ate in the next few months, among other things as a
consequence of monetary tightening.
The central bank is nevertheless continuing to express
concern about developments, since inflation is far
above the desired 3 per cent medium-term rate. Since
the bank began tightening monetary policy in March
2010, it has raised its key interest rate by 1.5 percent-
age points to a level equivalent to 6.25 per cent. The
central bank has indicated its willingness to continue
hiking interest rates, since it is beginning to view rising
food prices as a structural problem associated with
6.50 excessively low supply of certain goods. Our assessment
6.75 is that the bank will hold off until the first quarter of
2011, among other things to give its earlier rate hikes a
7.00
chance to have an impact.
7.25
India: Purchasing managers' index
7.50
62.5 62.5
7.75 60.0 60.0
8.00 57.5 57.5

8.25 8.25 55.0 55.0

8.50 8.50 52.5 52.5

05 06 07 08 09 10
50.0 50.0
Source: Reuters EcoWin
47.5 47.5

India: Continued good growth
Low export dependence, coupled with domestic
stimulus measures, has enabled India to weather the
economic crisis of recent years satisfactorily. Growth
has been good in 2010; second quarter GDP growth
was 8.8 per cent, or somewhat higher than in the first
quarter. Looking ahead, however, the signals are a little
more mixed. The purchasing managers’ index in the
service sector has fallen in recent months, while the
index for manufacturing recovered in October. The rate
of increase in industrial production has decelerated
sharply since last spring, and in September the year-on-
year percentage change was 4.4 per cent. Key interest
rate hikes and fading stimulus effects also indicate that
growth will slow somewhat during the second half of
2010. We have revised our 2010 GDP growth forecast
a bit downward to 8.7 per cent. GDP will grow by 8.0
per cent in 2011 and 7.0 per cent in 2012.
This year’s good harvest has helped curb food price
increases. CPI inflation has consequently fallen from
just below 11 per cent in April to 8.6 per cent in Octo-
45.0 45.0
42.5 42.5
07 08 09 10
Manufacturing sector Service sector
Source: Markit
India’s central bank exemplifies how emerging countries
are actively trying to counter the effects of capital in-
flows. This autumn, the bank intervened in the foreign
exchange market in order to limit the appreciation of
the rupee against the US dollar. Our assessment is that
the rupee will stand at 42 per USD one year from
now.
Unlike most other Asian emerging countries, however,
India is running a current account deficit. This deficit
has grown during 2010 as demand for imports has risen
and is expected to reach around 3 per cent of GDP. In
this situation, capital inflows help facilitate the financ-
ing of the deficit, but it is a source of concern that
these inflows are clearly dominated by portfolio invest-
ments rather than direct investments and can thus be
withdrawn quickly.

28   |  Nordic Outlook – November 2010

 The euro zone

Decent 2011, but debt reduction is burdensome

ƒƒ Exports will slow in 2011 and growth will Mixed indicators
level off Most leading indicators have continued to rise this au-
ƒƒ Ireland and Portugal are in bad shape − tumn. For example, Germany’s IFO index − which shows
financial aid required relatively strong co-variation with GDP growth − has
kept on climbing. In October the IFO reached its high-
ƒƒ No ECB refi rate hike until March 2012 est level since May 2007 (107.6). Respondents’ view of
current business conditions improved, while their future
expectations were also surprisingly positive despite a
In the euro zone as a whole, growth is in line with stronger euro and increased risks to global growth. This
our earlier forecasts. GDP will grow by 1.6 per cent signals that the country’s GDP growth, which reached
this year, far above the consensus view prevailing as a strong 3.9 per cent year-on-year in the third quarter
recently as this past summer. But differences within (4.3 in the second quarter), will gain further momen-
the region have widened: Germany is benefiting from tum during the rest of 2010. We expect German GDP
an exceptional export and investment surge this year, growth of almost 4 per cent year-on-year in the
while various other euro zone members − especially fourth quarter, pushing the full-year figure to 3.6 per
the PIIGS countries (Portugal, Ireland, Italy, Greece and cent.
Spain) − are ­burdened by competitiveness problems
IFO at three year high
and fiscal austerity measures. This two-speed euro zone Year-on-year percentage change (GDP), IFO index 2000=100
will continue in 2011 and 2012. The German economy 5.0 120
will decelerate but growth will remain somewhat 115
3.0
above trend, while the PIIGS countries will continue to 110
be weighed down by structural problems and budget 1.0 105
consolidation. Financial aid measures at the European -1.0
100
level, combined with national cost-cutting programmes, 95
-3.0 90
have indeed eased acute crisis symptoms. But the
85
problems are far from solved. Today they are especially -5.0
80
large in Ireland and Portugal. Euro zone growth will -7.0 75
reach 1.7 per cent in 2011 and 1.5 per cent in 2012, 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
somewhat above today’s consensus forecast.
GDP, Germany (LHS)
Germany in the lead, PIIGS lagging behind Current business conditions (RHS)
Composite leading index Expectations (RHS)
Source: Federal Statistics Office, IFO
112.5 112.5
110.0 110.0 However, other indicators are pointing towards a
107.5 107.5
slowdown. The purchasing managers’ index (PMI) for
105.0 105.0
102.5 102.5
the euro zone as a whole fell somewhat faster than
100.0 100.0 expected in October, reaching a level (53.4) compat-
97.5 97.5 ible with quarter-on-quarter GDP growth of about 0.3
95.0 95.0 per cent during the fourth quarter. The downturn in the
92.5 92.5 index was driven by the service sector, while manu-
90.0 90.0
facturing continued upward. Financial market players
87.5 87.5
85.0 85.0
also doubt the recovery, judging from Germany’s ZEW
00 01 02 03 04 05 06 07 08 09 10 index. However, the decline in the index unexpectedly
reversed in November; the current economic situation
Germany France PIIGS
Source: OECD
sub-index continued upward to its highest level since
July 2007 and the sub-index for the future climbed
Low inflation will enable the European Central Bank above zero.
to keep its refi rate low for an extended period in
order to support economic recovery in southern Europe. Exports will slow down
The first rate hike to 1.25 per cent will come in March The upturn in the IFO index reflects the success of Ger-
2012. The key rate will be 1.75 at the end of 2012. man manufacturers so far this year; order bookings are

Nordic Outlook – November 2010  |  29

 The euro zone

currently increasing by about 20 per cent year-on- expect fixed investments to grow by about 4 per cent
year, while industrial production and exports will climb annually in the euro zone during 2011-2012.
more than 10 per cent for the year as a whole.
Capital spending has rebounded
The manufacturing sector is also rebounding in France Year-on-year percentage change and per cent
10 85.0
and Italy, where production will increase by nearly 5
per cent this year. In other countries, the trend is far 5 82.5
more modest. In Portugal and Spain, for example, the 80.0
0
upturn will not exceed 1.5 and 1 per cent, respectively,
77.5
while Greece will note a 5 per cent downturn. -5
75.0
-10
72.5
Industrial production -15 70.0
Year-on-year percentage change
-20 67.5
2009 2010 2011 2012
00 01 02 03 04 05 06 07 08 09 10
Germany -16.4 9.0 4.4 4.1
Gross capital formation (LHS)
France -18.0 4.8 3.5 3.3 Capacity utilisation, manufacturing (RHS)
Source: Eurostat, DG ECFIN
Italy -18.4 4.8 2.9 2.5
Spain -16.2 0.9 1.7 3.1 As for private consumption, developments in Germany
are crucial. So far, German consumers seem to be
Greece -10.2 -5.0 -1.5 2.5
clutching their wallets tightly; in September, retail
Portugal -8.4 1.5 0.7 2.1 sales fell for the second month in a row.
Ireland -4.5 4.0 3.8 3.6 Consumer confidence is climbing
Euro zone -14.8 7.0 3.8 3.5 Index and year-on-year percentage change
5 4.0
Source: European Commission, SEB
0
3.0
Stronger domestic demand -5
2.0
To date, the economic recovery in the euro zone has -10
been driven by rising exports, especially from Germany. -15 1.0
Because of the stronger euro and a global industrial -20
0.0
cycle that is entering a more mature phase, export -25
growth will cool in 2011. To keep the recovery from -30
-1.0
losing momentum, domestic demand will have to be -35 -2.0
capable of taking over as a growth engine. 00 01 02 03 04 05 06 07 08 09 10

Rising capacity utilisation indicates that capital spend- Consumer confidence (LHS)
ing will accelerate during our forecast period: we Private consumption (RHS)
Source: DG Ecfin, Eurostat, SEB

A 20 per cent probability of recession

The probability of a renewed recession in the next
six months can be calculated with the help of “probit
analysis”. This method clearly illustrates the major
differences in economic potential that character-
ise the euro zone right now. It shows that over the
next six months, the risk of recession is very small in
France, Italy and Germany while the risk of a contin-
ued recession is highly apparent in Greece (80-85 per
cent risk). The risk of a recession in Portugal and Spain
is 10-15 per cent. However, taking into account the
risk of recession in the United States as well, and the
links that exist between the euro zone and the US as
well as individual euro zone countries, the recession
risks are proving generally higher. Our overall assess-
ment is that the risk of a “double dip” in the euro
zone is about 20 per cent.
Probability of recession in the next six months
Per cent
Probability Share
Germany <5 26.8
France <5 20.3
Italy <5 16.7
Spain 10-15 12.9
Greece 80-85 3.3
Portugal 10-15 2.2
Ireland 20-30 1.5
Euro zone 20 100
Note: “Share” refers to each country’s percentage of total
euro zone GDP in 2009.
Source: European Commission, SEB

30   |  Nordic Outlook – November 2010


The combination of a stronger labour market, rising
consumer confidence and accelerating pay hikes never-
theless indicates that private consumption may soon
begin making a positive contribution to economic
growth in Germany. We anticipate an increase of just
above 1 per cent in both 2011 and 2012 after this year’s
stagnation. In the euro zone as a whole, consumption
will rise by about 0.5 per cent this year and roughly 1
per cent in both 2011 and 2012.
Overall, this forecast implies that GDP growth will
remain just above 1.5 per cent in 2011-2012, about
the same as our forecast in August and slightly higher
than the consensus forecast. German GDP will grow by
3.6 per cent this year, 2.5 per cent in 2011 and just
below 2 per cent in 2012. France will grow by about
1.5 per cent a year throughout our forecast period,
Italy by around 1 per cent. Spanish GDP will shrink by
about 0.5 per cent this year, then show positive growth
of more than 0.5 per cent in 2011 and above 1 per cent
in 2012. Greek GDP will fall by 4 per cent this year and
by 2 per cent in 2011, with around zero growth in 2012.
More austerity required
Major fiscal austerity programmes are now being
implemented in many euro zone countries. Aside from
Greece, economic needs − and problems − now look
especially great in Ireland and Portugal. Among other
things, Greece has slashed wages and salaries and
boosted the retirement age in its public sector. Early in
November, the Portuguese parliament accepted a new
budget that includes higher banking fees, a VAT hike,
tighter expenditures and the sale of government assets.
According to Prime Minister José Sócrates, the budget
will enable the country to avoid “the danger zone of
financial market turbulence”. In Spain, sharp cutbacks
in the public sector and tax hikes are on the way.
Rising 10-year yield spreads against Germany
Percentage points
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
Oct Jan Apr Jul Oct Jan Apr Jul Oct
08 09 10
France Ireland Portugal
Greece Italy Spain
Source: Reuters EcoWin
These austerity measures will help ease budget deficit
and sovereign debt problems, but in many countries the
situation remains serious. Government debt is continu-
ing upward towards record levels, with lasting uncer-
tainty about long-term solvency as a consequence.
The euro zone
This autumn, the situation in Ireland has become
increasingly acute. This year’s budget deficit will reach
a stunning 32 per cent of GDP due to the government’s
concerted efforts to save the banking system. Although
much of the deficits are due to nonrecurring outlays,
Ireland is in very bad shape. Rapidly rising yields on its
bonds forced the government to announce EUR 6 billion
(3.8 per cent of GDP) in further cutbacks on November
4, well before publication of next year’s budget sched-
uled for December 7. The government hopes to bring
down the deficit to about 9.5 per cent of GDP in 2011
and 3 per cent by 2014. We do not believe it will fully
succeed in doing so. Instead, we anticipate a continued
deficit of more than 10 per cent in 2011 and well above
3 per cent in 2014. There is thus a great risk that Ire-
land’s sovereign debt rating will be downgraded from
the current Aa2 (according to Moody’s), even after
Ireland’s formal request for financial support from
the EU and the IMF on November 21.
Fiscal tightening, 2010-2013
Per cent of GDP
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
Portugal Italy Spain
Ireland Greece
Source: SEB
Total fiscal austerity measures during 2010-2013 cur-
rently appear likely to reach about 5 per cent of GDP
in Portugal, between 7 and 8 per cent in Ireland, just
above 1 per cent in Italy, about 10 per cent in Greece
and about 6 per cent in Spain − and further increases
cannot be ruled out.
However, German federal tax revenue has provided
upside surprises so far this year. One effect of the
rapid upswing in the economy has been surging corpo-
rate profits and thus large tax payments from compa-
nies. The German government has been able to revise
its budget deficit forecast downward several times.
Early in November, for example, government projec-
tions indicated that revenue will be a full EUR 62.5
billion larger in 2010-2012 (about 2.5 per cent of GDP)
than according to its earlier forecast. We are sticking
to our view that Germany will meet the 3 per cent EU
budget deficit ceiling as early as next year.
Nordic Outlook – November 2010  |  31
 The euro zone
Budget balance and sovereign debt
Per cent of GDP
Budget Debt
2010 2011 2012 2012
Ireland -32.0 -12.1 -10.6 118.2
Spain -9.8 -8.5 -7.0 78.5
Greece -10.1 -8.6 -8.0 153.5
Portugal -8.3 -7.6 -6.1 98.1
France -7.6 -7.1 -5.6 93.3
Slovakia -6.0 -5.2 -3.7 50.3
Belgium -5.0 -5.0 -3.5 107.7
Slovenia -6.0 -5.0 -3.5 49.9
Netherlands -6.0 -5.0 -3.5 75.3
Italy -5.3 -4.7 -3.2 129.2
Austria -4.7 -4.5 -3.0 79.7
Germany -4.0 -2.3 -1.8 81.5
Finland -3.4 -2.5 -2.2 51.9
Euro zone -6.6 -5.3 -5.0 94.0
Source: European Commission, SEB
Lower unemployment in 2011-2012
In the euro zone as a whole, unemployment rose to 10.1
per cent in September after moving sideways at 10 per
Watered-down sanctions when EU Stability
and Growth Pact is revised
In September the European Commission − led by Olli
Rehn, Commissioner for Economic and Monetary Policy
− unveiled a series of new economic policy propos-
als aimed at correcting shortcomings in euro zone
collaboration. The Commission presented a package of
measures intended to harmonise and tighten surveil-
lance of member countries’ fiscal policies. These
proposals are the EU’s most ambitious effort so far to
improve the stability and long-term growth forces in
the economies of EU member countries.
For example, the Commission presented a new time-
table for budget procedures, with a larger element of
advance budget surveillance, unlike the current sys-
tem of examination after the fact. Sanctions against
countries that violate the rules of the Pact will also be
tightened and made clearly more automatic.
Aside from restoring fiscal stability in the euro zone,
the Commission also wants to mobilise the forces that
drive economic growth by enacting various struc-
tural reforms, for example in the labour and service
markets.
The EU summit meeting in Brussels late in October
nevertheless revealed major disagreements about
the allocation of power in the EU system. In re-
sponse to a proposal to create a permanent rescue
32   |  Nordic Outlook – November 2010
cent since March of this year. The jobless rate appears
unlikely to rise any higher, despite weak growth in the
PIIGS countries and southern Europe. One major reason
why unemployment did not increase was the resilient
German labour market (unemployment there fell to
6.7 per cent in September). The German government’s
system of “Kurzarbeit” allowances, which enables
potentially redundant employees to work fewer hours
but retain most of their normal pay, has surpassed
expectations. Because companies could keep on a large
percentage of their labour force during last year’s
slump, they have now been able to ramp up production
quickly again during the upturn phase. These subsidies
may have saved more than 500,000 German jobs.
Unemployment will fall in 2011-2012
Per cent
11.0 11.0
10.0 10.0
9.0 9.0
8.0 8.0
SEB
7.0 forecast 7.0
6.0 6.0
5.0 5.0
00 01 02 03 04 05 06 07 08 09 10 11 12
Okun's Law NAIRU
Unemployment
Source: Eurostat, OECD, SEB
fund that would save member countries from financial
crises like the one that hit Greece last spring, Ger-
many proposed a revision of the Lisbon Treaty so the
EU could not be forced to pay the cost of getting a
crisis-ridden country out of its problems. The reason
is that today’s Lisbon rules forbid bail-outs, which a
permanent version of last spring’s temporary rescue
fund might imply.
France also managed to win acceptance for its
proposal to sideline the question of automatic and
stricter sanctions against countries that mismanage
their public finances. This means that today’s arbitrary
voting rules, in which a qualified majority of mem-
ber countries must vote for sanctions, will remain in
force.
These French and German demands imply that the Eu-
ropean Commission’s proposed new economic policy
legislation will be partly watered down. All member
countries − and the ECB − seem to agree that a strict-
er overall approach is needed, with more focus on
budget discipline, debt levels, long-term sustainability
in public finances and growth-promotion policies, but
it remains to be seen whether there is sufficient
political will to actually achieve an improvement.
 The euro zone

Yet similar systems have not prevented unemployment tract for Germany’s metalworkers, which expires in
from climbing in other euro zone countries. In France March 2012, pay will rise by 2.7 per cent year-on-year
the jobless rate now stands at 10 per cent, in Italy at starting in April 2011. Other unions are likely to make
8.3 per cent. In Spain the trend is disastrous: unemploy- similar demands, and the general recommendation by
ment stood at 20.8 per cent in September, more than German trade unions is that wages and salaries should
twice the September 2007 level. A strong tourist season increase by about 3 per cent year-on-year. This
with fewer lay-off notices nevertheless helped lower rate of pay hikes is also quite consistent with our own
Spanish unemployment in the third quarter − the first projections, which indicate pay increases of nearly 3
downturn since the second quarter of 2007. We still per cent year-on-year by the end of our forecast period
expect euro zone unemployment to end up averag- (see above chart). In Germany there seems to be rather
ing 10 per cent this year, 9.7 per cent in 2011 and 9.4 widespread acceptance of somewhat higher pay hikes
per cent in 2012 − a somewhat brighter forecast than (see the discussion below about internal devaluation).
today’s consensus view, which remains around 10 per
cent both in 2010 and 2011.
Inflation expectations just below 2 per cent
Net figure and per cent
This forecast is partly based on estimates of what level 35 4.5
30 4.0
of GDP growth is compatible with unchanged unemploy-
25 3.5
ment (see Nordic Outlook, August 2010). Our estimates 20 3.0
indicate that this growth requirement has decreased in 15 2.5
the euro zone over the past decade: from 2.3 per cent 10 2.0
5 1.5
in 1990-2000 to 0.9 per cent in 2000-2010. As the above
0 1.0
chart shows, the jobless rate will fall towards the long- -5 0.5
term non-accelerating inflation rate of unemployment -10 0.0
(NAIRU). Unemployment is now dropping faster than -15 -0.5
-20 -1.0
assumed by Okun’s Law − which relates unemployment
02 03 04 05 06 07 08 09 10
to the output gap − primarily due to the positive effects
of temporary job-sharing allowances. When these al- Households' expected price trend, next 12 months (LHS)
Break-even inflation, 2012 (RHS)
lowances are phased out, however, there is a risk that Source: DG ECFIN, Retuers EcoWin
unemployment will rebound.
Continued low inflation pressure
Pay increases will accelerate Although euro zone inflation in October, as measured
The sharp economic downturn of 2009 resulted in very
by the Harmonised Index of Consumer Prices (HICP),
limited pay demands from trade unions, which cared
came out at 1.9 per cent − somewhat higher than
more about preserving their members’ jobs than about
expected − most signs indicate continued low inflation
nominal wage and salary hikes. Pay increases in the
pressure. The October figure was pushed upward by a
euro zone manufacturing sector thus decelerated from
temporary jump in food prices. Even with oil prices at
a peak of just over 4 per cent in early 2009 nearly down
today’s level, the contribution of energy to inflation
to 1.5 per cent at present. Total hourly wage hikes have
will decline sharply in the months ahead. Capacity and
fallen from just below 3 per cent in 2009 to about 1.5
resource utilisation are also still low. Current pay agree-
per cent in 2010.
ments are low. In addition, inflation expectations are
Pay increases will accelerate in 2012 relatively restrained, though higher than a year ago.
Percentage points, year-on-year percentage change Break-even inflation is currently just below 2 per cent.
-2.0 4.5 Core inflation (HICP excluding energy and food prices) is
-1.5 4.0 also stable at around 1 per cent.
-1.0
3.5 Core inflation will bottom out early in 2011
-0.5 Per cent
3.0
0.0 4.5 4.5
0.5 2.5 4.0 4.0
1.0 2.0 3.5 3.5
SEB
3.0 forecast 3.0
1.5 1.5 2.5 2.5
2.0 2.0 2.0
1.0
00 01 02 03 04 05 06 07 08 09 10 11 12 1.5 1.5
1.0 1.0
Change in unemployment, shifted 2 years forward (LHS) 0.5 0.5
Change in total wage and salary cost in industry (RHS) 0.0 0.0
Source: Eurostat, SEB
-0.5 -0.5
-1.0 -1.0
But the economic recovery in the euro zone, especially
01 02 03 04 05 06 07 08 09 10 11 12
in Germany, will mean somewhat faster pay increases
ahead. For example, according to the collective con- HICP inflation Core inflation
Source: Eurostat, SEB

Nordic Outlook – November 2010  |  33

 The euro zone

We expect a decline in HICP inflation to 1.7 per cent sively low key interest rate in Germany is relatively
in December this year and 1.3 per cent in June 2011. limited, though, since the need for stronger German
Measured as annual averages, HICP inflation will be 1.5 domestic demand will gradually increase as the coun-
per cent this year, 1.3 per cent in 2011 and 1.4 per try’s export recovery enters a more mature phase. Nor
cent in 2012. Energy and food will contribute 0.3-0.5 should a faster-paced domestic economy − with higher
percentage points to inflation in 2011-2012. Our infla- nominal pay increases and private consumption − be
tion forecast is somewhat higher than in August, mainly a problem for German industry, which has greatly im-
due to VAT and other tax hikes in major euro zone proved its international competitiveness throughout the
countries. Core inflation will be somewhat below 1 per past decade. An adjustment in the relative cost level
cent until the second quarter of 2012, then begin a slow between the PIIGS countries and Germany may actu-
climb towards 1.4 per cent in December 2012. ally be a positive side effect of the ECB’s continued low
refi rate, since it may smooth out savings imbalances in
Big differences in competitiveness the euro zone (private savings are too low in the PIIGS
Unit labour costs, index 2000=100
countries, too high in Germany).
150 150
145 145 ECB: Decline in long-term refinancing
140 140
135 135
EUR billion
130 130 800 800
125 125 700 700
120 120
600 600
115 115
110 110 500 500
105 105 400 400
100 100
95 95 300 300

00 01 02 03 04 05 06 07 08 09 10 11 200 200
100 100
Portugal Italy Spain
Ireland Greece Germany 0 0
Source: OECD 98 00 01 02 03 04 05 06 07 08 09 10

Short-term refinancing ("main refinancing operations")

No ECB rate hike until March 2012 Long-term refinancing
The ECB is in no hurry to raise its key interest rate, Source: ECB

which has stood at 1 per cent since May 2009. It is true

In the euro zone as a whole, the banking and financial
that the central bank has made upward adjustments in
sector is also likely to need low interest rates for some
both its growth forecast for the euro zone (1.4-1.8 per
time to come, despite certain signs of stabilisation.
cent this year, 0.5-2.3 per cent in 2011) and its infla-
Credit and money supply growth remains historically
tion forecast (1.5-1.7 per cent and 1.2-2.2 per cent,
low despite its recent upturn, and the decline in long-
respectively). However, due to a combination of great
term ECB refinancing may be a sign of weaker demand.
uncertainty about growth prospects in the next couple
of years and major budget and growth problems in the
Overnight rate still below refi rate
Per cent
PIIGS countries, the euro zone central bank will hold
5.0 5.0
off on rate hikes in order to sustain the economic
4.5 4.5
recovery in southern Europe. 4.0 4.0
Continued low credit and money supply 3.5 3.5
growth 3.0 3.0
Year-on-year percentage change 2.5 2.5
15.0 15.0 2.0 2.0
12.5 12.5 1.5 1.5
1.0 1.0
10.0 10.0
0.5 0.5
7.5 7.5
0.0 0.0
5.0 5.0 Jan May Sep Jan May Sep Jan May Sep
08 09 10
2.5 2.5 EONIA O/N Refi rate
Source: Reuters EcoWin
0.0 0.0

-2.5 -2.5 We still foresee that the ECB will hike its refi rate to
99 00 01 02 03 04 05 06 07 08 09 10
1.25 per cent in March 2012. After that, there will be
Credits M3 two more hikes that same year, bringing to refi rate to
Source: ECB
1.75 per cent by the end of 2012. The European Over-
night Index Average of interbank interest rates (EONIA)
In 2011-2012 the refi rate level will thus be largely
is currently some 20 basis points below the refi rate,
tailored to the needs of southern Europe, rather than
but we expect it to coincide with the refi rate during
those of fast-growing Germany. The cost of an exces-
the first half of 2011.

34   |  Nordic Outlook – November 2010

 The United Kingdom

British economy will weather fiscal storm

ƒƒ Home prices are losing ground again
ƒƒ High inflation a headache for the BoE
ƒƒ Employment rising rapidly, but jobless
rate not yet declining
rates will ease the debt service burden — UK house-
holds are among the most indebted in the world — and
make more room for consumption, but at the same time
major public sector austerity packages will hold down
income and consumption.

Home prices represent a significant downside risk.

The Nationwide index has fallen during four of the past
During the past six months the British economy has
five months. Home prices are now 10 per cent above
performed better than feared, but large government
their low (February 2009) but also 12 per cent below
austerity programmes will slow activity ahead. A weak
their peak (October 2007). Indicators predict further
pound and loose monetary policy will help maintain
price declines, and various valuation measures reveal a
decent growth, however. We predict GDP growth of 1.7
need for additional downward price adjustments.
per cent in 2010 and 2.1 per cent in both 2011 and
2012: a bit below trend, but slightly above consensus. Cumulative changes since January 2008
We foresee no further monetary stimulus, but the Bank Per cent
of England (BoE) will quickly intervene if the recovery 0 0
begins to falter. Stubbornly high inflation is giving the -1 -1
central bank a headache: CPI will increase by 3.1 per
-2 -2
cent this year and 2.6 per cent in 2011, and household
inflation expectations are pointing upward. The first -3 -3
key interest rate hike will occur at the end of 2011. -4 -4

The latest business sentiment surveys give reason for -5 -5

cautious optimism. In manufacturing, service and con- -6 -6
struction, the purchasing managers’ index is above the
-7 -7
50 mark; the first two surveys show an upward short-
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
term trend. Corporate capital spending rebounded 08 09 10
earlier this year, and according to investment plans this GDP Employment Hours
Source: ONS, SEB
upturn will continue. Capital spending will grow by
an average of 8 per cent in 2011-2012. Exports are Employment is now rising rapidly. Large cutbacks in
another reason for our cautiously optimistic growth sce- public sector jobs are being offset by a strong upturn in
nario: here, too, indicators appear robust. The pound private employment. So far, about 45 per cent of job
has weakened by about 25 per cent in effective terms losses have been recovered. Part-time jobs account
since 2007, bolstering the competitiveness and increas- for the lion’s share of the upturn (65 per cent). The em-
ing the profit margins of exporters. But the pound is ployment upswing is having no significant impact on the
now fundamentally undervalued, and we expect it to jobless rate, since the labour supply is rising almost as
strengthen in the course of next year; the EUR/GBP ex- fast. Unemployment will remain at around 8 per cent
change rate will be 0.83 at the end of 2011. Exports during the next six months, then slowly decline.
will increase by an average of more than 9 per cent in
2011-2012, with foreign trade making an overall posi- Fiscal headwinds will accelerate in 2011. According to
tive contribution to the economy. the emergency budget, the government’s borrowing re-
quirement will fall by 10 per cent of GDP by 2015/2016,
Since 2009 consumption has increased rapidly in mainly via discretionary fiscal policy. The budget has
nominal terms, thanks to a decline of 4.5 percentage been well received; the UK’s sovereign credit rating
points in the household savings ratio. Brighter future no longer seems to be threatened, for example. In this
prospects, combined with higher asset values, have context, it is encouraging to note that the UK also car-
decreased the need for large household savings buffers, ried out a sharp fiscal tightening in the early 1990s, yet
but the decline in saving is probably behind us now. GDP grew by an average of 3 per cent yearly. Although
various factors now indicate that the economy can tol-
In real terms, consumption rose 1.1 per cent this year.
erate the fiscal austerity measures, the impact of such
It will accelerate slightly in 2011 and 2012. Low interest
large cutbacks is very uncertain.

Nordic Outlook – November 2010  |  35

Eastern Europe
Domestic demand awakening despite austerity
ƒƒ Moderate GDP growth
ƒƒ Small public sector debt
ƒƒ Currencies appreciating
The export-led recovery of the past year in Eastern
Europe − which in many places has been stronger than
in the West − is continuing. According to leading indica-
tors, however, the upturn in the manufacturing sector
in most countries is about to slow, due to sagging
global growth. But there is good potential for domes-
tic demand to assume a larger role as an economic
engine. Real wages have again begun to climb, and
unemployment is slowly falling. Meanwhile a gradual
thaw in tough credit conditions is under way. Overall,
we therefore expect GDP growth to accelerate further
in most of the region during 2011-2012 (see also SEB’s
Eastern European Outlook, October 2010).
However, growth will not reach the unsustainable pace
that prevailed before the crisis. This is because growth
is less credit-driven than before and due to such struc-
tural factors as labour market and emigration problems
in the Baltic countries and the slow pace of reform
in Russia. Many countries in Eastern Europe (includ-
ing what is sometimes called Central Europe) are also
tightening their fiscal policies, if only moderately. The
picture is mixed. In Poland, for example, fiscal tighten-
ing is mainly affecting households. Hungary, however, is
targeted its austerity measures to businesses by means
of “crisis taxes” in certain sectors, while planning to
lower household income taxes.
Russia’s GDP, whose growth will be unexpectedly weak
this year, will increase by 4.3-5.0 per cent in 2011-
2012, sustained by high commodity prices and in the
short term also by continued expansionary fiscal policy.
Our oil price forecast of USD 86-89/barrel in 2011-2012
is roughly USD 15 higher than assumed in the Russian
government’s medium-term budget plan, which aims at
achieving fiscal balance by 2015.
Due in part to strong fundamentals in Poland, we are
sticking to our above-consensus growth forecast. GDP
growth will climb from 3.5 per cent this year to 4.0-
4.5 per cent during the next couple of years. Capital
spending will be a major driving force. Since 2000, fixed
investment has been lower than in other fast-expanding
economies, averaging only 21 per cent of GDP, which
means that many needs still remain unmet. Above all,
we expect growing investments in infrastructure.
36   |  Nordic Outlook – November 2010
Ukraine has bounced back unexpectedly fast after last
year’s 15 per cent GDP slide, with the economic upturn
being driven by higher steel prices and a weak currency.
Growth will slow from 5 per cent this year to 4 per cent
in 2012, partly due to budget austerity requirements by
Ukraine’s creditor, the IMF, as well as reduced gas price
subsidies to households and businesses.
The region’s earlier problems with huge current account
deficits have eased greatly. Looking ahead, we expect
small current account deficits in most countries (and
a surplus in Russia). Inflation will be low but gradu-
ally rise. In the short term, inflation rates in Russia and
Ukraine will surge due to higher grain and gas prices.
Large budget deficits in Eastern Europe will successively
shrink and thus help keep public sector debt at rela-
tively low levels compared to Western countries.
Effective exchange rates in selected
countries
Index 100 = 2005
140 140
130 130
120 120
110 110
100 100
90 90
80 80
70 70
00 01 02 03 04 05 06 07 08 09 10
Russia, RUB Czech Republic, CZK
Poland, PLN Hungary, HUF
Source: Local statistical offices
We are adhering to our forecast that key interest rate
hikes will begin in the first half of 2011. Poland (in
Q1) and the Czech Republic will act first to ensure they
can meet their inflation targets. Given the combina-
tion of early interest rate hikes compared to the West,
relative growth advantages and relatively low public
sector debt, we predict further appreciation in most
Eastern European currencies. The Fed’s new quantita-
tive easing will also reinforce the trend of capital flows
to high-return emerging market investments.
We expect Polish zloty appreciation to 3.60 per euro by
the end of 2011, which probably means a slight overval-
uation in a long-term perspective. The Hungarian forint,
squeezed earlier this year by weak budget policies and
tense relations with the IMF, will gain strength and
reach 260 per euro in December 2011.
 The Baltics

Gradual recovery
ƒƒ Competitive exports
ƒƒ Structural problems in the labour market
ƒƒ Stronger financial market confidence
The recovery in the Baltics keeps gaining strength,
mainly as a result of competitive exports. But capital
spending and consumption are now also slowly start-
ing to recuperate, sustained by continued low interest
rates and some improvement in real disposable house-
hold income. These developments are consistent with
our forecasts since last winter. However, Latvia’s GDP
decline in 2010 is now expected to be clearly milder,
only 0.3 per cent, and the Estonian growth this year is
expected to be slightly higher.
previously estimated potential rate of 6-7 per cent.
In the medium term, it is reasonable to adjust annual
potential growth downward to around 5 per cent,
mainly due to the labour emigration wave of recent
years as well as a more balanced but weaker credit and
investment dynamic than before the crisis.
Exports will remain a growth engine
In the short term, exports will remain a major driv-
ing force in GDP growth. Year-on-year and in current
prices, they have climbed at 30-40 per cent in recent
months. Towards the end of 2010, though, we expect
growth to slow due to fast-fading positive base effects.
Export boom
Year-on-year percentage change, 3mma
50 50

Growth is resuming 40 40

GDP, year-on-year percentage change 30 30

15 15 20 20
10 10
10 10
0 0
5 5
-10 -10
0 0 -20 -20

-5 -5 -30 -30
-40 -40
-10 -10
01 02 03 04 05 06 07 08 09 10
-15 -15
Estonia Latvia Lithuania
Source: Local statistical offices
-20 -20
01 02 03 04 05 06 07 08 09 10
Looking ahead, weakening global demand will also lead
Estonia Latvia Lithuania to more sedate export growth. Meanwhile Baltic exports
Source: Local statistical offices
go mainly to countries and regions with a continued
All three countries have resumed positive growth during good growth dynamic such and Germany and the Nordic
the past two quarters, measured year-on-year, after countries. Latvia and Lithuania also trade extensively
depression-like GDP declines of 14-18 per cent in 2009. with nearby Eastern European countries. The Baltics
During the third quarter, the upturn gained strength in have very little exposure to such countries as the US
Estonia while Latvia noted its first GDP increase since and the UK.
the first quarter of 2008. Short-term indicators also
Restored competitiveness is one important reason
point towards continued economic upturn. For example,
behind the export upturn. Due to a successful internal
the European Commission’s sentiment indicator − which
devaluation strategy in the past two years, the Baltics
began to rebound in spring 2009 and mainly (in Esto-
have managed to regain previously lost export market
nia’s case almost completely) followed the pattern in
shares. Monthly wages and salaries have been cut by 12
the euro zone − has kept climbing this autumn, though
per cent in Estonia and Lithuania and nearly 20 per cent
levelling-off tendencies are now beginning to appear.
in Latvia. In our assessment, private sector pay levels
Overall, we anticipate decent GDP growth in 2011- bottomed out during the first half of 2010.
2012. We expect Estonia’s GDP to rise by 4.0 per cent
annually, while Latvia’s growth will reach 4.0 and 5.0
Sluggish recovery in domestic demand
As expected, domestic demand has remained depressed
per cent respectively and Lithuanian GDP will increase
during the autumn, but there are signs that household
by 4.0-4.5 per cent. Growth will thus not reach the

Nordic Outlook – November 2010  |  37

 The Baltics

consumption bottomed out this past summer. Labour neutral fiscal stance. Overall, we expect budget deficits
and residential market stabilisation in the past six to shrink from 8 per cent of GDP this year in Latvia and
months has contributed to this. During the correction, Lithuania to 3-4 per cent in 2012. We expect Estonia,
home prices in Latvia fell nearly 70-80 per cent from which has had by far the best public finances of the
mid-2007 peak levels. In Estonia, the downturn was three, to show a slight increase in deficits from 2 to 3
50-60 per cent, while Lithuanian home prices fell 40 per cent of GDP.
per cent. Looking ahead, we also expect consumption
to benefit from increased private sector pay, but the Improved market confidence
recovery in domestic demand will be sluggish. The main In the past year, markets have regained their confi-
reasons are that labour market improvements are ex- dence in the Baltic countries and their euro-pegged
pected to be slow and the current unwinding of private currencies. This was reinforced after the parliamentary
debt will continue during 2011. In Estonia, investments election in Latvia, where the centre-right coalition
may perhaps grow faster than we had anticipated in the government moved from minority to majority rule. Late
wake of euro zone accession on January 1, 2011. in October, Prime Minister Valdis Dombrovskis formed
a two-party coalition (previously three parties) that
Even higher unemployment controls 55 of the 100 seats in Parliament. Pricing of
Per cent credit default swap (CDS) contracts indicates that after
22.5 22.5
the Latvian election, the market has further lowered
20.0 20.0 the default risk both in Latvia and Lithuania.
17.5 17.5
Reduced risk of sovereign default
15.0 15.0
5-year CDS contracts, basis points
12.5 12.5 At
600present, 600
10.0 10.0 550 550
500 500
7.5 7.5
450 450
5.0 5.0 400 400
2.5 2.5 350 350
02 03 04 05 06 07 08 09 10 300 300
250 250
Estonia Latvia Lithuania 200 200
Source: Local statistical offices
150 150
100 100
Structural labour market problems 50 50
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
A painful economic policy of dramatic internal devalu-
10
ation and aggressive fiscal consolidation has wiped out Estonia Latvia Lithuania
earlier major economic imbalances in the Baltics, in Source: Reuters EcoWin

the form of wage inflation and import-driven current
account deficits (read more about this in SEB’s Eastern
European Outlook). In the past six months, deflation
pressure has eased and sharp current account improve-
ments have culminated. During 2011-2012 we expect
moderate inflation (however more accentuated in Es-
tonia) in the wake of higher private wages and salaries
next year and small current account deficits, due to
stronger imports.
Remaining imbalances, with accompanying political
challenges, include sizeable structural labour market
problems and continuing large public budget deficits
in Latvia and Lithuania. All three Baltic countries are
grappling with labour market matching problems, high
youth unemployment and large-scale emigration. Unem-
ployment, which peaked at around 20 per cent in the
first half of 2010, will gradually continue to fall and will
still average 14-15 per cent during 2012.
These labour market problems will lead to persistent
fiscal deficits. Latvia will continue to tighten its budget,
an assessment based on the unexpected success of
the governing coalition in the early October election.
In Lithuania and Estonia, we anticipate a relatively
The political risks appear largest in Lithuania. The
conservative-led coalition has been a minority govern-
ment since last spring, and there are signals that it will
ease austerity in the 2011 budget despite the large
public sector deficit. Apparently the government will
rely on higher GDP growth to shrink deficits. Despite lin-
gering political tensions and the unpopularity of Prime
Minister Andrius Kubilius, our assessment is still that the
government should be able to stay together until the
2012 parliamentary election.
Our main scenario is that Latvia and Lithuania can
join the euro zone in 2014. This is also consistent with
their official ambitions. But we foresee risks of delay
connected to budget developments, since it may be
difficult for them to meet the euro zone’s budget crite-
rion. In order to adhere to the timetable, deficits must
be brought down to 3 per cent of GDP by 2012 before
the EU assesses the Latvian and Lithuanian economies
in 2013.

38   |  Nordic Outlook – November 2010


Strong growth creating policy dilemma
ƒƒ Rapid GDP growth will decelerate
ƒƒ Exports can endure a stronger krona
ƒƒ Debts and home prices pose a future risk
ƒƒ The Riksbank will follow its rate path
ƒƒ Neutral fiscal policy in 2011, but
challenges ahead
Sweden’s GDP growth has surpassed expectations so far
during 2010. We predict GDP growth of a full 5.0 per
cent in 2010 (4.7 per cent adjusted for the number of
working days). This rapid recovery is broadly based. A
favourable export structure and the effects of the pre-
viously weak krona have given exports an extra push.
The strength of the domestic economy is diverging even
more clearly from other countries. An expansionary
fiscal policy and low interest rates helped to rapidly re-
verse the 2009 decline in consumption. Growth will be
above trend during the next couple of years, although
Sweden will eventually be affected in various ways by
the absence of a real overall resurgence in the OECD
economies. We expect GDP to grow by 3.5 per cent in
2011 and by 2.5 per cent in 2012 (3.5 and 2.9 per cent
adjusted for the number of working days).
GDP growth peaking in 2010
6 6
4 4
2 2
0 0
-2 SEB forecast
-4
-6
-8
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1
08 09 10 11
Quarter-on-quarter percentage change
Year-on-year percentage change
Source: Statistics Sweden, SEB
The labour market has improved faster than ex-
pected, even taking Sweden’s strong GDP growth into
account. Looking ahead, we expect a continued upturn
in employment, though at a calmer pace. Resource uti-
lisation is on the rise, but the output gap will not close
during our forecast period. At the end of 2012, however,
we foresee unemployment of 7.0 per cent, only 0.5-1
per cent above equilibrium level.
Sweden
Inflation will remain low, largely due to record-low
pay increases during 2010 and 2011, but inflation will
rise during 2012 as pay hikes accelerate and resource
utilisation normalises. We nevertheless believe that
underlying CPIF inflation will remain below 2 per cent
throughout our forecast period.
In the latest Monetary Policy Report, the Riksbank
adjusted its interest rate path downward, so it now
matches our August forecast. We expect that partly
because of good economic growth and continued rapid
credit expansion, the Riksbank will deliver rate hikes
approximately in line with our forecast. This will mean
a key interest rate of 1.25 per cent at the end of
2010, 2.25 per cent at the end of 2011 and 3.00 at
the end of 2012.
The recently re-elected Alliance government has chosen
a cautious fiscal policy strategy at the beginning of
its second four-year term. We estimate that the sum
of new programmes, mainly those announced in this
autumn’s government budget bill for 2011, is SEK 20-25
billion. But when temporary local government and in-
frastructure spending from 2010 fade away, fiscal policy
for 2011 will be largely neutral. The government has
announced that during its term of office there will be
limited room for reforms, equivalent to SEK 40 billion.
The government’s strategy during the next couple of
years is apparently to assert its control of the political
mid-field by being more of a caretaker than a reform-
er, but we expect it to pursue a more aggressive fiscal
policy towards the end of its term.
Policy mix may need to be re-assessed
-2
Because of the international economic policy discourse
-4 that is now under way, there will be reason to discuss
-6
a suitable policy mix in Sweden. The country can boast
a balanced budget, low and falling central government
-8 debt and large trade surpluses. The current account
Q3
12
balance is well in excess of the 4 per cent of GDP cited
as an acceptable level during recent G20 discussions.
Meanwhile the absence of a downward adjustment in
Swedish home prices diverges from almost all other
countries. Instead, the household debt ratio has accel-
erated and home prices are continuing to climb to new
record levels at a rapid pace, posing obvious risks in a
longer perspective.
Taken together, this may be interpreted as justifying
a more expansionary fiscal policy, with more ag-
gressive efforts to resolve important structural issues,
Nordic Outlook – November 2010  |  39
 Sweden

especially related to taxes. Combined with a clearer Meanwhile there are several factors indicating that
normalisation of interest rates, in order to avert future Swedish exports may continue to increase at a rather
credit and home price bubbles, from an international healthy pace. Export companies are relatively profit-
perspective this would be a natural policy mix in light able, largely due to the rapid cost adjustments they
of Sweden’s situation. implemented during the crisis. The recent appreciation
of the krona has not significantly affected the profit-
Strong rebound for exporters ability estimates in the National Institute of Economic
The sharp recovery in manufacturing is largely a result Research’s Business Tendency Survey. The quarterly
of the sectoral structure of Swedish exports. The global reports of industrial companies confirm this.
downturn of 2009 had a particularly dramatic impact on
such key Swedish exports as intermediate and capital The geographic focus and sectoral structure of Swedish
goods. Since then, the recovery has been strongest in exports are also rather favourable. The fiscal tightening
these areas. This is illustrated, for example, by the measures being enacted in many European countries
trend of imports in the euro zone, the recipient of more will mainly lead to weaker demand for consumer goods,
than one third of Swedish merchandise exports. thus hurting sectors of lesser importance to Swedish
exports. Another favourable circumstance is that key
Euro zone: Merchandise imports export markets like Germany and neighbouring Nordic
Year-on-year percentage change countries are continuing to perform well, while the
50 50
share of exports destined for the PIIGS countries is
40 40
small. See the table below. Exports to the expansive
30 30
Asian market are still relatively limited according to
20 20
merchandise trade statistics, but company reports
10 10
indicate a significantly faster eastward shift in export
0 0
-10 -10
flows. Asia’s role thus seems to be larger than the of-
-20 -20
ficial statistics show. This divergence may be partly due
-30 -30
to a rapid increase in service exports to Asia; informa-
-40 -40 tion about the distribution of such exports by country
Jan May Sep Jan May Sep Jan May Sep Jan May is lacking. Increased direct investments in Asia may
07 08 09 10 contribute to higher deliveries of services from Swedish
Capital goods Intermediate goods
Consumption goods parent companies.
Source: Eurostat
Our overall assessment is that despite a stronger krona,
Swedish merchandise exports have now almost regained exports will grow at the pace of global market expan-
their pre-crisis level. This means that the recovery is sion. This will result in export growth of 7.4 per cent in
entering a more mature phase; we thus expect the rate 2011 and 5.1 per cent in 2012.
of increase to slow in 2011. Certain factors indicate
a clear deceleration. The krona is no longer providing Merchandise exports, January-August 2010
an extra stimulus for exports. This may lead to espe- Per cent
% of total Year-on-year
cially noticeable effects early next year, when a large change, %
proportion of the currency hedging contracts at Swedish Europe 72.3 10.1
companies will expire. Global overcapacity exists in EU 57.6 10.7
certain important Swedish export sectors, and this may Euro zone 37.6 10.0
also increase sensitivity to currency rate changes. Germany 10.2 11.6
Norway 10.1 7.8
Merchandise exports
Index 100 = 2008 UK 7.7 18.2
110 110 Denmark 6.6 0.4
Finland 6.2 9.3
105 105
France 5.0 6.0
100 100 PIIGS 6.4 3.4
95 95 North America 8.3 26.4
90 90
US 7.2 26.1
South America 2.4 22.8
85 85
Asia 11.8 8.9
80 80 China 3.1 10.5
75 75 Total 100 11.8
05 06 07 08 09 10 Source: Statistics Sweden, SEB

Sweden Germany
Source: Statistics Sweden, Deutsche Bundesbank

40   |  Nordic Outlook – November 2010

 Sweden

With a certain time lag, capital spending by Swedish
manufacturers has also rebounded from its record low
in 2009. Although capacity utilisation has now risen,
there is still potential to boost production at many
companies without expanding capacity. We thus expect
capital spending to enter a calmer phase during 2011.
A rapid upswing in residential investments has also
occurred during 2010. Continued home price increases
indicate that this upward trend will continue in 2011.
chasing power at a rate equivalent to 0.5-1.0 per cent
annually. In addition, the stock market upturn and rising
home prices will result in an increasingly strong wealth
position. Household wealth has increased from 440 per
cent of income in 2009 to 500 per cent in 2010.
Household income and consumption
Percentage change
2009 2010 2011 2012

Gross fixed investment Consumption -0.8 3.5 2.8 2.5

Percentage change, 2009 level in Income 0.9 1.9 3.4 2.1
current prices (SEK bn)
Savings ratio 12.6 11.3 11.7 11.3
2009 2009 2010 2011 2012 Source: Statistics Sweden, SEB
Government
sector 103 6.7 -2.0 0.0 0.0
Lending to households
Housing 91 -23.4 20.0 12.0 10.0
Year-on-year percentage change
Business sector 362 -20.5 6.3 6.2 3.6 17.5 17.5

Total 555 -16.0 7.0 6.0 4.0 15.0 15.0

Source: Statistics Sweden, SEB 12.5 12.5

10.0 10.0
Rebound in investments 7.5 7.5
Index 100 = 2005
5.0 5.0
105 105

100 100 2.5 2.5

06 07 08 09 10
95 95
Total
90 90
Housing
85 85 Consumption + other purposes
Source: Riksbank
80 80

75 75 The housing market upturn looks set to continue in the

70 70 short term. Rising interest rates and the recently en-
acted loan-to-value ceiling on mortgages will help slow
65 65
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1
price increases, while rising employment and income
05 06 07 08 09 10 will pull in the opposite direction. The latest statistics
Housing Manufacturing indicate an unchanged rate of increase in mortgage
Source: Statistics Sweden
lending and home prices. Other indicators, such as the
SEB housing price index, show a continued upturn.
Strong households − risky housing
market Households continuing to increase their debts
An expansionary fiscal policy helped household income Per cent of disposable income
continue to increase at a healthy pace during the crisis 11 180

years, despite weak wage and salary income. Combined 10

160
with sharply lower mortgage interest rates, this has 9
140
made room for rising consumption. In the past year, 8

actual consumption figures have also rebounded as the 7 120

labour market has improved. In particular, auto pur- 6

100
chases have increased sharply. 5
80
4
The outlook for the next couple of years still looks 3 60
bright. Household confidence is on a par with previ- 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
ous historical highs. In the retail sector, optimism has
Sweden: Interest burden after taxes (LHS)
admittedly declined a bit, but since actual retail sales Sweden: Debts (RHS)
nevertheless rose, this downturn is probably temporary. US: Debts (RHS)
Source: Riksbank, Federal Reserve, SEB
The household savings ratio remains at a historically
high level, and stable employment and falling infla- The long-term trend will depend on whether economic
tion are contributing to stable income increases. Fiscal policy can be crafted in a way that prevents a sharp
policy is continuing to contribute positively to pur- downturn in home prices. In the August issue of Nordic

Nordic Outlook – November 2010  |  41

 Sweden

Outlook, we discussed these questions in more detail. There is no shortage of structural challenges, however.
Various underlying factors, for example a continued Employment in the manufacturing sector fell very
moderate interest burden, a slow pace of construction sharply during 2008, and the historical pattern indicates
and the rule system in the housing market will reduce that these jobs will come back only to a limited extent.
the risks of a downturn. On the other hand, historical Expansion will instead occur in the construction sector
experience show that practically no country has been and in private services. Such a rapid structural change
able to avoid a sharp adjustment after such a dramatic may contribute to an upward shift in equilibrium un-
upturn in household debt as is now occurring in Sweden. employment from about 6-6.5 per cent, the level that
prevailed before the crisis. This means that at the end
Strong labour market recovery of 2012, unemployment will not be especially far above
Employment rebounded as early as the end of 2009. its equilibrium level.
More than two thirds of the three per cent downturn
in jobs since 2008 has now been regained. Available Employment
indicators show that this trend will continue, at least Index 100 = 2008, 3 month moving average
107.5 107.5
over the next two quarters. Unemployment has recently
105.0 105.0
also shown signs of falling, although the indicator situa-
102.5 102.5
tion is more mixed here. As economic growth gradually 100.0 100.0
decelerates, the labour market recovery will also slow 97.5 97.5
down, but in 2012 GDP will continue to grow at above 95.0 95.0
its long-term trend. This indicates that unemployment 92.5 92.5
will fall throughout our forecast period. 90.0 90.0
87.5 87.5
Labour market 85.0 85.0
Jan May Sep Jan May Sep Jan May
Percentage change
2009 2010 2011 2012 08 09 10
Total Government sector
Employment -2.1 1.0 1.7 0.7 Manufacturing Services
Construction Retail
Labour supply 0.2 1.1 0.7 0.3 Source: Statistics Sweden, SEB

Unemployment, % 8.3 8.4 7.5 7.1

Average hours worked -0.5 0.7 -0.6 -0.1
Record-low pay increases
Collective pay agreements for 2010 and 2011 were
Productivity (GDP) -2.5 3.0 2.3 2.3 signed at a time when future expectations were very
depressed. The agreements thus ended up being record-
Source: Statistics Sweden, SEB
low in terms of pay hikes. Monthly wage and salary
Structural challenges statistics show that these low agreements had a strong
Indicators of resource utilisation, such as capacity uti- impact. Pay increases are record-low even taking into
lisation in manufacturing and labour shortages accord- account that the preliminary monthly figures are always
ing to the NIER Business Tendency Survey, have quickly adjusted upward. Despite the improved labour market,
climbed from the record lows reported in late 2009. we are thus sticking to our earlier forecast that 2010
Today they stand at about the levels prevailing during and 2011 pay hikes will end up around 2.0 to 2.5 per
the previous recession in 2002-2003. These levels indi- cent, that is, well below the historical average.
cate that capacity bottlenecks are not a major obstacle Record-low pay increases
to growth and pose no threat of rising inflation. Year-on-year percentage change
5.0 5.0
Labour shortages in the business sector 4.5 4.5
Net balance
4.0 4.0
35 70
3.5 3.5
30 60
3.0 3.0
25 50
2.5 2.5
20 40
2.0 2.0
15 30
1.5 1.5
10 20
1.0 1.0
5 10 01 02 03 04 05 06 07 08 09 10

0 0 Total Business sector

00 01 02 03 04 05 06 07 08 09 10 Source: National Mediation Office

Manufacturing (LHS) Retail (LHS) In 2012, however, we expect pay increases to rise to
Services (LHS) Construction (RHS)
Source: NIER 3.5-4.0 per cent. The next wage round will occur in a
significantly stronger labour market situation. The year-

42   |  Nordic Outlook – November 2010

 Sweden

on-year increase figures will also be affected by the
fact that the revision date in the earlier agreement will
occur relatively late in 2011. Uncertainty about wage
formation has also increased because the Employers’
Federation of the Swedish Engineering Industry (Teknik-
företagen) has just withdrawn from the 1997 Coopera-
tion Agreement on Industrial Development and Wage
Formation.
Low inflation
Year-on-year percentage change
5 5
4 SEB forecast
clear downside risk in this forecast. Producer prices,
which ordinarily lead consumer prices by about six
months, have so far risen only moderately. Measured
in Swedish kronor, broader commodity indices have not
risen very much either. In addition, short-term com-
modity price upturns often do not have time to affect
the CPI and PPI trend.
Even taking food prices into account, however, CPIF
will end up well below the Riksbank’s target throughout
our forecast period. But headline CPI will exceed the
target, due to rising household mortgage interest costs.
4

3 3
Riksbank will hike key rate as planned
In its October Monetary Policy Report, the Riksbank
2 2 adjusted its future rate hike plans downward. It not
1 1 only revised the rate path in the long term, but also
for the bank’s next interest rate policy meetings. The
0 0
Riksbank is now signalling rate hikes at two of the next
-1 -1 three meetings, thus increasing uncertainty in the short
-2 -2
term as well. But we are sticking to our forecast and
08 09 10 11 12 expect the Riksbank to hike its repo rate at the next
two meetings, that is, in December and February. In our
CPIF CPIF excl energy and food CPI
Source: Statistics Sweden, SEB judgement, third quarter growth will be stronger than
the Riksbank had forecasted, while the labour market
will strengthen and lending to households will increase.
Low inflation, but food an upside risk
After peaking late in 2009, inflation measured as CPIF Repo rate path
(CPI excluding mortgage interest expenses) has fallen. 3.50 3.50
In October it was 1.8 per cent. Low cost pressure will
3.00 3.00
mean continued weak underlying inflation over in the
next couple of years. The appreciation of the krona dur- 2.50 2.50
ing the past year will help ease inflation during the first 2.00 2.00
half of 2011. Core inflation (CPI excluding food, energy
and interest expenses) has also fallen from nearly 3 per 1.50 1.50

cent in late 2009 to less than 1.5 per cent in October. 1.00 1.00
We expect core inflation to continue downward to
0.50 0.50
about one per cent in mid-2011. After that there will be
a moderate upturn, especially because krona-related 0.00 0.00
Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov
effects will be fading.
10 11 12 13
Market pricing Riksbank Oct 2010
Food prices SEB forecast
Year-on-year percentage change Source: SEB

15.0 50
In our judgement, even in a longer perspective the
12.5 40
Riksbank will deliver key rate hikes roughly in line with
10.0 30
its latest rate path. Rapid credit growth, rising home
7.5 20
prices and gradually increasing resource utilisation all
5.0 10
point towards continued interest rate hikes. New regu-
2.5 0 lations, such as the recently introduced loan-to-value
0.0 -10 ceiling on mortgages, as well as restrictions on bank
-2.5 -20 lending due to the new Basel III capital adequacy rules,
-5.0 -30 will reduce the need for rate hikes. Another argument
97 98 99 00 01 02 03 04 05 06 07 08 09 10 against larger rate hikes is that in its latest report, the
PPI, food (LHS) Commodity prices (RHS) Riksbank explicitly discussed the risks of an excessively
CPI, food (LHS) rapid krona appreciation as a consequence of the way
Source: Statistics Sweden, The Economist
major central banks in the OECD countries are keeping
their key interest rates close to zero. As indicated by
We have adjusted our inflation forecast slightly upward
our conclusions in the box below, however, we do not
since August, mainly due to rising food prices next year.
regard rate hikes of the magnitude announced by the
We expect the upturn in Sweden to be consistent with
Riksbank as any major threat to the external balance of
that in the euro zone, 3-4 per cent, but we foresee a

Nordic Outlook – November 2010  |  43

 Sweden

the Swedish economy. Taken together, we expect a repo

10-year yield spread vs Germany
rate of 2.25 per cent in December 2011 and 3.00 per
Basis points
cent at the end of 2012. 100 100

Wider long-term yield spread 75 75

The spread between 10-year Swedish government bond
50 50
yields and their German equivalents has risen to about
30 basis points, the highest level since 2005. The most 25 25
important reason for this upturn is that strong economic
signals have made the Riksbank’s plans to raise its key 0 0

interest rate more credible, while the ECB’s refi rate -25 -25
will remain unchanged. Our Swedish repo rate forecast
for 2011 is above market expectations, indicating that -50 -50

the spread will continue to widen ahead. Offsetting this 98 99 00 01 02 03 04 05 06 07 08 09 10 11

is Sweden’s strong Model Actual

Source: SEB

Does the krona risk becoming too strong?

The latest Monetary Policy Report focused on the risk
that the krona may become too strong if the Riksbank
hikes its repo rate while the ECB and other major cen-
tral banks in the OECD countries leave their key rates
unchanged. Relevant questions are: In what respects,
and at what levels, will the strengthening of the krona
become a problem?
Trade balance and current account
Per cent of GDP
10
8 8
far from the average of the past 10-15 years that it
would radically alter Sweden’s competitiveness situ-
ation. Estimates of long-term equilibrium exchange
rates based on prices and labour costs also indicate
that even at these levels, the krona will be underval-
ued.
Net external position
Per cent of GDP
5 5
10
0 0
-5 -5

6 6 -10 -10
June 2010
4 4 -15 -15

-20 -20
2 2
-25 -25
0 0
-30 -30
-2 -2
94 96 98 00 02 04 06 08 10 -35 -35
99 00 01 02 03 04 05 06 07 08 09 10
Goods and services Services
Source: Statistics Sweden
Goods Current account
Source: Statistics Sweden, Riksbank
Our conclusion is that the rate hikes indicated by
the Riksbank’s interest rate path will not lead to a
For a long time, Sweden has been running large cur- strengthening of the krona that will cause any serious
rent account surpluses. These have been relatively problems to the Swedish economy.
stable, even at times when the export industry has
Exchange rates
been in crisis. There may be good reasons to run large
13 160
current account surpluses, for example to offset ear-
12 155
lier periods of deficits and to pay down external debt.
USD/SEK
The long period of surpluses has gradually improved 11 150

Sweden’s external position, which has now achieved a 10 EUR/SEK 145

balance. It is thus difficult to see any problem if this 9 140
large current account surplus continues to shrink. For
8 135
example, the surplus is also well above the 4 per cent
7 130
of GDP that has been discussed within the G20 as ac-
ceptable. 6 125

5 TCW 120
According to our forecast, the krona will continue
4 115
strengthening to about 120 in trade-weighted TCW
98 00 02 04 06 08 10
terms. This implies a somewhat stronger krona than
Source: Reuters EcoWin
the peaks of the past decade, but a level still not so

44   |  Nordic Outlook – November 2010

 Sweden

government finances, which means that the supply of
sovereign bonds will be limited. Our model for the yield
spread against Germany − which takes into account key
rates, economic growth and government finances − indi-
cates that the spread is now close to a reasonable level
for 2011, but we expect it to widen by another 15 basis
points to 50 towards the end of next year.
ing upturn was 35 per cent of GDP. During our forecast
period, we expect Sweden’s gross central government
debt to fall to 30 per cent of GDP. If we also take the
asset side (for example government owned companies
and the pension systems buffer funds) into account, the
country’s general government net financial position is
already positive at present.

New krona appreciation phase on the way Falling debt

The krona has regained the entire downturn that oc- Per cent of GDP
curred during the crisis, and the EUR/SEK exchange rate 80 80

is now in the middle of the 9-9.50 interval it occupied 75 SEB 75

70 forecast 70
during 2004-2007. The same is true of the USD/SEK
65 65
rate, although it has been significantly more volatile. In
60 60
recent weeks, however, the krona has lost ground. This
55 55
is due to several factors: 1) The Riksbank’s downward
50 50
adjustment of its rate path, which was partly intended
45 45
to blunt the rapid appreciation of the krona. 2) The 40 40
market has apparently had a long position in Swedish 35 35
kronor, which SEB’s client survey in the Scandie Views 30 30
report confirmed. 3) The USD has regained ground, 94 96 98 00 02 04 06 08 10 12
which often drives the krona weaker against the euro
Maastricht debt Debt
as well. 4) The period from mid-November to early Source: Eurostat, Swedish National Debt Office, SEB

December has a negative seasonal pattern for the SEK,

probably due to the allocation of PPM Swedish pension
fund capital to foreign assets. When this period is over,
assuming that the Riksbank is continuing to tighten its
monetary policy in accordance with our own forecast,
the upward trend for the krona should resume. We
estimate that the EUR/SEK exchange rate will be 9.15
at the end of this year and 9.00 at the end of the first
quarter of 2011.
There are strong reasons to forecast continued krona
appreciation in the long term. The relative gap in
economic performance is wider than for many years,
bolstering arguments for an unusually large difference
in monetary policies. At present, the likelihood that the
ECB will raise its key interest rate during 2011 is very
small. In addition, the krona seems weak in a long-term
perspective, despite its appreciation during the past
year. In an international environment in which most
countries would like to weaken their currency, there is
a higher probability that this long-term undervaluation
will be important.
We expect the EUR/SEK rate to stand at 8.75 late in
2011 and 8.60 late in 2012. The corresponding USD/SEK
rates will be 6.73 and 6.77.
Continued strong public finances
Strong public finances at the beginning of the crisis
enabled Sweden to pursue an expansionary fiscal policy
without jeopardising its credibility. After major budget
deterioration between 2007 and 2009, we now expect
the budget balance to be relatively close to zero during
our forecast period.
Central government debt rose by about 4 per cent of
GDP between 2008 and 2009 − a very modest upturn
compared to the 1990s crisis, when the correspond-
In its autumn budget bill, the government unveiled
reforms totalling about SEK 13 billion in 2011. Includ-
ing programmes outlined in the spring 2010 budget bill
and our assumptions about further measures in the 2011
spring budget bill, we reach a total of SEK 20-25 billion
in expansionary measures during 2011 (equivalent to 0.7
per cent of GDP). Despite these new measures, overall
fiscal policy will be neutral in 2011. This is because
temporary crisis aid in the form of local government
and infrastructure grants will disappear.
Public finances
Per cent of GDP
2009 2010 2011 2012
Revenue 52.3 51.3 50.8 50.9
Expenditures 53.3 51.8 50.7 50.1
Net lending -1.2 -0.5 0.1 0.8
Gen. gov’t gross debt 41.7 37.9 35.5 32.8
Central gov’t debt 38.3 35.4 32.7 30.0
Borrowing req., SEK bn 176 3 -10 -47
Source: Statistics Sweden, SEB
The central government borrowing requirement has
continued to provide downside surprises during the past
3-4 months, although not to the same extent as earlier
in the year. Once again, tax revenue has been surpris-
ingly high.
We are also assuming that the government will sell
SEK 25 billion worth of state-owned assets per year, as
announced. The parliamentary situation makes ap-
proval of new privatisations unlikely, but Parliament
has already approved the divestment of the govern-
ment’s holdings in the telecom group TeliaSonera and

Nordic Outlook – November 2010  |  45

 Sweden
the banking group Nordea. These holdings are sufficient
to generate SEK 25 billion per year throughout the
government’s current four-year term of office. Overall,
we expect a very small budget deficit of SEK 3 billion in
2010 and surpluses of SEK 10 billion in 2011 and SEK 37
billion in 2012. Looking ahead, there should also be a
discussion of whether the Riksbank needs its entire ex-
tra currency reserve buffer once the crisis has faded. In
any case, we estimate that some of the nearly SEK 100
billion (equivalent to about 3 per cent of GDP in 2010)
that the National Debt Office borrowed on behalf of the
Riksbank will be paid back, but that this will occur after
2012. We also believe that the Swedish government’s
lending to Iceland and Latvia, nearly SEK 10 billion, will
not be implemented.
Forecasts of the central government
borrowing requirement
SEK billion
2010 2011 2012
SEB 3 -10 -47
National Debt Office, November 5 -18 -78
National Institute of Economic
Research (NIER), September 21 22 22
National Financial Management
Authority (ESV), August 21 0 -25
Ministry of Finance, October 27 -6 -47
Source: National Debt Office, NIER, ESV, Government
Offices, SEB
From reformist government to
caretaker
After its 2006 election victory, the Alliance government
quickly started pushing through an ambitious reform
programme. Its focus was to strengthen the incentives
to work, for example by means of earned income tax
credits and reforms of unemployment insurance and
other transfer payment systems.
The Alliance’s promises for its new term of office were
noticeably more cautious. In the 2011 budget bill, its
reform measures are scattered among many fields,
but with some emphasis on funding for local govern-
ments and tax cuts for pensioners. During the rest of its
four-year term, the government has signalled relatively
modest reforms totalling SEK 40 billion, or a bit above
1 per cent of GDP. This will be allocated among vari-
ous fields, with the most costly reform being additional
earned income tax credits, an increase in the break-
point for paying national income tax and lower VAT on
restaurant meals. Compared to the Alliance’s reform
ambitions in the run-up to the 2006 election, the list
seems limited and defensive; the government is shifting
from a reformist role to a caretaker role.
The Alliance will be ruling as a minority government
during this term, which is one of the reasons behind
its more defensive policies. But the importance of this
situation should not be exaggerated. The budget law
46   |  Nordic Outlook – November 2010
that took effect in the mid-1990s makes the situation
easier for a minority government, since the opposition
must join forces and present a common counterpro-
posal in order to defeat a government budget bill. It
is highly unlikely that the Social Democrats, Left Party
and Green Party would join with the right-wing populist
Sweden Democrats to defeat the government’s budget
bill. The Red-Green coalition (Social Democrats, Left
Party and Greens) that campaigned jointly against the
Alliance in the autumn 2010 election has now collapsed,
and the Social Democrats are undergoing their own
crisis. However, the government may have problems
implementing other bills without negotiating in advance
to gain support from one or more opposition parties.
Challenges later in the government’s
term
The government’s orderly administration of its finances,
despite international instability, has contributed to
the strong confidence it enjoys among the voters. For
as long as possible, the government will remind them
that the crisis is not over and that caution is needed in
Sweden’s reform ambitions. Such a policy will make it
easier to stay in control of the political mid-field. Yet
the government will certainly need to show its cards
more clearly later in its four-year term. Given such a
strong public sector balance sheet, the debate about
what is a suitable level of central government debt will
probably reappear. In addition, international discourse
about global imbalances includes recommendations
that countries like Sweden with large current account
surpluses and low national debts should pursue a more
expansionary policy. In a situation of persistent high un-
employment, it will then be especially difficult for the
government to argue that Swedish public finances must
show surpluses over an economic cycle.
In the budget bill for 2011, Finance Minister Anders Borg
presented a number of reforms that will enjoy priority
if room for further spending becomes available. This list
will serve as a good guide to what may later emerge on
the political agenda. It includes corporate tax cuts, re-
moval of a 5 per cent extra income tax on the affluent
that was imposed as an austerity measure in the 1990s,
lower employer payroll fees and venture capital deduc-
tions (a study commission will examine these taxes and
give advice on what to prioritise).
The government’s choice of strategy will determine the
political frontlines for a fairly long time to come. The
choice between tax cuts and improvements in the busi-
ness climate, on the one hand, or a clear commitment
to health and welfare issues, on the other, will create
tensions. The government will either open itself up to
criticism from some elements of the business commu-
nity or to attacks from the opposition, which argued
during the 2010 election campaign that the government
had a hidden tax-cutting agenda.

Internal tensions within both the four-party Alliance
government and the opposition also play a part. The
Moderate Party, which dominates the governing coali-
tion, apparently has the most to gain from a strong fo-
cus on fiscal responsibility. If the signature issues of the
smaller Alliance parties must constantly be sacrificed
because of tight government finances, tensions within
the government are likely to increase − especially if
there is a continued trend towards growing dominance
by the Moderates in public opinion surveys.
Meanwhile the deep crisis within the Social Democratic
Party makes it difficult to assess how the political oppo-
sition will shape its policies. The announced departure
of party chair Mona Sahlin and internal conflicts are
likely to paralyse the party during the coming months.
Yet in our judgement, the process of self-examination
after their heavy election losses in September 2010 will
persuade the Social Democrats to take a step back to-
wards the middle in order to capture the political mid-
Sweden
field, thus opening up their left flank to the Left (for-
merly Communist) Party. The risk in such a strategy may
be that more traditional leftist voters will view it as an
acceptance of elements of the Alliance’s non-socialist
policies. There will also a greater focus on the Green
Party. In keeping with its rules, this party will be elect-
ing two new spokespersons in 2011. During the current
Parliament, the Alliance government will undoubtedly
seek support from the Greens on a number of occasions.
Will the Greens move towards the middle or the left?
The political landscape seems about to be reshaped in a
way that has not occurred for many years.
Nordic Outlook – November 2010  |  47
Denmark

Decent growth despite budget tightening

ƒƒ Growth is reverting to a calmer path
ƒƒ Good exports that are more competitive
ƒƒ No increase in key rate spread until 2012
After an unusually strong second quarter, we are adjust-
ing our 2010 Danish growth forecast upward from 1.8 to
2.2 per cent, but are sticking to our view that growth
will remain modest at just above 2 per cent yearly in
2011-2012 − mainly due to fiscal tightening.
Slower growth expected after strong Q2
Year-on-year percentage change and index
7.5
5.0
2.5
0.0
-2.5
-5.0
-7.5
94 96 98 00 02 04 06
Real GDP, quarterly data (LHS)
EU monthly sentiment indicator (RHS)
Source: Statistics Denmark, DG ECFIN
The second quarter GDP increase, 3.7 per cent
year-on-year, was largely due to temporary effects.
A hard-to-assess inventory contribution accounted for
2.1 percentage points. The second quarter of 2009 was
also extremely weak, providing a low base. Declining
sentiment indicators this autumn, after an earlier long
period of upturns, also signal a slowdown ahead. We
expect the GDP growth rate to fall below 3 per cent.
More competitive exports this past year
Real effective exchange rate, index 100 = 2005
107.5
105.0
Exports will keep growing at a healthy pace in 2011
but somewhat more slowly than in 2010, due to weaker
global demand and this autumn’s krone upturn following
earlier depreciation. Meanwhile Danish exporters can
now tolerate a fair degree of currency appreciation,
since wage and salary growth has been brought down to
a more modest level in recent years, similar to that of
competitor countries in Europe. Demand is also solid in
two major export markets, Germany and Sweden.
Sluggish upturn in domestic demand
Domestic demand has begun to recover this year and
will continue rising at a leisurely pace. Consumption
120 will benefit from continued gradual improvement in
the labour and housing markets, but wage and salary
110
growth will remain modest. Next year, household spend-
100 ing will be affected by the three-year budget consolida-
tion that the government announced last spring. This
90
overall programme is equivalent to 1.5 per cent of
80 GDP and includes lower indexing of pensions and other
70
transfer payments, as well as cancellation of some
previously planned tax cuts. Corporate capital spending
60 is rising, but sentiment surveys and capacity utilisation
08 10
signal no great needs. The construction industry is also
battered after the sharp downturn of recent years. Pub-
lic sector investments will be postponed due to budget
austerity.
Headline inflation has recently jumped to about 2.5
per cent, but core inflation has been calm. The upturn
is mainly due to base effects and higher energy and
food prices. In the short term, food prices will probably
continue upward, partly for global reasons, but over
time inflation will cool. Consumer price increases will
average about 2 per cent annually in 2011-2012.
After a rapid, dramatic deterioration, the budget deficit
will total about 5 per cent of GDP this year. Austerity,
107.5 smaller unemployment outlays and other factors will
shrink the deficit to 3 per cent in 2012.
105.0

102.5 102.5 As expected, the central bank has left its key lending
rate unchanged at 1.05 per cent, but this autumn it
100.0 100.0
has adjusted other key rates a bit upward in response
97.5 97.5 to rising European market interest rates. This is aimed
at keeping the krone exchange rate stable. Over the
95.0 95.0
next year, the spread against the ECB’s key rate will
92.5 92.5 remain at an extremely low 5 basis points. Continued
robust current account surpluses will allow this, without
90.0 90.0
weakening the krone against the euro. Only in 2012,
94 96 98 00 02 04 06 08 10
once the ECB starts hiking its repo rate, will there be a
Source: Reuters EcoWin
gradual normalisation of the spread towards 20 bps.

48   |  Nordic Outlook – November 2010


Above-trend growth in 2011
ƒƒ Growth is accelerating again
ƒƒ Broad-based growth in domestic demand
ƒƒ Core inflation to trend higher by mid-2011
ƒƒ Norges Bank to pause until next June
The outlook for the Norwegian economy is broadly
unchanged from the August Nordic Outlook. For 2010
the forecast for 0.5 per cent growth in overall GDP is
slightly lower due to a sharp drop in oil and gas produc-
tion in the third quarter − exaggerated by maintenance
at some fields − suggesting a more marked drop in such
exports. Overall growth should be 2.3 per cent next
year and ease to 2.2 per cent in 2012.
Momentum in mainland GDP − excluding oil/gas and
shipping − is stronger: while we are leaving our forecast
unchanged at 1.6 per cent for the current year, growth
should accelerate to 2.9 per cent in 2011 and 2012,
approximately 0.5 per cent above trend.
Private consumption recovering
Signs of accelerating economic activity have accu-
mulated in recent months. The recovery in domestic
demand is becoming more broadly based, in line with
our expectations. In particular, private consumption
rebounded in the third quarter following a surprisingly
soft trajectory over the first half of the year. In the
previous Nordic Outlook, we attributed the “consump-
tion conundrum” first and foremost to higher inflation,
driven by sharply higher electricity prices over the
winter, which squeezed real disposable income. Based
on solid fundamentals, we thus expect consumption to
regain strength going forward.
Momentum accelerated over the summer, as seen in
the monthly indicator for consumption of goods, which
rose by 1.1 per cent between the second and the third
quarter, following a slight decline over the first half of
the year. This development mirrors the improvement in
consumer confidence, with the quarterly index rising to
its highest level since late 2007, slightly above the long-
term average. In addition, home prices have regained
strength by rising 4.1 per cent in the six months to
October, while a slowing in the year-on-year rate to 6.2
per cent was due to base effects.
The squeeze on household real income has eased as
inflation has moderated, with the year-on-year rate on
consumer prices slowing from 3.4 per cent in March to
Norway
2.0 per cent in October. Moreover, interest rates are
still at low levels and Norges Bank now seems intent on
keeping policy rates unchanged to mid-2011.
Consumption of goods and home prices
6-month percentage change
6 12.0
5
4 8.0
3
2 4.0
1
0 0.0
-1
-2 -4.0
-3
-4 -8.0
01 02 03 04 05 06 07 08 09 10
Consumption of goods (LHS)
Home prices (RHS)
Source: Statistics Norway, Norwegian Association of Real Estate Agents
Growth in private consumption should pick up from
2.8 per cent in 2010 to 3.5 per cent in 2011 and
3.3 per cent in 2012. The forecasts are slightly above
the expected increase in households’ real disposable
income of approximately 3 per cent on average in 2010-
12. The household savings ratio is thus set to decline
slightly, but at 7.9 per cent as of the second quarter, it
was well above its long-term average. A possibly larger
decline in the savings ratio is an upside risk to our fore-
cast for private consumption.
However, household debt remains very elevated com-
pared to income. Although credit growth to households
has yet to show acceleration on the back of low interest
rates, its year-on-year growth of slightly above 6 per
cent is still stronger than that of income. Our forecast
thus assumes some debt consolidation when Norges
Bank re-starts its rate hiking cycle.
Unemployment about to peak
Unemployment is still at rather low levels, even though
the improvement in the labour market situation −
which started in late 2009/early 2010 − seems to have
tapered off. Registered unemployment increased rather
markedly in September and October to 3.0 per cent
of the labour force in seasonally adjusted terms, the
highest in almost five years. The recent increase does
not reflect a similar turn to the worse. Rather, some of
the labour market programmes that were added when
the financial crisis hit have been scaled back. Including
people enrolled in such programmes, overall registered
Nordic Outlook – November 2010  |  49
 Norway

unemployment has thus been stable recently and is below its long-term average. Positively, the capital
lower than a year ago. spending outlook among manufacturers has become
gradually less pessimistic, according to the latest Busi-
Employment and unemployment
ness Tendency Survey from Statistics Norway. Although
5 6.5
the investment intentions indicator is not back in posi-
6.0
4 tive territory, it hints that the downturn has come to an
5.5
3
end. In contrast, capital spending in the utility sector
5.0 looks set to grow strongly, as indicated by Statistics
2 4.5 Norway’s latest investment survey.
1 4.0
3.5 Moreover, construction orders have showed a strong
0 improvement over the past few quarters and hous-
3.0
-1 ing starts have trended higher as well, suggesting that
2.5
residential investment has turned the corner. The same
-2 2.0
94 96 98 00 02 04 06 08 10
is the case for capital spending in the private service
sector, which accounts for the lion’s share of non-oil
Employment, year-on-year percentage change (LHS) business investment.
LFS unemployment rate (RHS)
Source: Statistics Norway
Housing starts and orders
Moreover, unemployment according to the Labour Force 1200 120

Survey declined slightly from 3.6 per cent in the second 110
1100
quarter to 3.4 per cent in the third, due to a marginal 100
1000 90
decline in the labour force. Meanwhile, employment
80
was unchanged for the quarter and up a modest 0.4 per 900
70
cent over the past year. This rather small gain reflects 800 60
the fact that employment did not decline much during
700 50
the downturn, as the public sector added workers and
40
the private sector, except manufacturing and construc- 600
30
tion, was somewhat reluctant to reduce its workforce.
500 20
Although we foresee somewhat stronger employment 99 00 01 02 03 04 05 06 07 08 09 10
growth, it will broadly match the increase in the labour
force, and the LFS unemployment rate should average Housing starts, 1,000 sqm (LHS)
Orders, new residential buildings, 2Q earlier (RHS)
3.4 per cent in 2011 and 3.3 per cent in 2012. Source: Statistics Norway

Capital spending is turning the corner
Steep declines in non-oil business and residential fixed
investment have weighed heavily on growth in the past
couple of years, dropping almost 30 per cent from the
final quarter of 2007 until the second quarter of 2010.
We expect residential investment to grow by a solid
10 per cent in 2011 and almost as much in 2012,
although the level will still be almost 20 per cent below
its 2007 peak. Meanwhile, non-oil business investment
should be up more than 5 per cent next year.

Orders have recovered Oil sector investment will probably decline somewhat
Index 100 = 2005 more in 2010 than previously expected. However, Sta-
175 175 tistics Norway’s most recent survey saw oil companies
expecting record-high investment in 2011, and we still
150 150 expect a 5 per cent growth rate next year.

125 125 Exports have underperformed so far

While domestic demand is on the rise, the volume of
100 100 exports of non-oil goods has continued to be surprisingly
soft. Following an initial strong rebound last summer as
75 75 the global economy turned, such exports have remained
broadly unchanged so far in 2010, according to foreign
50 50
trade statistics.
99 00 01 02 03 04 05 06 07 08 09 10

Manufacturing orders Construction orders
Source: Statistics Norway
Capital spending in the manufacturing sector is likely to
decline further between 2010 and 2011. While manu-
facturing production on a quarterly basis has risen since
mid-2009, reaching 4.1 per cent year-on-year as of the
third quarter of 2010, capacity utilisation is still well
One might suspect that a somewhat stronger currency is
partly to blame, as the Norwegian krone has averaged
some four per cent higher in trade-weighted terms than
a year earlier. In addition, the fact that wages continue
to rise faster than among trading partners − which has
been the case for years − adds to the loss of competi-
tiveness.

50   |  Nordic Outlook – November 2010

 Norway

However, the lacklustre trend in non-oil exports owes
a lot to plunging exports of electricity and a decline
for refined oil products and non-transportation invest-
ment goods. Other than that, exports have risen in line
with what one would expect considering the recovery in
export markets in general and in manufacturing produc-
tion, in particular since intermediate goods make up a
lot of such exports.
slowing from 2.6 per cent at end-2009 to 2.1 per cent
according to our calculation. Meanwhile, core import
prices in October were 1.4 per cent lower than a year
earlier.
Core inflation very benign
Year-on-year percentage change
6 6
5 5

4 4
Merchandise exports excluding oil/gas,
3 3
ships etc.
2 2
Per cent of total exports
1 1
2000 2010* Year-on-year
0 0
change, %*
-1 -1
Europe 77.3 66.9 8.4
Sweden 12.7 10.7 15.0 -2 -2
99 00 01 02 03 04 05 06 07 08 09 10
Germany 11.7 8.5 3.3
UK 10.7 8.1 19.0 CPI CPI-ATE
Source: Statistics Norway
Denmark 7.3 4.9 -3.3
France 6.1 4.5 12.8 To a large extent, the decline in imported inflation re-
Italy 3.0 1.7 -3.6 flects the previous appreciation of the Norwegian krone
PIGS 5.7 5.2 3.3 by more than 10 per cent, using the import-weighted
US 8.4 9.8 31.0 index, between late 2008 and early 2010. The price in-
Asia 9.8 17.2 -3.8 dex for imported goods suggests that the downtrend in
China 0.8 3.9 -11.1 core import prices has further to run in the near term,
Japan 3.9 2.8 22.5 but also that a trough is likely before long. Such a signal
Total 8.5 is also coming from the fact that the import-weighted
NOK index is slightly weaker at present than a year ago.
* Jan-Aug.
Source: Statistics Norway, SEB Strong NOK has dented imported inflation
Manufacturing export orders were up 15 per cent in Year-on-year percentage change
6.0 -20
the year to the third quarter, but this strong gain was
affected by the rise in commodity prices, since orders 4.5 -15
are measured in nominal terms. Nonetheless, according 3.0 -10
to the quarterly Business Tendency Survey, which saw 1.5 -5
manufacturing sentiment rising to a three-year high,
0.0 0
exports orders increased in both the second and the
third quarter and manufacturers’ expectations were -1.5 5

the most optimistic in almost five years. In addition, in -3.0 10

a recent report from Norges Bank’s regional network,
export firms reported a marked pickup in production
and expected output to expand at about the same pace
in the near term.
In all, real exports of non-oil goods probably expanded
5 per cent from 2009 to 2010, but mostly due to the
high entry level going into the current year. Our fore-
cast for 3.5 per cent growth in 2011 thus implies an
accelerating trend.
Core inflation at a trough
Core inflation has been surprisingly soft so far in 2010.
The year-on-year rate on the CPI-ATE measure − ex-
cluding indirect taxes and energy − slowed from 2.4 per
cent last December to a four-year low of 0.9 per cent in
September before inching up to 1.0 per cent in October,
well below the 2.5 per cent medium-term target. The
downshift has been rather broad-based between do-
mestic and import prices, with core domestic inflation
-4.5 15
99 00 01 02 03 04 05 06 07 08 09 10 11
Core CPI, imported prices (LHS)
NOK import-weighted, 6-month earlier (RHS)
Source: Statistics Norway, SEB
Concerning the downtrend in domestic inflation, some
of it reflects markedly slower wage and salary growth
in recent years, from more than 6 per cent in 2008 via
4.5 per cent in 2009 to approximately 3.5 per cent in
the current year. Other than that and the currency ef-
fect, it is hard to pin the downshift in core inflation to
any similar weakening in demand, while wage growth is
likely to drift higher in the next couple of years.
Norges Bank: It is all about inflation
Since early summer, core inflation has fallen short of
Norges Bank’s expectations. The October Monetary Pol-
icy Report sent a clear message that the 2.00 per cent
deposit rate, raised most recently in May, is unlikely to

Nordic Outlook – November 2010  |  51

 Norway
be hiked until inflation shows a trough and starts trend-
ing higher again. A lower inflation forecast was the key
reason why the bank again revised its optimal rate path
downward, although less than the substantial revisions
in the two previous reports.
Norges Bank’s new inflation forecast implies that the
inflation target will not be met until the second half of
2013. Accordingly, while the previous Monetary Policy
Report implied a hike in the deposit rate around the
turn of the year, the new one extends the pause until
next summer, with two hikes before the end of 2011
and a 3.50 per cent key rate by end-2012.
Norges Bank's rate path
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Norges Bank's deposit rate
Optimal rate path, MPR 3/10
Optimal rate path, MPR 2/10
Source: Norges Bank
SEB’s forecast for the CPI-ATE index is only slightly
above that of Norges Bank. The trough is mostly likely
behind us, but any accelerating trend in core inflation
is unlikely before next summer. However, we do foresee
a somewhat stronger pick-up thereafter. Core inflation
should average 2.2 per cent in 2012, with core domestic
prices rising approximately 3 per cent while imported
inflation should be slightly above zero.
In addition to still-low core inflation, Norges Bank’s
room to manoeuvre on key interest rates will still be
constrained by monetary policy elsewhere. Much of
the core CPI shortfall relative to the bank’s forecast so
far in 2010 has been due to imported deflation, under-
scoring its focus on the exchange rate. However, by
mid-2011 the recovery in the Norwegian economy will
be well established and growth abroad firmer as well,
while core inflation should have started to trend higher.
Hence, we expect the deposit rate to be hiked 25
basis points next June, followed by another hike in
October, lifting it to 2.50 per cent by the end of 2011.
Moreover, with the output gap closed by early 2012
according to Norges Bank’s projection and with core in-
flation rising a bit faster in our forecast, the rate hiking
cycle should accelerate, with the deposit rate ending
2012 at 3.75 per cent.
NOK to regain strength in 2011
The long-term outlook is still strong for the NOK. How-
ever, as we concluded in the previous Nordic Outlook,
52   |  Nordic Outlook – November 2010
the near term has been hampered by weak flows and a
dovish Norges Bank.
It is very likely, though, that the period of NOK weak-
ness against the euro will soon end. After passing the
expected positive EUR/NOK seasonality in late Novem-
ber/early December, a number of factors support our
forecast of the EUR/NOK exchange rate returning below
8.00 in the first half of 2011.
Firstly, the flow outlook is gradually improving: Norges
Bank will refrain from selling NOK in December as usual
(due to more illiquid markets). In 2011 on average, we
estimate that Norges Bank will only sell NOK 150 million
per day (vs. the current NOK 800 million/day), accord-
ing to the 2011 budget. With regard to flows, we also
expect continued foreign interest in buying Norwegian
equities, with the foreign ownership rate on the Oslo
Stock Exchange gradually increasing towards 36-38 per
cent (versus 35.3 per cent at present).
Secondly, our expectations of a more broad-based
recovery and continuing rate normalisation by Norges
Bank should support the NOK in 2011. The fact that
Norges Bank will not lift key rates until mid-2011 is fully
discounted by markets. Hence, monetary policy will be
very neutral for the currency and flows will continue to
be the most important factor for the NOK. We reiterate
our forecasts of EUR/NOK at 8.00 by end-2010 with a
further decline towards 7.80 in the first half of 2011.
Exchange rate, EUR/NOK
10.0 10.0
9.5 9.5
9.0 9.0
8.5 8.5
8.0 8.0
7.5 7.5
7.0 7.0
02 03 04 05 06 07 08 09 10
SEB regression EUR/NOK spot
Source: SEB
The Norwegian 10-year government bond yield is
expected to climb somewhat in the near term, in line
with the German bond yield. The spread vs. Germany
has tightened from historically high levels lately to 66
bps and is expected to remain stable in the near term.
We expect Norges Bank to resume its rate hikes as of
mid-2011, resulting in a wider key interest rate spread
vs. the ECB. This should lead to a gradually widening of
the 10-year spread, reaching 90 bps in 2012.

Rapid export rebound, faster economic growth
ƒƒ Leading indicators climbing higher
ƒƒ Unemployment will continue downward
and pay increases will accelerate by 2012
ƒƒ Budget deficit below 3 per cent in 2011
The Finnish economy is continuing to recover. GDP
rose 3.4 per cent year-on-year in the second quarter,
mainly due to a rapid rebound in merchandise and
service exports, which rose 6.1 per cent year-on-year
(-5 per cent in the first quarter), but also due to a 2.7
per cent rise in private consumption. Capital spend-
ing remains lower than one year ago but is now also
increasing. The rapid improvement in the economy is
reflected by most leading indicators. Retail sales have
strengthened rapidly so far in 2010, and the con-
struction, manufacturing and service sectors have
all experienced clear improvements. Labour market
prospects have also brightened; hiring plans have risen
rapidly, and unemployment has continued to fall.
Overall economic performance is quite consistent with
our August forecast. We expect GDP growth of 2.7
per cent this year, a cautious upward revision of 0.2
percentage point since August, 3.0 per cent in 2011
and 2,8 per cent in 2012. Our growth forecast is well
above the prevailing consensus (2.1 per cent in 2010
and 1.8 per cent in 2011) but in line with the Finnish
central bank’s latest forecast in November.
Service sector leading the upturn
Index
70
50
30
10
-10
-30
-50
-70
00 01 02 03 04 05 06 07 08
Construction sector Service sector
Manufacturing sector
Unemployment has continued downward since peaking
at 8.9 per cent early in 2010. In September it stood at
8.1 per cent. Unemployment did not climb higher last
year largely because companies used short-term lay-
Finland
offs and did not need to terminate these employees.
Another important factor is that more people are leav-
ing the labour force than joining it; pensioners make up
a rapidly growing share of the population. We expect a
continued decline in joblessness to below 8 per cent in
December 2010 and just above 7 per cent in December
2011. Measured as annual averages, it will be 8.4 per
cent this year, 7.7 per cent in 2011 and 7.4 per cent in
2012, about the same as our August forecast.
The labour market improvement has not yet affected
wage formation, which was held back by rapidly ris-
ing unemployment in 2008-2009. Total pay increases
slowed from 3.3 per cent year-on-year in the first
quarter of 2010 to 2.3 per cent in the third quarter.
We expect a cautious rebound in the first half of 2011,
but hourly wage increases will remain below 3 per cent
throughout our forecast period. HICP inflation has been
relatively stable between 1.3 and 1.6 per cent so far
this year (1.4 per cent in September). We expect infla-
tion to accelerate somewhat later in the winter, due in
part to high energy and food prices. Inflation will climb
a bit more in the first quarter of next year. Measured as
annual averages, HICP inflation will reach 2.1 per cent
in 2011 and 2.0 per cent in 2012.
A favourable pre-crisis economic situation, with low
government debt and both budget and current account
surpluses, helped keep the Finnish economy stable
despite its record 8 per cent GDP slide last year. The
fiscal deficit − which will stand at 3.4 per cent of
GDP this year, the strongest budget in the whole euro
70 zone − will decrease to 2.5 per cent next year and
2.2 per cent in 2012. Public debt as measured by the
50
Maastricht criteria will grow from 47 per cent of GDP
30
this year to just above 50 per cent in 2012, a cautious
10 increase compared to many other euro zone countries.
-10
Despite this improvement, Finland needs a long-term
-30 budget consolidation programme and an economic and
-50 structural policy plan. This will be the task of the next
-70 government after the April 2011 parliamentary election.
09 10
Source: DG ECFIN
Nordic Outlook – November 2010  |  53
Economic data

DENMARK
Yearly change in per cent
2009 level,
DKK bn 2009 2010 2011 2012
Gross domestic product 1,660 -4.7 2.2 2.2 2.1
Private consumption 817 -4.3 1.9 2.2 2.6
Public consumption 492 3.4 0.8 0.3 0.5
Gross fixed investment 312 -14.1 -3.0 4.0 5.5
Stockbuilding (change as % of GDP) -2.4 1.0 0.0 0.0
Exports 784 -10.2 7.0 5.8 5.0
Imports 727 -13.2 5.5 5.7 6.0

Unemployment (%) 3.6 4.2 4.0 3.5

Consumer prices, harmonised 1.1 2.2 2.1 2.1
Wage cost 3.1 2.3 2.1 3.0
Current account, % of GDP 4.2 3.7 3.0 2.5
Public sector financial balance, % of GDP 3.6 -5.2 -3.5 -3.0
Public sector debt, % of GDP 41.4 44.0 46.0 48.0

FINANCIAL FORECASTS Nov 18 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Lending rate 1.05 1.05 1.05 1.05 1.65 1.95
10-year bond yield 2.81 2.85 3.00 3.25 3.50 3.60
10-year spread to Germany, bp 11 15 15 15 20 20
USD/DKK 5.47 5.36 5.36 5.73 5.87 5.87
EUR/DKK 7.46 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 2,256 -1.4 0.5 2.3 2.2
Gross domestic product (Mainland Norway) 1,732 -1.4 1.6 2.9 2.9
Private consumption 956 0.2 2.8 3.5 3.3
Public consumption 487 4.7 2.8 2.0 1.9
Gross fixed investment 467 -9.1 -5.2 4.9 4.2
Stockbuilding (change as % of GDP)
Exports 1,008 -4.0 -0.5 1.1 2.0
Imports 638 -11.4 6.7 3.8 4.5

Unemployment (%) 3.2 3.5 3.4 3.3

Consumer prices 2.1 2.4 1.4 2.2
CPI-ATE 2.6 1.4 1.6 2.2
Wage cost 4.5 3.5 3.7 4.0

FINANCIAL FORECASTS Nov 18 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Deposit rate 2.00 2.00 2.25 2.50 3.25 3.75
10-year bond yield 3.33 3.40 3.65 3.95 4.20 4.30
10-year spread to Germany, bp 63 70 80 85 90 90
USD/NOK 5.98 5.76 5.65 5.96 6.02 5.91
EUR/NOK 8.16 8.00 7.85 7.75 7.65 7.50

54   |  Nordic Outlook – November 2010

 Nordic key economic data

SWEDEN
Yearly change in per cent
2009 level,
SEK bn 2009 2010 2011 2012
Gross domestic product 3,108 -5.1 5.0 3.5 2.5
Gross domestic product, working day adjusted -5.0 4.7 3.5 2.9
Private consumption 1,516 -0.8 3.5 2.8 2.5
Public consumption 863 1.7 1.1 0.9 0.9
Gross fixed investment 555 -16.0 7.0 6.0 4.0
Stockbuilding (change as % of GDP) -41 -1.5 1.7 0.2 0.0
Exports 1,507 -12.4 11.0 7.4 5.1
Imports 1,294 -13.2 12.7 7.2 5.2

Unemployment (%) 8.3 8.4 7.5 7.1

Employment -2.1 1.0 1.7 0.7
Industrial production -19.1 10.0 7.0 4.0
Consumer prices -0.3 1.2 2.0 2.1
CPIX 1.9 2.0 2.4 1.6
Wage cost 3.4 2.0 2.3 3.9
Household savings ratio (%) 12.6 11.3 11.7 11.3
Real disposable income 0.9 1.9 3.4 2.1
Trade balance, % of GDP 3.5 2.5 2.8 2.8
Current account, % of GDP 7.5 6.5 6.0 5.5
Central government borrowing, SEK bn 176 3 -10 -47
Public sector financial balance, % of GDP -1.2 -0.5 0.1 0.8
Public sector debt, % of GDP 41.7 37.9 35.5 32.8

FINANCIAL FORECASTS Nov 18 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Repo rate 1.00 1.25 1.50 2.25 2.50 3.00
3-month interest rate, STIBOR 1.58 1.65 1.90 2.65 2.90 3.40
10-year bond yield 2.95 3.00 3.25 3.50 3.75 3.90
10-year spread to Germany, bp 25 30 40 40 45 50
USD/SEK 6.87 6.58 6.47 6.73 6.81 6.77
EUR/SEK 9.37 9.15 9.00 8.75 8.65 8.60
TCW 126.6 123.4 121.1 119.7 118.6 118.1

FINLAND
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 171 -8.1 2.7 3.0 2.8
Private consumption 94 -2.4 2.3 2.4 2.5
Public consumption 43 1.2 0.3 0.5 0.8
Gross fixed investment 34 -14.5 0.9 6.3 6.1
Stockbuilding (change as % of GDP) -1.2 0.3 0.1 0.0
Exports 62 -20.5 5.8 6.6 5.3
Imports 57 -18.1 4.2 6.8 6.0

Unemployment (%) 8.2 8.4 7.7 7.4

Consumer prices, harmonised 1.6 1.5 2.1 2.0
Wage cost 4.0 2.8 2.4 2.9
Current account, % of GDP 2.7 2.0 1.5 1.3
Public sector financial balance, % of GDP -2.5 -3.4 -2.5 -2.2
Public sector debt, % of GDP 43.8 47.1 49.7 51.9

Nordic Outlook – November 2010  |  55

 International key economic data

EURO ZONE
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 8,979 -4.0 1.6 1.7 1.5
Private consumption 5,170 -1.1 0.6 0.7 1.1
Public consumption 1,975 2.4 1.3 0.9 1.1
Gross fixed investment 1,773 -11.3 0.2 4.2 3.9
Stockbuilding (change as % of GDP) -0.7 1.0 0.2 0.0
Exports 3,259 -13.1 9.3 5.8 5.3
Imports 3,140 -11.8 9.5 5.9 5.5

Unemployment (%) 9.4 10.0 9.7 9.4

Consumer prices, harmonised 0.3 1.5 1.3 1.4
Household savings ratio (%) 9.6 9.5 9.3 9.0

US
Yearly change in per cent
2009 level,
USD bn 2009 2010 2011 2012
Gross domestic product 14,277 -2.6 2.7 2.2 3.4
Private consumption 10,132 -1.2 1.6 1.8 2.7
Public consumption 2,934 1.6 1.1 0.4 -0.3
Gross fixed investment 1,638 -18.4 3.8 8.4 12.6
Stockbuilding (change as % of GDP) -0.6 1.5 0.1 0.0
Exports 1,690 -9.5 11.5 9.9 13.7
Imports 2,116 -13.8 14.1 9.7 11.4

Unemployment (%) 9.3 9.7 9.5 8.4

Consumer prices -0.3 1.6 1.2 1.6
Household savings ratio (%) 5.9 5.6 5.8 6.3

LARGE INDUSTRIAL COUNTRIES

Yearly change in per cent
2009 2010 2011 2012
GDP
United Kingdom -5.0 1.7 2.1 2.1
Japan -5.3 3.1 1.6 1.5
Germany -4.7 3.6 2.5 1.8
France -2.5 1.5 1.4 1.5
Italy -5.1 1.0 0.9 1.3

Inflation
United Kingdom 2.2 3.2 2.6 1.9
Japan -1.3 -0.9 0.1 0.3
Germany 0.2 1.1 1.4 1.5
France 0.1 1.6 1.7 1.9
Italy 0.8 1.6 1.7 1.9

Unemployment (%)
United Kingdom 7.7 7.9 7.6 7.4
Japan 5.1 5.1 5.2 5.1
Germany 7.5 7.8 7.2 6.9
France 9.5 10.1 9.8 9.6
Italy 7.8 8.4 8.1 7.8

56   |  Nordic Outlook – November 2010

 International key economic data

EASTERN EUROPE

2009 2010 2011 2012

GDP, yearly change in per cent
Estonia -13.9 2.5 4.0 4.0
Latvia -18.0 -0.3 4.0 5.0
Lithuania -14.7 1.0 4.0 4.5
Poland 1.7 3.5 4.0 4.5
Russia -7.9 3.7 4.3 5.0
Ukraine -15.1 5.2 4.4 4.2

Inflation, yearly change in per cent

Estonia 0.2 2.7 3.0 4.0
Latvia 3.3 -1.2 1.3 1.5
Lithuania 4.2 1.0 2.0 3.0
Poland 3.5 2.7 2.9 2.9
Russia 11.7 6.8 7.5 7.4
Ukraine 15.9 9.5 10.9 10.1

FINANCIAL FORECASTS

Nov18 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12
Official interest rates
US Fed funds 0.25 0.25 0.25 0.25 0.50 1.00
Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50
Euro zone Refi rate 1.00 1.00 1.00 1.00 1.50 1.75
United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 2.00

Bond yields
US 10 years 2.90 2.90 3.10 3.35 3.40 3.60
Japan 10 years 1.07 1.10 1.20 1.50 1.70 1.90
Germany 10 years 2.70 2.70 2.85 3.10 3.30 3.40
United Kingdom 10 years 3.40 3.45 3.60 3.80 3.90 4.00

Exchange rates
USD/JPY 84 81 84 88 95 100
EUR/USD 1.36 1.39 1.39 1.30 1.27 1.27
EUR/JPY 114 113 117 114 121 127
GBP/USD 1.60 1.62 1.60 1.57 1.55 1.59
EUR/GBP 0.85 0.86 0.87 0.83 0.82 0.80

GLOBAL KEY INDICATORS

Yearly percentage change
2009 2010 2011 2012
GDP OECD -3,3 2.5 2.3 2.5
GDP world -0,6 4.7 4.1 4.5
CPI OECD 0,1 1.4 1.2 1.4
Export market OECD -11,5 8.8 6.6 7.8
Oil price, Brent (USD/barrel) 61,9 79.1 86.0 89.0

Nordic Outlook – November 2010  |  57

 Finland
St: Petersburg
Norway
Moskva Russia
Sweden
Estonia

Latvia
New York Denmark
Beijing
Lithuania
Dublin
Shanghai
London New Delhi
Poland
Germany
Warsaw
Ukraine
Luxembourg
Kiev

Singapore
Geneve

Nice

São Paulo

SEB is a leading Nordic financial services group. As a relationship bank, SEB

in Sweden and the Baltic countries offers financial advice and a wide range
of financial services. In Denmark, Finland, Norway and Germany the bank’s
operations have a strong focus on corporate and investment banking based on
a full-service offering to corporate and institutional clients. The international
nature of SEB’s business is reflected in its presence in 20 countries worldwide.
On 30 September 2010, the Group’s total assets amounted to SEK 2,254bn while
its assets under management totalled SEK 1,343bn. The Group has about 17,000
employees, excluding the German retail operations. Read more about SEB at
www.sebgroup.com.
With capital, knowledge and experience, we generate value for our customers −
a task in which our research activities are highly beneficial.
Macroeconomic assessments are provided by our Economic Research unit.
Based on current conditions, official policies and the long-term performance of
the financial market, the Bank presents its views on the economic situation −
locally, regionally and globally.
One of the key publications from the Economic Research unit is the quarterly
Nordic Outlook, which presents analyses covering the economic situation in the
world as well as Europe and Sweden. Another publication is Eastern European
Outlook, which deals with the Baltics, Poland, Russia and Ukraine and appears
twice a year.
SEMB0052 2010.11

www.sebgroup.com