Continued recovery despite new

Nordic Outlook
wave of European debt crisis
Inflation will fall despite rising
Economic Research – May 2011 resource utilisation
 Contents

International overview 5

Theme: The path to European debt restructuring 14

The United States 16

Japan 21

Asia 22

The euro zone 25

The United Kingdom 30

Eastern Europe 31

The Baltics 32

Sweden 34

Denmark 41

Norway 43

Finland 47

Economic data 49

Boxes

The commodity price upturn will fade 7

Rising oil prices will slow GDP growth 17
A shaky credit rating 19
The US will retain its leading role 20
Reducing China’s coal dependency 23
Domestic factors drive Indian food prices 24
Italy and France chug along in low gear 26
Fiscal stimulus pushing up Russian growth 31
High oil prices boost the budget surplus 44
The election of April 17, 2011 48

Nordic Outlook – May 2011  |  3

 Economic Research

This report was published on May 17, 2011.

Cut-off date for calculations and forecasts was May 12, 2011.

Robert Bergqvist Håkan Frisén

Chief Economist Head of Economic Research
+ 46 8 506 230 16 + 46 8 763 80 67

Daniel Bergvall Mattias Bruér

Economist Economist
+46 8 763 85 94 + 46 8 763 85 06

Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist
+ 46 8 763 80 77 + 46 8 763 80 93

Andreas Johnson Tomas Lindström

Economist Economist
+46 8 763 80 32 + 46 8 763 80 28

Gunilla Nyström Ingela Hemming

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

Susanne Eliasson Johanna Wahlsten

Personal Finance Analyst Small Business Analyst
+ 46 8 763 65 88 + 46 8 763 80 72

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

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

4   |  Nordic Outlook – May 2011


World economy will overcome new challenges
ƒƒ Temporary US slowdown
ƒƒ Inflation will fall
ƒƒ Idle resources delaying Fed action on rates
ƒƒ Rate hikes will push up SEK and NOK
ƒƒ Stronger emerging market currencies will
ease global imbalances
Over the past few months, the global economic recovery has
faced a number of challenges. Political unrest in the Mid-
dle East and North Africa − including a civil war in Libya − the
Japanese natural disaster and a renewed wave of European
sovereign debt crisis have created greater uncertainty about
the sustainability of the recovery. In particular, the worsening
situation in Greece represents growing political and financial
challenges to European cooperation. We regard a debt re-
structuring in Greece as increasingly likely (see the Theme
article).
In our judgement, the combination of higher oil prices, unex-
pectedly weak first quarter US growth and production disrup-
tions following the Japanese natural disaster justifies a down-
ward revision of our growth forecast for the 34 countries of
the Organisation for Economic Cooperation and Development
(OECD), from 2.8 to 2.4 per cent this year. Because of contin-
ued strong economic resilience in emerging market (EM)
countries, we are lowering our global growth forecast by only
0.2 percentage points.
Global GDP growth
Year-on-year percentage change
2009 2010 2011 2012
United States -2.6 2.9 2.8 3.8
Japan -6.3 3.9 0.5 2.4
Germany -4.7 3.6 3.5 2.7
China 9.2 10.3 9.3 8.5
United Kingdom -4.9 1.3 1.4 2.5
Euro zone -4.0 1.7 2.2 2.2
Nordic countries -4.6 2.9 3.3 2.7
Baltic countries -15.6 1.2 4.1 4.4
OECD -3.4 2.8 2.4 3.1
Emerging markets 2.7 7.3 6.5 6.2
World, PPP* -0.5 5.0 4.3 4.5
World, nominal -1.2 4.3 3.6 3.8
Source: OECD, SEB * Purchasing power parities­
International overview
We believe that in 2012, global GDP will again accelerate
despite some tightening of economic policy. The EM econo-
mies will continue their rapid growth, rising employment and
dynamic capital spending activity will make the US recovery
more self-sustaining, and post-disaster reconstruction work
will stimulate the Japanese economy. But in countries that are
further along in the economic cycle and have achieved high
resource utilisation, growth will slow in 2012. This applies, for
example, to Germany and Sweden as well as many EM econo-
mies, led by China. Altogether, we expect GDP growth to reach
3.1 per cent in the OECD countries, an upward revision from 2.8
per cent. Our forecast for 2012 assumes that the commodity
price upturn will have culminated and that oil prices will fall.
Rising commodity prices have pushed up inflation on a broad
front, creating increased concerns about a lasting upturn in the
inflation rate. Although an easing of commodity prices, com-
bined with low underlying cost pressure, will cause Consumer
Price Index (CPI) inflation to fall by late 2011, upside risks
have increased. Global deflation pressure from China and other
EM economies has eased, while resource utilisation is moving
towards more normal levels in many countries.
Because of rising resource utilisation and continued steps
towards more normally functioning financial markets, the exit
policies of central banks are approaching. We expect the
European Central Bank (ECB) to follow up its April interest rate
hike with another two interest rate hikes this year, resulting in
a refi rate of 1.75 per cent at the end of 2011. During 2012 the
ECB will continue raising the refi rate each quarter to a level
of 2.75 per cent by year-end. A relatively small output gap will
contribute to these rate hikes. Due to high unemployment, the
US Federal Reserve (Fed) will hold off until early 2012 before
starting to raise its key rate. Towards the end of 2012, the
American federal funds rate will stand at 2 per cent.
In the Nordic countries, key rate increases will continue.
Due to rapidly rising resource utilisation, Sweden’s Riksbank will
hike its repo rate to 2.75 per cent by the end of 2011 and to 3.75
per cent at the end of 2012. In Norway, Norges Bank will also
find it easier to adjust its deposit rate in line with the require-
ments of domestic conditions as the ECB carries out further
rate hikes.
While our main forecast is a continued economic recovery, the
global economy faces a number of risks and challenges. The
climate of international cooperation, both in Europe and at the
global Group of Twenty (G20) level, will be put to the test in an
environment that includes the emergence of worrisome politi-
cal tendencies towards isolationism and focusing on internal
problems. Global imbalances are disturbingly large. Size-
able cyclical and structural differences are creating tensions in
Nordic Outlook – May 2011  |  5
 International overview

the global foreign exchange system. In many places, debts and In India, there will be a mild deceleration in growth to 8.0
assets are continuing to build up, leading to explosive risks. per cent in 2011 and 7.0 per cent in 2012. Exports and industrial
Central government debts are rising, and the European debt production will continue to perform strongly after a winter
crisis is moving into a new phase where a restructuring of Greek slump.
sovereign debt appears more and more inevitable. The sustain- Inflation in EM Asia
ability of American federal finances is also beginning to be Per cent
questioned in earnest, although an increased awareness of the 12.5 12.5

problem is meanwhile contributing to a more sober approach 10.0 10.0

to US fiscal policies.
7.5 7.5

The US: Temporary slowdown in growth 5.0 5.0

The US economy slowed down in the first quarter, with GDP in- 2.5 2.5
creasing by less than 2 per cent. Growth was held back by cold
0.0 0.0
winter weather and lower public sector consumption (defence
expenditures), at the same time as rising food and petrol prices -2.5 -2.5
07 08 09 10 11
undermined household purchasing power. High energy prices
will also constrain growth in the near future. These are among China South Korea
Indonesia India
the reasons why we have revised our GDP forecast for 2011 Source: National statistical offices

downward to 2.8 per cent (from 3.6 per cent).

US: Financial saving in private sector Western Europe: A widening gap
Per cent of GDP The economic performance of the euro zone is displaying ever-
10.0 10.0
wider gaps, which was also illustrated by the first quarter’s GDP
7.5 7.5 numbers. The recovery in Germany is progressing at a rapid
5.0 5.0 pace. Optimism is at record-high levels according to the IFO
2.5 2.5
sentiment index. GDP will climb by 3.5 per cent this year and by
2.7 per cent in 2012. German unemployment has fallen to its
0.0 0.0
lowest level since 1992, and we expect it to continue falling to
-2.5 -2.5 5 per cent by the end of next year. France and Italy are grow-
-5.0 -5.0 ing at about their long-term trend of 1½-2 per cent, among
-7.5 -7.5 other things because their growth is driven to greater extent
60 65 70 75 80 85 90 95 00 05 10 15 by less vigorous domestic demand. Spain was on the brink of
Normal adjustment NO scenario Mean a new recession in the second half of 2010 but has stabilised
Source: SEB
somewhat since then; we expect growth of slightly below 1 per
However, underlying factors indicate that the slowdown is cent this year. Because of dramatic fiscal tightening in Greece,
temporary. The labour market is continuing to improve, and Ireland and Portugal, these countries will experience a decline
companies are highly optimistic. Because of strong corporate in GDP, further accentuating the two-speed economy in the
balance sheets and capital spending needs, private sector common currency area. Overall euro zone growth will end up
saving is likely to continue falling. Based on historical experi- at 2.2 per cent in both 2011 and 2012.
ence, this process will move relatively fast once a turnaround Large differences in consumer confidence
Net balance
has occurred, but due to continued consolidation needs in the 20.0 20.0
household sector, downward adjustment in private saving will
proceed more slowly than usual (see above chart). We predict 10.0 10.0

that GDP growth will average 3.8 per cent in 2012: clearly 0.0 0.0

above the consensus estimate. -10.0 -10.0

Emerging Asia: Growth despite tightening -20.0 -20.0

Asian emerging markets are the first in the economic cycle and -30.0 -30.0

are driving global expansion. We expect good growth to contin- -40.0 -40.0
ue in these countries during 2011 and 2012. Overheating risks
-50.0 -50.0
are starting to be increasingly apparent in a number of econo- 00 01 02 03 04 05 06 07 08 09 10 11
mies, but monetary policy tightening is helping to dampen their Germany France Italy Spain
growth, with a soft landing as the most likely scenario. Source: DG ECFIN

During 2011 the British economy will be held back by fiscal

China’s GDP will increase by 9.3 per cent in 2011 and by
tightening and by high inflation, which will undermine purchas-
8.5 per cent in 2012. Slower export expansion will contribute
ing power. The weak British pound and strong international
to a deceleration compared to last year’s GDP growth of 10.3
demand will nevertheless prop up economic growth. GDP will
per cent, but growth will exceed the targets in the country’s
increase by 1.4 per cent this year and 2.5 per cent in 2012.
new five-year plan. Inflation has largely been driven by food
prices and will begin to slow during the second half of this year.

6   |  Nordic Outlook – May 2011


Nordic strength
The Nordic countries are continuing their solid economic
performance. Good fundamentals in the form of budget
balances, public sector debt and current account balances are
providing support. Exporters are well positioned to respond to
international demand. Currency appreciation in Sweden and
Norway, in the wake of early key interest rate hikes, is having
rather little adverse impact on growth.
The Swedish economy will grow by 4.7 per cent in 2011, af-
ter a record gain of 5.5 per cent last year. Next year growth will
slow down, partly due to the emergence of supply-side restric-
tions. The other Nordic countries are showing more moderate
growth figures. In Norway, where the recession was very shal-
low, growth is being constrained by a tight labour market, a
strong currency and rising interest rates. The Danish economy
will grow by about 2½ per cent. Household consumption
is being constrained by high debt, low pay increases and tight
fiscal policy. In Finland, the euro zone country hardest hit dur-
ing the crisis, exports and capital spending will help fuel GDP
growth of 3.5 per cent in 2011 and 3.0 per cent in 2012.
The commodity price upturn will fade
The sharp upturn in commodity prices that began in the sum-
mer of 2010 is on its way towards ending. The recent cool-
down in prices is mainly due to a correction of earlier specula-
tive excesses. Later this year, the trend of commodity prices
will begin a slowdown based more on fundamentals.
Before the cool-down in early May, the HWWI world index of
energy commodities, expressed in USD, had risen by 45 per
cent since last summer. Brent crude oil had risen from USD
70 to over USD 125 per barrel, but recently it has retreated
somewhat to about 115. Since last summer, agricultural prices
have climbed about 55 per cent. They are now above their
2008 peak. Prices of industrial and precious metals have also
climbed sharply.
Global energy and food prices
Index
175
150
125
100
75
50
25
0 0
00 01 02 03 04 05 06 07 08 09 10
Energy commodities Food
Source: HWWI
We see a number of factors behind these price upturns.
The global recovery, especially the expansive economic trend
in Asia, has generated underlying demand pressure. Prices
have also risen due to a weakening US dollar. In addition,
supply-side disruptions like the La Niña weather phenomenon
and escalating unrest in North Africa and the Middle East
have had an impact on food and crude oil prices. Add a his-
International overview
GDP growth, Nordic and Baltic countries
Year-on-year percentage change
2009 2010 2011 2012
Sweden -5.1 5.5 4.7 2.6
Norway -1.4 0.4 2.3 2.9
Denmark -4.7 2.0 2.3 2.3
Finland -8.1 2.7 3.5 3.0
Nordics -4.6 2.9 3.3 2.7
Estonia -13.9 3.1 5.0 4.5
Latvia -18.0 -0.3 3.7 4.3
Lithuania -14.7 1.3 4.0 4.5
Baltics -15.6 1.2 4.1 4.4
Source: OECD, SEB­
torically high degree of speculative trading − and in the case
of precious metals elements of “safe haven” behaviour, with
many investors wishing to shield themselves from accelerat-
ing inflation and political turbulence.
Looking ahead, our assessment is that the commodity
price upturn will culminate this year, although commodi-
ties prices will generally remain at historically high levels in
2011-2012. In several areas, however, we expect prices to
fall somewhat during the second half of this year. This is
mainly because supply side disruptions will ease.
We have raised our Brent oil price forecast to an average of
USD 109/barrel in 2011, compared to USD 90 in the February
Nordic Outlook. In 2012 we expect an average price of USD
95/barrel. In the immediate future, lingering unrest in North
175 Africa and the Middle East will contribute to continued high
150
oil price levels. Above all, the shortage of low-sulphur crude
oil, of which Libya is an important producer, is keeping prices
125
up. However, during the second half of 2011 we expect oil
100 prices to fall due to more favourable supply-side conditions,
75 for example because of resumed production in Libya. The
50 members of the Organisation of Petroleum Exporting Coun-
tries (OPEC) now also have a better capacity situation than in
25
2008, when reserve capacity was very tight, making it difficult
11 to resist high price pressures.
Prices of food and other agricultural products are gener-
ally expected to decline in the second half of 2011. One key
factor is that the unusually long La Niña cycle will probably
end by summer. In the short term, however, we expect forces
that will keep prices of some agricultural commodities high.
Russia and Ukraine, two major grain producers, continue
to impose export quotas. And in the US, for example, maize
(corn) reserves are at record-low levels, while ethanol prices
are high.
Nordic Outlook – May 2011  |  7
 International overview
Gradual recovery in the Baltics
The three Baltic countries are continuing their gradual eco-
nomic recovery. Exports will remain a major driving force this
year, while domestic demand is slowly recuperating from the
crisis. In the next couple of years, annual growth will be 4-5
per cent, led by Estonia with 5 per cent in 2011. Our Latvian
forecast has been adjusted slightly downward.
Inflation impulses have mainly been external, and another
severe upturn in inflation similar to the 2005-2007 overheating
is not likely. Easing commodity prices and slow pay increases,
combined with continued private debt reduction, point towards
decelerating inflation this year. Overall, the economic imbal-
ances in the Baltics have greatly diminished, but major struc-
tural problems in the labour market as well as budget deficits in
Latvia and Lithuania pose continued challenges.
Inflation will fall
How the world economy reacts to rising commodity prices will
depend on a number of factors. Our main forecast is that the
impact of commodity prices will not lead to such large
secondary effects in the form of a broader wage-price spiral.
This is based primarily on two arguments:
ƒƒ The correlation between commodity prices and core
inflation has weakened significantly in the past decade.
This is especially true of energy prices, where secondary
effects have been very small, while rising prices for agricul-
tural products have had a somewhat larger impact on core
inflation. The credibility of inflation targets seems to have
served as an effective means of avoiding the type of price
spirals that were caused by the 1970s oil price upturn in
particular.
Unit labour cost
Year-on-year percentage change
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Europe (OECD countries) US
Source: OECD
ƒƒ Generally speaking, capacity utilisation is still rather
low in the OECD countries. This is reflected in a low rate
of pay increases. Combined with a cyclical recovery in pro-
ductivity growth, this means that the increase in unit labour
costs is close to zero both in the US and Western Europe.
Meanwhile a number of factors are leading to greater uncer-
tainty about the inflation trend than previously. Rising inflation
expectations have once again reawakened a debate on whether
inflation may take off despite low resource utilisation. This issue
is also complicated by widening gaps in resource utilisation
between different parts of the world economy.
8   |  Nordic Outlook – May 2011
Divergent resource situations
Generally speaking, emerging market economies have been
less severely affected by the crisis, both in terms of employ-
ment and output. SEB’s weighted indices show that employ-
ment is now nearly 5 per cent higher than at the outbreak of
the financial crisis, while output is at a substantially higher
level.
Employment compared to previous peak
Index 100=Q1 2008
Bottom Q1 2011 Q4 2012 Pot.*
United States 94 95 98 102
Euro zone 98 99 101 103
Germany 100 102 104 104
United Kingdom 98 100 102 103
Sweden 98 101 103 103
Norway 99 101 103 103
EM economies 100 105 110 110
* SEB’s estimate of potential level in Q4 2012
Källa: SEB
In the OECD countries, output and employment have
shown different trends in different countries. Generally
speaking, countries with large financial imbalances such as
the United States and Spain have noted a downturn in labour-
intensive portions of the economy (for example, construction
and distributive trades). In countries mainly affected by the
crisis through the collapse of world trade, such as Germany and
Sweden, the impact on the labour market has been relatively
mild. In the two latter countries, employment is already at a
higher level than when the crisis began. In the US, however,
employment is 5 per cent below the level of early 2008.
GDP level compared to previous peak
Index 100=Q1 2008
Bottom Q1 2011 Q4 2012 Pot.*
United States 96 101 107 110
Euro zone 95 97 101 104
Germany 93 99 104 105
United Kingdom 94 96 100 103
Sweden 93 101 108 109
Norway (mainl. GDP)** 98 102 108 107
EM economies** 97 110 124 122
* SEB’s estimate of potential level in Q4 2012
**Index 100=Q3 2008
Källa: SEB
As for GDP, the picture is different. American GDP is above its
pre-crisis level, while euro zone GDP remains 3 per cent below
it. Not even Germany has recovered its loss. Thanks to record-
high growth, output is at new highs in Sweden, despite its
deep downturn. In the case of Norway, the mild recession is
the main reason why it has already surpassed its previous high.
The UK diverges from the general pattern; despite a profound
 International overview

financial crisis the country has maintained employment fairly However, the impact of oil price changes seems to be larger
well, while its output level remains low. in the OECD countries than in the EM countries. This is partly
because price regulation in EM countries softens the impact
At the end of our forecast period, we predict that all regions of world market price variations. In China, for example, heavy
in the above table will have reached pre-crisis output dependence on domestic coal-fired power helped reduce the
levels. The emerging market economies will be a full 24 per impact of oil price changes. Oil price sensitivity is normally
cent higher. Sweden will be 8 per cent higher. The UK will be on greater in the US than in Western Europe, but at present the
a par with its output level early in 2008, which also implies a contribution of oil prices to inflation amounts to just above 1
five-year period of economic stagnation. The euro zone upturn percentage point in both regions.
will also be very modest.
Food, contribution to CPI
Core CPI (ex food and energy) Year-on-year percentage change
Year-on-year percentage change 3,5 3,5
5.0 5.0 3,0 3,0
4.5 4.5
2,5 2,5
4.0 4.0
2,0 2,0
3.5 3.5
3.0 3.0 1,5 1,5
2.5 2.5 1,0 1,0
2.0 2.0
0,5 0,5
1.5 1.5
0,0 0,0
1.0 1.0
0.5 0.5 -0,5 -0,5

0.0 0.0 00 01 02 03 04 05 06 07 08 09 10 11
03 04 05 06 07 08 09 10 11
United States Sweden
Euro Zone Emerging Markets
United States Sweden Source: Reuters EcoWin
Euro zone Emerging markets
Source: Reuters EcoWin
Exchange rate trends also play a major role. Especially in the
Levels of output and employment at the end of our forecast pe- US and the UK, weak currencies have amplified upward infla-
riod can be compared to our estimate of potentially sustainable tion pressure. In the EM economies, currency appreciation
levels. In the US, we estimate that both the output gap and the provides some protection against rising inflation pressure, as in
employment gap will be relatively large at the end of 2012. In Sweden and Norway.
the euro zone as a whole, there will also be idle resources, while
Inflationary forces*
Germany, Norway and Sweden will be close to equilibrium.
GDP Unemp Energy Food Currency
Our conclusion is that the labour market situation is the
United States - - + = +
best indicator of resource utilisation and thus of underlying
inflation pressure. This implies that at present, inflation pres- Euro zone - - + + -
sure is significantly lower in the US than in Western Eu- Germany = = + + -
rope, especially Germany, Norway and Sweden. In the next cou- United Kingdom - = + + +
ple of years, US growth is likely to be more job-intensive than in
Germany, for example, where productivity growth will recover Sweden = = + + -
to some extent. Generally, however, we are assuming that lost Norway = = + + -
productivity in countries with great labour market resilience will EM countries + + = + -
only be regained to a small extent.
* Refers to a qualitative classification of the relatively importance of these
factors at present.
Varying sensitivity to commodity prices Source: SEB
The inflation process is also affected by factors other than the
resource situation. The relative weight of food prices in
consumer baskets, for example, varies rather sharply. Their CPI inflation
CPI, year-on-year percentage change
share is naturally higher in developing countries with relatively
6 6
low GDP per capita. In China it is around 30 per cent, and in Forecast
5 5
Russia a full 40 per cent. In Western Europe, food accounts for SEB

4 4
around 15 per cent of the basket (excluding alcoholic beverages
and tobacco products), while in the US it is as low as 9 per cent. 3 3

In the EM countries, food prices contribute about 2.5 percent- 2 2

age points to inflation, while in the US and Western Europe they 1 1

only account for 0.2-0.3 per cent. When food prices peaked 0 0

in 2008 these contributions were larger, especially in Western -1 -1

Europe where food accounted for 1.0 percentage point. -2 -2
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Euro zone US
Source: Eurostat, BLS, SEB

Nordic Outlook – May 2011  |  9

 International overview

Altogether, our analysis shows that the strength of inflationary
factors varies between different regions. Assuming that com-
modity prices level off and eventually fall, our main conclusion
is that underlying inflation pressure is not strong enough to
keep CPI inflation at today’s levels. We thus expect clearly
lower inflation by early 2012.
Tighter fiscal policies in 2012
Public sector debt in the OECD countries is continuing to in-
crease. Next year, average gross debt will exceed 100 per
cent of GDP for the first time since the Second World War.
Funding needs will be record-sized. According to the Interna-
tional Monetary Fund (IMF), the average consolidation needed
in order to bring down debt to 60 per cent of GDP by 2030 will
be about 8 per cent of GDP. This is not counting the increased
costs of an ageing population.
Exit policy moving ever closer
Monetary policy makers now face challenges when it comes to
managing various risk factors. Rising energy prices are push-
ing up the inflation rate, while draining away strength from the
recovery − a classic dilemma for central banks. In such a situa-
tion, it becomes especially important to track inflation expec-
tations. Central banks can normally count on direct inflation-
ary effects from rising commodity prices to fade. The main risk
is instead that price increases are passed on, turning into a
broader price and wage spiral. This is particularly important in
a situation where resource utilisation is beginning to approach
normal levels.
Money supply
Year-on-year percentage change
15.0 15.0
12.5 12.5

The direction of fiscal policy varies greatly from one country 10.0 10.0
to another. The size of the austerity measures that have been 7.5 7.5
undertaken or planned is largely related to pressure from fi-
5.0 5.0
nancial markets. Crisis-plagued countries in the euro zone
2.5 2.5
are implementing austerity programmes equivalent to 5-10
per cent of GDP. In the UK, the dose of austerity is also in this 0.0 0.0

range. In the US, a policy shift will occur between 2011 and -2.5 -2.5
2012. In contrast to this year’s stimulus, fiscal tightening in 90 92 94 96 98 00 02 04 06 08 10

2012 will be sharper than expected. In 2012, the federal deficit US, M2 Euro zone, M3
is expected to shrink by 2.5 per cent of GDP, half of it due to Source: Federal Reserve, ECB

fiscal tightening. In Japan, a stimulus package equivalent to 0.8
percent of GDP has been announced to support reconstruction.
New packages can be expected, however.
Net lending
Per cent of GDP
2010 2011 2012 Debt*
United States** -8.8 -9.9 -7.4 101.5
Japan -9.5 -10.5 -9.8 235.0
United Kingdom -9.7 -8.0 -6.5 95.0
Euro zone -6.2 -4.5 -3.5 93.5
OECD -7.5 -6.0 -4.6 102.8
* Gross debt in 2012 ** Federal deficit
Source: European Commission, OECD, SEB
Monetary variables are also becoming important indica-
tors in a situation where a faulty transmission mechanism in
the financial system has served as a reason to keep key interest
rates exceptionally low. Despite earlier enormous loosening
of monetary policy, money supply and credit aggregates are
generally showing continued low growth figures. However, they
will increase when the “credit multiplier” normalises as a con-
sequence of a better economic outlook and stronger banking
systems. In Europe, the focus is on secondary effects via wage
formation, while financial transmission issues are more central
in the American debate.
Key interest rates
Per cent
7 7
6 SEB 6
forecast
5 5
4 4

Public sector finances in the Nordic countries are compara- 3 3

tively strong. Budget surpluses in Sweden and Norway will 2 2

contribute to expansionary fiscal policies in the next couple of
1 1
years. In Finland and especially Denmark, the situation is worse.
0 0
Some tightening has occurred; in Denmark it will continue, 00 02 04 06 08 10 12
while Finnish fiscal policy will largely be neutral.
Euro zone US
Source: ECB, Fed, SEB
On the whole, fiscal policies in the OECD countries will have
a tightening effect equivalent to 0.25 per cent of GDP Looking ahead, coordination of interest rate policy and non-
and 1.5 per cent next year, a somewhat larger shift than in conventional monetary policy will be important. Our view of the
our earlier estimate. Most countries will gradually reduce their Fed’s exit strategy looks as follows: bond purchases will be
budget deficits, but the US and Japan will reach their high- carried out according to the original plan and will be completed
est levels this year. It is worth noting that budget deficits are in June. During the autumn, the Fed will abstain from reinvest-
significantly lower in the euro zone than in other major OECD ing maturing loans and interest payments, which will signify
regions. a de facto cautious tightening. We believe that this will be

10   |  Nordic Outlook – May 2011

 International overview

possible without any major consequences for the interest rate
and liquidity situation. Interest rate hikes will then begin
in January 2012, and by the end of 2012 the federal funds
rate will stand at 2 per cent.
Key interest rates
Per cent
7 7
6 6
SEB
forecast
5 5
4 4
3 3
Although a number of Asian countries raised their key interest
rates at an early stage, key rates are still below pre-crisis levels.
Inflation is expected to peak in the second half of 2011, thanks
to an easing of food and commodity prices, but the need for
tightening remains because growth is running at or above
trend. In practice, these key interest rate hikes are merely a nor-
malisation of excessively loose monetary policies. Real interest
rates are low or even negative in most EM economies. Key rate
hikes will be supplemented by other measures, such as regula-
tion of capital inflows aimed at combating bubble tendencies in
asset markets.

2 2
Moderate upturn in bond yields
In recent months, global government bond yields have fallen,
1 1
after their rapid upturn last winter. US 10-year yields have
0 0 retreated from a peak of 3.74 per cent in February to 3.20 per
00 02 04 06 08 10 12
cent. The downturn in German long-term yields has been less
Euro zone Norway Sweden
Source: ECB, Norges Bank, Riksbank, SEB conspicuous. The German-US yield spread has practically been
wiped out, due to both disappointing American growth signals
The ECB based its decision to begin key interest rate hikes in
and gentler signals from the Fed compared to the ECB.
April on a combination of relatively bright growth prospects
and high actual inflation, as measured by the Harmonised In- Long-term yields are now slowly rebounding, among other
dex of Consumer Prices (HICP). We expect two more ECB hikes things because the date when the Fed will start phasing out
this year, bringing the refi rate to 1.75 per cent in December quantitative easing (“QE2”) is approaching. The American yield
2011. As resource utilisation rises, we then expect the ECB to curve will mainly be characterised by flattening, which will
continue with quarterly rate hikes to 2.75 per cent at the end of include clear upturns for 2-year yields. Looking a bit further
2012. Resource utilisation is approaching normal levels in ahead, bond yields will continue to move upward as central
a number of euro zone countries, while core inflation is creep- bank rate hikes proceed. Continued large government budget
ing upward at a slow pace. Core inflation of 1.5-2 per cent that deficits and the recapitalisation needs of the banking sector
also has an upward trend may be perceived as problematic. will help push up real interest rate to some extent, especially
in a situation of rising resource utilisation.
The ECB’s rate hikes will soften the dilemma facing the Nordic
central banks: their widening key interest rate spreads against The upturn in long-term yields will be modest, however,
other countries. Due to increasingly strained resource utilisa- among other things because inflation expectations will remain
tion in Sweden, we believe that the Riksbank will raise its rather stable. The upturn in inflation expectations that can be
repo rate at a somewhat faster pace than it has announced. inferred so far from index-linked bonds has been moderate and
We are still expecting rate hikes at every monetary policy meet- has mainly been a normalisation from depressed crisis levels.
ing during 2011, which means that the repo rate will be 2.75 We see little risk of a sizeable upturn in inflation expectations,
per cent at year-end. During 2012, the Riksbank will continue in an environment where actual inflation is falling and where
raising its key rate to 3.75 per cent. After holding off for a year, central bank rate hikes are helping to strengthen the credibility
Norges Bank resumed hiking in May. We expect Norges Bank of inflation-fighting. To summarise, we believe the yield on
to press ahead with hikes at the pace it has announced, which American 10-year Treasury bonds will stand at 3.65 per cent in
means that the level will reach 4.0 per cent by the end of December 2011 and at 4.30 per cent at the end of next year. Its
2011. German equivalent will gradually climb to a yield of 3.50 per
cent at year-end and stand at 4.00 per cent in December 2012.
Key interest rates lower than before the crisis
Per cent 10-year government bonds
13 13 Per cent
12 12
7.0 7.0
11 11
10 10 6.5 6.5
9 9 6.0 6.0
SEB
8 8
5.5 forecast 5.5
7 7
6 6 5.0 5.0
5 5 4.5 4.5
4 4 4.0 4.0
3 3
2 2 3.5 3.5
1 1 3.0 3.0
06 07 08 09 10 11 2.5 2.5
2.0 2.0
China Indonesia Thailand
India South Korea Malaysia 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: Central banks
US Germany
Source: Reuters EcoWin, SEB

Nordic Outlook – May 2011  |  11

 International overview
In recent months, Swedish 10-year government bond yields
have been trading very close to German levels, after previously
having been 15-20 per cent higher. Certain doubts about the
Riksbank’s continued rate hiking speed and signals of even
stronger Swedish government finances have contributed to
this. Looking ahead, we believe that expectations of Riksbank
rate hikes will lead to a faster upturn in Swedish long-term
yields. The spread against Germany will widen to 15 basis
points by the end of this year and to 25 points in December
2012; this is, however, a significant downward adjustment in
the spread compared to Nordic Outlook in February. In terms of
levels, the Swedish 10-year government bond will thus rise from
today’s 3.10 per cent to 4.25 per cent at the end of 2012.
Interest by foreign investors has pushed down Norway’s sov-
ereign long-term yield spread against Germany to a histori-
cally low level of below 50 basis points. Given our forecast of
Norges Bank, this assigns a high valuation to stable macro
conditions in Norway. Assuming a cautiously widening key
interest rate spread against the ECB, we believe there will be a
gradual normalisation of the 10-year yield spread against
Germany. We expect a 4.10 per cent yield on 10-year Norwegian
government debt at the end of 2011 and 4.65 per cent at the
end of 2012, i.e. a 65 point spread against Germany at the end
of our forecast period.
Stock markets facing resistance
Early in 2011, stock markets were pushed downward by de-
creasing risk appetite, among other things as a consequence of
unrest in North Africa and the Middle East. This downturn was
clearest in emerging market countries, where the stock markets
fell noticeably in some cases. Recently the correlation between
the world’s stock markets has again become stronger. In most
emerging economies, markets have regained the ground they
lost early in the year. US stock exchanges have picked up new
momentum in the past two months and have performed sig-
nificantly better than euro zone exchanges so far during 2011.
In Japan, the stock market has gained back around two thirds
of its large decline in the days following the March 11 natural
disaster.
International stock markets
Index 100 = July 2007
130
120
110
100
90
80
70
60
50
40
Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct Feb
07 08 09 10
US Emerging markets
Euro zone Sweden
Source: Reuters EcoWin, SEB
The factors that are now creating general uncertainty in the
world economy, for example the risks associated with euro
zone sovereign debt problems and the impact on oil prices of
the crisis in North Africa and the Middle East, will continue to
plague stock exchanges in the next six months. Underlying fac-
12   |  Nordic Outlook – May 2011
tors such as continued good corporate profits, strong balance
sheets and reasonable valuations nevertheless point towards
continued prospects of a global stock market upturn. A
commodity-driven downturn in inflation would also benefit
most stock exchanges. American companies, in particular, have
good prospects of achieving volume-driven earnings improve-
ments in the next couple of years. Monetary policy tightening
is a challenge, but we believe that the end of the Fed’s QE2 can
be implemented without any major impact on stock markets.
Historical experience also indicates that stock market upturns
can continue even after the Fed has begun its interest rate
hiking cycle.
Nordic stock markets have moved sideways so far this year
and are now close to their levels at the beginning of 2011. Given
the business structure of the region, the Nordic countries are
well positioned to respond to global demand. Currency appre-
ciation in Sweden and Norway will dampen earnings growth,
but first quarter company reports showed unexpectedly strong
skills in managing this challenge. In both Sweden and the other
Nordic countries, stock market valuations have reached a level
equivalent to their average during the past decade. Normal
valuations and continued currency appreciation will make it
difficult for Nordic stock markets to outperform their counter-
parts elsewhere over the next couple of years.
Global imbalances driving currencies
The imbalances in global trade flows eased somewhat during
the deep recession. For example, the American current account
deficit fell from 6 to 2½ per cent of GDP between 2006 and
2009. The underlying problems nevertheless remain, and the
US deficit is again on its way upward. China’s foreign exchange
reserve is continuing its explosive growth.
Global savings deficit/surplus
Per cent of total (2010)
Deficit Surplus
United States 40.3 China 20.0
Spain 6.2 Germany 15.0
Italy 5.0 Japan 12.3
130 Brazil 4.5 Russia 5.2
120
United Kingdom 4.4 Norway 5.1
110
100 France 4.0 Switzerland 3.7
90 Canada 3.8 Singapore 3.3
80
India 3.8 Netherlands 3.3
70
60 Turkey 3.3 Taiwan 3.2
50 Greece 2.9 Kuwait 2.6
40
Others 21.8 Others 26.3
11
Source: SEB
Structural reforms will occur slowly. The work of the G20 seems
to have lost momentum and to lack clear leadership. China’s
ambitions to transition to a more domestically driven growth
strategy are clear, but the process will take time. The country’s
determination to make political decisions will also be ham-
pered by the coming change of leadership. In the US, a greater
 International overview

desire to tackle public sector deficits is also a step in the right NOK exchange rate to remain relatively unchanged in the
direction, but the country is playing a high-stakes game with short term, but once the USD begins to regain ground, we see
its international credibility, since various types of structural potential for further NOK appreciation against the euro. We
reforms are occurring so slowly. expect the EUR/NOK exchange rate to stand at 7.70 by the
end of 2011 and 7.60 by the end of 2012: relatively close to
Trade imbalances and different cyclical situations will our estimate of its equilibrium exchange rate, which is 7.40.
continue to drive the foreign exchange market. Interest
rate hikes will contribute to a continued general appreciation in
EM currencies. Despite historically high valuations, continued
large current account surpluses in many EM countries point
towards further potential. To a greater extent than before, these
countries also seem to regard currency appreciation as a means
of combating inflation. So far this year, China has increased
the value of its currency by about 1½ per cent against the
USD, but the pace has accelerated in recent weeks. We expect
this trend to strengthen, and we foresee a USD/CNY exchange
rate of 6.20 at the end of 2011 and 5.85 at the end of 2012. This
implies an overall revaluation of nearly 17 per cent compared
to the summer of 2010. Recently, a coordinated revaluation of
leading EM currencies against the USD and other OECD curren-
cies has also come up on the agenda.

The US dollar will again weaken against most OECD currencies

in the near future. The Fed is lagging behind in its interest rate
hiking cycle. The USD is also weighed down by budget and cur-
rent account deficits. We thus expect the EUR/USD exchange
rate to climb to 1.48 by the end of June. As quantitative eas-
ing ends and the Fed’s rate hikes approach, we expect the USD
to begin regaining ground and moving towards more funda-
mentally justified levels. The European debt crisis will also con-
tribute to a decline in the EUR/USD rate to 1.35 towards the
end of 2012. We also expect the USD to appreciate against the
yen. An increased interest rate spread and further enlargement
of the Japanese budget deficit as a consequence of reconstruc-
tion efforts will cause the USD/JPY exchange rate to move up to
88 at the end of 2011 and to 94 at the end of 2012.

Since the second quarter of 2009, the Swedish krona has ap-
preciated by more than 15 per cent in trade-weighted terms.
Our assessment is that there is potential for further krona
appreciation over the next couple of years. Swedish economic
growth will be faster than in the euro zone, and key interest rate
gaps against the ECB and the Fed will widen over the coming
year. Sweden’s strong government finances will also continue to
attract investors, among them other central banks. Our forecast
is that the krona will strengthen to SEK 8.70 per euro by the
end of 2011 and further to SEK 8.50 by late 2012. This forecast
is supported by our estimate of the EUR/SEK equilibrium ex-
change rate, which is 8.30. We expect a USD/SEK exchange rate
of 6.21 by late 2011, moving to 6.30 as the USD regains ground
during 2012.

The NOK has recently benefited from high oil prices and a
positive flow situation. Looking ahead, the Norwegian central
bank’s foreign exchange purchases will worsen the flow situ-
ation and keep the krone exchange rate down. On the other
hand, the krone will be pushed upward by the bank’s relatively
vigorous key interest rate hikes. Altogether, we expect the EUR/

Nordic Outlook – May 2011  |  13

Theme

The path to European debt restructuring

ƒƒ Current bail-outs for Greece, Ireland and ESM) and the IMF. While yield spreads against Germany indi-
Portugal are not enough − more is needed cate that the financial market has greater confidence in Spain
− with spreads narrowing slightly − actual Spanish yields have
ƒƒ Debts in some of these countries are too big
– restructurings in 2012 at the earliest risen a bit along with German ones.
Wide yield spreads against Germany
ƒƒ Greece will be the first in 2012 − 50 per cent Percentage points

12 12
A Greek debt renegotiation is inevitable, as we see it. Our con- 10 10
clusion is that Greek internal and external debt has become too
8 8
much of a burden. In addition, the proceeds of the country’s
6 6
EUR 110 billion EU/IMF loan package will run out next year, one
year earlier than anticipated. 4 4

2 2

Greece 0 0
Jan Mar May Jul Sep Nov Jan Mar May
Per cent of GDP 10 11
2010 2011 2012 2016 Greece Italy Spain
Ireland Portugal
Budget balance -10.5 -7.6 -6.1 -2.1 Source: Reuters Ecowin

General gov’t gross At the political level, there are still hopes that already approved
debt 143 148 152 144 and any additional measures, plus the economic recovery, will
Current account -10.4 -8.2 -7.1 -3.8 gradually solve the problems of these indebted countries, but
we believe the challenges are too big. Our scenario is manage-
External position -98.2 -106.4 -113.5 -133.8
able for the euro zone within the framework of the existing
Source: IMF, SEB
crisis mechanism and further fiscal tightening, but it implies
Greece does not have − and by then is not expected to have − continued strains to economic, financial and political systems −
access to the capital market at sustainable interest rates, Given and large risk premiums and volatility for financial markets.
that Greece has already used about half its bail-out, borrowing
In Greece, restructuring can take different forms and would
requirements this year and next, including current deficits,
also need to include recapitalisation of banks:
exceed the remaining funds. All alternatives outlined below will
require new money to cover both current deficits and maturing ƒƒ Hard restructuring. Greece’s sovereign debt of about
loans. EUR 350 billion would be swapped for new government
Maturing debt bonds, with interest and principal payments that may be
EUR bn collectively guaranteed in some way by other euro zone
45 45 countries. Unlike its euro zone-supported debt package,
40 40
Greece’s debt to the IMF would be prioritised and not
35 35
written down. Nor do we believe that its debt to the euro
30 30
zone countries would be written down. This would be too
25 25
politically sensitive, especially assuming Greece will need
20 20
new loans and an expanded borrowing limit, since after
15 15
a writedown of loans it would still have a primary budget
10 10
deficit.
5 5
0 0
Q2 Q3 Q4 Q1 Q2 Q3 Q4 The swap would include a 50 per cent haircut on private
11 12
Greece Portugal Spain debts, i.e. to somewhat below current market value, which
Source: Bloomberg, SEB is 60 per cent of face value. Total debt, today about 150 per
We believe it is very likely that Ireland and Portugal will also be cent of GDP − of which nearly 50 per cent of GDP is owed
forced into some form of debt renegotiation − though softer to the IMF/euro zone − would thus fall to just above 100 per
− during 2012-2013. There is also a high probability that Spain cent of GDP. Planned privatisations totalling about EUR 50
will seek a bail-out from the EU’s crisis mechanism (the EFSF/ billion would probably lower the debt further to just above
80 per cent of GDP. The new government bonds would

14   |  Nordic Outlook – Maj 2010


bear a strong resemblance to the “Brady bonds” that once
helped Latin American countries out of their debt crises.
ƒƒ Semi-hard restructuring. Greece would receive an
expanded borrowing limit from the IMF/EFSF/ESM to buy
up outstanding government debt, including debt already
bought by the ECB, at market prices. Secondary market
prices might rise as a result of this but it will provide some
debt relief (how much is uncertain, though). A harder
version of this restructuring variant, to avoid rising market
values and also gain access to bonds held by institutions
that recognise them at face value, is to “force” these bond
holders to sell by demonstrating that the alternative is a
unilateral restructuring. Another possibility is to change
EFSF/ESM rules to permit bond purchases in secondary
markets (not only the primary market as now proposed),
with the EFSF/ESM instead carrying out market purchases
that Greece, with its expanded borrowing limit, then buys
back or pays off.
ƒƒ Soft restructuring. Greek sovereign debt would avoid a
formal write-down (nominal debt unchanged), but yields
and maturity dates would be adjusted.
Our main scenario is that Greece will undergo a hard restructur-
ing. In our assessment, this solution is supported by Germany
and the IMF, but France and the ECB are strongly opposed. One
reason is probably that they believe that the European econom-
ic and financial system does not have a strong enough immune
system to deal with losses in the balance sheets of banks and
pension companies. Another reason is fear of contagion, which
might worsen the situation of Ireland and Portugal but also trig-
ger a deterioration of Spain’s problems and force Spain to seek
a bail-out. As long as Greece receives continued international
support there will be no acute liquidity crises that pushes for
default. Instead, a restructuring of Greek debt will be coordinat-
ed between Greece, ECB and euro zone/IMF where conditions
for private lenders will be set. Continued and increased lending
facilities to manage financing the following years will also be
part of such a package.
There are a number of reasons why a restructuring will hap-
pen during 2012, not this year.
First: International lenders need to know more about the
health of the European banking system. The EU’s banking
stress tests, whose results will be published in June, will be
tougher than the 2010 tests. They will provide important in-
formation for assessing the potential secondary effects on the
financial system of a Greek restructuring. But potential losses
in the “strategic portfolios” of banks − aside from their trading
portfolios, which are recognised at market value − will not be
evaluated this year either based on sovereign debt restructur-
ings. Strategic portfolio holdings will, however, be recognised
at nominal value and allocated by country. An OECD study
published in August 2010 showed that only 17 per cent of the
banks’ sovereign risk was found in their market value-based
trading portfolios, which created/creates uncertainty about the
size of new unrealised losses in the system.
Second: Once Greece undergoes a debt restructuring, addi-
tional loans from the euro zone/IMF will be required in order to
finance current deficits (debt maturities would be renegotiat-
Theme
ed). Waiting for at least a year would give Greece more time to
reduce its deficit. A debt restructuring would still require Greece
to carry out further belt-tightening and far-reaching structural
reforms. This is because they are needed (sovereign debt of
80 per cent of GDP is still high) and because it would dissuade
other countries from following the same path.
Sovereign debt securities held by EMU banks
EUR bn
550 550
500 Ger 500
450 450
400 400
350 Ita 350
300
Spa
300
250 250
Fra
200 200
150 150
Gre
Bel
100 Ned 100
50
ECE Por
Ire 50
Svn Fin Lux Svk Mal Cyp
0 0
Trading portfolio Strategic portfolio
Source: OECD
Third: Because a Greek restructuring would have consequenc-
es for the banking systems of other countries and undermine
market confidence in other crisis-hit countries, the internation-
al community would like to put in place expanded resources for
the EFSF/ESM. This would give it the financial muscle required
to provide further help to Greece, Ireland and Portugal as
needed, but would also enable it to help Spain.
There are good reasons for caution. Further time is needed to
gather information about exposures and risks and give the euro
zone and the world economy a chance to build up their immune
systems. Otherwise there is a major risk that fear of losses by
banks may trigger withdrawal of liquidity/credit lines in the
banking system, creating something resembling the effects of
the Lehman Brothers collapse of September 2008.
At the political level, there is a continued lack of consensus,
and opposition to bailing out countries in crisis has grown
stronger and stronger in a number of countries. Greece, and in
time probably Ireland as well, will need more money and longer
time limits than provided by the existing packages. To ensure
sufficiently strong confidence in Europe’s financial rescue
mechanisms, political consensus will be needed.
In Germany, Chancellor Angela Merkel’s CDU party is grappling
with growing opposition to the rescue operations now being
carried out − and those that will be needed. Her position is
strengthened by a splintered opposition. But in other countries
too − including Finland, France, Italy, Austria and the Nether-
lands − political headwinds are fuelling populism, creating a
gap between voters and their representatives. Merkel’s coali-
tion has lost several German state elections so far during 2011.
Another key election on September 18 may deprive her of a
majority in the Federal Council (upper house), make it difficult
to govern and precipitate a federal election earlier than the one
scheduled for 2013. Our assessment is that a borrowing limit
of EUR 500 billion plus IMF resources will be sufficient to pro-
vide expanded aid to Greece, Ireland and Portugal as needed,
among other things to recapitalise banks harmed by write-
downs when Greece’s sovereign debt is restructured, as well as
to bail out Spain if that country needs such help.
Nordic Outlook – May 2011  |  15
The United States

High energy prices leading to slower growth

ƒƒ Temporarily weaker GDP growth in 2011 cal recoveries in the past 60 years. Weak service consumption,
which accounts for 66 per cent of total consumption, explains
ƒƒ Labour market continuing to strengthen the disappointment. Historically, real service consumption has
ƒƒ High inflation giving the Fed a headache risen by more than 4 per cent on average seven quarters into
the recovery. Since mid-2009 the upturn has been a modest
ƒƒ Fiscal tightening apparently on the way 1.6 per cent. Durable and non-durable goods consumption has
risen roughly in line with the historical pattern.
The US economic growth outlook in 2011 has dimmed appreci- Rising food and energy prices offset tax cuts
USD billions
ably in recent months. GDP growth fell below 2 per cent in the
-12 12
first quarter − unexpectedly low considering the optimism in -11
the Federal Reserve’s Beige Book and the strength of business- -10 10
-9
related indicators. Growth was held back by cold winter weath- -8 8
er and lower public sector consumption (defence spending), -7
-6 6
while surging food and petrol prices undermined household -5
-4
purchasing power. High energy price inflation will hamper -3
4

growth over the next few quarters as well, which is one reason -2 2
-1
why we have adjusted our GDP forecast for 2011 downward 0 0
from 3.6 to 2.8 percent. January February March April May
11
Cumulative effect of rising food and energy prices
Due to strong balance sheets and large capital spending needs Tax cut late in 2010
in the corporate sector, combined with continued improve- Source: SEB

ment in the labour market, we nevertheless believe that this
deceleration is temporary. In 2012 we expect GDP to grow by
3.8 per cent, well above the consensus estimate. Fiscal policy
appears likely to be tighter than previously assumed, but we
believe that positive effects in the form of greater confidence in
government budget sustainability will offset this.
Unemployment will continue falling and will stand at 7.5 per
cent by the end of our forecast period. The number of jobs will
increase by an average of 180,000 per month this year (and
slightly more in 2012). Rising inflation is the main reason why
the Fed will begin monetary policy normalisation, hiking its
key interest rate at the beginning of 2012; this is earlier both
compared to our February forecast and current market pricing.
Looking ahead, the labour market will contribute to stronger
income growth. Consumption will rebound. Altogether, con-
sumption will climb 3 per cent this year and in 2012: nearly
one percentage point below the 1994-2007 average and a bit
below our February forecast. Real disposable income will in-
crease at a somewhat faster pace, and the household savings
ratio will continue climbing to 6.5 per cent by the end of our
forecast period. High unemployment, tough credit conditions
and a persistent decline in home prices will contribute to the
upturn in the savings ratio.
Corporate profits and investments
2-year percentage change
30 30
20 20

Temporary slowdown in consumption 10 10

The stimulus measures enacted late in 2010, mainly in the form
0 0
of tax cuts, gave households USD 8 billion more in their wallets.
-10 -10
Yet consumption growth has decelerated and our short-term
forecast models, which include oil prices, point towards a -20 -20
continued slowdown. Counting from January 1, the cumula- -30 -30
tive effect of rising food and energy prices is larger than the 50 55 60 65 70 75 80 85 90 95 00 05 10
stimulative effect of federal tax cuts. This headwind is appar- Corporate profits
ent in household confidence indicators: both the University of Investment in equipment and software
Source: BEA, SEB
Michigan and Conference Board indices plunged in March but
regained some ground in April. They remain far above their
2009 lows. Corporate capital spending a key driving
force
Since the economic recovery began in 2009, consumption has Continued solid capital spending is an important cornerstone
grown by 4 per cent, or less than half the average during cycli- of our rather optimistic growth picture. The indicators have a

16   |  Nordic Outlook – May 2011


positive tilt, but with the ISM purchasing managers’ index in the
service sector having lost ground in April, the outlook is some-
what more uncertain. Yet strong corporate earnings growth
− profits are climbing at nearly 20 per cent year-on-year
− will probably result in a continued upswing in machinery and
software investments. During the first quarter, such spending
was nearly 15 per cent higher than a year earlier. Robust order
figures also indicate that a continued capital spending upturn is
likely, though at a slower pace than in recent quarters. Capacity
utilisation has climbed rapidly since it bottomed out in 2009,
but it has a way to go before reaching historical averages.
Private sector balance
Per cent of GDP
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
-7.5
60 65 70 75 80 85 90 95 00 05 10 15
Normal adjustment Average (1960-95)
NO scenario
Source: SEB
There are strong arguments for predicting that the investment
upturn will continue in 2012. Shifts in private sector financial
saving normally provide reliable signals about capital spending
and consumption. According to our forecasts, the downward
adjustment in financial saving will continue over the next cou-
ple of years. Continued debt retirement in the household sector
(though at a slower pace) indicates that this adjustment will
mainly occur in the corporate sector. Despite the capital spend-
ing upturn to date, fixed investment represents a historically
low percentage of GDP, which means there is significant upside
potential. Corporate capital spending will grow by nearly
10 per cent this year and 15 per cent in 2012. Last year it
grew by 5.7 per cent.
Rising oil prices will slow GDP growth
Today the United States and other OECD countries are not
as vulnerable to oil price shocks as 20-30 years ago. One rule
of thumb in the US is that a permanent upturn of USD 10
per barrel in oil prices will slow down GDP growth by 0.2
per cent annually for two years. Given our forecast that oil
prices will decline, we estimate that their negative impact on
GDP will be only 0.3 percentage points this year.
Meanwhile the risk of a more dramatic oil-driven deceleration
cannot be ruled out. Real oil prices (measured as the ratio
between Brent crude and core CPI) are higher today than in
both November 1979 and October 2007. These two peaks
were followed by an immediate cyclical downturn, according
to the NBER’s dating.
The difference between demand- and supply-driven oil price
upturns is another aspect, with supply-driven disruptions
damaging economies more. This time around the price in-
The United States
Renewed home price downturn
Home prices are again trending downward, after a slight upturn
last year. All price measures are approaching or already below
their 2009 lows. The S&P/Case-Shiller index has fallen for eight
months in a row. The downturn from July 2010 to February 2011
has been equivalent to a 12 per cent stock market decline.
Because of the price drop, it is cheaper to buy a home than
to rent one, an indication that home prices are close to bot-
toming out. But both psychological and economic factors point
towards further price declines. Expectations of future prices
play a role in buying decisions. These expectations are, in turn,
determined mainly by how the market looks today (adaptive
10.0 expectations). Many potential home buyers are also having
7.5 trouble qualifying for loans and instead choose to rent. Ac-
5.0
cording to our forecasts, home prices will fall by 5 per cent
this year. The risks are on the downside, among other things
2.5
because real home prices are still about 20 per cent above their
0.0
long-term historical average.
-2.5
-5.0 Meanwhile the wave of foreclosure sales rolls on, increasing the
-7.5
supply of vacant homes and pushing down prices. Several mil-
lion foreclosure sales may take place over the next three years;
one consequence is robust demand for long-term rental
flats. The number of single-family homeowners has declined
by 1.2 million since 2007, while the number of renters has in-
creased by 3.4 million. The outlook for construction companies
in the market for blocks of flats, in which long-term rentals are
the most common form of housing, thus looks fairly bright.
After years of decline, housing investments will grow by 1
per cent this year and 14 per cent in 2012.
The US dollar is undervalued
During the spring, several currencies (the Japanese yen, the
Chinese yuan and the Australian dollar) noted record-high
exchange rates against the US dollar. In real trade-weighted
terms, the USD is weaker than ever. Relative to its long-term
average value, the dollar is undervalued by about 10-15
per cent in trade-weighted terms. This indicates that the
currency will eventually rebound. But valuation measures are
crease is largely supply-driven, reflecting the risk premium for
developments in the Middle East. A simple estimate, in which
real oil prices are explained by such factors as global GDP
growth, indicates that the “supply premium” is about USD
15 per barrel.
Real oil prices at a historically high level
Ratio of Brent to core CPI
70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0
75 80 85 90 95 00 05 10
Source: Reuters EcoWin, SEB
Nordic Outlook – May 2011  |  17
 The United States

poor indicators of turnaround dates, since movements and
divergences from equilibrium levels tend to extend over long
periods.
According to our forecast, the dollar will continue to weaken
for another while, bottoming out at USD 1.48 to the euro
in June 2010. Continued large current account deficits are an
indication that further weakening of the dollar may be needed
in order to rebalance the US economy. The budget deficit and
national debt also look somewhat more alarming than corre-
sponding figures in the euro zone. The difference in monetary
policy also points to a lower dollar in the short term; whereas
the Fed is still holding off on hiking key interest rates, most
other central banks have begun the normalisation process.
We believe that the scales will tip and the dollar will begin to
Labour market on the right track
So far during 2011, employment has increased by an average of
190,000 per month. The outlook for continued job expansion
looks good: 50 per cent of company executives plan to increase
their labour force over the next six months: the highest since
measurements began nine years ago. The fly in the ointment is
initial claims for unemployment benefits that reached 437,000
in May, up from 390,000 two months ago. Our overall assess-
ment remains that employment will increase by an average
of 180,000 jobs a month this year and 200,000 in 2012.
Weak jobs recovery
Percentage of job losses relative to previous peak
7.5 7.5
5.0 5.0

strengthen when the Fed signals that key rate hikes are in the 2.5 2.5
cards, and/or initiates a monetary tightening by letting its bal-
0.0 0.0
ance sheet shrink as loans and interest payments fall due.
-2.5 -2.5
The dollar is undervalued
The Fed's real trade-weighted index
-5.0 -5.0
130 130
125 125 -7.5 -7.5
120 120 0 5 10 15 20 25 30 35 40 45
1981 cycle 2001 cycle
115 115 1990 cycle Current cycle
Source: BLS, SEB
110 110
105 105 A combination of stronger employment growth and falling la-
100 100
bour market participation has contributed to a relatively sharp
95 95
decline in unemployment since last November. We predict that
90 90
unemployment will continue downward, though at a far slower
85 85
pace. At the end of our forecast period, the jobless rate will
80 80
75 80 85 90 95 00 05 10 be 7.5 per cent.
Source: Federal Reserve, SEB
Despite this improvement, the labour market is far from achiev-
ing equilibrium. So far, only 20 per cent of lost jobs have been
Exports chugging along regained. Today the number of people at work is the same as 11
A combination of a weak dollar and an upswing in world trade
years ago, even though the population has grown by 30 million
explain the unusually rapid growth in US exports so far dur-
since 2000. Assuming the current rate of increase, it will be
ing the recovery. Since mid-2009, exports have accounted for
another four years before we are back at the pre-crisis level.
nearly half of GDP growth. Exports stand at 13 per cent of GDP,
their highest level since 1929. The best-performing sectors The deep recession may have driven the equilibrium unemploy-
in the economy are export-oriented: manufacturing, agriculture ment level higher. According to the Beveridge curve − which il-
and commodities. But imports are also growing fast, and the lustrates the association between the percentage of job vacan-
contribution of foreign trade to growth will thus be neutral this cies and unemployment − labour market matching is working
year and negative in 2012. The US current account deficit, more poorly than a few years ago: the current vacancy level
which totalled 3.2 per cent of GDP in 2010, will creep up to- is compatible with a 7 per cent unemployment rate. One
wards 4 per cent by the end of our forecast period. explanation is that many households are stuck in homes that
Exports a key driver of economic growth are worth less than their mortgages, which reduces geographic
Percentage points, per cent mobility. However, we believe that the upturn in equilibrium
6 6
employment has been moderate and that it stands at
4 4 around 5.5 per cent (essentially the same estimate made by
2 2 the Fed).
0 0

-2 -2 Low resource utilisation in the labour market is generating

-4 -4 downward wage pressure. During the past six months, average
-6 -6
hourly wages have stagnated. Compared to one year ago, they
-8 -8
have increased by a low 2 per cent. Combined with rapidly ris-
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 ing consumer prices, this means that purchasing power is being
08 09 10 11
Contribution from exports
undermined.
GDP growth, annualised
GDP growth, year-on-year
Source: BEA, SEB

18   |  Nordic Outlook – May 2011


Rents driving core inflation higher
The upturn in energy and food prices is driving up consumer
prices: inflation will peak at 3.2 per cent this autumn, the high-
est level in three years. The upturn is not broad-based; prices
of product categories such as clothing, household appliances
and furniture are falling. For services, the upward price trend is
around one per cent. The fact that relative price changes, not
broad-based movements, have driven up inflation indicates
that the upturn will be temporary, in the same way as three
years ago. Measured in annual averages, prices will rise by 3
per cent this year and 2 per cent in 2012.
Inflation on the rise
Year-on-year percentage change
6 6
5 5
SEB
forecast
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
00 01 02 03 04 05 06 07 08 09 10 11 12
Inflation Owners equivalent rent
Core inflation
Source: BLS, SEB
Core inflation has nevertheless risen faster than previously
anticipated. This is partly because rents, a major item in the
price index, are rising at a slightly faster pace as more people
choose to rent homes. However, very rapid price increases on
such items as airline tickets indicate that the oil price upturn
has also contributed to inflation. Although unemployment has
fallen rapidly since November 2010, our assessment is that core
inflation will remain low: unemployment remains well above
equilibrium. According to our forecasts, core inflation will
increase by 1.3 per cent in 2011 and 1.4 per cent in 2012 −
roughly in line with the Fed’s latest forecasts. Core inflation is
thus just below the Fed’s “target” of 1.7-2 per cent for underly-
ing inflation, measured by using the consumption deflator.
Fiscal tightening is apparently on the way
In only the past two months, the tone of US fiscal policy debate
has shifted remarkably. The focus today is exclusively on how
much cutbacks should be made and what portions of the pub-
lic sector should be reformed. Several factors have contributed
to this shift: 1) increased awareness of the problems among
politicians and the general public, 2) the Republicans’ alterna-
tive budget, which addresses soaring health care costs and re-
duces expenditures by USD 6 trillion over 10 years, 3) President
Obama’s counterproposal, which would trim the deficit by USD
4 trillion over 12 years, 4) S&P’s warning that it was lowering its
outlook for US sovereign debt, which increases the pressure on
US politicians regardless of their political colour.
In the next few months the focus will be on the debt ceiling and
what the Republicans will demand in exchange for letting the
ceiling be raised. The limit will be reached in May, but extraor-
dinary measures would allow the Treasury to extend borrowing
authority until about August 2. The Republican budget proposal
is not realistic, however, since it implies scrapping Obama’s
The United States
healthcare reform. The path to an agreement will instead prob-
ably go via Obama’s recent initiative to appoint a budget task
force with representatives of both parties. Its assignment will
be to carve out proposals that will provide guidelines for sus-
tainable government finances − a 75-25 allocation between
spending cuts and tax increases − and new self-triggering
cutback mechanisms that will limit debt. If this bipartisan task
force fails, there is reason to worry about both US government
finances and the impact on interest rates. One rule of thumb is
that for every percentage point that the budget deficit exceeds
the long-term average, the yield on 10-year Treasury bonds
increases by 25 basis points.
The lessons of the mid-1990s, when the Republicans paid a
high price for trying to derail a budget agreement, improve the
prospects for a bipartisan consensus this time around. The
deficit will fall from USD 1.45 trillion this year to USD 1.13
trillion in 2012: a more dramatic tightening than previously
forecasted. About half the budget deficit is cyclical, in our es-
timate. The structural deficit is thus around 5 per cent of GDP,
well above the 1970-2007 average of 3 per cent.
A shaky credit rating
Standard & Poor’s recently lowered its outlook for the
US government’s credit rating. This means that the rating
agency estimates that the probability of a downgrading dur-
ing the next two years is 33 per cent. Since the US has enjoyed
the highest credit rating, as well as a stable outlook, since
such measurements began 70 years ago, S&P’s decision was
unique. But the economic consequences should not be exag-
gerated: the rule of thumb is that long-term yields rise about
10 basis points if a credit rating is lowered by one step.
In retrospect, a lowering of the US government’s credit out-
look has been on its way for a while; because of high budget
deficits in recent years, the national debt will probably exceed
100 per cent of GDP by 2012. A combination of large budget
deficits and high debt often lead to downgrading. In 1995
Canada’s credit rating was lowered when its gross public
sector debt totalled 102 per cent of GDP. In 1998 Japan’s
credit rating was downgraded; its gross debt at that time was
120 per cent of GDP. The outlook for the United Kingdom’s
credit rating looked dim a year ago, but after the new coali-
tion government approved sizeable austerity measures, the
government’s creditworthiness is again stable, according to
the rating agencies.
The inability of politicians so far to reach a budget agreement
that genuinely addresses the long-term problems facing the
US government was the main reason why S&P acted as it
did. We now expect budget policy for fiscal 2012 to move in a
sufficiently tightening direction to avoid a lowering of the US
credit rating.
Steps towards normalised monetary policy
The Fed has clearly explained what is required for it to shift
the direction of its conventional and unconventional monetary
policy: changes in the resource situation, actual price trends
and inflation expectations. Recent tendencies towards faster
price increases and somewhat higher inflation expectations
Nordic Outlook – May 2011  |  19
 The United States
mean that the risk of deflation can be written off. This has
opened the way towards differences of opinion on the central
bank’s Federal Open Market Committee (FOMC), which sets key
interest rates. Several members have urged a normalisation of
monetary policy, but heavyweights Ben Bernanke, Janet Yellen
and William Dudley see reasons not to rock the boat.
Divergent views on how an expansion of the monetary base will
affect the inflation process are probably behind the differences
of opinion on the FOMC. The monetary base has tripled from
USD 800 billion to USD 2.4 trillion. Theoretically, this expansion
could trigger a raging inflation, even though traditional meas-
ures (labour market gaps, capacity utilisation) show that there
are plenty of idle resources in the US economy. Members with
this fundamental view react sharply when inflation curves and
expectations point upward. If inflation expectations rise further,
their arguments will gain in strength and the probability of early
interest rate hikes will increase.
Inflation expectations
Per cent
4 4
3 3
2 2
1 1
0 0
-1
-2
-3
04 05 06 07 08 09 10
5y 5y forward BE inflation
5y BE inflation
5y according to University of Michigan
Source: Reuters EcoWin, SEB
The US will retain its leading role
The possible decline of the United States is an increasingly
frequent topic of discussion. The issue can be analysed on the
basis of various dimensions, but GDP, military expenditures
and demographics are useful parameters.
In the 2000-2009 decade, real GDP grew by 21 per cent while
the US share of Group of Twenty (G20) GDP fell from 38 to 30
per cent. China’s rapid growth explains much of this relative
decline: In 2000 the US economy was eight times large than
that of China; ten years later it was “only” three times larger.
American military expenditures increased by 55 per cent
during the decade. Today the US spends 17 times more on
defence than Russia and nine times more than China. Cor-
responding figures ten years ago were six (Russia) and seven
(China).
The number of Americans was 282 million in 200, or 4.6 per
cent of world population. By 2010, US population had in-
creased to nearly 310 million or 4.9 per cent of world popula-
tion. Compared to Europe, Russia and Japan, Americans have
become significantly more numerous, and the US population
20   |  Nordic Outlook – May 2011
But we expect the Fed to hold off until the recovery is on firmer
ground, with a clearer improvement in the labour market and
a more pronounced upturn in core inflation. The money supply
multiplier remains at a low level, and as long as the money ends
up in bank balance sheets, an expansion of the monetary base
will not lead to an inflationary credit expansion in the economy.
Quantitative easing has stimulated the economy via rising asset
prices, lower real interest rates and a weaker dollar rather than
via increased bank lending.
Our view of the Fed’s exit strategy looks as follows: the planned
bond purchases will be carried out according to the original
plan and will be completed in June. During the autumn, the
central bank will abstain from reinvesting maturing loans and
interest payments, which will signify a cautious tightening.
Around the same time, the Fed will lay the groundwork for an
interest rate normalisation by removing the phrase “extended
period” from its press release after FOMC meetings. The most
important interest rate (federal funds) will be raised in
January 2012: somewhat earlier than market pricing indicates.
By the end of 2012 this rate will be 2 per cent.
-1
-2
-3
11
structure is also more favourable. Compared to China, US
population has risen marginally, but it has fallen compared to
India.
Our overall conclusion is that the US is maintaining its clout in
the world. In terms of GDP its influence has diminished over
the past decade, but in terms of military expenditures and
demographics its influence has increased.
Defence expenditures in a longer perspective
Per cent of GDP
15 15
14 14
13 13
12 12
11 11
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
50 55 60 65 70 75 80 85 90 95 00 05 10
Source: BEA, SEB

Disaster puts tentative economic recovery on hold
ƒƒ Effects more severe than after Kobe quake
ƒƒ Weak growth in 2011, but upswing in 2012
ƒƒ Reconstruction efforts will further strain
public sector finances
The earthquake and tsunami on March 11, combined with the
Fukushima nuclear reactor accident, are making all assess-
ments of Japanese economic trends very uncertain. Sentiment
indicators such as the purchasing managers’ index (PMI) and
the consumer confidence index have plunged. Most of the hard
data available so far has been even weaker than expected.
For example, industrial production fell more than 15 per cent
month-on-month in March: the biggest downturn since meas-
urements began in 1953. This ended Japan’s renewed recovery
trend after a weak fourth quarter.
The economic impact of the March events is likely to follow
the pattern of earlier natural disasters, such as the 1995 earth-
quake in Kobe, Japan and Hurricane Katrina in the American
South six years ago. In the short term, the destruction and
disruptions in transport and supply chains hamper production,
but the stimulus effects of reconstruction efforts gradually take
the upper hand.
The disaster in Japan: three scenarios
GDP, Index: 2000:1=100
113
109
105
101
97
93
00 01 02 03 04 05 06 07 08 09 10 11
Extreme scenario
Normal recovery (forecast)
Expected growth curve before the earthquake
Source: Cabinet Office, SEB
But it is clear that this time around, the impact will be more se-
vere than after the Kobe quake. The devastation is larger. About
1 per cent of Japan’s total capital stock, with a value equivalent
to 3-4 per cent of GDP, seems to have been destroyed. The
destruction of the Fukushima nuclear reactors will also lower
the energy supply for a long time. These reactors accounted for
some 6 per cent of Japan’s electricity; for the time being, natu-
ral gas can only replace part of this lost capacity. The vehicle
and electronics industries are hardest hit, but food production
is also affected due to radioactive contamination risks. Howev-
er, the share of these industries in total GDP is limited; vehicle
production represents less than 5 per cent of GDP.
Japan
Looking ahead, quarter-on-quarter GDP patterns will be
determined entirely by the reconstruction process. The recov-
ery early this year should contribute to positive first quarter
growth, while the impact of the disaster will mainly affect the
second quarter. During the second half, the effects of recon-
struction will begin to dominate. Altogether, we foresee 2011
GDP growth of only 0.5 per cent: a downward revision of 1.1
percentage points. In 2012, reconstruction will contribute
to higher GDP growth, which we have revised upward by
0.8 percentage points to 2.4 per cent. The reconstruction will
continue to contribute to GDP growth after 2012 as well.
Initial financial market reactions − a sharp slide on the Tokyo
Stock Exchange and a strengthening of the yen, driven both by
global risk aversion and financial flows back to Japan − have
partly reversed. The stock market has recovered most of its
decline, and the yen is at about the same exchange rate against
the US dollar as before the earthquake, among other things
due to a G7 currency intervention in late March. Looking ahead,
continued financial flows into Japan related to reconstruction
will push up the yen, but normalised risk appetite and gradu-
ally wider interest rate gaps with other countries will pull in the
other direction. We believe that the USD/JPY exchange rate
will rise to 88 at the end of 2011 and to 94 at the end of
2012.
The government has approved a supplementary budget of
about USD 50 billion for disaster assistance. It will be financed
113
by expenditure cuts, not by higher borrowing. This budget has
109 been called “a first step” in the reconstruction process. It is like-
105 ly that at least one more supplementary budget will be unveiled
101
and will be financed by increased borrowing. This will further
enlarge Japan’s budget deficit and government debt. Our as-
97
sessment is that the deficit will reach 10.5 per cent of GDP this
93 year and that government debt will reach 235 per cent by the
12
end of 2012. Eventually Japan, like the US, will need to establish
a clear plan for improving its government finances. Yet because
of the country’s enormous accumulation of private assets −
reflecting many years of large current account surpluses − the
risks of financial instability are small. Fundamentally, Japan is a
rich country with good potential in terms of resources, technol-
ogy and organisation to cope with the challenges created by
the disaster and reconstruction.
Nordic Outlook – May 2011  |  21
Asia

Moderate slowdown in growth

ƒƒ Minor growth impact from Japan disaster per cent. Indicators such as the purchasing managers’ index in
ƒƒ Need for continued tightening in China manufacturing point towards continued good growth. In April
the year-on-year increase in industrial production stood just
ƒƒ Inflation rate still high in India above 13 per cent. Retail sales growth increased by more than
17 per cent. We expect that China will again exceed its growth
Asian emerging economies grew at a healthy pace during the targets over the next couple of years, with GDP growth of 9.3
fourth quarter of 2010. Available information also indicates a per cent in 2011 and 8.5 per cent in 2012. A slower export
robust trend early in 2011. We expect continued good growth increase will help cool GDP growth from 10.3 per cent in 2010.
this year and next, despite further economic policy tightening. There was an unexpected first-quarter trade deficit of about
In our assessment, the secondary effects of the natural disaster USD 1 billion even though the trade balance returned to surplus
in Japan will be comparatively minor. For emerging Asia, the in April. This was partly due to seasonal patterns, but overall
relative importance of trade ties to Japan has gradually dimin- we believe the 2011 trade surplus will fall to around 2.5 per
ished due to the rise of China. We expect the largest adverse cent of GDP, compared to just above 3 per cent in 2010. The
impact to occur in the vehicle and electronics industries, due downturn is mainly due to rising commodity prices and, to a
to component shortages. Disruptions in trade flows and supply lesser extent, increased domestic demand. The politically sensi-
chains in the region will eventually be offset by increased im- tive trade surplus with the US remains high.
port demand in Japan as reconstruction work begins. Trade balance: Total and with the US
USD billion
Rising food and energy prices are driving up inflation in most 120 120
110 110
economies. Core inflation is also moving higher; in South Korea, 100 100
for example, the upturn is significant. Monetary policy is thus 90 90
80 80
continuing to be tightened in the region. For example, China, 70 70
India, South Korea and Taiwan have raised their key interest 60 60
50 50
rates. Despite these hikes, real key rates remain low; in India the 40 40
real interest rate is negative. Low real interest rates and solid 30 30
20 20
growth justify further monetary policy tightening. Our main 10 10
scenario implies a moderate slowdown in the growth rate, 0 0
-10 -10
but if inflation should climb sharply, this may trigger more ag-
00 01 02 03 04 05 06 07 08 09 10
gressive tightening policies that lead to sharp deceleration.
Total US
Source: National Bureau of Statistics of China
Continued good growth in Asia
Year-on-year percentage change China has raised its inflation target from 3 to 4 per cent for
15.0 15.0 2011, but this will still be hard to achieve; the inflation rate
12.5 12.5
remain elevated and was 5.3 per cent in April. The main driver is
10.0 10.0
food prices; April food inflation was 11.5 per cent. Core inflation
7.5 7.5
5.0 5.0
has also crept upward and stood at 2.3 per cent in March.
2.5 2.5
0.0 0.0
There are nevertheless many signs that inflation is about to
-2.5 -2.5
slow. The central bank’s latest survey indicates that the inflation
-5.0 -5.0 expectations of households have fallen a bit. The year-on-year
-7.5 -7.5 rate of CPI inflation declined by 0,1 per cent in April compared
07 08 09 10 11 to March. We expect inflation to fall during the second half of
China Indonesia South Korea 2011 as monetary tightening begins to be felt and the impact of
India Malaysia Thailand rising food prices fades. We expect full-year inflation to end
Source: National statistical offices
up at 4.9 per cent in 2011 and 4.4 per cent in 2012.
China: Rate of inflation will level out
In the first quarter of 2011, GDP rose by 9.7 per cent year-on- In his annual address to the nation early in March, Prime Minis-
year, marginally less than in the preceding quarter. China’s new ter Wen Jiabao declared that fighting inflation is the most im-
five-year plan lowers the growth target to an annual average portant task of economic policy in 2011. In keeping with this,
of 7 per cent in 2011-2015. The 2011 target has been set at 8 the People’s Bank of China has continued to tighten monetary

22   |  Nordic Outlook – May 2011


policy, hiking its key interest rate in February and April to the
current 6.31 per cent. Persistent high growth and rising inflation
will justify further tightening. We predict another rate hike
before the end of June. At year-end we thus expect a key
rate of 6.56 per cent.
Inflation has continued upward
Per cent
25 25
20 20
15 15
10 10
5 5
0 0
-5 -5
06 07 08 09 10 11
CPI Core inflation Food prices
Source: National Bureau of Statistics
However, raising the bank reserve requirements is a more
important policy tool than rate hikes. Bank reserve require-
ments have been raised five times during 2011 and eight times
since November 2010 and are now 21 per cent for most of the
larger banks. Authorities have also introduced a differentiated
control mechanism in which individual banks with excessively
aggressive lending are penalised with further increases in their
reserve requirements. This measure seems to have had an
effect; during the first four months of the year, when lending
ordinarily takes off, new credits fell by more than 10 per cent
year-on-year.
The China Banking Regulatory Commission has announced
new capital ratio regulations in line with the Basel III rules.
Systemically important banks must have a minimum capital
adequacy ratio of at least 11.5 per cent and other banks must
have 10.0 per cent.
Available indicators show a continued upturn in home prices,
but at a slower pace. We believe that the probability of an
overall housing market crash is rather small, although there
are clear bubble tendencies in some major cities. But because
the national price index has been replaced by individual series
for 70 different cities, the situation will be harder to track.
According to official statements, China is continuing to pursue
a “proactive” fiscal policy, but in practice it is being tightened in
the same way as monetary policy. We expect the government
budget deficit to shrink from 2.5 per cent of GDP in 2010 to
around 2 per cent this year.
The appreciation of the yuan against the US dollar is continu-
ing and has totalled around 1.5 per cent since the beginning of
2011. Because the dollar is weakening against other currencies,
the real effective USD/CNY exchange rate is close to its year-
end level, but in recent weeks the rate of appreciation against
the dollar has speeded up. Official signals indicate that Chinese
authorities have become more inclined to allow faster appre-
ciation as a means of curbing import costs. Our assessment is
that appreciation against the dollar will accelerate and that the
Asia
USD/CNY exchange rate will stand at 6.20 by year-end and 5.85
at the end of 2012.
Continued yuan appreciation
130 6.50
125 6.75
7.00
120
7.25
115
7.50
110
7.75
105
8.00
100 8.25
95 8.50
05 06 07 08 09 10 11
USD/CNY (RHS) Real exchange rate (LHS)
Source: BIS, Reuters Ecowin
Reducing China’s coal dependency
The latest five-year plan (2011-2015), together with the Fuku-
shima nuclear power disaster in Japan, has drawn attention
to China’s energy supply situation. At present, most energy is
supplied by fossil fuels. The country is heavily dependent on
coal, since ample domestic resources make it a cheap fuel.
China has both the largest coal production and consumption
in the world. Coal accounts for around 70 per cent of energy
supply, compared to a global average of 30 per cent, causing
large-scale air pollution and carbon dioxide emissions. Coal
dependency makes China less sensitive to high oil prices,
however.
More efficient resource utilisation is a major theme of China’s
five-year plan. The target is a 16 per cent reduction in energy
intensity by 2015, but also a change in the allocation of en-
ergy sources intended to reduce carbon dioxide emissions.
China aims at reducing the share of coal in total energy sup-
ply while increasing the role of natural gas and non-fossil
fuels. Large-scale expansion of nuclear power is thus a central
element of the five-year plan; at present, nuclear power only
accounts for a few per cent of total energy supply.
As in many other countries, however, the nuclear power
plant disaster in Japan has affected China’s nuclear energy
programme. The granting of permits for new nuclear power
plants has been frozen and safety inspections have been
intensified. The aggressive expansion of nuclear power
thus looks set to slow down over the next couple of years.
The target of boosting capacity from today’s 11 gigawatts
to 40 gigawatts in 2015 will thus be difficult to achieve. The
Fukushima disaster may instead lead to further expansion of
China’s renewable energy programme.
India: High inflation requires tightening
India’s growth remains strong, although its increase in GDP
slowed somewhat to 8.2 per cent during the last quarter of
2010. The purchasing managers’ index in manufacturing re-
mains high, and other indicators also point towards continued
expansion. Industrial production seems stronger again after a
clear slump around year-end, and exports have taken off. We
expect GDP growth of 8.0 per cent in 2011 and 7.0 per cent
in 2012.
Nordic Outlook – May 2011  |  23
 Asia

The inflation rate is still high, amounting to 9 per cent in March. According to the budget for the 2012 fiscal year, which began in
Food accounts for nearly 25 per cent of the consumer price April, the government’s target is to lower its deficit from 5.1 per
index, so rising food prices are having a major impact. Core cent of GDP to 4.6 per cent. Plans to trim expenditures may be
inflation has also risen appreciably. difficult to implement, however, since high oil and food prices
will push up the costs of providing subsidies. The budget is also
The Reserve Bank of India has hiked its key interest rate three based on growth forecasts that are more optimistic than both
times in 2011 and nine times since March 2010, when the cur- our own forecast and the consensus assessment. The govern-
rent tightening cycle began. Despite increases totalling 2.5 ment intends to introduce new legislation that will broaden its
percentage points since last year to a current level of 7.25 per tax base starting in fiscal 2013. A reform of the tax system will
cent, the real interest rate is still negative. Continued monetary be essential in order to achieve a balanced budget in the future.
policy tightening can be expected in the coming months. The
central bank has declared that its priority is to combat inflation; The results of the census carried out every ten years were
it will thus pursue a tightening policy at the expense of lower recently announced. According to the census, India’s popula-
short-term economic growth. The bank has set an inflation tion growth has slowed to 1.6 per cent a year during the past
target of 6 per cent by the close of fiscal 2012, which ends next decade, compared to a pace of around 2 per cent during the
March. We expect inflation to fall during the second half of 2011 preceding two decades. This is explained by falling birth rates.
as the impact of rising food prices fades and monetary policy The population is now 1.2 billion and is expected to stabilise at
continues to tighten. 1.7 billion by 2060. By way of comparison, China’s population
rose by around 0.6 per cent annually in the past decade and is
expected to peak at 1.4 billion in 2030 and then decline.
Domestic factors drive Indian food prices
The high inflation rate in India is largely driven by rapidly in- The trend towards a strengthening of the rupee against the
creasing food prices. While prices fell early this year, they later dollar has continued during 2011, although this appreciation
resumed their upturn. To a significant extent, these increases has only been about 1 per cent since the turn of the year. We
are driven by domestic factors. Rapidly rising income in rural expect that the rupee will stand at 42.90 per USD one year
and under-developed regions has led to a sharp increase in from now.
demand for food.
Continued rupee appreciation against the dollar
Food price hikes have outpaced global prices 52.5 52.5
Index 100 = 2006
190 190
50.0 50.0
180 180
170 170
160 160 47.5 47.5
150 150
140 140 45.0 45.0
130 130
120 120 42.5 42.5
110 110
100 100
40.0 40.0
90 90
80 80
06 07 08 09 10 11 37.5 37.5
00 01 02 03 04 05 06 07 08 09 10 11
Food prices, India Global food prices
Source: HWWI, Office of the Economic Adviser to the Government of India Source: Reuters EcoWin

India has not managed to respond to the increase in demand

with higher production. Per capita food production has
instead levelled out during the past decade. Production is
hampered by small, inefficient agricultural units, water sup-
ply problems and overuse of fertilisers. The underdeveloped
food industry suffers from a shortage of investment and an
abundance of red tape. Poor competition and over-regulation
at the retail level make the situation worse. Because of restric-
tions, imports cannot meet rising demand. Without reforms,
food production cannot be increased satisfactorily. At present,
political leaders are unwilling to make changes due to the risk
of losing support from important voter categories.

Taken together, this means that food prices in India are ex-
pected to rise faster than global prices, while import depend-
ency will increase. Given the size of India’s economy, higher
imports will contribute to pushing up global food prices.

24   |  Nordic Outlook – May 2011

 The euro zone

Germany pulling ahead, high inflation all of 2011

ƒƒ Growth of just above 2 per cent despite plagued euro zone country to request a bail-out, after Greece
problems in southern Europe and Ireland; its rescue package will total nearly EUR 80 billion.
The risk that Spain might also be forced to seek outside aid is
ƒƒ German unemployment at 20-year low high, and the question of debt restructuring mechanisms in
ƒƒ HICP inflation above ECB target all year Greece is another source of uncertainty (see Theme article).
ƒƒ Refi rate at 2.75 per cent in December 2012 Germany pulling further ahead
The German economy pulled ahead of the rest of the euro
The euro zone continues to grow at a relatively healthy overall zone last year. GDP growth ended up at 3.6 per cent, or about
pace despite the debt crisis in southern Europe. The German 2 percentage points higher than in France and Italy and nearly
economy, which benefited from a sharp surge in exports 4.5 points ahead of the average for Greece, Ireland, Portugal
and capital spending last year, will be the main growth and Spain (GIPS).
engine, with GDP rising more than 3 per cent this year. France
According to leading indicators, the favourable trend in Ger-
and Italy are growing at a significantly slower pace, mainly
many will continue this year. The IFO business sentiment
because their growth is driven to a greater extent by their less
index is at a three-year high, and the purchasing managers’
vigorous domestic demand. Spain was on the brink of a new
index (PMI) is also high: around 60 in both manufacturing and
recession in the second half of 2010, but has stabilised some-
services. In addition, German order bookings are continuing
what since then; we expect growth of a bit below 1 per cent this
to increase at about 20 per cent year-on-year and industrial
year. Greece, Ireland and Portugal will report negative growth
production by 10-15 per cent (rising in February by a record-
this year, however. This means a further accentuation of the
breaking 14.8 per cent). German industrial production will
two-speed economy in the currency area. Total euro zone
expand by about 8 per cent this year and 5.5 per cent in 2012.
growth will reach 2.2 per cent in both 2011 and 2012 (con-
In the euro zone as a whole, output will rise by 5 and 4 per cent,
sensus: 1.7 per cent both years).
respectively.
Euro zone: Growth at 2.2 per cent in 2011
Percentage change Continued low interest rates, strong momentum in the export
5.0 5.0
sector and rising capacity utilisation also point towards acceler-
2.5 2.5 ated capital spending, especially in Germany, but also to some
0.0 0.0
extent elsewhere in the euro zone; we expect fixed investment
SEB to increase 4-5 per cent a year in the region as a whole during
-2.5 forecast -2.5
2011-2012.
-5.0 -5.0
Higher capital spending in the region
-7.5 -7.5 Year-on-year percentage change and per cent
10 87.5
-10.0 -10.0
85.0
04 05 06 07 08 09 10 11 12 5
82.5
Quarter-on-quarter, annualised 0
Year-on-year percentage change 80.0
Source: Euroframe, Eurostat, SEB
-5 77.5
75.0
Inflation as measured by the Harmonised Index of Con- -10
72.5
sumer Prices (HICP) was running at 2.8 per cent in April -15
70.0
and will remain in the 2.5-3 per cent range for the rest of
-20 67.5
2011; not until March 2012 will it drop below 2 per cent. Given
00 01 02 03 04 05 06 07 08 09 10 11
high inflation, combined with capacity and resource utilisation
Gross capital formation (LHS)
approaching normal levels in a number of countries, the Euro- Capacity utilisation (RHS)
pean Central Bank (ECB) will raise its key interest rate two more Source: Eurostat, DG ECFIN

times this year and four times in 2012. The refi rate will thus
end up at 1.75 per cent in December of this year and 2.75
per cent in December 2012.
The euro zone debt crisis remains a significant problem,
however, and it risks delaying the economic recovery in the
currency union. As expected, Portugal became the third debt-
Diverges in the labour market situation of the various euro zone
countries are now leaving a mark on their relative consumer
confidence levels. A strong labour market has improved the
mood of households in Germany. Consumer confidence
there is now approaching the previous peak from 2007, and
private consumption is expected to rise by about 1.5 per cent

Nordic Outlook – May 2011  |  25

 The euro zone

yearly in 2011-2012. In other euro zone countries, the trend is
sluggish. While confidence has rebounded from 2009 lows, the
figures have moved sideways in the past year and remain far
below their 2007 peaks. Yet a gradual labour market improve-
ment in most countries will help create a certain upswing in
household consumption this year and in 2012, despite percep-
tible fiscal tightening measures in most crisis countries. Euro
zone private consumption will increase by 1-1.5 per cent
a year in 2011-2012. Domestic demand contributed about 1.5
percentage points to GDP growth last year; this will increase to
nearly 2 percentage points this year and next.
Large differences in consumer confidence
Net balance
20.0
10.0
0.0
zone as a whole will grow by 2.2 per cent in both 2011 and
2012.
GDP
Year-on-year percentage change
2009 2010 2011 2012
Germany -4.7 3.6 3.5 2.7
France -2.5 1.5 1.9 1.9
Italy -5.2 1.2 1.3 1.5
Spain -3.7 -0.1 0.8 1.5
Greece -2.0 -4.5 -3.5 0.1
20.0
Portugal -2.5 1.4 -1.4 0.5
10.0
Ireland -7.6 -1.0 -0.2 1.7
0.0

-10.0 -10.0
GIPS countries -3.8 -0.7 -0.2 1.2

-20.0 -20.0
Euro zone -4.0 1.7 2.2 2.2
-30.0 -30.0
Source: Eurostat, SEB

-40.0 -40.0
Continued debt crisis
-50.0 -50.0 Overall euro zone budget deficits were 6 per cent of GDP
00 01 02 03 04 05 06 07 08 09 10 11
last year, down 0.3 percentage points from 2009. Virtually all
Germany France Italy Spain member countries showed large deficits, especially the GIPS
Source: DG ECFIN
countries.
Altogether, we foresee German GDP growth of 3.5 per cent
this year and 2.7 per cent in 2012: a small upward adjust- High GDP growth and falling unemployment will help further
ment on our February forecast, and well above the consensus improve Germany’s budget situation in the next couple of years.
forecast. Growth will end up just below 2 per cent in France this Tax revenue rose 5.5 per cent year-on-year in January, more
year and next and about 1.5 per cent annually in Italy. The euro than expected. We expect the budget deficit to shrink from

Italy and France chug along in low gear
Because of differing economic structures, major euro zone
countries have shown divergent growth patterns, both during
the crisis and the recovery phase. Germany’s GDP fell by a
full 4.7 per cent in 2009, rebounding by 3.6 per cent in 2010.
The French economy demonstrated greater stability; its 2009
downturn was only 2.5 per cent, followed by a modest 1.5 per
cent upturn in 2010.
A large export sector (about 40 per cent of GDP) makes Ger-
many more dependent on world market ups and downs. Since
exports also consist largely of cyclical intermediate and in-
vestment goods, this amplifies German fluctuations, France,
like Italy, has significantly lower relative exports: 20-25
per cent of GDP. Exports are also focused to a greater extent
on consumer products, which are less volatile. Household
are more competitive, helping make it easier for Germany to
tolerate the strong euro exchange rate. This difference is
reflected in its external balance. Germany is showing a current
account surplus of some 5 per cent of GDP, while France and
Italy have relatively large deficits.
Altogether, we expect growth in France and Italy to remain
close to trend in the next couple of years. This will lead to
fairly small fluctuations in unemployment and signify major
differences in resource utilisation. In Germany, the output gap
will approach zero in 2012, while other major euro countries
will show sizeable output gaps of around 2-2.5 per cent of
GDP.
Germany's labour market has resisted the trend
Unemployment, per cent
22.5 22.5

consumption (just below 60 per cent of GDP) was also rela- 20.0 20.0
tively stable in France during the crisis, despite rising unem- 17.5 17.5
ployment; private consumption rose by 0.5 per cent both in
15.0 15.0
2008 and 2009. Consumption also held up decently in Italy.
12.5 12.5
Germany will continue to grow faster than France and Italy in 10.0 10.0
the near future, among other things because its strong labour
7.5 7.5
market will help sustain household consumption. Due to weak
5.0 5.0
public sector finances, some fiscal tightening will also be
00 01 02 03 04 05 06 07 08 09 10
necessary in France and Italy. Because of their long period of
relatively strong productivity growth, German manufacturers Germany France Italy Spain
Source: Eurostat

26   |  Nordic Outlook – May 2011

 The euro zone

3.3 per cent of GDP last year to about 2 per cent in 2011 and Yields on 10-year government bonds
1.5 per cent in 2012. Germany will thus meet the 3 per cent Spread against Germany, percentage points
Maastricht criterion by a wide margin as early as this year. 10.0 10.0
9.0 9.0
8.0 8.0
In the euro zone as a whole, we anticipate that budget deficits
7.0 7.0
will fall to 4.3 per cent of GDP this year and 3.3 per cent in 6.0 6.0
2012. Total central government debt in the currency union will 5.0 5.0
climb from just above 85 per cent of GDP this year to about 90 4.0 4.0

per cent in 2012, The new “euro pact” − aimed at improving 3.0 3.0
2.0 2.0
the currency union’s competitiveness by such means as homo- 1.0 1.0
geneous labour market, wage formation and corporate taxa- 0.0 0.0
tion rules − may eventually have some impact on growth and Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
08 09 10 11
budget developments in individual countries but will not affect France Ireland Portugal
Greece Italy Spain
events in the near future. Source: Reuters EcoWin

As expected, Portugal became the third deficit- and debt-
plagued euro zone country to ask the European Union and the
International Monetary Fund for financial help. Such bail-out
loans now total about EUR 275 billion (Greece, 110; Ireland, 85;
Portugal, nearly 80).
Public budget balance, selected countries
Per cent of GDP
2009 2010 2011 2012
Germany -3.0 -3.3 -2.1 -1.5
France -7.5 -7.0 -5.5 -3.5
Italy -5.4 -4.6 -3.8 -3.3
Spain -11.1 -9.2 -6.5 -5.9
Greece -15.4 -10.5 -7.6 -6.1
Portugal -10.1 -9.1 -5.5 -4.9
Ireland -14.3 -32.4 -9.1 -8.0
Euro zone -6.3 -6.0 -4.3 -3.3
Source: European Commission, SEB
Unemployment on its way down
German unemployment has continued downward and is now
somewhat above 6 per cent according to Eurostat’s harmonised
measure, its lowest level in 19 years. A combination of a rapid
economic upswing and the government’s allowance system to
encourage job-sharing has contributed to this favourable trend.
The labour market reforms of recent years (Hartz I-IV) have also
led to structural improvements; matching between job seek-
ers and vacancies is working better in the German labour
market, for example as indicated by the “Beveridge curve”,
which shows the relationship between vacancy levels and
unemployment. The movement of this curve since 2008 shows
that today’s vacancy rate of about 1 per cent is compatible with
lower unemployment than before. Matching has also improved
in the euro zone as a whole, but not as clearly. Continued
optimistic hiring plans and relatively strong growth indicate
that German unemployment will continue downward to
just below 5.5 per cent by the end of 2012. This is probably
somewhat lower than the long-term equilibrium level.
Germany: Beveridge curve
y-axis: job vacancy rate; x-axis: unemployment rate
1.2 1.2

1.1 Jan 2000 1.1

1.0 1.0
The market is now once again focusing on Spain and 0.9 0.9
Greece. A combination of weak banking and property sec- 0.8 Jan 2011 0.8
tors, a large budget deficit, weak growth and record-high 0.7 0.7
unemployment continues to plague the Spanish economy. 0.6 0.6
During the spring, however, Spain has avoided secondary 0.5 0.5
effects from the worsening situation in Greece, Ireland and 0.4 0.4
5.0 6.0 7.0 8.0 9.0 10.0 11.0
Portugal. Instead, Spain’s yield spread against Germany has Monthly observations
shown a narrowing tendency. Despite this de-coupling, it Regression line 2000 Jan -2007 Dec
Regression line 2008 Jan-2011 Jan
cannot be ruled out that the ECB’s key rate hikes will Source: Federal Employment Agency, Eurostat, SEB
drive up the borrowing costs of Spanish households so
much that home and other property prices fall further. French unemployment (currently 9.5 per cent) began to fall in
This would worsen the situation of hard-pressed Span- September 2010, Italian unemployment (8.3 per cent) some-
ish savings banks (“cajas”) and the central government’s what later. The labour market will strengthen in both countries
finances. this year, but not as quickly as in Germany; the jobless rate will
average 9.2 per cent in France and 7.9 per cent in Italy. Spanish
In Greece, the sovereign debt problem has intensified dur- unemployment (now above 20 per cent) will move downward,
ing the spring, as reflected in record credit default swap though later and at a slower pace; the number of registered
(CDS) premiums and government bond yields. Greek unemployed dropped unexpectedly in April, and job creation
debt restructuring is beginning to seem increasingly will pick up somewhat as the tourist season begins this sum-
likely, although it may lead to increased uncertainty about mer. Euro zone unemployment will be just below 9.5 per
the situation in other peripheral euro zone countries (see cent in December 2012, compared to a long-term equilibrium
Theme article). level of about 8.5 per cent.

Nordic Outlook – May 2011  |  27

 The euro zone

Unemployment will fall slowly been justified mainly on the basis of fiscal arguments, but one
Per cent major side effect is that they will eventually also lead to a pay
10.5 10.5 squeeze in the private sector.
10.0 10.0

9.5 9.5 High inflation during the rest of 2011

9.0 9.0 Euro zone HICP inflation was driven up to 2.8 per cent in April,
8.5 8.5
the highest figure since September 2008 (3.2 per cent). Energy
and food contributed about 1.4 percentage points of this.
8.0 8.0
Inflation has thus climbed nearly 3.4 percentage points since
7.5 7.5
bottoming out in July 2009 and by 1.2 points since April 2010.
7.0 7.0
00 01 02 03 04 05 06 07 08 09 10 11 12 We expect continued high energy and food prices to keep HICP
Unemployment rate inflation at 2.5-3 per cent during the rest of this year. Not until
NAIRU according to the OECD March 2012 will it drop below 2 per cent again. By then,
Source: Eurostat, OECD, SEB
the contribution from energy and food will have fallen to 0.6
No wage pressure yet percentage points. It will drop further to 0.1 point in December
The improvement in the German labour market has begun to 2012. VAT hikes in several GIPS countries will contribute to
affect wage and salary negotiations and has resulted in some higher inflation. Measured as annual averages, HICP inflation
strikes, including a nationwide train drivers’ strike. Yet although will reach 2.8 per cent this year and 1.7 per cent in 2012, a
unions have increased their pay demands, so far no new collec- relatively large upward adjustment for this year compared to
tive contracts have established higher levels than previously. our February forecast.
This spring’s pay demands in the construction and chemical in-
dustries were 7 and 5.9 per cent, respectively, yet these sectors Underlying inflation − HICP adjusted for energy and food − has
ended up with wage and salary hike agreements of about remained relatively stable at around 1 per cent since October
3 per cent on an annual basis (construction: 3 per cent from 2009, but it climbed to 1.3 per cent in March. Experience from
May 1, 2011 and then 2.3 per cent from June 1, 2012; chemical the past decade nevertheless shows that high energy prices
industry: 4.1 per cent for 14 months). usually only spill over into higher underlying inflation to a minor
extent, while contagion is somewhat more likely when it comes
It should be added that the current metalworkers’ collective to food prices. Pay increases and resource utilisation have the
agreement provides pay increases of 2.7 per cent by March biggest impact on the trend of core inflation. Our estimates
2012. Now that citizens of various Eastern European countries indicate that core inflation will rise at a moderate pace ahead,
are gaining access to the German labour market (the seven- remaining a bit below 2 per cent throughout our forecast pe-
year transition rules introduced when the EU expansion oc- riod. Measured as annual averages, core inflation will end up
curred in 2004 expire in May), this will help hold down wage at 1.2 per cent this year and 1.5 per cent in 2012.
and salary increases during the next couple of years. We thus
High HICP inflation throughout 2011
expect pay increases of a moderate 2.5 per cent in Germany Year-on-year percentage change
this year and slightly above 3 per cent in 2012. Euro zone pay 4.5 4.5
hikes will end up at about 1.5 per cent this year and just 4.0 4.0
3.5 SEB 3.5
over 2 per cent in 2012. forecast
3.0 3.0
Low pay increases this year, higher in 2012 2.5 2.5
Percentage points, year-on-year percentage change 2.0 2.0
-2.0 4.5 1.5 1.5
-1.5 4.0 1.0 1.0
0.5 0.5
-1.0 3.5
0.0 0.0
-0.5 3.0 -0.5 -0.5
0.0 2.5 -1.0 -1.0
0.5 01 02 03 04 05 06 07 08 09 10 11 12
2.0
1.0 HICP inflation Core inflation
1.5
Source: Eurostat, SEB
1.5
1.0
2.0
0.5
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Refi rate of 1.75 per cent this December
The ECB began a normalisation of its key interest rate in April.
Change in unemployment, shifted 1 year forward (LHS)
Change in wage and salary cost in manufacturing (RHS) This decision was based on a combination of relatively bright
Source: Eurostat, SEB
growth prospects for the euro zone as a whole and high actual
The pay squeeze in southern Europe will continue over the next HICP inflation. The ECB believes that inflation risks are on
couple of years. The need for internal devaluation, i.e. restora- the upside, among other things due to rising inflation expecta-
tion of competitiveness via lower wage increases and/or faster tions and the threat of secondary effects that lead to a broader
productivity growth than in other countries, totals about 20-30 upturn in inflation. We expect two more ECB hikes this year,
per cent. Public sector pay cuts in various GIPS countries have bringing the refi rate to 1.75 per cent in December 2011.

28   |  Nordic Outlook – May 2011

 The euro zone

Two more refi rate hikes in 2011 Credit and M3 growth have continued to edge up
Per cent Year-on-year percentage change
5.0 5.0 15.0 15.0
4.5 4.5
12.5 12.5
4.0 4.0
3.5 3.5 10.0 10.0
3.0 3.0 7.5 7.5
SEB forecast
2.5 2.5
5.0 5.0
2.0 2.0
1.5 1.5 2.5 2.5
1.0 1.0
0.0 0.0
0.5 0.5
0.0 0.0 -2.5 -2.5
08 09 10 11 12 99 00 01 02 03 04 05 06 07 08 09 10

EONIA O/N Refi rate Credits M3 money supply

Source: Reuters EcoWin, SEB Source: ECB

Even though HICP inflation will fall early in 2012, we expect the To enable the ECB to raise its refi rate in keeping with our
ECB to continue normalising interest rates and believe that the forecast without making the euro too strong, the US Federal
refi rate will stand at 2.75 per cent in December 2012. The Reserve’s rate hikes will have to occur at a fairly rapid pace
euro overnight index average (EONIA) − the interest rate that during 2012. Another precondition that must be met is that the
commercial banks must pay − will move up with the refi rate European Financial Stability Facility and its successor, the Eu-
towards 1.75 per cent in December 2011 and 2.75 per cent in ropean Stability Mechanism, will assume a genuinely important
December 2012. role in sustaining economic improvements in southern Europe,
thus enabling the ECB to gradually shift emphasis towards its
The ECB will hike its key rate to 2.75 per cent for several rea- inflation-related tasks.
sons. Resource utilisation is approaching normal levels in a
number of euro zone countries, while core inflation is creeping The process of selecting a new ECB president to take the helm
upward at a slow pace. Core inflation of 1.5-2 per cent that also in November does not affect our view of monetary policy or
has an upward trend may be perceived as problematic. Leading the bank’s refi rate path. Italy’s central bank governor Mario
ECB representatives have previously stated that core inflation Draghi appears to be the main candidate, especially after
may need to be close to 1 per cent to enable the ECB to meet its receiving support from Germany once that country’s chief
inflation target in a world where commodity prices are trending central banker Axel Weber had removed himself from consid-
higher. eration. Italy’s poor track record in combating inflation may
possibly work against Draghi, but there are few alternatives and
Higher inflation expectations
Break-even inflation, per cent they also come from smaller member countries (Erkki Liikanen
3.00 3.00 of Finland, Yves Merch of Luxembourg and Nout Wellink of the
2.75 2.75 Netherlands).
2.50 2.50
2.25 2.25
2.00 2.00
1.75 1.75
1.50 1.50
1.25 1.25
1.00 1.00
0.75 0.75
0.50 0.50
0.25 0.25
Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov Mar
07 08 09 10 11
5 Year 10 Year 30 Year

In addition, credit and money supply growth has recovered

from the lows of early 2010. But the rate of increase is still as
slow as 2-2.5 per cent, which has never previously coincided
with ECB interest rate hikes. In its latest monthly bulletin,
however, the central bank pointed to the liquidity gap that was
created during the long period of credit growth that exceeded
a sustainable pace. Given this approach, key interest rate hikes
are more logical even when there is a moderate rate of growth
in credit volume and money supply aggregates. The risks in
our refi rate forecast are on the downside next year, how-
ever.

Nordic Outlook – May 2011  |  29

The United Kingdom

Austerity hampering growth

ƒƒ Weak growth this year, better in 2012
ƒƒ Austerity + weak pound = dual economy
ƒƒ High inflation in 2011, far slower in 2012
ƒƒ Bank of England rate hike this autumn
The British economy has stagnated since last autumn; GDP
grew 0.5 per cent in the first quarter over the fourth quarter
of 2010, which saw an equally large decline. GDP growth this
year will be only 1.4 per cent (consensus 1.6). Fiscal tighten-
ing and debt retirement in the banking sector will slow the
recovery. In addition, the upturn in oil prices − which already
exceed 2008’s record levels measured in pounds − will pull
down GDP by 0.2-0.3 percentage points. Next year an up-
swing in real disposable income, a continued weak pound and
the Summer Olympics in London will help lift growth. GDP will
climb by 2.5 per cent in 2012 (consensus 2.2).
Tough fiscal austerity measures will dominate the econo-
my. Fiscal policy will lower GDP more than 1 percentage point
per year. The budget deficit, which exceeded 10 per cent of
Rising oil prices, combined with the effects of the VAT hike,
have pushed up inflation to very high levels. CPI inflation will
peak at 4.6 per cent in July and average an estimated 4.2 per
cent this year. The last couple of months, however, inflation has
been lower than anticipated. Inflation expectations have also
fallen; coupled with spare capacity and subdued pay increases,
this will give the Bank of England some breathing space. We
expect inflation to continue slowing, among other things as
the VAT effect fades; 2012 average annual inflation will be at
the BoE’s targeted 2 per cent (consensus 2.3). The broad M4
money supply measure is falling year-on-year, another indica-
tion of lower inflation a bit further ahead.
Inflation and wage growth
Year-on-year percentage change, rolling 3-year averages
22.5 22.5
20.0 20.0
17.5 17.5
15.0 15.0
12.5 12.5
10.0 10.0

GDP in 2010, will shrink to 6.5 per cent in 2012, thereby putting 7.5 7.5
the UK’s credit rating on solid ground. Despite austerity and 5.0 5.0
subdued growth, employment curves are pointing upward. 2.5 2.5
In the past year, private sector employment has risen by 1.9 per 0.0 0.0
cent (400,000 jobs). Meanwhile there are major staff cutbacks 75 80 85 90 95 00 05 10
in the public sector. Within 4 years, 310,000 public positions
Inflation Compensation rate
will be gone; 40 per cent of these cuts have already occurred. Source: ONS, OECD, SEB

Indicators point to a continued rise in private employment,

The BoE ordinarily ignores the direct impact of higher oil prices
though at a slower pace. The jobless rate will remain stable
on the inflation rate, but the situation is complicated because
around 8 per cent this year, then fall slowly in 2012.
inflation has exceeded the bank’s target for some time, increas-
Household confidence indicators are in the cellar. Aside from ing the risks of rising inflation expectations. We thus believe
fiscal austerity, purchasing power is threatened by high infla- that the BoE will hike its key interest rate in November,
tion; in 2010 real disposable income fell for the first time in once it becomes clear that the recovery is on firmer ground. At
30 years. Tough credit conditions and higher home mortgage the end of 2012, the key rate will be 1.75 per cent.
rates are contributing to a continued housing market squeeze.
The ECB has begun its rate hiking cycle, whereas the BoE
Prices will fall 5 per cent this year and then level out in 2012.
has left its key rate unchanged, thus squeezing the pound.
Consumption will be weak over the next few quarters but
Once the BoE begins hiking its key rate, the pound will re-
bounce back in 2012 as lower inflation and better pay increases
gain some lost ground. The EUR/GBP exchange rate will
lift purchasing power and optimism.  
stand at 0.88 at the end of 2011 and 0.84 at the end of
Capital spending and exports will drive the recovery this 2012.
year. The low exchange rate of the pound will help. Corporate
confidence indicators still exude optimism but have fallen
since the turn of the year. In manufacturing and services, the
purchasing managers’ index is around 55, in the construction
sector somewhat lower. Our composite business indicator is
compatible with GDP growth of around 0.5 per cent quarter-
on-quarter.

30   |  Nordic Outlook – May 2010


Domestic demand will follow exports upward
ƒƒ High inflation will culminate during the
second half of 2011
ƒƒ Robust market confidence
ƒƒ Oil and stimulus policy benefit Russia
The Eastern European economies will accelerate in 2011-2012,
even though global growth will slow a bit and many countries
including Poland will tighten their fiscal policies moderately.
Competitive exports will remain the central driving force this
year. Continued good demand in Germany will be especially
helpful to Central Europe. Russia and Ukraine are far less de-
pendent on Germany, but instead benefit from high commodity
prices. Meanwhile domestic demand is on the way up from
its crisis-period hibernation. Except for Poland, the region’s
domestic sectors were hard hit by the global credit crisis,
mainly due to relatively large foreign currency borrowing. The
first signs of recovery in consumption came in 2010, driven by
rebounding real wages, stabilising labour markets and thawing
credit conditions. Looking ahead, these factors will continue
to stimulate consumption, though a rapid upturn in inflation in
the past six months is undermining purchasing power.
Russia: Inflation undermines purchasing power
Year-on-year percentage change
20
15
10
5 5
0 0
-5
-10
06 07 08 09 10
Real wages Inflation (CPI)
Retail sales, constant prices
Source: Reuters EcoWin
The upturn in inflation is largely due to higher energy
and food prices. Fiscal tightening, such as VAT hikes, is also
contributing to some extent. Underlying price pressures are
generally low and increasing slowly. In the second half of 2011
the commodity price upturn will fade and prices of energy and
agricultural products will fall, causing the inflation rate to cul-
minate in most places. Our conclusion is thus that the recent
slowdown in consumption, for example in Russia, is temporary.
The large budget deficits that resulted from the financial crisis
will shrink to more sustainable levels. Public sector debt will
keep growing somewhat, but it is relatively low or moderate
Eastern Europe
compared to many Western countries. In the past year, better
growth and good control of public finances have strengthened
market confidence in Eastern Europe. CDS prices for Russia,
Ukraine and Latvia have thus fallen, unaffected by euro zone
financial turmoil. Since late 2010, Eastern European currencies
have trended upward. Assuming continued relatively good glo-
bal risk appetite, there will be further moderate currency appre-
ciation in the coming year, due to relative growth advantages
and capital inflows. There will also be further interest rate hikes,
for example in Poland and Russia, which began tightening
monetary policy early in 2011. Viewed in the long term, Poland’s
real effective exchange rate is now only at a neutral level.
Fiscal stimulus pushing up Russian growth
Of the largest Eastern European economies, we believe that
Russia will grow the fastest. GDP will increase by 5.3 per
cent in 2011 and 5.0 per cent in 2012, in line with potential
growth of close to 5 per cent. This is a 0.7 percentage point
upward revision compared to the last Nordic Outlook and is
well above the consensus forecast. One crucial assumption
is that, in the run-up to the December 2011 parliamentary
election, high oil and gas prices will give the government
room to again shift its fiscal policy in an expansionary direc-
tion. In January this year, Russia adopted a budget for 2011
20
including austerity measures equivalent to 2 per cent of GDP.
Prime Minister Vladimir Putin has provided some signals of
15
fiscal loosening. In his annual address to Parliament in April,
10 he announced plans to raise minimum wages and increase
central government salaries by 6.5 per cent starting July 1.
He also promised restructuring efforts, for example to ease
demographic problems.
-5
Looking ahead, we believe that domestic demand will con-
-10
tribute more and more to growth, but consumption will get
11
less support from the labour market. Unemployment fell to
7.1 per cent in March, close to its 6.5-7 per cent equilibrium
level. Capital spending, which remains weak, will grow due to
higher capacity utilisation and better company profits. If Rus-
sian joins the World Trade Organisation, probably as early as
this year, one result may be larger foreign direct investment.
Reports of lingering bad loans in banks and the tendency to-
wards new capital outflows this past year are warning signals
amid our positive forecast.
Nordic Outlook – May 2011  |  31
Baltics

Continued gradual recovery

ƒƒ Strong exports, rising domestic demand short term, energy and food price hikes are a significant burden
on households, but we believe this will ease later in the year.
ƒƒ High unemployment with structural
problems Job creation in domestically oriented sectors is also sluggish.
During 2011, consumption will continue to be hampered by pri-
ƒƒ Rapid inflation upswing will fade vate debt retirement. Capital spending by companies is weak,
but rising capacity utilisation in manufacturing and healthier
housing markets mean that fixed investments will grow.
The gradual recovery of the Baltic economies after their deep
recession is continuing, in line with our above-consensus The fundamental imbalances in the Baltics have improved
forecasts. All three countries returned to positive year-on-year substantially in the past two years. Internal devaluations and
growth in the second and third quarters of 2010. In Estonia and aggressive budget-tightening have wiped out earlier wage-driv-
Lithuania, this growth strengthened further in the first quarter en inflation. Extreme current account deficits have turned into
to 8.0 respectively 6.9 per cent − though from low levels. The surpluses. Core inflation is now rising slowly from low figures
upturns in the monthly EU business and household sur- (Latvia and Lithuania still have core deflation). The current ac-
veys have decelerated this year, but the same pattern has count balance in Latvia and Lithuania is moving back into small
been visible in the euro zone, for example. Index levels are a bit deficits as imports rebound.
above historical averages, but optimism in Latvia has shown
a weaker trend than in the other countries, due to declining But there are still remaining imbalances and challenges.
household confidence. This is probably because unlike Estonia Among these are large budget deficits in Latvia and
and Lithuania, Latvia is continuing to tighten its fiscal policy. Lithuania (7.7 and 7.1 per cent of GDP last year, respectively)
We are making some downward adjustments in our Latvian and structural labour market problems, including waves
GDP forecast. of emigration during the crisis and high long-term and youth
unemployment in all three countries. The Latvian and Lithua-
EU sentiment indicator nian deficits continue to shrink to 3 and 4 per cent of GDP,
Index
respectively, in 2012. Labour market problems will persist even
120 120
115 115 if unemployment eases.
110 110
105 105 Estonia joined the euro zone in January 2011. Latvia is aim-
100 100
ing at accession in 2014, while Lithuania’s ambition is to join
95 95
90 90 as soon as it meets the criteria. Our assessment is that Latvia
85 85 has a good chance of qualifying by 2014. Among other
80 80
75 75
things, this will require a budget deficit of no more than 3 per
70 70 cent of GDP in 2012. Lithuania’s accession will probably
65 65 be delayed until 2015 due to excessive budget deficits. High
04 05 06 07 08 09 10 11
inflation may also prevent earlier accession. Public sector debt
Estonia Lithuania will probably not be a problem. While both Latvia’s and Lithua-
Latvia Euro zone
Source: Reuters EcoWin nia’s debts have climbed rapidly from low pre-crisis levels (16
and 9 per cent of GDP, respectively), the upturn in debt is now
To date, the economic upturn in the Baltics has largely been decelerating. Their 2012 debt levels will be a bit over 40 and
driven by dynamic exports, which have benefited from better 50 per cent of GDP, respectively. This is below the 60 per cent
competitiveness due to previous large pay cuts and a favour- Maastricht ceiling.
able geographic position. Improvements in competitiveness
ended late in 2010 when private sector pay and inflation re- Estonia: High inflation will soon peak
bounded, but exports are continuing to enjoy good demand Estonia is better positioned for recovery than Latvia and
from nearby countries. For Estonia, the Swedish and Finnish Lithuania. This is because its public finances are under control
markets are especially important, while expansion in Germany − it was the only EU country with a 2010 budget surplus (0.1
and neighbouring Eastern European economies means more to per cent of GDP) and it has the EU’s lowest debt (6.6 per cent)
Latvia and Lithuania. − and because its exports are relatively larger. GDP growth will
climb from 3.1 per cent in 2010 to 5.0 per cent in 2011 and 4.5
Meanwhile the role of exports as a growth engine is fading as
per cent in 2012.
domestic demand gradually recovers. Private consumption
is benefiting from rising pay and higher employment. In the

32   |  Nordic Outlook – May 2011

 Baltics

Unemployment fell unexpectedly fast from a peak of about term by higher excise taxes on such products as petrol, alco-
20 per cent early in 2010 to less than 14 per cent in the fourth holic beverages and cigarettes. Inflation, measured as annual
quarter last year, a downturn mainly related to the export sec- averages, will climb to 4.4 per cent this year, then fall slightly in
tor. Looking ahead, the jobless rate will improve more slowly to 2012.
an average of 11 per cent in 2012.
Latvia: Exports and private consumption
LVL billion, constant prices
Inflation (HICP) has climbed faster in Estonia than in Latvia and
Lithuania, from zero early in 2010 to 5.4 per cent in April − the 1.6 1.6
highest figure in the euro zone. Since late 2010, inflation has 1.4 1.4
stabilised at this relatively high level. Inflation expectations
1.2 1.2
have failed to rise. We believe that these trends will mainly
1.0 1.0
continue. Inflation will average 5.0 per cent in 2011; next year’s
average will be 4.0 per cent. 0.8 0.8

0.6 0.6
Estonia’s inflation surge can be largely explained by higher
0.4 0.4
global energy and agricultural/food prices plus base ef-
00 01 02 03 04 05 06 07 08 09 10
fects. Fiscal tightening measures have also contributed to
some extent. Energy and food inflation will ease later this year, Exports of goods and services
Private consumption
and base effects are already history. Meanwhile wages are Source: Reuters EcoWin

rising slowly. Yet some price pressure still exists: prices of such
foods as potatoes, apples and milk rose dramatically in March. The EUR 7.5 billion IMF/EU-led international loan pack-
There was also probably a minor inflationary effect related to age introduced in December 2008 expires this year. Latvia
euro zone accession on January 1, 2011, with companies taking has drawn most of this sum but in the past year has phased
the opportunity to raise prices. down its utilisation compared to the original plan, due to its
recovery and strong external balances. After the latest IMF/EU
One important restraining factor in our inflation analysis is review in April, Latvia got the green light to borrow EUR 970
weak money supply growth. Changes in money supply have million from the IMF, the EU, the Nordic countries and other EU
turned out to have a relatively strong impact on underlying countries. Meanwhile the World Bank was expected to approve
inflation. The money supply has recently been squeezed, and a loan of EUR 100 million, but Latvia only intends to draw on
no major upturn can be expected as long as the debt adjust- the latter. After the entire loan programme expires at the end of
ment process continues. 2011, repayments will begin in 2012. Latvia will probably fund
Estonia: HICP, core HICP and money supply these via borrowing in the global capital market.
Year-on-year percentage change
12.5 50 Lithuania: Worrisome labour shortage
45
10.0 40
Exports continue to drive growth, but the expansion will be-
7.5
35 come more broad-based in 2011 as fiscal tightening has been
30
25
eased. Since the second half of 2010, the retail and construc-
5.0
20 tion sectors have begun to wake up, contributing to a high GDP
15
2.5
10
growth rate of nearly 7 per cent in the first quarter of 2011.
0.0 5 Home prices in major cities are now also poised for an upturn.
0
-2.5 -5
GDP will increase by 4.0 per cent in 2011 and 4.5 per cent
00 01 02 03 04 05 06 07 08 09 10 in 2012, after last year’s weak 1.3 per cent growth. Inflation,
M2 money supply (RHS)
which has been driven by food and energy until now, will climb
HICP (LHS) somewhat higher. In April the year-on-year rate was 4.4 per
HICP excl energy, food, alcohol, tobacco (LHS)
Source: Reuters EcoWin cent. We predict 4.0 per cent in 2012 as a whole.

Latvia: Dual economy
Latvia’s economic turnaround has been on more solid ground
since the country resumed positive year-on-year growth in
the third quarter of last year. GDP fell 0.3 per cent in 2010 as a
whole. But this year Latvia’s dual economy is still apparent:
exports are performing strongly while domestic demand
is moving upward fitfully. In the fourth quarter of 2010, ex-
ports were back at their 2008 peak, while private consumption
remained depressed. Overall, GDP growth will reach 3.7 per
cent in 2010 and 4.3 per cent in 2012.
Unemployment is slowly falling after a peak of more than 18
per cent in the second quarter of 2010. It stood at 17 per cent
in the fourth quarter and is expected to be 12 per cent in 2012.
Despite high unemployment there are clear signs of labour
shortages. Looking ahead, these bottlenecks will become
increasingly acute and will hamper the economic recovery.
The problems are mainly in the transport, IT, textile and food
processing sectors.

Unemployment will fall from 17.2 per cent in the fourth quarter
of 2010 to an average of 14.7 per cent in 2012. In April, the
inflation rate was 4.3 per cent; it will be sustained in the short

Nordic Outlook – May 2011  |  33

Sweden

Deceleration from a high level

ƒƒ Export industry can tolerate stronger krona
ƒƒ Interest rate hikes cool off housing market
ƒƒ Upside risks in the next wage round
ƒƒ Riksbank rate hike at every 2011 meeting
ƒƒ Strong budget figures allow new stimulus
The Swedish economy is continuing its rapid expansion, though
many indicators are beginning to slow from extremely high
levels. We expect GDP growth of 4.7 per cent in 2011 and 2.6
per cent in 2012 (3.0 corrected for working days): unchanged
compared to Nordic Outlook in February. But the driving forces
in the economy have shifted, with faster export growth and
somewhat less expansive consumption. Uncertainty about how
well the export sector would handle the stronger Swedish krona
diminished early in 2011. Meanwhile the reaction of households
to rising home mortgage rates has been unexpectedly clear.
The slowdown in growth during 2012 will partly be a conse-
quence of supply side constraints that gradually make them-
selves felt. Unemployment will fall below 7 per cent as early
as this year och move towards 6 per cent by the end of 2012:
somewhat below equilibrium level. We expect wages and sala-
ries to rise at a total rate of nearly 4 per cent during 2012, from
about 2.5 per cent during 2010 and 2011. Because of demands
one per cent of GDP. The change in policy mix towards more
expansive fiscal policy and tighter monetary policy, which we
discussed in the last Nordic Outlook, will thus continue.
Manufacturers strong, despite the krona
Exports have now completely regained their 2008 and 2009
decline. Confidence indicators for the manufacturing sector fell
somewhat in April, but their levels still point towards continued
growth that is well above trend. Companies’ responses in vari-
ous surveys reinforce the view that the strong Swedish cur-
rency is not threatening their competitiveness; a large majority
maintain that the exchange rate is not a problem. The quarterly
reports of export companies, which reveal expansive future
plans, confirm this picture.
The strength of the international upturn will thus determine
Sweden’s export prospects. Because of strong increases early in
2011 and continued strong forward-looking indicators, we have
adjusted our export forecast upward. We are now expecting
growth of more than 10 per cent this year and eight per cent
next year. This forecast implies that the level of exports will
return to its long-term trend by the end of 2012.
Exports back at trend level 2012
Index 100 = 2007
130 130
120 120

for compensation for low pay increases during the crisis and 110 110

high inflation expectations, the risks are on the upside. 100 100
SEB
forecast
90 90
Despite international price increases for food and energy,
Swedish inflation excluding interest rate changes (CPIF) has 80 80

been less than 2 per cent. Core inflation will soon bottom out, 70 70
but because of low increases in unit labour cost and continued 60 60
krona appreciation, the upturn will probably be slow. 00 01 02 03 04 05 06 07 08 09 10 11 12

Total Trend, 1998-2009

We still believe that the Riksbank will hike its key interest Source: Statistics Sweden

rate at every monetary policy meeting this year, bringing

it to 2.75 per cent in December. Because of rising inflation ex-
pectations, as well as rate hikes by the European Central Bank,
the Riksbank will proceed somewhat faster than it has an-
nounced so far. Increasingly strained resource utilisation in the
Swedish economy points towards continued rate hikes in 2012;
we expect a repo rate of 3.75 per cent by September.
Swedish government finances are continuing to improve
faster than expected. Together with low government debt,
this will allow room for further fiscal stimulus measures.
We expect proposals equivalent to another SEK 5-10 billion
to be unveiled in the September budget bill. Combined with
the measures announced in the spring budget, this will bring
total fiscal stimulus in 2012 to SEK 30-35 billion, equivalent to
Higher industrial investments in 2011
Partly due to low capacity utilisation, capital spending by Swed-
ish manufacturers was unchanged in 2010, despite a rapid
increase in production. Late in the year, however, capacity
utilisation climbed rapidly. It is now above its historical aver-
age, according to the National Institute of Economic Research’s
Business Tendency Survey. We foresee that due to a continued
upturn in capacity utilisation, combined with a historically low
fixed investment level, capital spending by manufacturers will
increase by 13 per cent this year and then continue upward
at a rapid pace in 2012 as well. This forecast is supported by
Statistics Sweden’s latest capital spending survey, which indi-
cates that companies have revised their 2011 investment plans
upward.

34   |  Nordic Outlook – May 2011

 Sweden

Residential investments rose sharply in 2010 after their down-
turn during the crisis. Record-high increases in the number of
housing starts indicate that new construction will continue to
grow during 2011. A low level of residential investments com-
pared to other countries, combined with strong population
gains in many larger cities, are underlying reasons for a contin-
ued upturn. Yet there are signs that higher mortgage interest
rates and the recent introduction of a loan-to-value ceiling on
home loans will have a larger impact on the housing market
than expected. Some single-family home builders reported
per cent of income, while the percentage of households paying
adjustable interest rates has increased. In addition, mortgage
rates have climbed about 50 points more than the repo rate.
Rising food and oil prices will also undermine purchasing power
to a greater extent than they did in 2006-2008. These factors
will contribute about -0.5 per cent yearly during 2010-2012.
Solid consumer confidence
Year-on-year percentage change, net balance
12.5 50
10.0 40

falling demand early in 2011, resulting in a downward revision 7.5 30

5.0 20
in the housing starts forecast. Total residential investments
2.5 10
will be held down by a levelling-off of renovation, following a
0.0 0
doubling in 2010 after the government introduced a temporary
-2.5 -10
tax deduction for home renovations and repairs. Altogether, -5.0 -20
residential investments will increase by 11 per cent this year and -7.5 -30
by 4.6 per cent in 2012. 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Investments pick up Private consumption (LHS)

Retail sales (LHS)
Year-on-year percentage change Confidence among consumers and retailers (RHS)
30 30 Source: Statistics Sweden

20 20 On the other hand, there are powerful forces that will help fuel
a continued upturn in consumption. Real household income
10 10
is rising by 2.5-3 per cent annually, mainly due to a record-fast
0 0 rise in employment. Tax cuts will give households an extra
SEK 7 billion this year (0.5 per cent of income) and another
-10 -10
SEK 15 billion (nearly 1 per cent of income) in 2012. According
-20 -20 to generally reliable short-term indicators such as consumer
-30 -30
confidence, the slowdown is temporary, and we expect stronger
00 01 02 03 04 05 06 07 08 09 10 figures ahead. Overall, we expect consumption to grow by 2.5
Total Business Housing per cent both this year and in 2012, a downward revision from
Source: Statistics Sweden
3.3 per cent in 2011.

Interest rates slow the consumption boom

Private consumption rose by 3.5 per cent in 2010, on a par with Household income and consumption
the highest growth levels of the past 20 years. Early in 2011, Year-on-year percentage change
however, sagging retail sales raised the question of how much 2009 2010 2011 2012
impact rising interest rates and inflation will have on people’s Consumption -0.4 3.5 2.5 2.5
willingness to spend.
Income 1.6 1.4 2.3 2.9
Interest rates, oil and food hurting real income
Contribution to real household income, percentage points Savings ratio, level 12.9 10.7 10.6 10.9
2.0 2.0
Source: Statistics Sweden, SEB
1.5 SEB forecast 1.5

1.0 1.0 Lending to households will slow

0.5 0.5 Lending to households is continuing to decelerate, but the
0.0 0.0
annual rate of increase still exceeds 7 per cent. This is above a
-0.5 -0.5
sustainable level. Accelerations and decelerations in household
borrowing have historically coincided with shifts in monetary
-1.0 -1.0
policy. This pattern has applied even in situations where the
-1.5 -1.5
economic cycle and the labour market have been moving in the
04 05 06 07 08 09 10 11 12
opposite direction. It is thus likely that the deceleration in lend-
Interest rate expenditure (ex taxes) Food prices
Petrol prices ing will continue.
Source: Statistics Sweden, SEB

In recent issues of Nordic Outlook, we have discussed housing

We predict that rising mortgage rates will lower disposable
market risks in detail as well as the special characteristics that
household income by more than one percentage point a year in
distinguish the Swedish residential market from that of other
both 2011 and 2012. During the monetary policy tightening of
countries. Mortgage rates that have climbed even faster than
2006-2008, this effect was only 0.7 per cent yearly. Key interest
the repo rate, as well as the early effects of the new ceiling on
rate hikes are expected to be somewhat faster this time around
loan-to-value ratios, now seem to be having an effect on the
(350 basis points in 27 months, compared to 325 points in 32
housing market. In March, the year-on-year rate of increase
months). In addition, household debt has risen by about 25

Nordic Outlook – May 2011  |  35

 Sweden

in home prices was as low as 2.5 per cent. Looking ahead,
however, the signals are a bit mixed. In many parts of Sweden,
it is taking longer to reach financial close on home purchases,
a sign of a further slowdown in price increases ahead. Yet our
own home price indicator is signalling a continued upturn in
prices. The housing market seems to be cooling off during a
period of strong economic expansion and rising employment,
which increases the likelihood of a soft landing, although there
are still great risks.
According to short-term indicators, the labour market im-
provement will continue. Hiring plans in the NIER’s Economic
Tendency Survey and the number of newly listed job openings
remain at high levels. We continue to believe that unemploy-
ment will drop below 7 per cent as early as this year and contin-
ue downward towards 6 per cent in 2012. The number of jobs
will grow by 110,000 this year and by 65,000 in 2012.
Unemployment is falling
9.0 4750

Monetary policy affects household borrowing 8.5

4700
16 5.0 4650
SEB
4.5 8.0
15 forecast 4600
14 4.0 7.5 4550
13 3.5
7.0 4500
12 3.0
4450
11 2.5 6.5
4400
10 2.0
6.0
4350
9 1.5
8 1.0 5.5 4300
02 03 04 05 06 07 08 09 10 11 12
7 0.5
6 0.0 Unemployment, per cent (LHS)
99 00 01 02 03 04 05 06 07 08 09 10 11 Employment, thousands (RHS)
Source: Statistics Sweden, SEB
Household borrowing, year-on-year percentage change (LHS)
Repo rate, per cent (RHS) Productivity continues to recover strongly, which is normal in
Source: Statistics Sweden, Riksbank
a recovery phase, yet the 2012 level will still be about 2 per
cent below the long-term trend. In this respect, current devel-
Slowdown in home prices opments differ from the 1990s economic crisis. At that time,
Year-on-year percentage change long-term production capacity was hurt by a sharp upturn
15.0 15.0
in equilibrium unemployment, while productivity quickly ex-
12.5 12.5
ceeded its previous trend level. This time around, it looks as if
10.0 10.0
there is a risk that long-term damage will occur mainly on the
7.5 7.5 productivity side.
5.0 5.0
Labour shortages in the business sector
2.5 2.5 Net balance
35 70
0.0 0.0
30 60
-2.5 -2.5
25 50
-5.0 -5.0
04 05 06 07 08 09 10 11 20 40

Source: Statistics Sweden 15 30

10 20
Labour market continuing to strengthen 5 10
Unemployment was just above 7.5 per cent during the first 0 0
quarter. This means that half the upturn during 2008 and 2009 00 01 02 03 04 05 06 07 08 09 10

has now been reversed. Employment has improved even more
noticeably. The number of people with jobs is now already
higher than at the peak in 2008.
Labour market
Percentage change
2009 2010 2011 2012
Employment -2.1 1.0 2.4 1.4
Labour supply 0.2 1.1 1.4 0.4
Unemployment, % 8.3 8.4 7.2 6.3
Average hours worked -0.5 0.8 -0.4 -0.4
Productivity (GDP) -2.7 3.4 2.6 2.0
Source: Statistics Sweden, SEB
Manufacturing (LHS) Distributive trade (LHS)
Services (LHS) Construction (RHS)
Source: NIER
Resource utilisation keeps climbing
Resource utilisation indicators are continuing to creep upward.
The percentage of companies reporting labour shortages as
the main constraint on increased production kept climbing
in the first quarter, but there were major differences between
economic sectors. Whereas labour shortages shrank in manu-
facturing, they increased sharply in the construction sector. In
other sectors, the upturn continued at about the same pace as
before. Today the shortage figures in the business sector
are now somewhat above the historical average.
Other indicators provide a somewhat more soothing picture.
Capacity utilisation fell somewhat during the first quarter, and

36   |  Nordic Outlook – May 2011

 Sweden

our own composite resource indicator was stable at a level just cating that these problems have worsened. Taken together,
above the historical average. we believe that the 6 per cent jobless rate that we predict by
the end of 2012 will actually be somewhat below long-term
Capacity utilisation above historical average
2.0 2.0
equilibrium unemployment.
1.5 1.5
Higher pay increases in 2012
1.0 1.0
The 2010 wage round was dominated by the economic crisis.
0.5 0.5 Collective agreements ended up at historically low levels, which
0.0 0.0 are now reflected in incoming wage and salary statistics. Pre-
-0.5 -0.5 liminary monthly figures indicate that pay increases in 2011 will
-1.0 -1.0
be only 2.5 per cent.
-1.5 -1.5 The two sides have now begun positioning themselves for the
-2.0 -2.0 2012 wage round. About 70 agreements for some 400,000
03 04 05 06 07 08 09 10 employees will expire during 2011. Agreements for white-collar
Riksbank, RU indicator SEB's indicator employees in industry expire this September, but the parties
Source: Riksbank, SEB
have postponed the start of their next contract negotiations
Assuming an improved labour market, it is highly likely that until late January 2012 to allow coordination with blue-collar
resource indicators will continue to climb and that at some agreements. The manufacturing sector’s ambition is to regain
point they will be back at their 2006/2007 peaks. By then its role as the first to negotiate. We expect industrial wage talks
unemployment will be higher than the NIER estimate of equilib- to enter their most intensive phase around the turn of the year.
rium unemployment, but quite close to the Riksbank’s previous Other negotiations will be concentrated in March and April,
estimate. Both the government and NIER have recently adjust- when retail and local government sector contracts are among
ed their equilibrium estimates downward, among other things those that expire. Expiration dates are less concentrated in
citing the government’s labour market policies. 2012 than was the case in 2010.
We share the view that government policies have helped
enlarge labour supply, thereby making a strong increase in 2011 and 2012 wage round
employment possible. However, we are more sceptical as to
whether equilibrium unemployment has actually fallen. Several Expiration Employees Categories included
of the actions taken to reduce labour market exclusion have 2011
instead contributed to rising equilibrium unemployment, for Mar 31 128,000 Church of Sweden
example because individuals with a weak connection to the la-
Sep 30 174,000 White-collar (industry)
bour market are now recorded as openly unemployed. Another
factor that may work in the same direction is the increasing 2012
exclusion from the labour market of certain immigrant groups Jan 31 350,000 Mainly industrial
that may find it difficult to land jobs due to language problems,
Feb 28 82,000 Auto sales and service et al
low educational levels and/or discrimination.
Long-term unemployment at high levels
Mar 31 454,000 Retail, IT and telecom
Including labour market measures Apr 30 1,180,000 Local gov’t, temporary staffing
6.0 6.0
5.5 5.5 May 31 138,000 Hotel, restaurant et al
5.0 5.0
4.5 4.5
Sep 30 160,000 Central gov’t et al
4.0 4.0 Source: National Mediation Office
3.5 3.5
3.0 3.0
2.5 2.5
The economic environment will be totally different from
2.0 2.0 that surrounding the 2010 wage round. Corporate profitabil-
1.5 1.5 ity is relatively good, and the improved labour market with its
1.0 1.0
01 02 03 04 05 06 07 08 09 10 11
rising shortages indicates greater risks of bottleneck problems.
Meanwhile CPI inflation is currently high, undermining real
Longer than 6 months Longer than 24 months
Longer than 14 months wages. In light of these circumstances, employee unions will
Source: Statistics Sweden
probably present relatively high wage and salary demands. For
The available indicators hardly support the belief that equi- example, the unions in the manufacturing sector have already
librium unemployment is falling. The level of labour shortages presented arguments as to why they believe it is reasonable for
indicates that we are not especially far from labour market Swedish wages to increase at a faster pace than the European
balance. The “Beveridge curve”, which shows the association average. We are sticking to our forecast that pay hikes in 2012
between unemployment and the number of job vacancies, will be nearly 4 per cent, but the risks are on the upside. The
instead points to a structural deterioration in terms of labour annual average will be pushed up somewhat because the revi-
market matching. The continued increase in the number of sion date in the existing agreements is at the end of 2011.
people registered as job seekers for very long periods at the
Public Employment Service is also a bad omen, perhaps indi-

Nordic Outlook – May 2011  |  37

 Sweden

Low core inflation will rise slowly behind the clear upturn in inflation expectarions over the past
Despite rising energy and food prices, CPIF inflation (CPI with six months. In a situation of strong economic growth and esca-
constant mortgage rates) has remained low. The reason is lating resource utilisation, rising long-term inflation expecta-
that core inflation, defined as CPIF excluding energy and food, tions will undoubtedly give the Riksbank some headaches.
continued falling early in 2011 and was 0.9 per cent in March. Rising inflation expectations
Continued energy price increases will push up inflation in the Year-on-year percentage change
next few months, but we expect CPIF will still mostly remain 3.25
SEB's
3.25
Q2 forecast
below two per cent during the next couple of years. 3.00 3.00

2.75 * 2.75
Core inflation will soon bottom out, but the upturn will occur *
2.50 2.50
very gradually. During 2011 most movement will be sideways. 2.25 2.25
A combination of low pay increases and falling imported goods
2.00 2.00
prices due to the stronger krona will keep the lid on inflation.
1.75 1.75
Downward pressure due to the krona will slowly ease, while
1.50 1.50
wage and salary growth will accelerate next year. Not until the
1.25 1.25
end of next year will inflation approach the Riksbank’s target, 95 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
we believe. The risk that resource utilisation will drive core
Prospera, 2 years Prospera, 5 years
inflation above two per cent lies mainly beyond our forecast Source: Prospera

horizon.
Inflation Continued Riksbank interest rate hikes
Year-on-year percentage change Labour market developments and inflation expectations are
5 5
increasing the likelihood that interest rate hikes will be im-
SEB forecast
4 4 plemented at a faster pace than the Riksbank has announced
3 3 to date. In a situation where more and more indicators are
2 2
showing that the labour market is relatively close to equilib-
rium, while inflation expectations are relatively high even in a
1 1
long-term perspective, it will be increasingly difficult to justify
0 0 a repo rate that is far below a neutral level. Risks of excessively
-1 -1 large spreads on key interest rates in other countries have also
-2 -2
diminished, now that the ECB has begun its hiking cycle. We
08 09 10 11 12 are thus adhering to our forecast that the Riksbank will raise
CPIF CPIF excl energy and food CPI its key rate at every monetary policy meeting up to and
Source: Statistics Sweden, SEB
including September 2012. This implies that the repo rate
Food prices were unusually low early in 2011, and year-on-year will be 2.75 per cent at the end of 2011 and 3.75 per cent
change is still below one per cent. Producer prices have begun at year-end 2012. The Riksbank will thus reach a level that we
to climb, however, and higher food prices in other European believe corresponds to a neutral interest rate after the changes
countries indicate that an upturn may be on the way in Sweden that have occurred in the wake of the financial crisis, including
as well. We expect food price increases to accelerate to about regulatory reforms that are resulting in higher borrowing costs
three per cent by year-end. for banks.
Diverging Riksbank expectations
The lowering of value-added tax on restaurant services will 4.00 4.00
theoretically lower CPI inflation by 0.4 per cent during 2012, 3.75 3.75
but in the short term the entire tax cut will not be passed on to 3.50 3.50
consumers. The announced tax increases on alcoholic bever- 3.25 3.25

ages and tobacco products will boost CPI by 0.2 per cent, while 3.00 3.00
2.75 2.75
indexing of energy taxes will add another tenth. The total con-
2.50 2.50
tribution of taxes is expected to be fairly neutral, both this year
2.25 2.25
and next. Our overall CPI forecast has changed very little since 2.00 2.00
February, but it conceals a rather large downward adjustment in 1.75 1.75
2011 core inflation, while the contribution of energy prices has 1.50 1.50
become significantly higher. May Aug Nov Feb May Aug Nov Feb May Jan
11 12 13 14
Market pricing Riksbank, April 2011
High CPI will drive up inflation expectations SEB forecast
Source: SEB

A sharply higher weighting for short-term mortgage interest

Meanwhile various factors are helping reduce the risks of an
rates has driven up CPI inflation. The effect has been more
even more aggressive repo rate path, with hikes of 50 basis
powerful than expected, and forecasts have thus been adjusted
points at a time. Core inflation early in 2011 was significantly
upward significantly in recent months. At times, CPI will exceed
less than expected, keeping CPIF inflation below two per cent
3.5 per cent this year. It will be a bit above 2 for our entire fore-
despite sharply rising oil prices. Slower growth in lending vol-
cast period. A CPI upturn driven by interest rate hikes need not
ume and home prices will also help reduce the upside risks.
be a problem in itself, but this is probably one important reason

38   |  Nordic Outlook – May 2011


Although the Riksbank has toned down the role of home prices
in its monetary policy, there are many indications that the risk
of a housing bubble has been important to several members of
the central bank’s Executive Board.
The latest published Executive Board minutes show deepening
disunity on how to pursue monetary policy in different phases
of the economic cycle and what potential there is to steer infla-
tion and resource utilisation to the desired levels. The members
who have voted against repo rate hikes, Lars E O Svensson
and Karolina Ekholm, have revised their alternative rate
paths sharply upward in the long term, an indication that in
the fairly immediately future they might change their minds.
If the trend towards rapidly declining unemployment and
rising inflation expectations continues, their positions may
be different within a year or so. If home prices should begin
to fall in a situation of high resource utilisation, for example,
the arguments that Svensson in particular has been push-
ing hard in recent years could be completely turned upside
down; a strict interpretation of the inflation target would not
support easing the rate hike path out of consideration for
the housing market.
Slowly widening yield spread to Germany
In recent months, the yield differential against Germany on 10-
year government bonds has fallen. At present, Swedish 10-year
bonds actually have lower yields than German ones. This is
partly because expectations of ECB rate hikes have risen, while
expectations regarding the Riksbank have fallen somewhat. In
addition, the very limited supply of Swedish government bonds
has continued to limit upward pressure on yields.
Slowly widening yield-spread vs Germany
Basis points
1.25
1.00
0.75
0.50
0.25
SEB
0.00
forecast
-0.25
-0.50
-0.75
-1.00
05 06 07 08 09 10 11 12
Repo rate spread (LHS)
10-year government yield (RHS)
Source: Reuters EcoWin, SEB
Looking ahead, we believe that widening key interest rate
spreads are more important than the difference in volume
of securities issued. The yield spread will thus rise slowly
during the next couple of years. We have nevertheless noted
recent signals that supply may be a more important factor than
we had thought. We have thus adjusted our forecast downward
to 20 basis points at the end of 2011 and 30 points at the end
of 2012. One reason is that we expect the Swedish National
Debt Office to lower its supply of bonds in its revised borrowing
plan on May 18. The yield on a 10-year government bond
will thus climb to 3.65 per cent in December 2011 and to
4.25 per cent in December 2012.
Continued krona appreciation
Since the second quarter of 2009, the Swedish krona has
Sweden
strengthened continuously. In February 2011 it reached SEK
8.70 per euro, an exchange rate movement of nearly 20 per
cent. Its appreciation against the US dollar and in trade-weight-
ed (TCW) terms has been almost as large. The strong recovery
of the Swedish manufacturing sector has been one important
explanation, since the association between the krona exchange
rate and the market for Swedish industrial goods has been very
strong since floating exchange rates were introduced in 1992.
The Riksbank’s interest rate hikes have been another important
factor over the past year. In recent months, however, the krona
has weakened by 2-3 per cent to about SEK 9.00 per euro,
due among other things to international market instability,
the ECB’s unexpectedly early rate hike and some doubt about
the pace of Riksbank rate hikes. The krona has continued to
strengthen against the dollar during much of 2011, although
the USD regained some ground against the SEK recently.
Still room for stronger SEK
12 160
155
11
150
10 145
9 140
135
8 130
125
7
120
6
115
5 110
96 98 00 02 04 06 08 10
TCW Index, 1992NOV18=100 (RHS) USD/SEK (LHS)
EUR/SEK (LHS)
Source: Reuters EcoWin
Our assessment is that there is potential for further krona
appreciation over the next couple of years. Swedish economic
0.4
growth will be faster than in the euro zone, and key interest rate
0.3 gaps against the ECB and the Fed will widen over the coming
0.2 year. Sweden’s strong government finances will also continue
0.1 to attract investors, among them other central banks. At the
0.0 same time, there is reason to believe that krona appeciation will
-0.1
be somewhat slower than we had previously assumed, partly
-0.2
due to faster rate hikes by the ECB. The export sector will also
-0.3
-0.4
weaken as an economic driving force as expectation indicators
-0.5 level off.
Our forecast is that the krona will strengthen to SEK 8.70
per euro by the end of 2011 and further to SEK 8.50 by late
2012. This forecast is supported by our estimate of the EUR/
SEK equilibrium exchange rate, which is 8.30. We expect a USD/
SEK exchange rate of 6.20 by late 2011, moving to 6.30 as the
USD regains ground during 2012. Our forecast implies that in
TCW terms, the krona will reach 115, its strongest level since
1996.
Public finances continuing to surprise
After two years of deficits, Swedish public sector finances have
now returned to a surplus. The deficit in 2009 was 1 per cent
of GDP and fell last year to 0.3 per cent. Despite continued
expansionary fiscal policy, the surplus will be 0.8 per cent
this year and 1.3 per cent in 2012.
Central government finances are gradually improving. The
central government surplus (negative borrowing require-
Nordic Outlook – May 2011  |  39
 Sweden

ment) will total SEK 57 billion this year and SEK 64 billion
in 2012. The sale earlier this year of government-owned shares
in the commercial bank Nordea contributed nearly SEK 20
billion and we expect decisions Parliament has already made
to enable the government to divest an additional SEK 35 billion
worth of state-owned companies this year and next, most of it
probably next year.
Public finances
Per cent of GDP
2009 2010 2011 2012
Revenue 52.2 50.8 50.1 50.0
Expenditures 53.2 51.1 49.3 48.7
Net lending -1.0 -0.3 0.8 1.3
Gen. gov’t gross debt 41.9 39.0 34.2 30.3
Central gov’t debt 37.2 33.5 30.1 26.9
Borrowing req., SEK bn 176 1 -57 -64
Source: Statistics Sweden, SEB
This trend implies that Swedish central government debt
will fall to a record-low 27 per cent of GDP in 2012. The
government is moving ever closer to a political crossroads,
where it must choose between either a tight budget focusing
on safety margins, surpluses and reduced debt or committing
itself to desirable tax cuts or expenditure reforms. Our conclu-
sion in the box entitled “Is there an optimal government debt
level?” (Nordic Outlook, February 2011) was that Sweden’s cen-
tral government debt is now at such a low level that it is difficult
to justify further debt reduction.
Government debt keeps falling
Per cent of GDP
80
75 SEB
70 forecast 70
liability to central government income tax. The dominant Mod-
erate Party is thus continuing to successfully pursue its policy
of cutting taxes on labour, but the smaller parties in the non-
socialist Alliance government are also getting their slice of the
pie: the Centre Party through lower VAT on restaurant services,
the Christian Democrats via tax cuts for pensioners and the
Liberals to some extent through the higher threshold on central
government tax. The spring reform proposals will cost about
SEK 20 billion.
Because of the tax cuts announced in the spring budget bill,
much of the amount available for reforms next year has already
been taken. This will limit room for expenditure increases.
However, we expect additional expansionary measures equiva-
lent to SEK 10 billion to be included in the autumn budget bill.
This will bring the dose of fiscal stimulus in 2012 up to SEK 30
billion, or about 0.9 per cent of GDP. After the September 2010
election, the Alliance became a minority government. It has
suffered some reversals in Parliament. This is one reason why
the Alliance will probably try to include as many of its proposals
as possible in the autumn budget bill. This will deprive the op-
position of its ability to defeat these proposals by voting down
individual bills, since the rules for defeating a government
budget are stricter.
80
75

65 65
60 60
55 55
50 50
45 45
40 40
35 35
30 30
25 25
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

General government debt Central government debt

Source: Eurostat, Swedish National Debt Office, SEB

The government’s spring fiscal policy bill contained more

concrete stimulus measures than we had expected, thus repre-
senting a step towards more aggressive economic policy. The
bill emphasised tax cuts, including a fifth stage in the earned
income deduction reform and a higher income threshold for

40   |  Nordic Outlook – May 2011

 Denmark

Modest expansion amid debt, fiscal austerity

ƒƒ Continued sub-par recovery in 2011
ƒƒ Weak consumption and construction
ƒƒ Strong public and external balances
ƒƒ Household debt still the Achilles heel
ƒƒ Policy puzzle: bracing for the worst?
will remain positive. Survey-based employment indicators
have been improving recently, and job creation is likely to turn
positive in the second half of the year. We expect growth of
around 2 per cent in both 2011 and 2012.
Consumption and confidence
20 10

15

10 5
Denmark’s recovery from the 2008-2009 recession is likely to 5
continue through our forecast period but remain sub-par,
0 0
with GDP growth of 2-2.5 per cent. Private consumption
-5
faces headwinds from weak income growth and high debt lev-
-10 -5
els, but exports will benefit from strong demand in key markets
and capital spending is set to pick up speed. -15

-20 -10
The Danish economy has come out of the crisis looking robust. 92 94 96 98 00 02 04 06 08 10
Public finances are in better shape than feared, with the budget Consumer confidence, net balance (LHS)
deficit staying below 3 per cent of GDP and the current account Consumption, per cent (RHS)
Source: Reuters EcoWin
surplus topping 5 per cent of GDP in 2010. Wage inflation has
declined to close to 2 per cent. The weakness is household Exports will lift capital spending
debt, which means consumption is likely to be more sensitive More positive signals are also emerging from the business
to rising short-term interest rates than in previous expansions. sector, where manufacturing indicators in particular have taken
Against this background, the current policy outlook is puzzling. off in 2011. So far, exports have been the driving force in the
The government is pushing through more austerity, the central recovery, as Danish producers benefit from soaring growth
bank has accumulated record foreign exchange reserves and in such major export markets as Germany and Sweden. Rising
the debt office has covered funding needs well into 2012. The capacity utilisation has also led to a stabilisation in non-resi-
most likely explanation is that authorities want a clear policy dential fixed investment.
buffer. Household balance sheets remain fragile. Signalling to Capacity utilisation and investment
markets that the rest of the economy is “overcapitalised” may 30 15
reduce the risk of a confidence shock.
20 10

Sub-par consumption upswing 10 5

Private consumption is likely to continue to lag the normal
0 0
post-recession recovery pattern. Not only has there been no
post-recession surge in spending as in 1994 and 2004, but -10 -5

consumer confidence has fallen, suggesting that spending is -20 -10

starting to lose momentum again.
-30 -15
Consumers are responding to a range of disincentives to 92 94 96 98 00 02 04 06 08 10

spending. First, employment is still falling and wages are be-
ing outpaced by consumer prices. Second, the positive income
effect from earlier stimulus packages is now being reversed.
Third, home prices have stalled after a feeble attempt at a
rebound, and ECB rate hikes are likely to add to the pressure for
de-leveraging.
Altogether, this suggests that income growth will remain
modest and the household savings ratio will remain elevated
in 2011 and 2012. However, while this probably means that
spending growth will be modest in the coming years, it
Non-residential investment, per cent (LHS)
Capacity utilisation in manufacturing, percentage points (RHS)
Source: Reuters EcoWin
Strong leading indicators suggest that capital spending will
start rising in the second half of 2011, but due to low capacity
utilisation and weak domestic demand, growth will likely re-
main modest. Even housing investment has stabilised, but with
prices more than 20 per cent below their peak and the supply
overhang from the building boom of the ‘00s still not fully
absorbed, the upside is limited.

Nordic Outlook – May 2011  |  41

 Denmark

Internal and external strength
While the recession was deep and expansion so far has been
sub-par, Denmark appears to have emerged from the crisis
looking remarkably robust.
Public sector finances are clearly not a pressing concern. Early
in the year, some data appeared to point to a deficit of more
than 5 per cent of GDP in 2010. However, revised Eurostat data
paint a much stronger picture, with the deficit peaking at
below 3 per cent of GDP and the debt ratio likely to peak
below 45 per cent of GDP.
unfolds over the coming 1-2 years. However, unlike the situa-
tion in southern Europe and the UK, this is a purely domestic
imbalance.
The policy conundrum
Against this backdrop, the current policy debate is puzzling.
With strong internal and external balances and with consump-
tion facing debt-driven headwinds, authorities might be ex-
pected to provide modest support for income growth.
Repo spread and currency reserve
2.0 500

Budget and current account 450

1.5
Per cent of GDP 400
6 6
1.0 350
5 5
300
4 4
0.5 250
3 3
2 2 200
0.0
1 1 150
0 0 -0.5 100
-1 -1 99 00 01 02 03 04 05 06 07 08 09 10 11

-2 -2 Repo spread vs ECB, percentage change (LHS)

-3 -3 Currency reserve, DKK billions (RHS)
Source: Reuters EcoWin
97 98 99 00 01 02 03 04 05 06 07 08 09 10

Current account Budget balance
Source: Reuters EcoWin
External balances also look strong, with the current account
surplus exceeding 5 per cent of GDP for the first time and a
net foreign debt close to zero. Competitiveness is not a concern
either, with wage inflation close to 2 per cent and rising curren-
cies in other parts of Scandinavia reducing relative prices.
Household debt still the Achilles heel
The only real weak spot is high debt. At 193 per cent of GDP,
non-financial private sector debt remains at the very top
of the international range. Households hold most of this debt
and have not reduced its amount since the crisis. Instead, they
have shifted to debt instruments that are less expensive to
service, including adjustable rate mortgages – almost all with
no equity payments.
Outstanding debt
DKK trn
2.50
2.25
2.00
1.75
1.50
Instead, the government is waging its election campaign on
new austerity measures, including an increase in the retirement
age. Fiscal policy is likely to reduce GDP growth by 0.5-1
per cent in both 2011 and 2012, and while long-term sustain-
ability is a laudable objective, it is clearly not the most pressing
one. Meanwhile, the central bank has raised foreign exchange
reserves to more than DKK 450 billion, covered government
funding well into 2012 and called for fiscal austerity and tighter
mortgage lending rules.
The most likely explanation for this defensive attitude is that
authorities want a visible policy buffer. The fragile housing mar-
ket is very interest rate-sensitive, rates are going up and a fixed
exchange rate policy means the central bank may have to raise
rates if foreigners decide to sell their Danish financial assets.
Signalling to markets that the rest of the economy is “overcapi-
talised” may reduce the risk of a self-fulfilling confidence shock,
but it comes at the price of a weaker recovery and may even
2.50 direct attention to the weakness it is trying to hide.
2.25
2.00
1.75
1.50

1.25 1.25

1.00 1.00
0.75 0.75
0.50 0.50
0.25 0.25
90 92 94 96 98 00 02 04 06 08 10

Non-financial companies Households

Source: Reuters EcoWin

With more than 60 per cent of all outstanding mortgages on

adjustable rates and more than 50 per cent with no equity
payments, consumer spending will be more sensitive to rising
interest rates than in previous expansions. Home prices could
come under renewed pressure as the ECB rate hike cycle

42   |  Nordic Outlook – May 2011


Rising investment gives the upturn another leg
ƒƒ Investment to fuel the recovery
ƒƒ Tighter labour markets, higher wage growth
ƒƒ Core CPI will trend moderately higher
ƒƒ Norges Bank restarts its normalisation
Last year’s 2.2 per cent growth in mainland GDP – excluding
oil, gas and shipping – was somewhat stronger than expected.
The same was true of overall GDP growth: a very modest 0.4
per cent, due to a sharp drop in oil sector investment and lower
oil and gas exports. However, growth in mainland GDP slowed
in late 2010 and was probably below trend in early 2011 as well.
On the demand side, first quarter growth was held in check by
stalling private consumption and on the supply side by a sharp
drop in electricity production.
The contours of a broader-based recovery in domestic demand
nonetheless remain intact: residential investment was strong
at the start of the year and non-oil business investment has
turned the corner as well. Moreover, oil companies are planning
to increase their capital spending substantially in 2011, which
will stimulate demand elsewhere in the economy. In all, our
forecast for GDP growth is little changed from the last Nordic
Outlook: mainland GDP should be up 3.2 per cent in 2011
and expand 3.7 per cent in 2012, while we foresee growth in
overall GDP of 2.3 per cent and 3.0 per cent, respectively.
Fundamentals will again lift consumption
Private consumption was soft in early 2011 as spending on
goods (half of the total) declined by 0.7 per cent quarter-on-
quarter, slowing abruptly from a solid average quarterly growth
of 1.4 per cent in the second half of 2010. Weakness around the
turn of the year reflected a jump in electricity prices which
squeezed household spending power. This repeated a pattern
seen last spring after a similar surge in electricity prices.
Confidence suggests stronger consumption
12,5
10,0
7,5
5,0
2,5
0,0
-2,5
-5,0
98 99 00 01 02 03 04 05 06 07 08
Consumption of goods, y/y % change, 3 m average (LHS)
Consumer confidence, net balance (RHS)
Source: SSB, FNO/TNS Gallup
Norway
Growth in private consumption should nonetheless reach
3.4 per cent in 2011 and 3.8 per cent in 2012. Consumer con-
fidence improved in the first quarter to a four-year high. This is
consistent with stronger growth in private consumption than
our forecast implies, but the very high level of gross household
debt is likely to restrain consumption growth, once Norges
Bank starts hiking its key interest rate in earnest.
However, household disposable income rose more than 5 per
cent year-on-year in the final quarter of 2010, and the savings
ratio is well above the long-term average. Moreover, wage
growth is set to accelerate in 2011. The trend-setting nego-
tiations for blue-collar workers in the private sector imply a
marginal pickup in wage growth from 3½ per cent in 2010 to
3.6-3.7 per cent in 2011. Last year’s agreement in the manufac-
turing sector set pay increases of 3 per cent, but they ended up
½ percentage point higher due to local wage drift. Wage drift
should be strong this year as well, due to a tighter labour mar-
ket and solid profit growth, while pay increases for white-collar
employees are likely to continue outpacing those for blue-collar
ones.
Negotiations in the central and local government sectors set-
tled on pay hikes of 4 per cent and 4.3 per cent, respectively.
Overall wage and salary growth should accelerate from 3.8 per
cent to 4.2 per cent in 2011 and 4.6 per cent in 2012.
Tighter labour markets
Rising employment will also provide a lift to household in-
come. The labour market has tightened faster than expected.
Including those in government-sponsored labour market pro-
grammes, the downward trend in overall registered unemploy-
ment that started a year ago has gathered speed so far in 2011.
In addition, the unemployment rate according to the Labour
Force Survey declined a rather marked ½ percentage point
from the final quarter of 2010 to 3.1 per cent in the first quarter,
as job growth accelerated to 1 per cent year-on-year.
Part of the drop in the unemployment rate was also due to a
50
surprising 0.2 per cent decline in the labour force since the
40 fourth quarter of 2010. The 0.6 per cent year-on-year increase
was less than population growth; hence, the participation rate
30
has declined.
20
The Labour Force Survey may have underestimated the “real”
10
increase in the labour force, however. Net immigration has
0 been strong in recent years and was 42,000 in 2010. This was
equivalent to two thirds of population growth and 1.6 per cent
-10
09 10 11
of the labour force. The figure may be a bit larger in 2011. How-
ever, only residents of Norway listed in the National Registry are
counted as being part of the labour force. Many people taking
jobs in Norway are not included in the Registry. Thus the actual
Nordic Outlook – May 2011  |  43
 Norway
increase in the labour force is probably larger, and employment
is probably higher as well.
Labour market is tightening
3 month moving average
5 7.00
4 6.00
3
5.00
2 and should rise further, in light of strong order inflow and a
4.00
1 rather large order backlog. However, housing starts remain
0
3.00
2.00
-1
-2 1.00
97 98 99 00 01 02 03 04 05 06 07 08 09 10
Employment, year-on-year percentage change (LHS)
Unemployment, per cent (RHS)
Source: Statistics Norway
In any case, growth in the labour force is likely to pick
up, limiting any further decline in unemployment, which
is expected to average 3.1 per cent in 2011. At the same
time, new jobless claims have trended markedly downward in
recent months (15 per cent lower in April than a year earlier).
Meanwhile a noticeable increase in new vacancies over the six
months to April indicates a rising demand for labour: various
surveys of hiring plans suggest the same.
High oil prices boost the budget surplus
The revised fiscal budget for 2011 once again highlights Nor-
way’s very strong fiscal position. With much higher oil prices
and the improving cycle lowering the non-oil budget deficit
relative to the original plan, the central government overall
budget surplus will swell from NOK 262 billion in 2010
to NOK 313 billion in 2011 or 11.5 per cent of GDP. Mean-
while, the Global Pension Fund Global (GPFG, the sovereign
wealth fund) is expected to rise from 136 per cent to 163 per
cent of mainland GDP by year-end.
The cyclically-adjusted non-oil budget deficit is now seen
broadly unchanged in nominal terms from 2010, while shrink-
ing from 4.3 per cent to 3.7 per cent of the GPFG in 2011. After
two years of overshooting, the deficit thus adheres to the
fiscal policy rule which states that the adjusted deficit over
time shall match the expected 4 per cent real return on the
GPFG. As such, the government might claim that fiscal policy
has been tightened and the budget is “responsible”. However,
the improvement is not due to active budget measures, and
the tightening effect of a modest 0.3 percentage point of
mainland GDP is not much for an economy operating near full
capacity with growth expected to be above trend.
On current assumptions, the Government Pension Fund
Global is expected to increase by almost 9 per cent annually
on average in 2011-2015 which is stronger than the likely
nominal growth rate in mainland GDP (5.7 per cent on aver-
age over the past 10 years). Hence, even assuming then the
structural non-oil budget deficit is kept at the current level
relative to the GPFG, the fiscal policy rule has an inherent
expansionary bias as it implies an increase in the use of the oil
income in the budget in both nominal and real terms.
44   |  Nordic Outlook – May 2011
Strong residential investments
Residential investments turned the corner in 2010 after having
plunged by a third during the ten quarters to end-2009 and
should grow briskly in the current year. Housing completions
were ten per cent higher in the first quarter of 2011 than a year
earlier, but there are many more homes in the pipeline. Housing
starts thus jumped 32 per cent year-on-year in the first quarter
lower than demographics would suggest, while strong labour
migration is fuelling further growth in demand.
Continued imbalances in the housing market helped drive
up existing home prices by 8.3 per cent in 2010; they have
surged 25 per cent since their most recent low in November
2008. The increase has been almost uninterrupted. Prices
dropped in April for only the second time in 29 months and the
year-on-year rate of increase (8 per cent in April) has peaked,
but it is doubtful that prices have seen a definitive turning
point. Demand for both existing and new homes is running
much stronger than supply. Turnover has been at record levels
since mid-2010, and the supply of existing homes for sale is
low.
Housing starts turn upwards
30 40.0
25
20 35.0
15
30.0
10
5
25.0
0
-5 20.0
-10
-15 15.0
98 99 00 01 02 03 04 05 06 07 08 09 10 11
Existing home prices, year-on-year % change (LHS)
Housing starts, 6 month aggregate (RHS)
Source: Statistics Norway, Norwegian Association of Real Estate Agents
Home prices are high relative to for example household in-
come. As the supply of new homes increases and higher inter-
est rates start to bite, home price inflation should start to slow
somewhat, but probably not on a sustained basis until 2012.
Business investment on the mend
Non-residential building starts have also trended upward since
late 2009 and were 13 per cent higher in the first quarter of
2011 than a year earlier, indicative of improving non-oil busi-
ness investment. The year-on-year change in such investments
turned positive in late 2010, but the level was still well below
the peak in 2007, when investment was booming.
Although manufacturing capacity utilisation remains below its
long-term average, manufacturers have increased their capital
spending intentions to a three-year high, suggesting that actual
investment is on the mend following the very deep slump
from early 2008 until last autumn.
Manufacturing makes up only a small part of overall non-oil
business investments (some 12 per cent in 2010), but the
increased optimism in this sector is mirrored in reports from
Norges Bank’s regional network, which covers a broad spec-
 Norway

trum of enterprises in the private sector as well as the public cent rise in the year to the first quarter of 2011 overstates the
sector. Here, capital spending expectations turned noticeably underlying trend, since orders are measured in nominal terms,
more positive in late 2010 to the strongest level since early but it nonetheless mirrors a very solid inflow. On a seasonally-
2007. Although expectations slipped marginally in early 2011, adjusted trend basis, orders continued to move higher at the
the survey suggests a very strong recovery. Non-oil business start of the year, rising almost five per cent from the final quar-
investments may be volatile on a quarter-to-quarter basis, ter of 2010 (and by a third from a year earlier) to the highest
but expectations as measured in this survey have historically level since mid-2008, strongly indicating rather healthy produc-
shown a strong correlation with actual outcomes in the next tion growth going forward.
couple of quarters.
Manufacturing production and sentiment
Investment on the mend 10,0 20
Year-on-year percentage change
7,5 15
38 38
5,0 10
30 30
5
23 23 2,5
0
15 15 0,0
-5
8 8 -2,5
-10
0 0 -5,0 -15
-8 -8
-7,5 -20
-15 -15
-10,0 -25
-23 -23 98 99 00 01 02 03 04 05 06 07 08 09 10 11
98 99 00 01 02 03 04 05 06 07 08 09 10
Manufacturing prod, y/y % change, 3 m average (LHS)
Non-oil business investment Manufacturing sentiment, % of labour force, 2Q earlier (RHS)
Residential investment Source: Statistics Norway
Source: Statistics Norway

Overall, private non-oil capital spending should be up 7.6

per cent from 2010 to 2011, including a 10.5 per cent increase
in residential investments and 6.5 per cent in business invest-
ments.
In addition, capital spending in the oil sector looks set to surge
in 2011. Statistics Norway’s latest investment survey among
companies operating on the Norwegian continental shelf thus
put the value of planned spending 12.5 per cent above the level
in 2010. However, some projects still awaiting approval by the
authorities are likely to come on stream, suggesting that oil
sector investments will increase even more strongly and carry
Inflation to trend slowly higher
On balance, inflation has remained surprisingly benign. Overall
CPI inflation spiked in late 2010 due to higher electricity prices,
which have since receded, but core inflation using the CPI-ATE
measure – excluding taxes and energy − stayed at or below 1
per cent during the seven months to March. The year-on-year
core inflation rate jumped ½ percentage point to 1.3 per cent
in April, but this acceleration was due to surging airfares (a very
volatile component).
Core inflation remains benign
Year-on-year percentage change
3.5 3.5

over into 2012 as well. Measured in volume terms, we have 3.0 SEB 3.0
forecast
made an upward revision in our forecast for growth in such 2.5 2.5
spending from 9 per cent to 12 per cent in 2011 with a further 7 2.0 2.0
per cent gain in 2012.
1.5 1.5

Moderate growth in manufacturing 1.0 1.0

Manufacturing production rose strongly from mid-2009 but 0.5 0.5

was broadly unchanged during the second half of 2010. How- 0.0 0.0

ever, the first quarter of 2011 saw an improvement. Quarter-on- -0.5 -0.5
quarter growth was a rather moderate 0.5 per cent, and year- 99 00 01 02 03 04 05 06 07 08 09 10 11 12

on-year growth rate was 2.8 per cent. Source: Statistics Norway, SEB

Inflation pressure should start to build as the negative output

Surveys suggest slower production momentum, since senti-
gap is all but closed. Core domestic inflation has yet to show a
ment dipped slightly in the first quarter and the purchasing
definite upturn (except for airfares) due to declining food prices
managers’ index (PMI) eased to a four-month low. However, for
and slower rent inflation, although prices for other Norwegian-
some times these indicators have been stronger than actual
produced goods have trended upward recently. Our forecast
production and current levels are consistent with a near-term
assumes that core domestic inflation will start moving up, but
acceleration. The sentiment indicator remained well above its
cyclical inflation pressure will probably build only gradually,
long-term average, consistent with above-trend growth, and
with most of the effect coming in 2012. Meanwhile, downward
manufacturers remain optimistic about the short-term outlook,
inflation pressure from the rising exchange rate has become
reporting improving orders − with domestic orders rising more
less intensive, but developments in the import-weighted NOK
strongly than export orders. Meanwhile, the PMI reading of 55.6
index still suggest that import prices will be held in check.
in April remained firmly in the “growth zone”.
In all, we expect core inflation on the CPI-ATE measure to
The order situation suggests the same. A very sharp 45.5 per

Nordic Outlook – May 2011  |  45

 Norway

average 1.2 per cent in 2011, marginally less than in 2010,
and 2.0 per cent in 2012.
Norges Bank restarts normalisation
The deposit rate was hiked 25 basis points to 2.25 per cent at
Norges Bank’s monetary policy meeting May 12. The hike was
the first in a year after the bank started the normalisation proc-
ess in October 2009 and hiked three times (each 25 points) to
May 2010.
The latest move was in line with the upward revision to the rate
path in the March Monetary Policy Report signalling a slighter
faster policy normalisation. The rate path was lifted despite the
core inflation being lower and the NOK exchange rate stronger
than expected, and the assessment of heightened uncer-
tainty to the global outlook. Hence, the solid outlook for the
Norwegian economy gained the upper hand: with the output
gap seen closing earlier, Norges Bank expected stronger wage
growth and core inflation to trend up in the medium term to
be near the 2.5 per cent target by late 2013. The consideration
of guarding against future imbalances also factored into the
bank’s consideration.
Policy rates to rise gradually
Per cent
7 7
6 6
5 5
4 4
High price for Norwegian quality
In the wake of the global financial and fiscal crisis,
Norwegian government bonds stand out for their high
quality. There is great continued interest from foreign
investors, and the supply is limited. As a result, the yield
spread against Germany is at historically low levels. At
today’s levels Norwegian government bonds are expensive,
given our Norges Bank forecast. Assuming a cautiously
widening key interest rate spread against the ECB as well
as the potential for a strong Norwegian krone in a slightly
longer perspective, we foresee a gradual normalisation of
the 10-year yield spread against Germany. We expect a
4.10 per cent yield on 10-year Norwegian government
debt in 2011 and 4.65 per cent in 2012.
The NOK has strengthened on the back of elevated oil
prices and a positive flow situation. While the flow outlook
will gradually deteriorate due to higher foreign exchange
purchases by Norges Bank, the central bank’s key interest
rate hikes will partly offset this. The krone is likely to
continue range trading against the euro in the short term,
but once the weak US dollar regains some strength, the
krone should again gradually appreciate against the euro.
In 2012, strong fundamentals and a wider key rate spread
against the ECB should take the EUR/NOK exchange rate
closer to its fair value (7.40). We forecast a EUR/NOK rate
of 7.70 by the end of 2011 and 7.60 by the end of 2012.

3 3

2 2

1 1

0 0
02 03 04 05 06 07 08 09 10 11 12 13

Norges Bank deposit rate Optimal rate path, MPR 1/11

Source: Norges Bank, SEB

The next focus point regarding monetary policy will be the

policy meeting June 22 and the release of a new Monetary
Policy Report. The rate path will probably be left broadly un-
changed, indicating gradually higher deposit rates. After all,
the recent hike should not be seen as a “tightening”. Rather,
Norges Bank is restarting its policy normalisation process by
lifting its foot a bit from the accelerator. The deposit rate is only
1 percentage point above current inflation which is not sign
of a “tight” monetary policy for an economy operating close
to “normal” capacity already and as economy-wide capacity
utilisation is set to rise further. Hence, the rather sharp decline
in the unemployment rate so far in 2011 (declining faster than
Norges Bank expected in March) and accelerating wage growth
are signs that the economy is operating near full capacity with
cyclical inflation pressure likely to build.

SEB has long been more aggressive in the call for higher key
rates than Norges Bank and the bank followed up by revising
up its rate path in the March MPR. We still expect the deposit
rate to be hiked twice to 2.75 per cent by end-2011 with
five hikes (each of 25 points) to follow next year to 4.00
per cent at end-2012 in line with the bank’s rate path.

46   |  Nordic Outlook – May 2011

 Finland

Moderate recovery from a low level

ƒƒ Domestic demand gaining momentum this year, growing by more than 4 per cent in 2011 and by 5
per cent in 2012.
ƒƒ Stable public finances inspire confidence
Leading indicators improving
ƒƒ Election outcome will not change policies
50 50
40 40
30 30
Finland’s economic recovery is continuing. After suffering the 20 20
10 10
euro zone’s sharpest GDP decline in 2009, the economic sig-
0 0
nals look promising. The crisis hit the export sector hardest, -10 -10
while the banking sector and the labour market emerged rela- -20 -20
-30 -30
tively unscathed. Due to comparatively low public sector debt
-40 -40
and a budget deficit that was below the euro zone’s 3 per cent -50 -50
of GDP ceiling as early as 2010, the Finnish economy can re- -60 -60
-70 -70
cover without major austerity packages. So far, the upturn has
04 05 06 07 08 09 10 11
not been as vigorous as might have been expected, given the
Manufacturing sector Construction sector
earlier large downturn; in 2010, GDP grew by only 3.1 per cent. Service sector
We are sticking to our forecast of 3.5 per cent GDP growth Source: DG ECFIN

in 2011 and 3.0 per cent in 2012. This implies that the level of
GDP will not exceed its previous 2008 peak until 2012. According to the latest measurements, consumer confidence
has cooled somewhat but remains at decent levels. Looking
GDP level still below its 2008 peak
Constant prices
ahead, real household income will improve as unemployment
20.0 170 and inflation fall and pay increases accelerate. Household
165 consumption will climb around 2.5 per cent annually in 2011
15.0
160 and 2012.
10.0
155
Capacity utilisation and capital spending
5.0 150 87.5 20
145 85.0
0.0 10
140 82.5
-5.0 80.0 0
135
77.5 -10
-10.0 130
00 01 02 03 04 05 06 07 08 09 10 75.0
-20
72.5
Year-on-year percentage change (LHS)
70.0 -30
GDP level (RHS)
Source: Eurostat 67.5
-40
Leading indicators have continued to improve, especially in the 65.0
62.5 -50
service sector. The upturn in manufacturing is relatively broad-
00 01 02 03 04 05 06 07 08 09 10 11
based. In the timber and paper industry, growth was relatively
Capacity utilisation (LHS)
strong in 2010 but is now slowing, due to the strong euro. Percentage change in capital spending, constant prices (RHS)
Exports are benefiting from good growth in important markets Source: Statistics Finland, OECD

such as Sweden, Germany and Russia as well as a favourable

industrial mix. Overall, exports will climb by around 7 per cent
annually in 2011 and 2012, but the export level at the end of
our forecast period will be lower than earlier peak levels.
To date, capital spending has been driven by rising residential
investments. Spare capacity is still hampering fixed invest-
ments in the business sector, but a turnaround is near. As
capacity utilisation in the economy approaches previous peaks,
the need for capital spending will increase. High expectations
by companies concerning new orders and production also point
towards an upswing. We expect capital spending to take off
Unemployment peaked at just below 9 per cent in 2009, then
fell to 8 per cent late in 2010. So far this year, it has climbed
back to 8.5 per cent. This upturn is partly rooted in the meas-
ures to prevent lay-offs that were part of government policy
during the crisis. Because companies were able to retain
much of their labour force during the crisis years, the upturn
in joblessness was less than the GDP decline justified. Now
this effect is working in the opposite direction. Due to higher
productivity, economic growth is having a smaller impact on
the labour market and also causing some reversals in the un-
employment trend.

Nordic Outlook – May 2011  |  47

 Finland

The number of vacancies has increased, however, signalling The current cyclical improvement, including lower unem-
a stabilisation in the labour market. We thus believe that the ployment and rising tax revenue, will help gradually reduce
jobless rate will again decline as the production upturn boosts Finland’s budget deficit to 1.9 per cent of GDP in 2011 and
demand for labour, although strong productivity growth will 1.5 per cent in 2012. Public sector debt will fall marginally to
slow this downturn. Unemployment will fall to 7.3 per cent 48 per cent of GDP in 2012.
by the end of 2011, with an annual average of 8.0 per cent this
year and 7.0 per cent in 2012. Public sector deficit and debt
Rising number of job vacancies Per cent of GDP
14.0 57.5
9.5 20.0
12.0 55.0
22.5 10.0
9.0 52.5
25.0 8.0 50.0
8.5
27.5 6.0
47.5
8.0 4.0
30.0 45.0
2.0
7.5 32.5 42.5
0.0
35.0 -2.0 40.0
7.0
-4.0 37.5
37.5
6.5 -6.0 35.0
40.0
-8.0 32.5
6.0 42.5 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
03 04 05 06 07 08 09 10 11
Deficit Debt
Unemployment (LHS) Source: Eurostat
Thousands of vacancies, 12-month moving average (RHS)
Source: Statistics Finland

The election of April 17, 2011

High unemployment has pushed down the rate of pay
increases from about 4 per cent annually during much of the
past decade to about 2 per cent. Looking ahead, falling unem-
ployment will help accelerate wage and salary hikes, which will
end up at around 3 per cent a year in 2011 and 2012.
Food and energy prices have pushed HICP inflation higher; in
March the inflation rate was 3.5 per cent. Because of continued
relatively low resource utilisation, underlying inflation pressure
is relatively low. Inflation will remain high this summer but later
slow down. Annual average HICP inflation will be 2.3 per
cent in 2011 and 2.0 per cent in 2012.
Prices and wages
Year-on-year percentage change
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
04 05 06 07 08 09 10 11
Prices Wages
Source: Statistics Finland
The 2011 parliamentary election was a setback for all large,
established parties. Instead the True Finns (PS), a populist
euro-sceptic party led by Timo Soini, made strong gains (from
4 per cent to 19 per cent of all votes). The National Coali-
tion Party won the most seats in Parliament. Its leader, Jyrki
Katainen, who is expected to become the new prime minister,
is now sounding out the political situation preparatory to form-
ing a government. One question raised during the election
campaign, and also important internationally, concerns support
from euro zone countries to Greece, Ireland, Portugal and Spain
(the GIPS countries) and the European Financial Stability Facil-
ity (EFSF). The Centre and National Coalition parties support
Finland’s participation in these initiatives, while PS is opposed.
The controversy surrounding aid to Portugal has made the PS
now say that it cannot participate in government negotiations.
After the PS decision, Katainen and the National Coalition
Party must now rely on a number of smaller parties to create
a majority. At present, it looks like a majority government will
be formed. Although some issues were passionately debated
during the election campaign, in our assessment the direction
of Finnish policy will not change to any great extent, either
domestically or on international issues. The success of PS will
thus apparently not threaten the euro zone’s bail-out packages
for Greece, Ireland or Portugal.

Finland, Denmark and Luxembourg were the only euro zone

countries with public sector deficits below the Maastricht
ceiling (3 per cent of GDP) last year. The budget consolida-
tion programmes of the 1990s, followed by nearly a decade of
surpluses, helped create strong finances at the outset of the
latest crisis. This is now enabling Finland to avoid major auster-
ity programmes. Fiscal credibility is extra important for a small,
open and cyclically sensitive economy.

48   |  Nordic Outlook – May 2011

 Economic data

DENMARK
Yearly change in per cent
2010 level,
DKK bn 2009 2010 2011 2012
Gross domestic product 1,746 -5.3 2.0 2.3 2.3
Private consumption 853 -4.3 2.3 2.0 2.5
Public consumption 513 3.1 1.0 -0.5 0.0
Gross fixed investment 287 -15.4 -2.5 4.0 6.0
Stockbuilding (change as % of GDP) -1.9 0.7 0.0 0.0
Exports 881 -9.7 3.5 6.0 5.5
Imports 784 -12.1 3.1 5.0 6.0

Unemployment (%) 3.6 4.2 4.0 3.7

Consumer prices, harmonised 1.1 2.2 2.4 2.0
Hourly wage increases 3.1 2.3 2.1 2.0
Current account, % of GDP 3.6 5.3 5.0 4.5
Public sector financial balance, % of GDP -2.7 -2.7 -2.5 -2.0
Public sector debt, % of GDP 41.8 42.6 43.0 42.5

FINANCIAL FORECASTS May 12 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Deposit rate 1.30 1.30 1.55 1.80 2.35 2.90
10-year bond yield 3.30 3.40 3.50 3.65 3.90 4.20
10-year spread to Germany, bp 19 15 15 15 15 20
USD/DKK 5.23 5.03 5.14 5.32 5.52 5.52
EUR/DKK 7.46 7.45 7.45 7.45 7.45 7.45

NORWAY
Yearly change in per cent
2010 level,
NOK bn 2009 2010 2011 2012
Gross domestic product 2,266 -1.4 0.4 2.3 3.0
Gross domestic product (Mainland Norway) 1,770 -1.3 2.2 3.2 3.7
Private consumption 991 0.2 3.6 3.4 3.8
Public consumption 498 4.7 2.2 2.6 2.0
Gross fixed investment 434 -7.4 -8.9 8.3 7.4
Stockbuilding (change as % of GDP) -2.6 3.3 -0.3 -0.1
Exports 995 -4.0 -1.3 0.8 2.3
Imports 694 -11.4 8.7 4.8 4.6

Unemployment (%) 3.2 3.6 3.1 2.9

Consumer prices 2.1 2.5 1.9 2.3
CPI-ATE 2.6 1.4 1.2 2.0
Wage increases 4.2 3.7 4.2 4.6

FINANCIAL FORECASTS May 12 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Deposit rate 2.25 2.25 2.50 2.75 3.25 4.00
10-year bond yield 3.47 3.70 3.90 4.10 4.35 4.65
10-year spread to Germany, bp 36 45 55 60 60 65
USD/NOK 5.50 5.37 5.41 5.50 5.63 5.63
EUR/NOK 7.83 7.95 7.85 7.70 7.60 7.60

Nordic Outlook – May 2011  |  49

 Nordic key economic data

SWEDEN
Yearly change in per cent
2010 level,
SEK bn 2009 2010 2011 2012
Gross domestic product 3,301 -5.3 5.5 4.7 2.6
Gross domestic product, working day adjusted -5.2 5.3 4.7 3.0
Private consumption 1,601 -0.4 3.5 2.5 2.5
Public consumption 898 1.7 2.6 0.9 0.9
Gross fixed investment 587 -16.3 6.3 11.0 4.6
Stockbuilding (change as % of GDP) -1.5 2.1 0.2 0.0
Exports 1,649 -13.4 10.7 11.0 8.6
Imports 1,455 -13.7 12.7 10.1 9.2

Unemployment, (%) 8.3 8.4 7.2 6.3

Employment -2.1 1.0 2.4 1.4
Industrial production -19.4 9.6 11.0 6.0
Consumer prices -0.5 1.2 3.3 2.5
CPIF 1.7 2.0 1.8 1.8
Wage increases 3.4 2.6 2.5 3.9
Household savings ratio (%) 12.9 10.7 10.6 10.9
Real disposable income 1.6 1.4 2.3 2.9
Trade balance, % of GDP 3.2 2.5 2.8 2.9
Current account, % of GDP 6.8 6.2 6.0 5.8
Central government borrowing, SEK bn 176 1 -57 -64
Public sector financial balance, % of GDP -1.0 -0.3 0.8 1.3
Public sector debt, % of GDP 41.9 39.0 34.2 30.3

FINANCIAL FORECASTS May 12 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Repo rate 1.75 1.75 2.25 2.75 3.25 3.75
3-month interest rate, STIBOR 2.46 2.55 2.95 3.40 4.00 4.30
10-year bond yield 3.06 3.20 3.40 3.65 4.00 4.25
10-year spread to Germany, bp -5 -5 5 15 25 25
USD/SEK 6.30 6.08 6.10 6.21 6.37 6.30
EUR/SEK 8.97 9.00 8.85 8.70 8.60 8.50
TCW 120.8 119.6 118.1 117.0 116.8 115.4

FINLAND
Yearly change in per cent
2010 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 180 -8.3 3.1 3.5 3.0
Private consumption 97 -2.1 2.7 2.4 2.4
Public consumption 44 0.9 0.4 0.2 0.3
Gross fixed investment 33 -14.5 0.1 5.1 5.9
Stockbuilding (change as % of GDP) 0.9 0.4 0.2 0.3
Exports 70 -20.3 5.0 7.4 6.4
Imports 65 -17.6 2.6 6.0 6.2

Unemployment (%) 8.2 8.4 8.0 7.0

Consumer prices, harmonised 1.6 1.7 2.3 2.0
Wage increases 4.0 2.6 2.4 2.9
Current account, % of GDP 2.3 2.4 2.5 2.3
Public sector financial balance, % of GDP -2.6 -2.5 -1.9 -1.5
Public sector debt, % of GDP 43.8 48.4 48.3 48.0

50   |  Nordic Outlook – May 2011

 International key economic data

EURO ZONE
Yearly change in per cent
2010 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 9,189 -4.0 1.7 2.2 2.2
Private consumption 5,301 -1.1 0.8 1.2 1.3
Public consumption 2,014 2.5 0.7 0.5 0.3
Gross fixed investment 1,764 -11.2 -1.0 4.1 5.3
Stockbuilding (change as % of GDP) -0.8 0.4 0.2 0.0
Exports 3,734 -13.1 10.9 6.3 5.4
Imports 3,613 -11.7 9.0 5.7 4.9

Unemployment (%) 9.5 10.0 9.8 9.5

Consumer prices, harmonised 0.3 1.6 2.8 1.7
Household savings ratio (%) 9.6 9.6 9.3 9.0

US
Yearly change in per cent
2010 level,
USD bn 2009 2010 2011 2012
Gross domestic product 14,871 -2.6 2.9 2.8 3.8
Private consumption 10,514 -1.2 1.7 3.0 3.0
Public consumption 3,032 1.6 1.0 -1.0 -0.7
Gross fixed investment 1,821 -18.4 3.9 7.7 14.8
Stockbuilding (change as % of GDP) -0.6 1.4 -0.1 0.0
Exports 1,926 -9.5 11.7 8.5 10.7
Imports 2,422 -13.8 12.6 5.7 10.3

Unemployment (%) 9.3 9.6 8.8 7.9

Consumer prices -0.3 1.7 3.1 2.0
Household savings ratio (%) 5.9 5.8 5.6 6.2

LARGE INDUSTRIAL COUNTRIES

Yearly change in per cent
2009 2010 2011 2012
GDP
United Kingdom -4.9 1.3 1.4 2.5
Japan -6.3 3.9 0.5 2.4
Germany -4.7 3.6 3.5 2.7
France -2.5 1.5 1.9 1.9
Italy -5.2 1.2 1.3 1.5

Inflation
United Kingdom 2.2 3.3 4.2 2.0
Japan -1.4 -0.7 0.2 0.4
Germany 0.2 1.2 2.2 1.9
France 0.1 1.7 2.2 1.9
Italy 0.8 1.6 2.4 2.0

Unemployment (%)
United Kingdom 7.7 8.0 7.8 7.4
Japan 5.1 5.1 5.0 4.7
Germany 7.7 7.1 6.2 5.6
France 9.5 9.8 9.5 9.2
Italy 7.8 8.4 8.2 7.9

Nordic Outlook –May 2011  |  51

 International key economic data

EASTERN EUROPE

2009 2010 2011 2012

GDP, yearly change in per cent
Estonia -13.9 3.1 5.0 4.5
Latvia -18.0 -0.3 3.7 4.3
Lithuania -14.7 1.3 4.0 4.5
Poland 1.7 3.8 4.5 4.6
Russia -7.9 4.0 5.3 5.0
Ukraine -15.1 4.2 4.7 4.5

Inflation, yearly change in per cent

Estonia 0.2 2.7 5.0 4.0
Latvia 3.3 -1.2 4.4 3.1
Lithuania 4.2 1.2 3.5 4.0
Poland 4.0 2.7 3.7 2.8
Russia 11.7 6.9 9.3 7.6
Ukraine 15.9 9.4 9.5 9.0

FINANCIAL FORECASTS

May 12 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12
Official interest rates
US Fed funds 0.25 0.25 0.25 0.25 1.25 2.00
Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50
Euro zone Refi rate 1.25 1.25 1.50 1.75 2.25 2.75
United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 1.75

Bond yields
US 10 years 3.23 3.35 3.45 3.65 4.00 4.30
Japan 10 years 1.12 1.20 1.30 1.40 1.70 2.00
Germany 10 years 3.11 3.25 3.35 3.50 3.75 4.00
United Kingdom 10 years 3.39 3.55 3.65 3.85 4.15 4.45

Exchange rates
USD/JPY 81 82 84 88 92 94
EUR/USD 1.42 1.48 1.45 1.40 1.35 1.35
EUR/JPY 115 121 122 123 124 127
GBP/USD 1.63 1.63 1.61 1.59 1.59 1.61
EUR/GBP 0.87 0.91 0.90 0.88 0.85 0.84

GLOBAL KEY INDICATORS

Yearly percentage change
2009 2010 2011 2012
GDP OECD -3.4 2.8 2.4 3.1
GDP world -0.5 5.0 4.3 4.5
CPI OECD 0.1 1.5 2.5 1.7
Export market OECD -12.9 11.5 8.3 8.4
Oil price, Brent (USD/barrel) 61.9 79.9 109.0 95.0

52   |  Nordic Outlook – May 2011

Economic Research available on Internet.
Nordic Outlook published by SEB Economic Research is available on the Internet at: www.seb.se. This page is open to all.

To get access to all other research and trading recommendations for Merchant Banking’s customers on the Internet at www.mb.se,
a password is needed that is exclusice to these clients. If you wish to get access to this web site, please contact Merchant Banking to
receive the password.

This report is directed only at persons who (i) are outside the United Kingdom, (ii) have professional experience in matters relating to investments falling
within article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended) (the “Order”), (iii) are persons falling
within articles 49(2)(a) to (d) (“high net worth companies, unincorporated associations etc.”) of the Order or (iv) persons who are intermediate customers
under chapter 4 of the FSA conduct of business rules (all such persons being referred to as “relevant persons”).

This document does not constitute an offer or invitation to subscribe for or purchase any securities and neither this document nor anything contained herein
shall form the basis of any contract or commitment whatsoever. Recipients are urged to base their decisions upon such investigations as they deem neces-
sary.

All information contained in this report has been compiled in good faith from sources believed to be reliable. However, no representation or warranty, express
or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. In addition SEB accepts no
liability whatsoever for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection therewith.

Your attention is drawn to the fact that a member of, or any entity associated with SEB or its affiliates, officers, directors, employees or sharheolders of such
members may from time to time have a long or short position in, or otherwise participate in the markets for, the securities and the currencies of countries
mentioned herein.

Skandinaviska Enskilda Banken AB (publ) is incorporated in Stockholm, Sweden with limited liability and is a member of the Stockholm Stock Exchange; it is
regulated by the Financial Services Authority for the conduct of designated investment business in the UK; and is a member of the London Stock Exchange.

Transactions involving debt securities will be executed by or with the Bank unless you are informed otherwise at the time of dealing.

Confidentiality Notice
This report is confidential and may not be reproduced or redistributed to any person other than its recipient from the Bank.

Skandinaviska Enskilda Banken AB (publ), 2011. All rights reserved.

 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 some 20 countries
worldwide. On 31 March 2011, the Group’s total assets amounted to SEK 2,118bn
while its assets under management totalled SEK 1,372bn. The Group has about
17,000 employees. 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.
SEMB0063 2011.05

www.sebgroup.com