Nordic Outlook

Somewhat brighter growth outlook — but mounting policy challenges

Economic Research – November 2010

International overview


The United States Japan Asia The euro zone The United Kingdom Eastern Europe
The Baltics

18 25 26 29 35 36

Sweden Denmark Norway Finland Economic data

39 48 49 53 54

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

8 10 15 19
20 20 21 22 24 30 32 44

Nordic Outlook – November 2010 | 3

Economic Research

This report was published on November 24, 2010. Cut-off date for calculations and forecasts was November 18, 2010.

Robert Bergqvist Chief Economist + 46 8 506 230 16 Daniel Bergvall Economist +46 8 763 85 94 Ann Enshagen Lavebrink Editorial Assistant + 46 8 763 80 77 Andreas Johnson Economist +46 8 763 80 32

Håkan Frisén Head of Economic Research + 46 8 763 80 67 Mattias Bruér Economist + 46 8 763 85 06 Mikael Johansson Economist + 46 8 763 80 93 Tomas Lindström Economist + 46 8 763 80 28

Gunilla Nyström Global Head of Personal Finance Research + 46 8 763 65 81 Susanne Eliasson Personal Finance Analyst + 46 8 763 65 88 SEB Economic Research, K-A3, SE-106 40 Stockholm

Ingela Hemming Global Head of Small Business Research + 46 8 763 82 97 Johanna Wahlsten Small Business Analyst + 46 8 763 80 72

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

4 | Nordic Outlook – November 2010

International overview

Brighter growth outlook, but mounting policy challenges
ƒ ƒ ƒ ƒ Fed’s stimulus programme will help Low inflation despite challenges Continued debt worries in the euro zone Dilemma for Nordic central banks
During the next couple of years, we foresee no major inflation risks in the 33 countries of the Organisation for Economic Cooperation and Development (OECD), despite the ultra-loose monetary policies now being pursued. Rising commodity prices and the effects of weaker currencies will lead to slightly higher inflation, but deflationary forces will continue to predominate. This means there is room for central banks in major OECD countries to hold off on hiking their key interest rates for at least another year or so. In addition, the effects of quantitative easing by the Fed and other central banks will also help keep longer-term market interest rates down and stimulate asset prices. Over the next couple of years, fiscal policies in OECD countries will not be as contractive as we previously expected, but ongoing debt retirement − mainly in the private sector − and lingering weaknesses in the financial system will help blunt the effects of monetary policy. On the whole, we regard a somewhat higher growth forecast than previously as justified. We have raised both our 2010 and 2011 GDP forecast by 0.3 percentage points, both for the OECD and emerging markets. Our upward revision for 2012 is somewhat smaller. A low-interest environment, growth slightly above trend in the OECD countries and continued strong growth in developing economies will mean a relatively favourable environment for the stock market.

In recent months the world economic outlook has become somewhat brighter. Expectations of quantitative easing (QE) by the US Federal Reserve contributed to stronger optimism, reflected among other things in rising share prices. Meanwhile underlying economic signals in the United States have been more reassuring, after major disappointments during the summer. Emerging economies have continued to perform strongly, and worries about a hard landing in China and elsewhere have diminished. In Europe, too, economic signals have been positive, for example in Germany, the United Kingdom and various Nordic countries. At the same time, though, uncertainty about the government financial crisis in southern Europe and Ireland has once again increased alarmingly.

Global GDP growth
Year-on-year percentage change 2009 United States Japan Germany China United Kingdom Euro zone Nordic countries Baltic countries OECD Emerging markets World, PPP* World, nominal -2.6 -5.3 -4.7 8.7 -5.0 -4.0 -4.5 -15.6 -3.3 2.5 -0.6 -1.3 2010 2.7 3.1 3.6 10.2 1.7 1.6 2.7 0.9 2.5 7.1 4.7 4.0 2011 2.2 1.6 2.5 9.0 2.1 1.7 2.8 4.0 2.3 6.3 4.1 3.4 2012 3.4 1.5 1.8 8.0 2.1 1.5 2.4 4.5 2.5 6.5 4.5 3.8

GDP, OECD countries
Index 2000 = 100
130.0 127.5 125.0 122.5 120.0 117.5 115.0 112.5 110.0 107.5 04 05 06 07 08 09 10 11 12 SEB forecast 130.0 127.5 125.0 122.5 120.0 117.5 115.0 112.5 110.0 107.5



* Purchasing power parities Source: OECD, SEB

New crisis wave Rapid recovery

SEB's main scenario
Source: OECD, SEB

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

Nordic Outlook – November 2010 | 5

International overview

outweighted the upside risks. This time, we foresee somewhat more symmetrical risks. The probability of stronger economic performance has increased from 15 to 20 per cent, mainly due to changes in the US risk picture.

Capital spending growth will be crucial
In the OECD countries, the slowing trend in the recovery that we foresee in late 2010 and early 2011 is partly connected to the waning strength of the inventory cycle. In the US, this is reinforced by the fading of federal fiscal stimulus measures. Debt retirement in the household sector after the bursting of the housing bubble will hamper consumption during the next couple of years. An upswing in capital spending is therefore vital in order to ensure a continued recovery. In some respects, the situation looks rather hopeful. Capital spending has taken off in many countries during 2010. Although upturn figures have been high because fixed investment was deeply depressed in 2009, there are factors that point towards a sustained recovery: ƒ Non-residential fixed investment is deeply depressed, even in a longer time perspective. Unlike normal economic expansions, the capital spending level in the OECD countries remained rather low during the 2006-2007 boom. Balance sheets, especially in large American corporations, are much stronger than normal. This will make larger self-financing of capital investments possible, facilitating the upturn while the financial system remains relatively fragile. Historical associations signal that capital spending growth is more dependent on the change in capacity utilisation than on its actual level. This indicates that a recovery in fixed investments may begin at an earlier stage.

ing process in the financial system and household debt retirement is under way. In the US, a clear improvement in the labour and housing markets will not occur until well into next year. Only then can consumption provide genuine support to the economic recovery. German consumers remain cautious and need the encouragement of slightly higher pay increases ahead, while tough austerity programmes will limit the potential for an upturn in British consumption.

Economic policy challenges at many levels
While the economic outlook for the next couple of years seems a bit brighter, international economic policy collaboration faces a variety of challenges and conflicts. Despite lofty ambitions − for example in the Group of Twenty (G20) countries − when it comes to coordinating economic policies in response to global imbalances, this autumn has been full of disappointments. Progress at the recent G20 summit in Seoul, South Korea, was limited. In currency policy, for example, tensions have escalated. The task of rebuilding euro zone institutions is also characterised by major conflicts. Meanwhile efforts are under way to reform the infrastructure of the financial system. International bodies are examining the potential for developing new instruments to make the credit market more stable and less pro-cyclical. Several boxes and our Theme article discuss these issues later in this report.


Current accounts
Per cent of GDP
12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 99 00 01 02 03 04 05 06 07 08 09


US: Non-residential fixed investments
As a percentage of GDP, current prices
14.5 14.0 13.5 13.0 12.5 12.0 11.5 11.0 10.5 10.0 9.5 9.0 70 75 80 85 90 95 00 05 10 14.5 14.0 13.5 13.0 12.5 12.0 11.5 11.0 10.5 10.0 9.5 9.0


China US

Euro zone Japan

Source: IMF

Fundamentally, the challenges are all about getting to grips with the imbalances and systemic deficiencies that triggered the crisis, but also easing the impact of the somewhat uncoordinated stimulus policies now being implemented, which themselves create new problems. Many countries face a two-dimensional challenge when it comes to contributing to a rebalancing of the world economy. It is a matter of formulating fiscal, monetary and structural policies in ways that contribute to better balance, both short- and long-term and in a national and international perspective.

Source: US Department of Commerce

Although US small businesses are still suffering from fairly restrictive credit conditions, we thus foresee good capital spending growth as an important driving force for economic expansion during a period when the inventory cycle is losing momentum. Meanwhile a heal-

6 | Nordic Outlook – November 2010

International overview

Internal rebalancing is a matter of phasing out public stimulus and aid policies as soon as more private investments and consumption can take over as growth engines. External rebalancing, for some countries, is a matter of such steps as reducing their dependence on consumption-driven growth and increasing their dependence on exports. For others, such as China, it is the opposite: reducing dependence on exports in favour of domestic demand.

economy: overly aggressive stimulus policies in low interest rate countries or an excessively cautious commitment to domestic driving forces in surplus economies. Some of the drawbacks associated with extreme stimulus measures have thus appeared earlier than expected. These effects, in the form of a weaker US dollar and rising commodity and asset prices, do not primarily affect the countries that implement such measures, but affect other parts of the world via global transmission mechanisms. The main targets of criticism are excessively cautious Chinese currency policy, on the one hand, and overly aggressive stimulus programmes in the US, on the other. At the G20 summit in Seoul, the US tried to launch a proposal to restrict how large a country’s current account surplus or deficit could be. A proposal to establish such a restriction equivalent to 4 per cent of GDP was voted down, but the IMF will continue examining similar ideas and will report back to the next G20 summit. It is obvious, however, that international political cooperation is not strong enough at present to resolve all the disagreements that have arisen.

Mounting currency-related tensions
The world economic situation, with rapid growth in many emerging economies as well as continued difficult financial problems and a fragile recovery in large portions of the OECD countries, requires a wide variety of suitable political medicines. The forces driving currency movements have been dominated by these cyclical differences. Currencies have appreciated in countries with strong government finances and where the central bank has been able to withdraw part of its monetary stimulus. In many cases, these are countries with large commodity exports that have benefited from high prices. Fundamentally, this is a trend that often contributes to better global balance, since many problem countries receive a little extra help from exports, whereas currency appreciation cools off rapidly-growing economies. In recent months, however, this trend has led to more troublesome consequences, resulting in currency policy tensions − sometimes described as “currency war”. One basic reason for this is the ultra-loose monetary policy being pursued in the US, the euro zone, Japan and the UK, culminating in the Fed’s quantitative easing. Because of the “search for returns”, surplus liquidity migrates to countries with higher potential returns. This increases currency appreciation pressures in export-dependent countries, especially in Asia. These countries have responded by resorting to currency interventions. In recent months, various countries have also used financial regulation, tariffs and taxes to stem the inflow of foreign capital. In the OECD, there is a milder version of the same dilemma for countries that are now on the way towards slowly tightening their monetary policies. In the prevailing low-inflation environment, currency appreciation has helped squeeze inflation to levels perceived as uncomfortable. Central banks are thus abstaining from normalising interest rates to the extent that domestic factors would justify. This also applies to Norway and Sweden, for example. Among the 10 largest economies, Australia is now the only one that has not cited currency rate trends as a reason to slow the pace of its key interest rate hikes.

Emerging economies will remain the engine

Emerging economies, especially in Asia, will continue to serve as the largest engine in the world economy. During the next couple of years GDP will increase by 6-7 per cent in emerging economies, compared to OECD growth close to the trend level: about 2½ per cent. As a share of global GDP, Asian emerging economies have now climbed to just below one fourth. The proportion of global exports destined for these economies has risen from less than 5 per cent in 1980 to nearly 15 per cent.

Asian emerging economies
1980 GDP Exports Imports Accumulated direct investments 7.9 4.7 4.6 4.4

As a percentage of the global economy 1990 11.0 5.5 5.7 4.9 2000 15.1 9.5 8.3 6.0 2009 22.6 15.9 14.5 8.3

NOTE: South Korea, Hong Kong, Singapore and Taiwan are classified as developed and are not included here. Sources: IMF, UNCTAD, SEB

Disunity on policy conclusions
One reason why international cooperation has seized up this autumn is differences of opinion about what is the fundamental reason behind the imbalances in the world

Asian emerging economies largely managed to avoid the downturn that affected the OECD countries during the crisis years, then began a rapid recovery. This is due to several factors. The role of intra-regional trade has increased. Meanwhile improved macro policies and greater flexibility have made these economies more resilient in the face of global downturns. From a growth standpoint, the potential for “decoupling” − with different growth paths for emerging economies and OECD countries − has increased. Nordic Outlook – November 2010 | 7

International overview

Ireland the focus of new debt worries
Market worries about European sovereign debt problems have intensified again. Rising risk premiums for Ireland and Portugal have pushed up their government bond yields to levels well above those prevailing before the bail-out package for Greece and the European Financial Stability Facility (EFSF) were launched last spring. Yet the underlying situation in Ireland and Portugal is not as serious as in Greece. The two countries have lower government debt and better underlying credibility. They consequently have a good chance of avoiding defaults or debt write-downs. IMF studies show that markets often overreact in crises and that the upturn in yields is not due to bad fundamentals alone. International aid also provides political leaders with a form of backing that enables them to implement unpopular belt-tightening measures. Ireland and Portugal are also such small economies that the financial aid mechanisms now in place will be able to deal with their problems. Instead, developments in Spain will determine whether the European debt crisis will again dominate global financial markets. The sovereign debt problem is smaller in Spain than in the other PIIGS countries (Portugal, Ireland, Italy and Greece). On the other hand, Spain has a larger external debt burden if the private sector is also included. Signals of renewed economic weakness are also especially serious in a situation where unemployment is around 20 per cent. Although our main scenario is that Spain will manage without international help, there will be continued uncertainty ahead. Wider yield spreads between euro zone countries will probably also persist during the foreseeable future. The market has learned the lesson that even in the euro zone, risks must be priced on the basis of the conditions in each respective country. European institutions also seem to need a certain level of pressure from market forces in order to muster the strength to reform the Stability Pact and establish a credible rule system.

Renewed market worries
Yield spread vs Germany, 10-year government bonds
10 9 8 7 6 5 4 3 2 1 0 Oct Jan 08 Apr Jul 09 Oct Jan Apr Jul 10 Oct 10 9 8 7 6 5 4 3 2 1 0

France Greece

Ireland Italy

Portugal Spain

Source: Reuters EcoWin

The banking crisis has made the situation acute in Ireland. Costs related to saving the banking sector will push up the Irish government budget deficit to more than 30 per cent of GDP this year: money that has not yet been borrowed in the market. Excluding bank support, the deficit is more than 10 per cent of GDP. The uncertainty surrounding Ireland’s banking system showed to be too large for general government austerity programmes to calm the markets. Ireland, EU and the IMF have now agreed on a support package. The details are not yet known, but will temporarily calm down market worries. Thereafter though, the focus will probably shift to Portugal. But at the same time as emerging economies have shown increasing resilience, world economic integration has continued to increase. This applies both to the real economy via trade flows and direct investments and to the financial sphere via short-term capital flows and integrated capital markets. Financial integration has been an important prerequisite for the rapid growth trend of the past decade. During 2010, however, its drawbacks in the form of capital flows that lead to sharply appreciating currencies and bubble tendencies in asset markets have become apparent. In the short term, Asian countries are trying to soften the impact of these phenomena by using both domestic tightening measures and capital controls. In the long term, the best medicine is to increase the role of domestic demand in growth, thereby making these economies less dependent on exports and currencies. Looking ahead, we expect Chinese currency policy to play some part in this. The pace of yuan appreciation will remain cautious, however. We expect China to boost the value

of the yuan by 4 per cent against the USD during the coming year, but this is unlikely to do much to mollify critics who accuse China of pursuing an excessively rigid currency policy.

Nordic fundamentals are paying off
The Nordic countries are continuing to benefit from strong economic fundamentals, especially their low sovereign debt levels. Their export structure, both in terms of sectors and countries, also puts them in a good position to take advantage of the global recovery. In our assessment, these countries will also cope well with the appreciation of their currencies this autumn. We are revising our Nordic growth forecasts upward. In Sweden, GDP will increase by 5 per cent this year, significantly faster than in other EU countries. During the next couple of years, too, we expect GDP growth to be above trend. In the other Nordic countries, growth will be more subdued. Strong exports will enable the Danish economy to continue growing by more than 2

8 | Nordic Outlook – November 2010

International overview

per cent a year, despite fiscal tightening. In Finland, the economic recovery has gained strength in recent months. We now see prospects for GDP growth of 3 per cent in 2011. As in Sweden, this growth will be broadbased. The Norwegian economy will grow by more than 2 per cent a year, but high resource utilisation is already beginning to limit supply-side potential in Norway.

Our assessment is that Latvia and Lithuania will join the euro zone in 2014, in keeping with their ambitions.

More symmetrical inflation risks
Rising commodity prices and the Fed’s quantitative easing programme have contributed to growing uncertainty regarding inflation trends in the OECD countries. Inflation expectations, measured as break-even inflation in the index-linked bond market, have also risen − especially in the US. A mechanistic calculation indicates that a commodity price upturn might push up inflation as much as 2 percentage points, but in recent decades the impact of commodity prices at the consumer level has been rather small. Low resource utilisation is one reason why the impact of commodity prices is unlikely to be larger this time around. Taken together, we have adjusted CPI inflation upward by 3-4 tenths of a percentage point in the US and the euro zone as a consequence of the commodity price increase, especially via the impact of higher oil and food prices.

GDP growth, Nordic and Baltic countries
Year-on-year percentage change 2009 Sweden Norway Denmark Finland Nordics Estonia Latvia Lithuania Baltics
Source: OECD, SEB

2010 5.0 0.5 2.2 2.7 2.7 2.5 -0.3 1.0 0.9

2011 3.5 2.3 2.2 3.0 2.8 4.0 4.0 4.0 4.0

2012 2.5 2.2 2.1 2.8 2.4 4.0 5.0 4.5 4.5

-5.1 -1.4 -4.7 -8.1 -4.5 -13.9 -18.0 -14.7 -15.6

Core inflation will remain low
Year-on-year percentage change
3.0 2.5 2.0 1.5 1.0 0.5 0.0 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
SEB forecast

3.0 2.5 2.0 1.5 1.0 0.5 0.0

Gradual recovery in the Baltic countries
After their extreme economic downturn in 2009, all three Baltic countries showed positive year-on-year GDP growth during the past two quarters. We continue to predict a gradual export-led recovery. Meanwhile domestic demand is beginning to thaw. The Baltics have restored their competitiveness after successfully applying an internal devaluation policy, but the growth of private consumption and capital spending will be sluggish due to public sector pay freezes in 2011, high unemployment including structural problems and continued private debt retirement.

Euro zone

Source: Eurostat, BLS, SEB

US: The credit channel has stabilised
Ratio, year-on-year percentage change
12 10 8 6 4 2 0 86 88 90 92 94 96 98 00 02 04 06 08 10 12 10 8 6 4 2 0

The Fed’s expansion of its balance sheet has provided new fuel for discussion about the risk of triggering inflation by printing money and boosting the money supply. Broad money supply aggregates have again begun to grow, but still at a very slow pace. The credit multiplier also seems to have started rising again but is not far from its lows. Our conclusion is that monetary measures are signalling lower deflation risk but that there is still plenty of time for the Fed to withdraw liquidity if a real-term upturn should take off in earnest. We have revised our overall inflation forecast slightly upward and consider the risk picture more symmetrical than before. But most indications are still that inflation will remain low during the next couple of years. Resource utilisation remains low in the OECD, leading to historically low pay hikes. Unit labour cost is also being pushed down by cyclical recovery in productivity.

M2 money supply Credit multiplier (M2/monetary base)

Source: Federal Reserve

Overall, we expect decent annual GDP growth of 4-5 per cent in the Baltics during the next couple of years. Estonia is adopting the euro on January 1, 2011.

Central bank stimulus nearing its end
In the US, the euro zone, Japan and the UK, monetary stimulus measures remain the most important instru-

Nordic Outlook – November 2010 | 9

International overview

ment for safeguarding economic recovery. Low underlying inflation pressure and stable inflation expectations will enable central banks to continue their zero interest rate policies well into 2012. Another option is unconventional monetary policy aimed at keeping the entire yield curve − in nominal and real terms − at the lowest possible level as well as keeping inflation expectations at a suitable distance

from zero. The challenge for the central banks will be to achieve maximum impact from their stimulus measures, on the one hand, while preserving their long-term credibility, on the other. Their strategy for accomplishing this is to emphasise their readiness to resume stimulus measures using the relevant tools, but meanwhile to carefully avoid spelling out their timetable for this exit strategy. the relationship between supply and demand will not be as strained as in 2006-2008. This indicates that Saudi Arabia, with its large production reserves, will continue to have a major influence on prices. Saudi Arabia’s aim is to keep the price of Brent oil in the USD 70-90/barrel range. We believe that the price of Brent will end up in the upper part of this range − slightly above today’s level.

Calmer commodity price trend
Since the summer, commodity prices have gained new upward momentum after a brief slump last spring. Metals and agricultural commodities have climbed to new record levels, measured in US dollars. The fact that commodity prices, especially oil prices, are rising so early in the OECD countries’ economic cycle may pose a danger to their relatively fragile economic upturn. We see four main reasons for the rapid price movements of recent months: 1) Less uncertainty about the world economic trend. 2) Poor grain harvests due to weather effects. 3) An increased element of speculative trading (especially evident from grain contracts). 4) The decline in the USD, which creates upward pressure on prices, since commodities are priced mainly in dollars and producers want compensation for USD depreciation. The latter two factors have been closely linked to the Fed’s QE2 measures.

What is driving commodity prices?
Index, thousands
900 800 700 600 500 400 300 Jan May 08 Sep Jan May 09 Sep Jan May Sep 10 12 10 8 6 4 2 0

High commodity prices
Index, monthly data, USD
500 450 400 350 300 250 200 150 100 50 00 01 02 03 04 05 06 07 08 09 10 500 450 400 350 300 250 200 150 100 50

S&P GSCI Commodity index (LHS) Baltic Dry (RHS)

Source: S&P, Baltic Exchange

Agriculture Industrial metals

Source: HWWI

Agricultural prices will be weather-driven for another while. Most agriculturally related commodity prices have soared rapidly this autumn, especially cotton, but wheat prices have levelled off after their sharp upturn in July-August due to extreme weather in two major producer countries, Russia and Ukraine. In the short term, there is a risk that the La Niña weather phenomenon will affect agricultural production into early next year, thereby pushing prices up further. But in a more long-term perspective, underlying supply and demand conditions point towards a calmer price trend. Gold will continue to glitter. Gold prices reached new nominal record highs this autumn. Here, too, the Fed’s announcement of a new quantitative easing round contributed to a sharp price increase, but adjusted for inflation, gold prices are nearly 30 per cent below their peak levels in the 1980s. We expect gold prices to remain high due to long-term uncertainty about inflation or deflation, the solvency of countries and the future currency system. World Bank representatives have indicated that they are open to allowing gold to regain some kind of role in a reformed global currency system, and this may push up gold prices further.

This autumn’s commodity rally, which has recently lost some steam, is thus only partially due to fundamental factors. We thus continue to expect a more moderate price upturn ahead, with levellingoff tendencies later in our forecast period. Another indication is that this autumn, the Baltic Dry freight index has shown a downward trend, ending its strong correlation with commodity prices in recent years. Oil is climbing towards USD 90. In their latest monthly reports, the International Energy Agency (IEA) and the Organisation of Petroleum Exporting Countries (OPEC) both adjusted their 2011 global oil demand forecast slightly upward. In spite of this,

10 | Nordic Outlook – November 2010

International overview

Unit labour costs
Year-on-year percentage change
9 8 7 6 5 4 3 2 1 0 -1 -2 -3 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3

− for example by way of higher commodity prices and wages. The low-return environment in the West is also triggering unwanted capital inflows that lead to undesirably strong currencies and increase the risks of asset bubbles. The room for continued interest rate hikes is limited by appreciation pressure. In some countries, capital controls − now an acceptable policy tool − are one way of protecting their currency.

Slower pace of Nordic key rate hikes
The differences in monetary policy conditions between the major OECD countries and Sweden and Norway are also becoming increasingly clear. Developments in these two Nordic countries show a number of similarities with certain Asian countries. Rapid domestic credit growth and a risk of housing market bubbles justify higher interest rates. But wider key rate spreads against the major OECD countries imply currency appreciation, among other things resulting in slower inflation. The central banks in Sweden and Norway may thus indirectly be forced to adjust their interest rates to those in other countries in order to avoid an excessively strong currency.

Europe (OECD countries)

Source: OECD

Looking ahead, central banks will emphasise that expanding their balance sheets is still part of the monetary policy arsenal. Japan is closest to expanding quantitative easing, while the probability of new QE rounds from the Fed or Bank of England is far smaller. We expect the European Central Bank (ECB) to limit itself to offering liquidity and accepting government securities as collateral for borrowing from the ECB.

Financial conditions less expansive in Sweden
Rebase 100 = 2003:3
103 102 101 7 100 99 98 97 96 95 94 93 92 03 04 05 06 07 08 09 10

Key interest rates
Per cent
7 6 5 4 3 2 1 0 00 02 04 06 08 10 12
SEB forecast

Tighter conditions

103 102 101 100 99 98 97 96

6 5 4 3 2 1 0

Easier conditions

95 94 93 92



Euro zone
Source: SEB

Euro zone

Source: ECB, Fed, SEB

Our assessment is that the QE programmes now in place will be carried out but that unconventional monetary policy will then be nearing its end. New purchases of government securities will be increasingly controversial. Because many countries regard QE as a substitute for currency intervention, new programmes may jeopardise G20 collaboration and coordination, thereby escalating currency policy tensions. Meanwhile the justification for new monetary stimulus is diminishing, since market lending conditions have actually improved, though not normalised. Growth and inflation risks have become more symmetrical, which points in the same direction. Central banks in emerging economies often face a diametrically opposite set of problems, compared to those of major OECD countries. There is a risk that domestic bottlenecks will spread, boosting inflation pressures

For a long time, the situation of Norges Bank in Norway has been characterised by this dilemma. In a gentler form, it is also beginning to be true of Sweden’s Riksbank. In its latest Monetary Policy Report, the Riksbank adjusted its key interest rate path downward, stating more explicit references than previously to international uncertainty and the consequences of interest rate hikes for the krona. Looking ahead, we expect the Riksbank to deliver rate hikes largely in accordance with the path it has now announced. This means that we are not significantly changing our forecast from the last Nordic Outlook. We expect the Riksbank to hike its key rate in December and February, thus reaching a rate of 1.50 per cent. After that, hikes will be less frequent, mainly due to the risks of an excessively strong krona. By the end of 2011, the repo rate will stand at 2.25 per cent and by the end of 2012 at 3.0 per cent. Our forecast is thus higher than today’s prevailing market pricing.

Nordic Outlook – November 2010 | 11

International overview

Because of low inflation in Norway, we expect Norges Bank to hold off until next summer before resuming rate hikes. Towards the end of 2011 the deposit rate will reach 2.50 per cent. We expect Norway’s output gap to be closed by early 2012; for this reason we expect a slightly faster pace in the bank’s rate hikes. By late 2012 the deposit rate will stand at 3.75 per cent.

Funding requirements, PIIGS countries, 2011
EUR billion Greece Ireland Italy Portugal Spain Maturing loans 38.5 4.4 279.4 26.2 124.5 Net lending 20.0 22.6 75.2 13.1 90.4 Total (% of GDP) 25.1 16.7 22.2 22.7 20.2

Key interest rates
Per cent
7 6 5 4 3 2 1 0 00 02 04 06 08 10 12
SEB forecast

7 6 5 4 3 2 1 0

Source: Bloomberg, SEB

In the short term, the recommendations of the EU, IMF and other bodies are also cautious − reflecting a desire not to interrupt the fragile recovery with excessively synchronised austerity policies. This means that countries in a position to do so are being asked to postpone belt-tightening or even stimulate the economy. Overall, fiscal policies appear likely to be mildly contractive during the next couple of years. In some of the PIIGS countries the dose of austerity is very large, and it is also likely that further measures will be necessary. Among major countries, only the UK has decided to implement a large austerity package. In countries like Germany and France, very modest austerity measures are being implemented. In the US, we expect an agreement to extend the Bush administration’s tax cuts to be reached at the last minute. In spite of this, federal fiscal policy will have a tightening effect equivalent to about 1 per cent of GDP. In Japan, the government has announced new stimulus measures this autumn despite huge government debt.

Euro zone


Source: ECB, Norges Bank, Riksbank, SEB

Because the two central banks will carry out relatively cautious rate hikes due to the risks of strong currencies and low inflation, home prices will continue upward in Norway and Sweden. This will increase the risk of painful corrections ahead. Certain other steps are being taken to slow the price trend, for example the recently enacted loan-to-value ceiling on mortgages in Sweden. Given Sweden’s strong central government finances, a policy mix that includes faster key interest rate hikes and a more expansionary fiscal policy would be an alternative, but at present the Riksbank and the government do not seem prepared to change their division of responsibility in Sweden’s stabilisation policy. This is despite the fact that such an arrangement would be well in line with international discussions concerning today’s imbalances, but also with lessons about the importance of not allowing lending and home prices to expand for too long.

Net lending
Per cent of GDP 2010 United States Japan United Kingdom Euro zone OECD
Source: OECD, IMF, SEB

2011 -9.7 -9.1 -9.4 -5.5 -6.7

2012 -6.9 -8.5 -7.6 -5.0 -5.5

-11.1 -9.8 -11.4 -6.2 -7.8

Different fiscal strategies
The global financial and credit crisis pushed public sector deficits and debts to unsustainable levels in many countries. In the long term, major belt-tightening will thus be necessary. For example, IMF calculations indicate that current deficits combined with demographic strains will require austerity measures in the range of 6-9 per cent of GDP in order to stabilise government debt in the G20 countries. The severe crisis in the PIIGS countries also show that immediate measures are needed to ease acute financial mistrust.

Major countries are apparently not being pressured by financial markets to speed up their austerity measures. Interest rates have remained depressed, despite the large supply of government securities. This will enable these countries to prop up their economies to a fairly high degree during the next couple of years and thereby postpone their adjustment burdens.

Long-term yields sideways next six months
Globally, government bond yields fell sharply during the first eight months of 2010. During the spring, the accelerating crisis in the PIIGS countries drove down

12 | Nordic Outlook – November 2010

International overview

long-term yields in major OECD countries. After that, a gloomier economic outlook in the US provided new momentum for this trend. By the end of August, the yield on 10-year German government bonds bottomed out at around 2.10 per cent, well below prevailing yields when the financial crisis culminated late in 2008. With a certain time lag, American bond yields have also fallen: from 4 per cent in April 2010 to 2.4 per cent in early October. Increasingly clear signals that the Fed was preparing new QE measures initially helped give yields an extra downward push. Once the size of the stimulus programme was announced, bond yields bounced back upward by 40-50 basis points in both the US and Germany. More stable economic signals in the US, combined with a normalisation of inflation expectations, also contributed to the yield upturn. The phase-out of the ECB’s liquidity measures has also driven yields in Germany. This has been especially true of yields on short-term bonds, but long-term yields have also been affected to some extent.

their German equivalent at 3.40 per cent. We expect Nordic government bond yields to climb somewhat faster. Partly because of continued key rate hikes, the spread between Swedish 10-year bonds and German ones will widen from today’s 25 to 50 basis points by the end of 2012. The equivalent Norwegian spread will rise from around 65 to 90 points in December 2012.

Fundamentals still controlling currencies
In the past year, fundamentals have been the main driving force in the foreign exchange market. Currencies have appreciated in countries with strong government finances and where the central bank has been able to withdraw part of its monetary stimulus. In many cases, these are countries with large commodity exports that have benefited from high prices. In recent months this more or less natural trend has led to troublesome consequences, resulting in currency policy tensions − sometimes described as “currency war”. Looking ahead, we believe that exchange rates will continue to be driven by growth and interest rate differentials. In this environment, the G3 currencies (USD, EUR and JPY) and the British pound will be losers in the immediate future. Of this group, we expect the USD to continue to be pulled down by the Fed’s policies for another while, but we do not anticipate any surprises. The USD is thus relatively close to bottoming out. We expect the EUR/USD exchange rate to be back above 1.40 early next year. After that, strong US economic growth combined with lingering debt problems in the PIIGS countries will cause the EUR/USD rate to fall again towards 1.25 or 1.30. The pound will also see a similar trend against the euro: further short-term weakening, then a return to more fundamentally justified levels of around GBP 0.80 per euro.

10-year government bond yield
Per cent
7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 99 00 01 02 03 04 05 06 07 08 09 10 11 12
SEB forecast

7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0


Source: Reuters EcoWin, SEB

We do not expect bond yields to revert to their latesummer lows. Worries about a new US and global recession will gradually fade in 2011, while the upturn in commodity prices will help dispel risks of deflation. Yet there are reasons to expect continued low bond yields ahead. Central banks will be pursuing very expansionary monetary policies, and a normalisation of key interest rates is far away in time. The Fed’s bond purchases will also help hold down bond yields in the US, and the Fed will also continue to be prepared to act if an upturn in long-term yields should threaten the economic recovery. Our forecast of a continued decline in core inflation during much of 2011 also points towards continued low yields. Our conclusion is that bond yields both in the US and Germany will remain at today’s levels until the second half of 2011. Only when the time for central banks to hike interest rates begins to move closer will long-term yields climb cautiously. By the end of 2012, 10-year US Treasury yields will stand at 3.60 per cent and

Exchange rates
Index 100 = July 2007
160 150 140 130 120 110 100 90 80 70 60 Jul Nov 07 Mar Jul 08 Nov Mar Jul 09 Nov Mar Jul 10 Nov 160 150 140 130 120 110 100 90 80 70 60




Source: Reuters EcoWin

As for the USD/JPY exchange rate, the trend towards a stronger yen is probably close to ending. We expect the USD/JPY rate to remain in the vicinity of 80 for another

Nordic Outlook – November 2010 | 13

International overview

while and then gradually move towards 100 as American long-term yields slowly creep upward. The Riksbank’s lowering of its key interest rate path in October contributed to a temporary reversal in the Swedish krona appreciation trend, but we expect this appreciation to regain its strength as the Riksbank delivers further key rate hikes in December and February. We believe that because of continued good export growth and a favourable valuation, the EUR/SEK exchange rate will reach 9.00 during the first half of 2011 and then continue to 8.75 by the end of 2011. The Norwegian krone has lost ground recently, since both monetary policy and the flow outlook have worsened. Norges Bank has underscored its displeasure while carrying out large sales of NOK on behalf of the Government Pension Fund of Norway. In the next few months, the flow outlook in particular will improve. We foresee a move towards an EUR/NOK rate of 8.00 by the end of 2010. After that, the EUR/NOK rate will continue to 7.75 by late 2011 and 7.50 by late 2012.
120 110 100 90 80 70 60 50 40 30

Stock markets still below 2007 peaks
Rebase 100 = 2007:7
120 110 100 90 80 70 60 50 40 30 Jun Oct 08 Feb Jun Oct 09 Feb Jun 10 Oct

Oct Feb 07

US Euro zone

Emerging markets Sweden

Source: Reuters EcoWin, SEB

Equities benefiting from low interest rates

Low interest rate policies around the world and strong balance sheets, together with decent world economic growth − driven by expansive developing economies − have sustained strong stock markets during the past year. The Fed’s QE announcement in August helped stock exchanges worldwide regain their upward momentum. American share price indices have climbed more than 10 per cent since late August, but the formal decision to launch QE2 provided no further stimulus for the stock market; the decision was expected. Macroeconomic strength, combined with an advantageous sectoral and market exposure, contributed to favourable performance on Nordic stock exchanges. In recent weeks, share prices have moved sideways. Because of high expectations, company earnings reports for the third quarter were not able to boost share prices in general, despite higher profits and a surprisingly strong volume trend. The appreciation of Nordic currencies also contributed to a more subdued stock market trend.

We see potential for a continued stock market upturn. Low interest rates have helped boost the valuations of nearly all other asset classes (commodities, bonds etc.), but so far equities have only followed profits, without any extra multiplier effect. Nordic companies also have relatively low valuations. Share prices of Nordic listed companies divided by carrying amount (book value) are 15 per cent below their 10-year average, according to SEB Enskilda’s forecast. It is reasonable to believe that next year, share prices will move in such a way as to bring valuations closer to the 10-year average. It should be added that profits are expected to increase at a healthy pace; in 2012 an increase of about 10 per cent is expected. Nordic export companies will be able to continue taking advantage of increased exposure to emerging markets. At the same time, there are reasons to bear in mind various risks, included flare-ups of financial worries in Europe. The risk of a global trade war has not been entirely averted. Another risk is that the profit growth expected by companies may turn out to be too high, but this is offset by a significant upside risk for company sales growth estimates. Overall, most indications are that Nordic stock exchanges will perform strongly in 2011.

14 | Nordic Outlook – November 2010

International overview

Basel III update
In November 2010, the G20 heads of state and government who met in Seoul gave the green light to the implementation of Basel III, based on a proposal by the Basel Committee on Banking Supervision. This decision will mean a gradual phase-in of tighter capital adequacy rules (starting in January 2013) and new global minimum liquidity rules (starting in 2015) by 2018. The purpose of Basel III is to strengthen the resilience of the banking sector, prevent excessive risk-taking and leveraging and reduce the pro-cyclical effect of the financial system on the real economy. In the long term, these changes will create greater stability both in the financial system and in the real economy. Because there will be increased competition for capital, however, it will lead to higher interest rates, lower capital supply and resulting costs to the real economy during the transitional period 2012-2018. There are strong differences of opinion as to the magnitude of these effects, but the extension of this transition period compared to the original December 2009 proposal will reduce such adverse effects. In brief, Basel III will mean that the minimum requirement for the core Tier 1 capital ratio will be raised from 2 to 4.5 per cent of a bank’s risk-weighted assets. The requirement for Tier 1 capital will be raised from 4 to 6 per cent. In addition, banks must hold a capital conservation buffer of 2.5 per cent of riskweighted assets. This means that banks must have total common equity of at least 7 per cent

in order to avoid regulatory restrictions on their operations. In addition, depending on economic and financial circumstances, the authorities may implement a counter-cyclical capital buffer, which may vary between 0 and 2.5 per cent. If all these capital adequacy requirements are fully implemented, this means that the level of core Tier 1 capital will be raised from 2 to a maximum of 9.5 per cent and for Tier 1 capital from 4 to 11 per cent. The situation will also include a stricter definition of what should be regarded as capital. The liquidity rules are based on two measures: The liquidity coverage ratio and the net stable funding ratio. The first measure requires a bank to hold enough liquid assets to survive 30 days of major funding problems. The second measure is aimed at achieving a better balance between the maturities of a bank’s assets and liabilities, that is, to ensure that available stable funding will be larger than the need for such funding. In addition to these measures, a leverage ratio will be tested, specifying that capital must exceed 3 per cent of the bank’s exposures. For Nordic banks, the most significant features of Basel III are the changes in liquidity rules. More long-term, stable borrowing via an amended borrowing structure and longer maturities will increase the expenses of banks. This will affect interest rates for borrowers as well as the profitability of the banking sector.

Nordic Outlook – November 2010 | 15


Greater need for new monetary system
ƒ ƒ Meagre Seoul summit but progress in 2010 New global monetary system on agenda

The contours of a new monetary system
The world has gone without a formal international monetary system for nearly 40 years. The Bretton Woods (BW) system was ended in 1971 after having been operating since 1945. BW was a global fixed exchange rate system anchored by the US dollar, and indirect by gold. This system also resulted in the establishment of the International Monetary Fund. The IMF was assigned the task of focusing on balance of payments problems, currency policy and free trade in order to promote economic growth and trade, generate income and jobs and stop competitive devaluations. For four decades, the US dollar has remained the de facto anchor in the “non-system” that followed BW. But this question has been raised: Does the world need a new multilateral monetary system in order to reduce economic imbalances and return to high and stable economic growth? The G20 has entrusted the IMF − during France’s G20 chairmanship in 2011 − to present proposals on the mechanisms for a new system.

This autumn the climate of cooperation among the Group of 20 countries has deteriorated. There are several reasons for this worrisome disunity. The need for private and public debt retirement is hampering the domestic growth dynamic in many countries, increasing their dependence on exports and thus tempting them to weaken their currencies in various ways. There is also genuine disagreement among G20 countries about the actual causes of their shared imbalances and systemic problems. Many countries have weak governments, also making it harder to implement politically demanding belt-tightening and structural reforms. But on some points, the G20 summit confirmed progress made in recent international discussions, for example, the decision to introduce new capital adequacy and liquidity requirements for banks (Basel III). In addition, power relationships in the International Monetary Fund (IMF) have been modernised to give emerging economies a greater say. The G20 also decided that concrete country-specific economic policy action plans should be established. This will strengthen the Mutual Assessment Process (MAP), which will continuously evaluate countries to establish whether they are pursuing policies that adversely impact other countries.

World trade volume
World Trade Monitor, index 100 = 2000, seasonally adjusted
World trade total Emergning economies Advanced economies




G20’s 2011 focus under French leadership
Looking ahead, the G20 has identified a number of issues that will dominate its work until the next summit in Cannes late in 2011. Some of the key issues are: 1. The IMF, Bank for International Settlements (BIS) and Financial Stability Board (FSB) will propose new tools to reduce financial sector risk levels, based on a systemic perspective, to be reported to G20 finance ministers and central bank governors at their next meeting. 2. The IMF will examine and propose guidelines on how to identify when a country is showing excessively large current account surpluses or deficits. The American proposal for quantitative restrictions on acceptable current account surpluses or deficits (which was admittedly rejected in Seoul) is an example of the kinds of issues the IMF will further consider. 3. The IMF will examine the need and possible mechanisms for a new international monetary system.







0 91 93 95 97 99 01 03 05 07 09


Source: Netherlands Bureau for Economic Policy Analysis

We see four main reasons why the issue of a global monetary system has been raised again: 1. A decade of rapid globalisation has made countries highly economically and financially interdependent. There is a great need for cooperation in many areas to avoid disruptions and reduce the risk of protectionism. 2. Large differences in the cyclical position of countries and related financial and monetary policy issues create international tensions. A new system may not solve imbalance problems but can help ensure that

16 | Nordic Outlook – November 2010


adjustments are not jeopardised by unwanted currency policies or destabilising capital or currency movements. 3. There are worries about the USD’s future stability. 4. Weaknesses in today’s system explain why some central banks build up excessive currency reserves.

First steps taken towards a new system
The steps towards a new international monetary system have been halting and tentative. There is an obvious political dimension. Decisions may have major consequences for capital flows, currency movements and economic growth. The advantages enjoyed today by the US (see above) would decrease. But statements by both the US Treasury Department and the Fed indicate American openness. The dominance of the dollar may gradually diminish in the future as alternative solutions emerge and as other economies − such as China − gain additional economic and financial clout. A new international monetary system would not be a BW type fixed exchange rate system anchored by one currency or gold. Fixed exchange rates are oldfashioned and make adjustments difficult for countries that need to undergo structural reforms. But increased currency cooperation will impact monetary policy and may also affect room for manoeuvre in fiscal policy. To some extent, these steps have already been initiated by the IMF’s Mutual Assessment Process (MAP)

Reserve status: Privileges, responsibilities
A country whose currency enjoys the privilege of reserve status has a high degree of freedom in its economic policies. This also represents an international confirmation of its economic and political strength. The United States has benefited from being able to borrow internationally in its own currency at relatively low cost. Meanwhile US investments in other countries have yielded good returns. One result is that today the US has a positive annual net return of USD 160 billion even though its debts exceed its assets by USD 2.9 trillion. Today’s international monetary system is dominated by the US dollar in a way that is not justified by the size of the US economy and financial markets. The US economy accounts for 20-25 per cent of the world economy, while US equity and fixed income markets account for 30-35 per cent of global financial markets.

China's skyrocketing currency reserve
USD billion
3000 2500 2000 3000 2500 2000 1500 1000 500 0 86 88 90 92 94 96 98 00 02 04 06 08 10

Current account
Per cent of GDP 2005 United States Germany Japan Spain Greece Portugal Ireland Sweden Norway Denmark Finland
Source: IMF, WEO, October 2010

2010 -3.2 6.1 3.1 -5.2 -10.8 -10.0 -2.7 5.9 16.6 3.4 1.4

2015 -3.3 3.9 1.9 -4.3 -4.0 -8.4 -1.2 6.2 15.8 2.5 1.7

1500 1000 500 0

-5.9 5.1 3.6 -7.4 -7.3 -9.1 -3.5 6.9 16.3 4.1 3.4



Source: Reuters EcoWin

Yet 60-65 per cent of world currency reserves consist of US dollars and 85 per cent of global foreign exchange transactions have a “dollar leg”. Over 50 per cent of debts in the global banking system are USD-denominated. At times of instability, the dollar also assumes the role of “safe haven” currency, confirming that it remains the world’s dominant reserve currency. Among reasons for the USD’s role are lack of credible alternatives or confidence in one’s own currency. The world has relied heavily on the US in economic, financial and political terms. Worries about the US economy and its major adjustment needs are raising questions about alternative reserve currencies and ways of ensuring that global monetary stability will not be dependent on one currency.

The IMF’s future may include global agreements on reasonable currency movements during periods of adjustment and the size of currency reserves, current account balances and external financial positions. The US proposal to create a ceiling/floor for a country’s current account surplus/deficit is one element of the issues the IMF will address. The goal is to find an objective framework the G20 can agree on for putting pressure on an individual country to change economic policies. Some form of sanctions will probably be needed if the system is to be effective. Central banks may also agree on clearer frameworks, greater currency cooperation and intervention aid. But this will require active participation from governments, since currency policy is often the responsibility of finance ministries, not central banks. The IMF would continue to strengthen its role, both institutionally and financially, in order to reduce the need for large currency reserves. It could also serve as guarantor of a new weighted reserve currency that should reasonably include such major world currencies as the US dollar, British pound, euro, Japanese yen and Chinese yuan. Nordic Outlook – November 2010 | 17

The United States

The Fed gives the economy a helping hand
ƒ ƒ ƒ ƒ The recovery will gradually strengthen The labour market is healing but the housing market is shaky Low inflation, but deflation threat avoided The Fed will hike its key rate in mid-2012
account for most of GDP declines, are close to historic lows as a percentage of GDP, so further declines are unlikely, and 2. primarily via a weaker dollar and rising asset values, the Fed’s renewed quantitative easing package (“QE2”) will improve growth prospects.

Most cyclical sectors: not much downside
Per cent of GDP
32.5 30.0 27.5 25.0 22.5 20.0 17.5 50 55 60 65 70 75 80 85 90 95 00 05 10 32.5 30.0 27.5 25.0 22.5 20.0 17.5

American GDP growth averaged 1.9 per cent in the second and third quarters, compared to an average of 4.4 per cent in the two preceding quarters. Growth will continue to sputter for another while but will strengthen in 2011 when employment growth picks up. Moreover, the Federal Reserve’s stimulus measures will help consumption and corporate capital spending to recover, despite fiscal tightening. Meanwhile exports are benefiting from a continued weak US dollar. GDP growth will reach 2.7 per cent this year, 2.2 per cent in 2011 and 3.4 per cent in 2012. Unemployment will fall in 2011 but inflation will remain low. The Fed will not hike its key interest rate until mid-2012.

Durable goods + business inv. + inventory inv.
Source: BEA, SEB

GDP: "Soft patch" for a year
6 5 4 3 2 1 0 -1 -2 -3 -4 -5 Q1 Q3 09 Q1 Q3 10 Q1 Q3 11 Q1 Q3 12
Source: BEA, SEB


SEB forecast

5 4 3 2 1 0 -1 -2 -3 -4 -5

A new wave of home price declines is the biggest risk to continued recovery. Policy mistakes may also throw our scenario off. Our forecast assumes that the federal tax cuts now in place will be extended at the last minute. This will limit the tightening effect of fiscal policy to around 1 per cent of GDP in 2011. But if the prevailing political paralysis and deep divide between congressional Democrats and Republicans continues, the economy may suffer serious damage as early as 2011.

Composite ISM and GDP growth
Index, year-on-year percentage change
62.5 60.0 57.5 55.0 52.5 50.0 47.5 45.0 42.5 40.0 37.5 35.0 02 03 04 05 06 07 08 09 10 11 12 SEB forecast 6 5 4 3 2 1 0 -1 -2 -3 -4 -5



Note: NBER dates

Recession risk 20 per cent
According to our forecast, GDP growth will remain at around 2 per cent in the next few quarters, but such a long period of low but positive growth is historically unusual. The economy usually grows above trend (2.7 per cent, according to SEB’s estimates) or is in recession. Our model projections indicate that during the next six months, the recession risk is higher than usual, yet lower than a month ago: about 20 per cent. The main reasons why there will be no new recession are: 1. the most cyclical sectors in the economy, which ordinarily 18 | Nordic Outlook – November 2010

ISM Composite index (LHS)

Real GDP (RHS)

Source: ISM, SEB

Manufacturing sector steaming ahead
Although the National Federal of Independent Business (NFIB) index has climbed in the past three months, it is still at a depressed level. Large companies are more

The United States

optimistic: Contrary to expectations of a decline, the ISM purchasing managers’ index for manufacturing rose in October. The service sector index also gained strength. Right now our composite indicators show that GDP will increase at approximately the same rate in the fourth quarter as in the third. The weak dollar will enable exports to help drive growth in the coming 6-9 months, after two quarters of large negative contributions from net exports. Annual export growth will average 12 per cent in 2010-2012, which is high in a historical perspective, but the administration’s target last spring of doubling exports over a five-year period still seems distant. The recovery in US industrial production is continuing at a healthy pace. During the recession, 11 years of production upturn were wiped out, but after a strong surge in the past year, the industrial production index is back at its 2004 level. Our forecast is that industrial production will increase by 5.4 per cent this year, 4.1 per cent in 2011 and 5.6 per cent in 2012.

Higher saving is holding back consumption
The living standard of middle class Americans has deteriorated in the past decade. The income of the median household has fallen slightly in real terms. Access to cheap loans and the accompanying inflation in asset prices nevertheless helped prop up the public mood and sustain consumption for a long time. The financial crisis has changed the playing field. Even though a recovery has been under way for 15 months, household confidence indicators remain depressed, especially the Conference Board survey, which is more than 40 points below its historical average. Our consumption model, which includes the above indicators, shows rather low consumption growth during the next several months.

Contribution to change in real GDP
Average since Q3 2009, percentage points
2.0 1.5 1.0 0.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5

Consumers are feeling blue
Deviation from the mean, 10-year percentage change
60 40 20 0 -20 -40 -60 -80 80 85 90 95 00 05 10 20 15 10 5 0 -5 -10 -15 -20 -25

0.0 -0.5 -1.0 -1.5

Inventories PCE Eq and S Federal

Residential State and local Net exports
Source: Reuters EcoWin, SEB

Michigan (LHS) Conference Board (LHS) Median household income (RHS)

Source: Michigan, Conference Board, Census Bureau, SEB

Even though the stock market has risen sharply since bottoming out, enormous wealth has been wiped out: on average, households have become USD 100,000 poorer than before the crisis. This, in turn, points Where we are now − a bit more than one year into the recovery − GDP is thus usually growing at close to 7 per cent year-on-year. Our calculations also indicate that private consumption growth averages 5.8 per cent year-on-year: three times stronger than the trend this time.

Unusually weak recovery
According to a new CNN survey, more than 70 per cent of the American public believes that the recession is still under way. The official declaration from the National Bureau of Economic Research (NBER), however, is that the deepest and longest-lasting recession of the post-war period ended in June 2009. GDP fell more than 4 per cent and the downturn lasted 18 months. The historical pattern is that GDP grows at a rapid pace during the first three years of a recovery, followed by a pause for breath in year four. Another rule of thumb is “the deeper the recession, the more powerful the recovery”. This explains why the recoveries of the early 1990s and 2000s sputtered: the preceding recessions were unusually mild. The same logic does not apply this time around; during the first year of recovery, GDP growth has been less than half the historical average, and forecasts indicate continued sluggishness over the next few years.

Weak recovery in historical perspective
Averages cover 9 recession/recovery cycles from 1948
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Year 1 Year 2 Year 3 Year 4 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

Average GDP growth (YoY) 1 to 4 years into recovery Comparable SEB forecasts in the current cycle Comparable consensus forecasts in the current cycle

Source: BEA, NBER, Consensus Economics Inc.,SEB

Nordic Outlook – November 2010 | 19

The United States

towards a continued slight increase in saving. Our estimate is that the household savings ratio will continue upward to an average of 6.3 per cent in 2012. One source of near-term concern is that many chronically unemployed people are beginning to reach the maximum period of unemployment benefits, 99 weeks. These payments average USD 300/week. It is a close call whether Congress will approve another extension of these benefits. Without another extension some one million Americans will reach the end of their benefit period each month from December to April. The income loss will be sizeable: USD 70 billion or 0.5 per cent of GDP. Meanwhile lower transfer payments will be offset by a gain in private wages and salaries. Our overall assessment is that household consumption will rise by 1.8 per cent in 2011 and 2.8 per cent in 2012.

The jobless rate will be 9.5 per cent in 2011 and 8.4 per cent in 2012, measured as annual averages.

Long-term unemployment on the way down
There are still more than 6 million chronically unemployed people (41.7 per cent of the total), yet the situation looks a little better than during the summer, when 6.8 million (46 per cent) of those without jobs belonged to this category. Falling long-term joblessness is especially positive, since the risk of being pushed out of the labour market is diminishing. Many of the long-term unemployed lose both their willingness and ability to work (hysterisis), and this is an often permanent effect of a deep recession.

Long-term unemployment down from peak
Per cent of total unemployment, per cent
50 45 40 35 30 25 20 15 10 5 80 85 90 95 00 05 10 12 11 10 9 8 7 6 5 4 3

Economy vulnerable to energy price shock
Oil prices are flirting with the USD 90 level again. One benevolent interpretation is that the upturn is due to stronger demand in the world economy, especially in Asia. But there are many signs that the price increase is connected to the Fed’s new monetary stimulus measures. Since the American central bank began to indicate that quantitative easing was in the pipeline, oil prices (Brent crude) have climbed by 6 per cent. Rising energy costs squeeze household income in real terms. Their ability to absorb the upturn is limited by all the idle capacity at the production stage and in the labour market. Oil prices reached USD 90/barrel for the first time in October 2007, and a few months later the US recession began. The difference is that US unemployment was 4.7 per cent in October 2007, while it is 9.6 per cent today. Capacity utilisation in the manufacturing sector is below 73 per cent today (79 per cent three years ago), and consumer confidence is now at 50 (95 three years ago). A number of factors indicate that a new recession is not imminent, but the American economy is more vulnerable to an energy price shock today than in October 2007.

Long-term unemployment (LHS) Unemployment rate (RHS)

Source: BLS, SEB

Labour market beginning to heal
The October employment report contained a number of bright spots. Above all, non-farm payrolls increased significantly faster than expected and income rebounded. Other parts of the report indicated a poorly functioning labour market: 1.1 million full-time jobs have disappeared since this past summer, labour market participation has fallen to the lowest level for a quarter century and the percentage of people with jobs − the indicator that many labour market experts consider the most important barometer of the situation − is approaching earlier lows. Employment will continue to climb, according to our forecasts, but weak GDP growth over the next six months will not lay the groundwork for any impressive increase in job numbers. Unemployment will remain high this winter and then start falling again.

However, the downturn in long-term unemployment is hardly due to any underlying improvement in the labour market situation. Overall joblessness has moved sideways in recent months. Instead, the downturn seems connected to the fact that more and more of the long-term unemployed are approaching the end of their benefit period. This leads many of them to accept jobs that they had previously rejected. Another effect is that people lose their motivation to remain official job seekers, thus dropping out of the registered labour force and not being counted in unemployment figures.

Home prices
Index Jan 2006 = 100
110 105 100 95 90 85 80 75 70 65 06 07 08 09 10 110 105 100 95 90 85 80 75 70 65

Case-Shiller 20 FHFA

Existing home sales
Source: Reuters EcoWin, SEB

20 | Nordic Outlook – November 2010

The United States

Companies can still ramp up production without appreciably increasing their headcount. In the third quarter, productivity rose 2.5 per cent year-on-year. The rate of increase thus remains strong, indicating that clear job growth will not materialise for another while. Productivity will rise 3.4 per cent this year and 1.4 per cent in 2011, according to our forecasts.

Housing starts at rock bottom
Millions, annualised
2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 60 65 70 75 80 85 90 95 00 05 10 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25

Shaky housing market
Home prices, measured by the Case-Shiller price change index in the 20 largest metropolitan areas, have lost ground in recent months and are now only 4 per cent above spring 2009 lows. In the past month, the downturn was broad-based, with prices falling in 19 of 20 metro areas. Some regions have been especially hard hit: home prices in metropolitan Las Vegas and Detroit have fallen to 1999 and 1995 levels, respectively.

Source: US Census Bureau

QE will push up growth a bit
The Federal Reserve has decided to buy USD 600 billion worth of government bonds over an eight-month period. The central bank’s balance sheet will thus continue to swell, reaching 20 per cent of GDP, compared to 6 per cent before the crisis. Having lowered the price of money (interest rates) to an absolute minimum, the Fed is now pumping up liquidity instead. In theory, quantitative easing (QE) can stimulate the economy in several ways: 1) lower interest rates boost consumption and investments in interest rate-sensitive sectors, 2) a weaker dollar benefits foreign trade, 3) rising stock market valuations stimulate consumption and capital spending via the wealth effect, 4) home prices climb, leading to new borrowing and consumption and 5) looser monetary policy is ordinarily accompanied by easier credit conditions and an increase in bank lending. Speculation about a new monetary stimulus package took off after the Fed’s meeting in Jackson Hole, Wyoming late in August, contributing to a rally in many asset classes. For example, US stock market indices have gained some 13 per cent since summer. The estimated stimulus effects vary, depending on the source. Fed calculations show that bond purchases of USD 500 billion are equivalent to a 50-75 basis point interest rate cut and that the 2009 QE package lowered long-term yields by about 50 per cent. One rule of thumb is that an interest rate cut of 75 bps boosts GDP by 1.2 per cent in a two-year perspective. The impact will probably be smaller this time around, as the recent upturn in long-term yields also indicates. Important monetary policy channels such as the housing market and bank lending are still out of commission. Households are continuing to retire their debts and − at least those with a good credit history − are already seeing very favourable financing conditions. As long as consumer demand is being squeezed, companies lack incentives to accelerate capital spending, despite low or even negative real interest rates. Capital shortages are not a problem at present: the balance sheets of major corporations are in very good shape, and banks have more than USD 1 trillion in surplus reserves. Monetary policy has an impact, but it is weaker than usual. The Fed’s QE measures will help boost growth in the course of 2011, thereby reducing the likelihood of a Japanese-type deflation scenario.

Price changes in various asset classes since Jackson Hole
Aug 27 S&P 500 Dollar index 10-yr Treasury bonds (%) 1,065 82.9 2.65 1.03 1.61 78.5 1,236 194bps Nov 19 Change 1,200 78.5 12.7% -5.3%

Core inflation comparison
Year-on-year percentage change
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5

2.87 +22bps 0.72 -31bps 2.07 +46bps 83.6 1,345 6.4% 8.8%

10-yr TIPS (%) 10-yr BE (%)
Oil, USD Gold, USD Corp. spread
Source: SEB

174bps -20bps

Japan (1989 - 2002)

US (2006 - 2010)

Source:BLS, Statistics Bureau, SEB

Nordic Outlook – November 2010 | 21

The United States

Home prices will probably stay depressed this autumn and winter. Indicators are divided: some valuation measures and indices of what households can afford (even adjusted for tighter lending conditions) show that home prices should be rising. On the other hand, the large inventory of homes is pointing towards a continued price squeeze; this is the indicator to which we have attached the most importance in recent years. By definition, about 15 per cent of home mortgages are problem loans, but the problems of the banking sector are wider than this. Insufficient documentation and irregularities during foreclosure procedures have been revealed, causing banks to announce a new moratorium on foreclosures − providing (involuntary) support to the housing market in the form of free housing for millions of Americans who have defaulted on their mortgages. This stimulus totals USD 2.6 billion per month, according to The Wall Street Journal. Most of this money will likely go towards other consumption. Looking ahead, the moratorium will reduce the supply of existing homes; in recent years about one third of sales have been foreclosures. New home sales may also benefit slightly, which is positive for new construction and GDP. Housing starts will total 600,000 units this

year and 650,000 next year, measured as annual averages. By way of comparison, the historical average is 1.5 million. The large percentage of vacant units − both single-family homes and rental flats − is continuing to prevent a recovery in housing construction.

US dollar is getting cheaper
Index, USD/EUR
1.15 1.20 1.25 1.30 1.35 1.40 1.45 1.50 1.55 1.60 07 08 09 10 92.5 90.0 87.5 85.0 82.5 80.0 77.5 75.0 72.5 70.0

Dollar per euro, reversed (LHS) US dollar Index (RHS)

Source: Reuters EcoWin, SEB

Declining dollar having little impact on CPI
Since early summer, the dollar decline hit 14 per cent in trade-weighted terms before reversing some of that that Fed policies will drive up inflation in the long term. Inflation expectations (5Y 5Y forward BE inflation) show an upturn of nearly 70 bps since late August and approached a 10-year peak a few weeks ago.

The market is worried about inflation
Market reactions indicate rising concern that the Fed’s stimulus measures will lead to inflation down the road. Since late August − when speculation about a new round of QE took off − real interest rates (TIPS) have fallen (-31 basis points) while nominal interest rates have risen somewhat (+22 basis points). Like a mirror image, inflation expectations (break-even inflation) have risen by 46 bps during the same period. In mid-October, TIPS reached a record-low 0.36 per cent.

According to the market deflation risks have evaporated
Per cent
3.5 3.0 2.5 2.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 04 05 06 07 08 09 10

Nominal vs real yields
Per cent
6 5 4 3 2 1 0 04 05 06 07 08 09 10 6 5 4 3 2 1 0

1.5 1.0 0.5 0.0

5y 5y forward BE inflation

Source: Reuters EcoWin, SEB

10-year TIPS ("real rate") 10-year Treasury bond ("nominal rate") 10-year break-even inflation

Source: Reuters EcoWin, SEB

However, alternative measures of inflation expectations indicate that deflation remains a risk. One Cleveland Fed yardstick that focuses on how the public perceives inflation looking ahead 10 years ahead has fallen to its lowest-ever level (1.53 per cent in October). In addition, there are powerful price-lowering forces such as continued reductions in private sector borrowing and enormous quantities of idle resources in the economy. For example, 17.1 per cent of the labour force, or 26 million Americans, are unemployed or underemployed. Our conclusion is that it is too early to declare an end to the danger of deflation.

This year’s downturn in long-term yields has an entirely different dynamic than in 2008, when 10-year Treasury bonds fell to their lowest yield in modern times (2.07 per cent). At that time, deflation worries drove down nominal yields; expected 10-year inflation stood at 0 per cent according to the break-even measure. This time around, the market seems convinced

22 | Nordic Outlook – November 2010

The United States

movement in recent weeks. Although it still has some way to go before hitting its 2008 and 2009 lows, this movement has created concerns in other countries. Rapid, sharp dollar slides have led to problems before. In the 1970s, for example, the declining dollar was one reason why global inflation took off. Meanwhile a new Fed study shows that a 10 per cent decline in the dollar only drives up inflation by 0.3 percentage points. Among the factors limiting its impact are that foreign companies do not want to lose US market share, but instead accept lower profit margins. It is thus most likely that core inflation will continue to be squeezed by factors mainly determined in the domestic market, such as rents and services. In line with our earlier forecasts, core inflation has continued to fall. Core consumer prices are rising at their slowest pace since records began; 0.6 per cent in October. There are many indications that inflation will fall somewhat further. In light of this, the Fed has cited the risk of deflation as one of the main motives for its new stimulus measures. Unit labour cost (ULC), one of the most important driving forces in the inflation process, has fallen during four out of the past five quarters.

A Republican wind is blowing
The Republicans achieved strong gains in the November 2 mid-term elections, recapturing a majority in the House of Representatives but not in the Senate. The most important question now is whether the two main parties can work together. A popular adage on Wall Street is that “political gridlock is good”, since it prevents the passage of new legislation affecting the business community − something that is hardly true this time around, since the economy faces major structural problems. Political blockages and obstacles to collaboration will increase the probability of a new recession. In the short term, the single most important compromise will be an extension of the George W. Bush administration’s tax cuts. Other key issues are property taxation, extending the time limits on unemployment benefits and a flare-up of protectionism. Another certainty is a re-working of the health care reform, which is the object of growing criticism. Looking further ahead, the structural deficit in the federal budget cannot be swept under the carpet. As a rule, the electorate has always punished or rewarded an incumbent president’s party on the basis of how the economy is performing. We can thus assume that Barack Obama will present pro-business and growth-promoting proposals between now and the 2012 presidential election, but the Republicans seem determined to sabotage the president’s plans. For example, the Republican leader in the Senate, Mitch McConnell, has repeatedly declared that his party’s highest priority is to make Obama a one-term president. There is a risk that this will harm the economy. The tough budget situation at the state and local government level will slow GDP growth by about 0.5 percentage points next year. In addition, the Obama administration’s two-year tax cuts will likely expire, along with the 99-week limit on unemployment benefits. Infrastructure projects funded by the stimulus package have also peaked, in our assessment. Taken together, this means that federal fiscal policy will now have a clear tightening effect on GDP growth: about -1 percentage points in 2011. The federal budget deficit, which totalled more than USD 1.4 trillion in fiscal 2009, will slowly shrink to USD 1.3 trillion in 2010 and USD 1.26 trillion in 2011. The deficit as a percentage of GDP will gradually decline but will remain at a high 8.4 per cent in 2011. The national debt, which stood at 84 per cent of GDP in 2009, will exceed 100 per cent by 2012.

Core inflation uncomfortably close to zero
Year-on-year percentage change
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 SEB forecast 7 6 5 4 3 2 1 0

Core CPI inflation (LHS) Core PCE inflation (LHS)

Fed Funds (RHS)
Source: BLS, BEA, SEB

Our forecast is that core inflation, measured by CPI, will fall from 0.9 per cent this year to 0.6 per cent in 2011. Prices will remain under control during the following year as well, but our assessment is that inflation curves will begin to point slightly upward. Core inflation will amount to 1 per cent in 2012. The Fed’s favourite yardstick is core inflation as measured by the personal consumption expenditure (PCE) deflator. According to this, core inflation will now fall below the central bank’s comfort interval. Alternative measures of underlying price pressure do not, in principle, indicate any price pressure at all. This is why the Fed − as it did after the previous inflation when the dotcom (IT) bubble burst − will stick to ultra-loose monetary policy during the foreseeable future. It will not hike the federal funds rate until mid-2012.

Nordic Outlook – November 2010 | 23

The United States

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

Federal government budget balance
Per cent of GDP
5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 -12.5 80 85 90 95 00 05 10 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 -12.5

Source: US Department of the Treasury, SEB

Erskine Bowles, a Democrat, and Alan Simpson, a Republican − co-chairs of the deficit commission appointed by President Obama − surprised everyone by unveiling their personal conclusions in mid-November. Their proposals would lead to a reduction in the federal budget deficit from USD 1.3 trillion this year to USD 400 billion by 2015. The proposed reforms would also slowly begin to shrink the national debt, which now stands at USD 13.7 trillion. It remains to be seen whether their proposals will reach Congress for a vote later this year, since the support of least 12 of the other 16 deficit commission members will be needed first. The proposals include cutbacks in the Social Security pension and Medicare systems, raising the retirement age and lowering defence appropriations. The tax system would be simplified, with one attractive feature being that tax revenue would increase, at the same time as both income and corporate taxes would be cut. Lower tax rates would be offset by eliminating other tax credits and deductions. Fiscal policy would not be affected during 2011.

24 | Nordic Outlook – November 2010


Continued recovery but increased uncertainty
ƒ ƒ ƒ Record-strong yen hampering export firms Deflation pressure is continuing Bank of Japan intervention and stimulus
have recently been strong. This is usually a sign that corporate capital spending is about to take off. Deflation is maintaining its grip. In September, the inflation rate was -0.6 per cent, while core inflation was -1.5 per cent for the fourth straight month. CPI will fall by nearly 1 per cent this year. We expect 2011 inflation to be close to zero. The US Fed’s quantitative easing policies and the crisis in southern Europe have contributed to a sharp rise in the yen. Since January, the yen has gained some 15 per cent against the euro and 10 per cent against the dollar. This autumn the Bank of Japan intervened in an attempt to counter yen appreciation. We expect the USD/ JPY rate to stand at 88 at the end of 2011.

After a very strong start in the first quarter of 2010, growth decelerated noticeably in the second quarter, then took off again in the third quarter; according to preliminary figures, GDP climbed then by an annualised 3.9 per cent. Growth figures for the first and second quarters have been revised substantially upward. We expect GDP to increase by 3.1 per cent in 2010. Growth will then slow to 1.6 per cent in 2011 and 1.5 per cent in 2012.

Sharp decline for purchasing managers' index
65 60 55 50 45 40 35 30 25 20 15 06 07 08 09 10 65 60 55 50 45 40 35 30 25 20 15

The yen is stronger than ever against the USD
400 350 300 250 200 150 100 50 77 80 83 86 89 92 95 98 01 04 07 10 400 350 300 250 200 150 100 50

Total Export order bookings

Order bookings
Source: Markit


Source: Reuters EcoWin

Recent indicators are reflecting the fragility of the recovery. The purchasing managers’ index in manufacturing has fallen sharply from a peak of 54.7 in May to 47.2 in October. Order bookings are at their lowest since April 2009. Export order bookings have also fallen below 50. The slowdown is also clearly evident in hard data. During the past three months, industrial production has fallen back to its January level. Exports have also been subdued in recent months. We believe this will continue during the first half of next year. In 2011, export growth will end up just above 4 per cent. There are some positive signs in the domestic economy, however. Unemployment fell slightly to 5 per cent in September, helping to fuel private consumption. We estimate that consumption will increase by about 2 per cent this year. The number of housing starts has risen for four months in a row. Aside from weak figures for September, order bookings for the machinery industry

Economic stimulus measures are now in effect on a broad front. This autumn, the government presented a new fiscal stimulus programme in the form of an extra budget equivalent to USD 55 billion, equivalent to about 1 percent of GDP. Among other things, this stimulus will be used to prop up regional economies and small businesses. This means that central government debt will keep climbing and will reach 240 per cent of GDP by 2012. Early in October, the BoJ lowered its key interest rate from 0.1 per cent to the 0-0.1 per cent range. It also unveiled an asset purchase programme equivalent to USD 62 billion. About 80 per cent will be used for purchases of government securities and the rest to buy corporate bonds, commercial paper and exchangetraded funds (ETFs). We expect this programme to have only a limited impact, however.

Nordic Outlook – November 2010 | 25


Global economic engine despite slower growth
ƒ ƒ ƒ Capital inflows creating tensions Soft landing in China Continued good growth in India
ated with various problems. Capital inflows generate appreciation pressure on Asian currencies, which could make their exports less competitive. There is also a heightened risk of asset price bubbles and a threat of instability if the capital flows should reverse. A number of countries have tried to limit these inflows by means of regulation or intervention in the foreign exchange market. This autumn, growing criticism of US monetary policy has begun to be heard in emerging economies, thereby increasing the risk of more widespread measures in these countries.

Asia’s resilience during the economic crisis has further increased the importance of that region to the world economy. Asian emerging countries have moved from just above a 10 per cent share of global GDP in 1990 to nearly one fourth in 2010. But during the third quarter, their GDP growth rate decelerated, mainly as a consequence of slower expansion in exports and industrial production. Looking ahead, we expect continued deceleration, though growth will remain higher than the global average. So far, the strong performance of the Asian economies has not led to any broad inflation pressure although rising food prices are pushing up consumer prices in China, India and elsewhere.

Inflation in Asia
Year-on-year percentage change
12.5 10.0 7.5 5.0 2.5 0.0 -2.5 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 07 08 09 10

GDP growth decelerates
Year-on-year percentage change
15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 07 08 09 10 15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5


China India

Indonesia Malaysia

South Korea Thailand

Source: Local statistical offices

China: Gradual deceleration
In China, economic growth slowed during the third quarter. GDP rose by 9.6 per cent year-on-year, compared to 10.3 per cent in the second quarter. There are no signs of an economic hard landing. While it is true that the rate of increase in exports decelerated clearly in September, neither purchasing managers’ indices, retail sales, industrial production nor bank lending reflected any significant drop in activity − thereby confirming the picture of a controlled soft landing we described in our August report. GDP growth will reach 10.2 per cent in 2010 and decelerate to 9 per cent in 2011. In 2012, GDP growth will be 8 per cent. The contribution of exports to growth will decrease in the next couple of years, while the role of domestic demand will increase. There are various examples of China’s efforts to reduce dependence on exports and continue its transition towards more domestically driven demand. An important element is investing in the development of China’s central and western areas, which are lagging behind the more industrialised and

China India

Indonesia Malaysia

South Korea Thailand

Source: Local statistical offices

The main risks in Asia are connected to large-scale capital inflows. Good global liquidity combined with major differentials in interest rates and growth prospects between Asia, on the one hand, and the United States and Western Europe on the other are the driving forces behind this trend. During the autumn, the US Federal Reserve’s quantitative easing policy and accompanying downward pressure on the dollar have further strengthened speculative capital flows to Asia. These inflows are leading, among other things, to rising share and property prices as well as a heavy demand for fixed income securities. These developments are associ-

26 | Nordic Outlook – November 2010


urbanised eastern part of the country. One example is the build-up of a functioning financial system and improvement in rural infrastructure, thereby countering bottleneck problems in the agricultural sector. Consumption in rural areas has been stimulated by providing discounts to households for purchases of capital goods. China’s five-year plan for 2011-2015 will also focus on strengthening domestic demand and the “quality” of growth. Central government expenditures for health care will continue to increase, reducing the need for households to save and thereby stimulating consumption. A growth model based on domestic demand rather than export growth will provide more stable development with fewer imbalances, but GDP growth will probably no longer be able to reach double-digit figures.

national level have risen roughly in line with disposable per capita income. Chinese authorities have also begun to use interest rate policy in order to cool down the economy. In October, the central bank raised its key rate by 25 basis points to 5.56 per cent. This was the first rate hike since December 2007 and a reaction to rising CPI inflation in recent months. In October, the inflation rate reached 4.4 per cent, which was the fastest increase since September 2008 and well above the central bank’s 3 per cent target for 2010. Rising food prices drove up inflation; core inflation, which excludes food and energy, was 1.1 per cent in September for the third month in a row. There is limited room for further rate hikes as long as developed economies keep their key interest rates at extremely low levels, due to problems related to speculative currency flows. However, our assessment is that the central bank’s concern about the rapid increase in the inflation rate will result in more interest rate hikes in late 2010 and early 2011. China is also considering price controls to contain inflation.

Broad-based tightening
The housing market remains hyperactive, and in a number of major cities there are clear signs of overheating. At the national level, home prices continue to climb rapidly, although the rate of increase has decelerated somewhat since this past summer. In September, the year-on-year rate of increase was 9 per cent. In some major cities, home prices have reached a level higher than an average household can manage.

China: CPI, core inflation and key rate
Per cent
9 8 7 6 5 4 3 2 1 0 -1 -2 00 01 02 03 04 05 06 07 08 09 10 9 8 7 6 5 4 3 2 1 0 -1 -2

China: Slower increase in home prices
Year-on-year percentage change
25 20 15 10 5 0 -5 -10 -15 -20 07 08 09 10 25 20 15 10 5 0 -5 -10 -15 -20

CPI Core inflation

Key rate (one year interest)
Source: National Bureau of Statistics of China

70 cities Beijing

Shenzhen Hangzhou

Cautious appreciation
Since China’s central bank resumed the appreciation of the yuan against the US dollar in June, the currency has appreciated by a modest 3 per cent. Communication from the bank indicates that this appreciation will continue at a modest pace, out of concern for Chinese export companies. But there are good arguments for letting the currency strengthen. Such appreciation will counteract inflationary tendencies triggered by imports but will also help boost household purchasing power, thereby facilitating the transition to an economy more based on domestic demand. We expect China to keep its promises of continued, modest-paced yuan appreciation against the dollar. It is likely that periods of yuan appreciation will alternate with periods of depreciation, in order to decrease the risk that “one-way bets” will boost speculative capital inflows. Over the next 12 months we foresee an appreciation of the yuan against the dollar of around 4 per cent and that the USD/CNY rate will then be 6.40.

Source: National Bureau of Statistics of China

This autumn, the government has implemented new measures to cool down the housing market. It has further restricted residential loans to households by lowering the permitted loan-to-value ratio. Bank reserve requirements have also been raised, and a property tax will probably be introduced during 2011. The authorities have also pledged to build housing units that even low-income households can afford, in order to slow down the long-term price increases for housing. In our assessment, these measures are sufficient to ensure that a sharp decline in home prices can be avoided. We are thus sticking to our main scenario, in which prices will level off. One reason for this is that in a longer-term perspective, price increases have not been alarmingly high. Since 1998, when China’s private housing market began to develop, home prices at the

Nordic Outlook – November 2010 | 27


The relatively slow appreciation of the yuan has become an important issue in the US; the House of Representatives approved a bill that would allow American companies to demand import tariffs on imports from China to compensate for the weak yuan. Yet it is unlikely that this proposal will be implemented in practice. Both China and US have an interest in not escalating their disagreements. And although the tone of discourse has occasionally been shrill, there are still signs of a desire to reach consensus. China has expressed a willingness to specify a target for reduction of its trade surplus. Meanwhile, the US has chosen not to single out China as a currency manipulator.

ber. Changes in the weightings India uses to measure inflation have also contributed to the slowdown. In our assessment, the inflation rate will continue to decelerate in the next few months, among other things as a consequence of monetary tightening. The central bank is nevertheless continuing to express concern about developments, since inflation is far above the desired 3 per cent medium-term rate. Since the bank began tightening monetary policy in March 2010, it has raised its key interest rate by 1.5 percentage points to a level equivalent to 6.25 per cent. The central bank has indicated its willingness to continue hiking interest rates, since it is beginning to view rising food prices as a structural problem associated with excessively low supply of certain goods. Our assessment is that the bank will hold off until the first quarter of 2011, among other things to give its earlier rate hikes a chance to have an impact.

Cautious yuan appreciation against the USD
6.50 6.75 7.00 7.25 7.50 7.75 8.00 8.25 8.50 05 06 07 08 09 10
Source: Reuters EcoWin

6.50 6.75 7.00 7.25 7.50 7.75 8.00 8.25 8.50

India: Purchasing managers' index
62.5 60.0 57.5 55.0 52.5 50.0 47.5 45.0 42.5 07 08 09 10 62.5 60.0 57.5 55.0 52.5 50.0 47.5 45.0 42.5

India: Continued good growth
Low export dependence, coupled with domestic stimulus measures, has enabled India to weather the economic crisis of recent years satisfactorily. Growth has been good in 2010; second quarter GDP growth was 8.8 per cent, or somewhat higher than in the first quarter. Looking ahead, however, the signals are a little more mixed. The purchasing managers’ index in the service sector has fallen in recent months, while the index for manufacturing recovered in October. The rate of increase in industrial production has decelerated sharply since last spring, and in September the year-onyear percentage change was 4.4 per cent. Key interest rate hikes and fading stimulus effects also indicate that growth will slow somewhat during the second half of 2010. We have revised our 2010 GDP growth forecast a bit downward to 8.7 per cent. GDP will grow by 8.0 per cent in 2011 and 7.0 per cent in 2012. This year’s good harvest has helped curb food price increases. CPI inflation has consequently fallen from just below 11 per cent in April to 8.6 per cent in Octo-

Manufacturing sector

Service sector
Source: Markit

India’s central bank exemplifies how emerging countries are actively trying to counter the effects of capital inflows. This autumn, the bank intervened in the foreign exchange market in order to limit the appreciation of the rupee against the US dollar. Our assessment is that the rupee will stand at 42 per USD one year from now. Unlike most other Asian emerging countries, however, India is running a current account deficit. This deficit has grown during 2010 as demand for imports has risen and is expected to reach around 3 per cent of GDP. In this situation, capital inflows help facilitate the financing of the deficit, but it is a source of concern that these inflows are clearly dominated by portfolio investments rather than direct investments and can thus be withdrawn quickly.

28 | Nordic Outlook – November 2010

The euro zone

Decent 2011, but debt reduction is burdensome
ƒ ƒ ƒ Exports will slow in 2011 and growth will level off Ireland and Portugal are in bad shape − financial aid required No ECB refi rate hike until March 2012

Mixed indicators
Most leading indicators have continued to rise this autumn. For example, Germany’s IFO index − which shows relatively strong co-variation with GDP growth − has kept on climbing. In October the IFO reached its highest level since May 2007 (107.6). Respondents’ view of current business conditions improved, while their future expectations were also surprisingly positive despite a stronger euro and increased risks to global growth. This signals that the country’s GDP growth, which reached a strong 3.9 per cent year-on-year in the third quarter (4.3 in the second quarter), will gain further momentum during the rest of 2010. We expect German GDP growth of almost 4 per cent year-on-year in the fourth quarter, pushing the full-year figure to 3.6 per cent.

In the euro zone as a whole, growth is in line with our earlier forecasts. GDP will grow by 1.6 per cent this year, far above the consensus view prevailing as recently as this past summer. But differences within the region have widened: Germany is benefiting from an exceptional export and investment surge this year, while various other euro zone members − especially the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) − are burdened by competitiveness problems and fiscal austerity measures. This two-speed euro zone will continue in 2011 and 2012. The German economy will decelerate but growth will remain somewhat above trend, while the PIIGS countries will continue to be weighed down by structural problems and budget consolidation. Financial aid measures at the European level, combined with national cost-cutting programmes, have indeed eased acute crisis symptoms. But the problems are far from solved. Today they are especially large in Ireland and Portugal. Euro zone growth will reach 1.7 per cent in 2011 and 1.5 per cent in 2012, somewhat above today’s consensus forecast.

IFO at three year high
Year-on-year percentage change (GDP), IFO index 2000=100
5.0 3.0 1.0 -1.0 -3.0 -5.0 -7.0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 120 115 110 105 100 95 90 85 80 75

Germany in the lead, PIIGS lagging behind
Composite leading index
112.5 110.0 107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0 00 01 02 03 04 05 06 07 08 09 10 112.5 110.0 107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0

GDP, Germany (LHS) Current business conditions (RHS) Expectations (RHS)
Source: Federal Statistics Office, IFO



Source: OECD

Low inflation will enable the European Central Bank to keep its refi rate low for an extended period in order to support economic recovery in southern Europe. The first rate hike to 1.25 per cent will come in March 2012. The key rate will be 1.75 at the end of 2012.

However, other indicators are pointing towards a slowdown. The purchasing managers’ index (PMI) for the euro zone as a whole fell somewhat faster than expected in October, reaching a level (53.4) compatible with quarter-on-quarter GDP growth of about 0.3 per cent during the fourth quarter. The downturn in the index was driven by the service sector, while manufacturing continued upward. Financial market players also doubt the recovery, judging from Germany’s ZEW index. However, the decline in the index unexpectedly reversed in November; the current economic situation sub-index continued upward to its highest level since July 2007 and the sub-index for the future climbed above zero.

Exports will slow down
The upturn in the IFO index reflects the success of German manufacturers so far this year; order bookings are

Nordic Outlook – November 2010 | 29

The euro zone

currently increasing by about 20 per cent year-onyear, while industrial production and exports will climb more than 10 per cent for the year as a whole. The manufacturing sector is also rebounding in France and Italy, where production will increase by nearly 5 per cent this year. In other countries, the trend is far more modest. In Portugal and Spain, for example, the upturn will not exceed 1.5 and 1 per cent, respectively, while Greece will note a 5 per cent downturn.

expect fixed investments to grow by about 4 per cent annually in the euro zone during 2011-2012.

Capital spending has rebounded
Year-on-year percentage change and per cent
10 5 0 -5 -10 -15 85.0 82.5 80.0 77.5 75.0 72.5 70.0 67.5 00 01 02 03 04 05 06 07 08 09 10

Industrial production
Year-on-year percentage change 2009 Germany France Italy Spain Greece Portugal Ireland Euro zone -16.4 -18.0 -18.4 -16.2 -10.2 -8.4 -4.5 -14.8 2010 9.0 4.8 4.8 0.9 -5.0 1.5 4.0 7.0 2011 4.4 3.5 2.9 1.7 -1.5 0.7 3.8 3.8 2012 4.1 3.3 2.5 3.1 2.5 2.1 3.6 3.5


Gross capital formation (LHS) Capacity utilisation, manufacturing (RHS)
Source: Eurostat, DG ECFIN

As for private consumption, developments in Germany are crucial. So far, German consumers seem to be clutching their wallets tightly; in September, retail sales fell for the second month in a row.

Consumer confidence is climbing
Index and year-on-year percentage change
5 0 -5 -10 -15 -20 -25 -30 -35 00 01 02 03 04 05 06 07 08 09 10 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0

Source: European Commission, SEB

Stronger domestic demand
To date, the economic recovery in the euro zone has been driven by rising exports, especially from Germany. Because of the stronger euro and a global industrial cycle that is entering a more mature phase, export growth will cool in 2011. To keep the recovery from losing momentum, domestic demand will have to be capable of taking over as a growth engine. Rising capacity utilisation indicates that capital spending will accelerate during our forecast period: we

Consumer confidence (LHS) Private consumption (RHS)
Source: DG Ecfin, Eurostat, SEB

A 20 per cent probability of recession
The probability of a renewed recession in the next six months can be calculated with the help of “probit analysis”. This method clearly illustrates the major differences in economic potential that characterise the euro zone right now. It shows that over the next six months, the risk of recession is very small in France, Italy and Germany while the risk of a continued recession is highly apparent in Greece (80-85 per cent risk). The risk of a recession in Portugal and Spain is 10-15 per cent. However, taking into account the risk of recession in the United States as well, and the links that exist between the euro zone and the US as well as individual euro zone countries, the recession risks are proving generally higher. Our overall assessment is that the risk of a “double dip” in the euro zone is about 20 per cent.

Probability of recession in the next six months
Per cent Probability <5 <5 <5 10-15 80-85 10-15 20-30 20 Share 26.8 20.3 16.7 12.9 3.3 2.2 1.5 100 Germany France Italy Spain Greece Portugal Ireland Euro zone

Note: “Share” refers to each country’s percentage of total euro zone GDP in 2009. Source: European Commission, SEB

30 | Nordic Outlook – November 2010

The euro zone

The combination of a stronger labour market, rising consumer confidence and accelerating pay hikes nevertheless indicates that private consumption may soon begin making a positive contribution to economic growth in Germany. We anticipate an increase of just above 1 per cent in both 2011 and 2012 after this year’s stagnation. In the euro zone as a whole, consumption will rise by about 0.5 per cent this year and roughly 1 per cent in both 2011 and 2012. Overall, this forecast implies that GDP growth will remain just above 1.5 per cent in 2011-2012, about the same as our forecast in August and slightly higher than the consensus forecast. German GDP will grow by 3.6 per cent this year, 2.5 per cent in 2011 and just below 2 per cent in 2012. France will grow by about 1.5 per cent a year throughout our forecast period, Italy by around 1 per cent. Spanish GDP will shrink by about 0.5 per cent this year, then show positive growth of more than 0.5 per cent in 2011 and above 1 per cent in 2012. Greek GDP will fall by 4 per cent this year and by 2 per cent in 2011, with around zero growth in 2012.

This autumn, the situation in Ireland has become increasingly acute. This year’s budget deficit will reach a stunning 32 per cent of GDP due to the government’s concerted efforts to save the banking system. Although much of the deficits are due to nonrecurring outlays, Ireland is in very bad shape. Rapidly rising yields on its bonds forced the government to announce EUR 6 billion (3.8 per cent of GDP) in further cutbacks on November 4, well before publication of next year’s budget scheduled for December 7. The government hopes to bring down the deficit to about 9.5 per cent of GDP in 2011 and 3 per cent by 2014. We do not believe it will fully succeed in doing so. Instead, we anticipate a continued deficit of more than 10 per cent in 2011 and well above 3 per cent in 2014. There is thus a great risk that Ireland’s sovereign debt rating will be downgraded from the current Aa2 (according to Moody’s), even after Ireland’s formal request for financial support from the EU and the IMF on November 21.

Fiscal tightening, 2010-2013
Per cent of GDP
10 9 8 7 6 5 4 3 2 1 10 9 8 7 6 5 4 3 2 1

More austerity required
Major fiscal austerity programmes are now being implemented in many euro zone countries. Aside from Greece, economic needs − and problems − now look especially great in Ireland and Portugal. Among other things, Greece has slashed wages and salaries and boosted the retirement age in its public sector. Early in November, the Portuguese parliament accepted a new budget that includes higher banking fees, a VAT hike, tighter expenditures and the sale of government assets. According to Prime Minister José Sócrates, the budget will enable the country to avoid “the danger zone of financial market turbulence”. In Spain, sharp cutbacks in the public sector and tax hikes are on the way.

Portugal Ireland

Italy Greece

Source: SEB

Rising 10-year yield spreads against Germany
Percentage points
10 9 8 7 6 5 4 3 2 1 0 Oct Jan 08 Apr Jul 09 Oct Jan Apr Jul 10 Oct 10 9 8 7 6 5 4 3 2 1 0

Total fiscal austerity measures during 2010-2013 currently appear likely to reach about 5 per cent of GDP in Portugal, between 7 and 8 per cent in Ireland, just above 1 per cent in Italy, about 10 per cent in Greece and about 6 per cent in Spain − and further increases cannot be ruled out. However, German federal tax revenue has provided upside surprises so far this year. One effect of the rapid upswing in the economy has been surging corporate profits and thus large tax payments from companies. The German government has been able to revise its budget deficit forecast downward several times. Early in November, for example, government projections indicated that revenue will be a full EUR 62.5 billion larger in 2010-2012 (about 2.5 per cent of GDP) than according to its earlier forecast. We are sticking to our view that Germany will meet the 3 per cent EU budget deficit ceiling as early as next year.

France Greece

Ireland Italy

Portugal Spain

Source: Reuters EcoWin

These austerity measures will help ease budget deficit and sovereign debt problems, but in many countries the situation remains serious. Government debt is continuing upward towards record levels, with lasting uncertainty about long-term solvency as a consequence.

Nordic Outlook – November 2010 | 31

The euro zone

Budget balance and sovereign debt
Per cent of GDP Budget 2010 Ireland Spain Greece Portugal France Slovakia Belgium Slovenia Netherlands Italy Austria Germany Finland Euro zone -32.0 -9.8 -10.1 -8.3 -7.6 -6.0 -5.0 -6.0 -6.0 -5.3 -4.7 -4.0 -3.4 -6.6 2011 -12.1 -8.5 -8.6 -7.6 -7.1 -5.2 -5.0 -5.0 -5.0 -4.7 -4.5 -2.3 -2.5 -5.3 2012 -10.6 -7.0 -8.0 -6.1 -5.6 -3.7 -3.5 -3.5 -3.5 -3.2 -3.0 -1.8 -2.2 -5.0 Debt 2012 118.2 78.5 153.5 98.1 93.3 50.3 107.7 49.9 75.3 129.2 79.7 81.5 51.9 94.0

cent since March of this year. The jobless rate appears unlikely to rise any higher, despite weak growth in the PIIGS countries and southern Europe. One major reason why unemployment did not increase was the resilient German labour market (unemployment there fell to 6.7 per cent in September). The German government’s system of “Kurzarbeit” allowances, which enables potentially redundant employees to work fewer hours but retain most of their normal pay, has surpassed expectations. Because companies could keep on a large percentage of their labour force during last year’s slump, they have now been able to ramp up production quickly again during the upturn phase. These subsidies may have saved more than 500,000 German jobs.

Unemployment will fall in 2011-2012
Per cent
11.0 10.0 9.0 8.0 7.0 6.0 5.0 00 01 02 03 04 05 06 07 08 09 10 11 12
SEB forecast

11.0 10.0 9.0 8.0 7.0 6.0 5.0

Source: European Commission, SEB

Lower unemployment in 2011-2012
In the euro zone as a whole, unemployment rose to 10.1 per cent in September after moving sideways at 10 per

Okun's Law Unemployment

Source: Eurostat, OECD, SEB

Watered-down sanctions when EU Stability and Growth Pact is revised
In September the European Commission − led by Olli Rehn, Commissioner for Economic and Monetary Policy − unveiled a series of new economic policy proposals aimed at correcting shortcomings in euro zone collaboration. The Commission presented a package of measures intended to harmonise and tighten surveillance of member countries’ fiscal policies. These proposals are the EU’s most ambitious effort so far to improve the stability and long-term growth forces in the economies of EU member countries. For example, the Commission presented a new timetable for budget procedures, with a larger element of advance budget surveillance, unlike the current system of examination after the fact. Sanctions against countries that violate the rules of the Pact will also be tightened and made clearly more automatic. Aside from restoring fiscal stability in the euro zone, the Commission also wants to mobilise the forces that drive economic growth by enacting various structural reforms, for example in the labour and service markets. The EU summit meeting in Brussels late in October nevertheless revealed major disagreements about the allocation of power in the EU system. In response to a proposal to create a permanent rescue fund that would save member countries from financial crises like the one that hit Greece last spring, Germany proposed a revision of the Lisbon Treaty so the EU could not be forced to pay the cost of getting a crisis-ridden country out of its problems. The reason is that today’s Lisbon rules forbid bail-outs, which a permanent version of last spring’s temporary rescue fund might imply. France also managed to win acceptance for its proposal to sideline the question of automatic and stricter sanctions against countries that mismanage their public finances. This means that today’s arbitrary voting rules, in which a qualified majority of member countries must vote for sanctions, will remain in force. These French and German demands imply that the European Commission’s proposed new economic policy legislation will be partly watered down. All member countries − and the ECB − seem to agree that a stricter overall approach is needed, with more focus on budget discipline, debt levels, long-term sustainability in public finances and growth-promotion policies, but it remains to be seen whether there is sufficient political will to actually achieve an improvement.

32 | Nordic Outlook – November 2010

The euro zone

Yet similar systems have not prevented unemployment from climbing in other euro zone countries. In France the jobless rate now stands at 10 per cent, in Italy at 8.3 per cent. In Spain the trend is disastrous: unemployment stood at 20.8 per cent in September, more than twice the September 2007 level. A strong tourist season with fewer lay-off notices nevertheless helped lower Spanish unemployment in the third quarter − the first downturn since the second quarter of 2007. We still expect euro zone unemployment to end up averaging 10 per cent this year, 9.7 per cent in 2011 and 9.4 per cent in 2012 − a somewhat brighter forecast than today’s consensus view, which remains around 10 per cent both in 2010 and 2011. This forecast is partly based on estimates of what level of GDP growth is compatible with unchanged unemployment (see Nordic Outlook, August 2010). Our estimates indicate that this growth requirement has decreased in the euro zone over the past decade: from 2.3 per cent in 1990-2000 to 0.9 per cent in 2000-2010. As the above chart shows, the jobless rate will fall towards the longterm non-accelerating inflation rate of unemployment (NAIRU). Unemployment is now dropping faster than assumed by Okun’s Law − which relates unemployment to the output gap − primarily due to the positive effects of temporary job-sharing allowances. When these allowances are phased out, however, there is a risk that unemployment will rebound.

tract for Germany’s metalworkers, which expires in March 2012, pay will rise by 2.7 per cent year-on-year starting in April 2011. Other unions are likely to make similar demands, and the general recommendation by German trade unions is that wages and salaries should increase by about 3 per cent year-on-year. This rate of pay hikes is also quite consistent with our own projections, which indicate pay increases of nearly 3 per cent year-on-year by the end of our forecast period (see above chart). In Germany there seems to be rather widespread acceptance of somewhat higher pay hikes (see the discussion below about internal devaluation).

Inflation expectations just below 2 per cent
Net figure and per cent
35 30 25 20 15 10 5 0 -5 -10 -15 -20 02 03 04 05 06 07 08 09 10 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0

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

Pay increases will accelerate

Continued low inflation pressure
Although euro zone inflation in October, as measured by the Harmonised Index of Consumer Prices (HICP), came out at 1.9 per cent − somewhat higher than expected − most signs indicate continued low inflation pressure. The October figure was pushed upward by a temporary jump in food prices. Even with oil prices at today’s level, the contribution of energy to inflation will decline sharply in the months ahead. Capacity and resource utilisation are also still low. Current pay agreements are low. In addition, inflation expectations are relatively restrained, though higher than a year ago. Break-even inflation is currently just below 2 per cent. Core inflation (HICP excluding energy and food prices) is also stable at around 1 per cent.

The sharp economic downturn of 2009 resulted in very limited pay demands from trade unions, which cared more about preserving their members’ jobs than about nominal wage and salary hikes. Pay increases in the euro zone manufacturing sector thus decelerated from a peak of just over 4 per cent in early 2009 nearly down to 1.5 per cent at present. Total hourly wage hikes have fallen from just below 3 per cent in 2009 to about 1.5 per cent in 2010.

Pay increases will accelerate in 2012
Percentage points, year-on-year percentage change
-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 00 01 02 03 04 05 06 07 08 09 10 11 12 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0

Core inflation will bottom out early in 2011
Per cent
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 01 02 03 04 05 06 07 08 09 10 11 12
SEB forecast

4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0

Change in unemployment, shifted 2 years forward (LHS) Change in total wage and salary cost in industry (RHS)
Source: Eurostat, SEB

But the economic recovery in the euro zone, especially in Germany, will mean somewhat faster pay increases ahead. For example, according to the collective con-

HICP inflation

Core inflation
Source: Eurostat, SEB

Nordic Outlook – November 2010 | 33

The euro zone

We expect a decline in HICP inflation to 1.7 per cent in December this year and 1.3 per cent in June 2011. Measured as annual averages, HICP inflation will be 1.5 per cent this year, 1.3 per cent in 2011 and 1.4 per cent in 2012. Energy and food will contribute 0.3-0.5 percentage points to inflation in 2011-2012. Our inflation forecast is somewhat higher than in August, mainly due to VAT and other tax hikes in major euro zone countries. Core inflation will be somewhat below 1 per cent until the second quarter of 2012, then begin a slow climb towards 1.4 per cent in December 2012.

Big differences in competitiveness
Unit labour costs, index 2000=100
150 145 140 135 130 125 120 115 110 105 100 95 00 01 02 03 04 05 06 07 08 09 10 11 150 145 140 135 130 125 120 115 110 105 100 95

sively low key interest rate in Germany is relatively limited, though, since the need for stronger German domestic demand will gradually increase as the country’s export recovery enters a more mature phase. Nor should a faster-paced domestic economy − with higher nominal pay increases and private consumption − be a problem for German industry, which has greatly improved its international competitiveness throughout the past decade. An adjustment in the relative cost level between the PIIGS countries and Germany may actually be a positive side effect of the ECB’s continued low refi rate, since it may smooth out savings imbalances in the euro zone (private savings are too low in the PIIGS countries, too high in Germany).

ECB: Decline in long-term refinancing
EUR billion
800 700 600 500 400 300 200 100 800 700 600 500 400 300 200 100 0 00 01 02 03 04 05 06 07 08 09 10

Portugal Ireland

Italy Greece

Spain Germany
Source: OECD

0 98

No ECB rate hike until March 2012

The ECB is in no hurry to raise its key interest rate, which has stood at 1 per cent since May 2009. It is true that the central bank has made upward adjustments in both its growth forecast for the euro zone (1.4-1.8 per cent this year, 0.5-2.3 per cent in 2011) and its inflation forecast (1.5-1.7 per cent and 1.2-2.2 per cent, respectively). However, due to a combination of great uncertainty about growth prospects in the next couple of years and major budget and growth problems in the PIIGS countries, the euro zone central bank will hold off on rate hikes in order to sustain the economic recovery in southern Europe.

Short-term refinancing ("main refinancing operations") Long-term refinancing
Source: ECB

In the euro zone as a whole, the banking and financial sector is also likely to need low interest rates for some time to come, despite certain signs of stabilisation. Credit and money supply growth remains historically low despite its recent upturn, and the decline in longterm ECB refinancing may be a sign of weaker demand.

Overnight rate still below refi rate
Per cent
5.0 4.5 4.0 3.5 3.0 2.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 May 08 Sep Jan May 09 Sep Jan May Sep 10
Source: Reuters EcoWin

Continued low credit and money supply growth
Year-on-year percentage change
15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 99 00 01 02 03 04 05 06 07 08 09 10 15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5

2.0 1.5 1.0 0.5 0.0 Jan


Refi rate


Source: ECB

In 2011-2012 the refi rate level will thus be largely tailored to the needs of southern Europe, rather than those of fast-growing Germany. The cost of an exces34 | Nordic Outlook – November 2010

We still foresee that the ECB will hike its refi rate to 1.25 per cent in March 2012. After that, there will be two more hikes that same year, bringing to refi rate to 1.75 per cent by the end of 2012. The European Overnight Index Average of interbank interest rates (EONIA) is currently some 20 basis points below the refi rate, but we expect it to coincide with the refi rate during the first half of 2011.

The United Kingdom

British economy will weather fiscal storm
ƒ ƒ ƒ Home prices are losing ground again High inflation a headache for the BoE Employment rising rapidly, but jobless rate not yet declining
rates will ease the debt service burden — UK households are among the most indebted in the world — and make more room for consumption, but at the same time major public sector austerity packages will hold down income and consumption. Home prices represent a significant downside risk. The Nationwide index has fallen during four of the past five months. Home prices are now 10 per cent above their low (February 2009) but also 12 per cent below their peak (October 2007). Indicators predict further price declines, and various valuation measures reveal a need for additional downward price adjustments.

During the past six months the British economy has performed better than feared, but large government austerity programmes will slow activity ahead. A weak pound and loose monetary policy will help maintain decent growth, however. We predict GDP growth of 1.7 per cent in 2010 and 2.1 per cent in both 2011 and 2012: a bit below trend, but slightly above consensus. We foresee no further monetary stimulus, but the Bank of England (BoE) will quickly intervene if the recovery begins to falter. Stubbornly high inflation is giving the central bank a headache: CPI will increase by 3.1 per cent this year and 2.6 per cent in 2011, and household inflation expectations are pointing upward. The first key interest rate hike will occur at the end of 2011. The latest business sentiment surveys give reason for cautious optimism. In manufacturing, service and construction, the purchasing managers’ index is above the 50 mark; the first two surveys show an upward shortterm trend. Corporate capital spending rebounded earlier this year, and according to investment plans this upturn will continue. Capital spending will grow by an average of 8 per cent in 2011-2012. Exports are another reason for our cautiously optimistic growth scenario: here, too, indicators appear robust. The pound has weakened by about 25 per cent in effective terms since 2007, bolstering the competitiveness and increasing the profit margins of exporters. But the pound is now fundamentally undervalued, and we expect it to strengthen in the course of next year; the EUR/GBP exchange rate will be 0.83 at the end of 2011. Exports will increase by an average of more than 9 per cent in 2011-2012, with foreign trade making an overall positive contribution to the economy. Since 2009 consumption has increased rapidly in nominal terms, thanks to a decline of 4.5 percentage points in the household savings ratio. Brighter future prospects, combined with higher asset values, have decreased the need for large household savings buffers, but the decline in saving is probably behind us now. In real terms, consumption rose 1.1 per cent this year. It will accelerate slightly in 2011 and 2012. Low interest

Cumulative changes since January 2008
Per cent
0 -1 -2 -3 -4 -5 -6 -7 Q1 Q2 Q3 08 Q4 Q1 Q2 09 Q3 Q4 Q1 Q2 10 Q3 0 -1 -2 -3 -4 -5 -6 -7




Source: ONS, SEB

Employment is now rising rapidly. Large cutbacks in public sector jobs are being offset by a strong upturn in private employment. So far, about 45 per cent of job losses have been recovered. Part-time jobs account for the lion’s share of the upturn (65 per cent). The employment upswing is having no significant impact on the jobless rate, since the labour supply is rising almost as fast. Unemployment will remain at around 8 per cent during the next six months, then slowly decline. Fiscal headwinds will accelerate in 2011. According to the emergency budget, the government’s borrowing requirement will fall by 10 per cent of GDP by 2015/2016, mainly via discretionary fiscal policy. The budget has been well received; the UK’s sovereign credit rating no longer seems to be threatened, for example. In this context, it is encouraging to note that the UK also carried out a sharp fiscal tightening in the early 1990s, yet GDP grew by an average of 3 per cent yearly. Although various factors now indicate that the economy can tolerate the fiscal austerity measures, the impact of such large cutbacks is very uncertain.

Nordic Outlook – November 2010 | 35

Eastern Europe

Domestic demand awakening despite austerity
ƒ ƒ ƒ Moderate GDP growth Small public sector debt Currencies appreciating
Ukraine has bounced back unexpectedly fast after last year’s 15 per cent GDP slide, with the economic upturn being driven by higher steel prices and a weak currency. Growth will slow from 5 per cent this year to 4 per cent in 2012, partly due to budget austerity requirements by Ukraine’s creditor, the IMF, as well as reduced gas price subsidies to households and businesses. The region’s earlier problems with huge current account deficits have eased greatly. Looking ahead, we expect small current account deficits in most countries (and a surplus in Russia). Inflation will be low but gradually rise. In the short term, inflation rates in Russia and Ukraine will surge due to higher grain and gas prices. Large budget deficits in Eastern Europe will successively shrink and thus help keep public sector debt at relatively low levels compared to Western countries.

The export-led recovery of the past year in Eastern Europe − which in many places has been stronger than in the West − is continuing. According to leading indicators, however, the upturn in the manufacturing sector in most countries is about to slow, due to sagging global growth. But there is good potential for domestic demand to assume a larger role as an economic engine. Real wages have again begun to climb, and unemployment is slowly falling. Meanwhile a gradual thaw in tough credit conditions is under way. Overall, we therefore expect GDP growth to accelerate further in most of the region during 2011-2012 (see also SEB’s Eastern European Outlook, October 2010). However, growth will not reach the unsustainable pace that prevailed before the crisis. This is because growth is less credit-driven than before and due to such structural factors as labour market and emigration problems in the Baltic countries and the slow pace of reform in Russia. Many countries in Eastern Europe (including what is sometimes called Central Europe) are also tightening their fiscal policies, if only moderately. The picture is mixed. In Poland, for example, fiscal tightening is mainly affecting households. Hungary, however, is targeted its austerity measures to businesses by means of “crisis taxes” in certain sectors, while planning to lower household income taxes. Russia’s GDP, whose growth will be unexpectedly weak this year, will increase by 4.3-5.0 per cent in 20112012, sustained by high commodity prices and in the short term also by continued expansionary fiscal policy. Our oil price forecast of USD 86-89/barrel in 2011-2012 is roughly USD 15 higher than assumed in the Russian government’s medium-term budget plan, which aims at achieving fiscal balance by 2015. Due in part to strong fundamentals in Poland, we are sticking to our above-consensus growth forecast. GDP growth will climb from 3.5 per cent this year to 4.04.5 per cent during the next couple of years. Capital spending will be a major driving force. Since 2000, fixed investment has been lower than in other fast-expanding economies, averaging only 21 per cent of GDP, which means that many needs still remain unmet. Above all, we expect growing investments in infrastructure. 36 | Nordic Outlook – November 2010

Effective exchange rates in selected countries
Index 100 = 2005
140 130 120 110 100 90 80 70 00 01 02 03 04 05 06 07 08 09 10 140 130 120 110 100 90 80 70

Russia, RUB Poland, PLN

Czech Republic, CZK Hungary, HUF
Source: Local statistical offices

We are adhering to our forecast that key interest rate hikes will begin in the first half of 2011. Poland (in Q1) and the Czech Republic will act first to ensure they can meet their inflation targets. Given the combination of early interest rate hikes compared to the West, relative growth advantages and relatively low public sector debt, we predict further appreciation in most Eastern European currencies. The Fed’s new quantitative easing will also reinforce the trend of capital flows to high-return emerging market investments. We expect Polish zloty appreciation to 3.60 per euro by the end of 2011, which probably means a slight overvaluation in a long-term perspective. The Hungarian forint, squeezed earlier this year by weak budget policies and tense relations with the IMF, will gain strength and reach 260 per euro in December 2011.

The Baltics

Gradual recovery
ƒ ƒ ƒ Competitive exports Structural problems in the labour market Stronger financial market confidence
previously estimated potential rate of 6-7 per cent. In the medium term, it is reasonable to adjust annual potential growth downward to around 5 per cent, mainly due to the labour emigration wave of recent years as well as a more balanced but weaker credit and investment dynamic than before the crisis.

The recovery in the Baltics keeps gaining strength, mainly as a result of competitive exports. But capital spending and consumption are now also slowly starting to recuperate, sustained by continued low interest rates and some improvement in real disposable household income. These developments are consistent with our forecasts since last winter. However, Latvia’s GDP decline in 2010 is now expected to be clearly milder, only 0.3 per cent, and the Estonian growth this year is expected to be slightly higher.

Exports will remain a growth engine

In the short term, exports will remain a major driving force in GDP growth. Year-on-year and in current prices, they have climbed at 30-40 per cent in recent months. Towards the end of 2010, though, we expect growth to slow due to fast-fading positive base effects.

Export boom
Year-on-year percentage change, 3mma
50 40 30 50 40 30 20 10 0 -10 -20 -30 -40 01 02 03 04 05 06 07 08 09 10

Growth is resuming
GDP, year-on-year percentage change
15 10 5 0 -5 -10 -15 -20 01 02 03 04 05 06 07 08 09 10 15 10 5 0 -5 -10 -15 -20

20 10 0 -10 -20 -30 -40



Source: Local statistical offices



Source: Local statistical offices

All three countries have resumed positive growth during the past two quarters, measured year-on-year, after depression-like GDP declines of 14-18 per cent in 2009. During the third quarter, the upturn gained strength in Estonia while Latvia noted its first GDP increase since the first quarter of 2008. Short-term indicators also point towards continued economic upturn. For example, the European Commission’s sentiment indicator − which began to rebound in spring 2009 and mainly (in Estonia’s case almost completely) followed the pattern in the euro zone − has kept climbing this autumn, though levelling-off tendencies are now beginning to appear. Overall, we anticipate decent GDP growth in 20112012. We expect Estonia’s GDP to rise by 4.0 per cent annually, while Latvia’s growth will reach 4.0 and 5.0 per cent respectively and Lithuanian GDP will increase by 4.0-4.5 per cent. Growth will thus not reach the

Looking ahead, weakening global demand will also lead to more sedate export growth. Meanwhile Baltic exports go mainly to countries and regions with a continued good growth dynamic such and Germany and the Nordic countries. Latvia and Lithuania also trade extensively with nearby Eastern European countries. The Baltics have very little exposure to such countries as the US and the UK. Restored competitiveness is one important reason behind the export upturn. Due to a successful internal devaluation strategy in the past two years, the Baltics have managed to regain previously lost export market shares. Monthly wages and salaries have been cut by 12 per cent in Estonia and Lithuania and nearly 20 per cent in Latvia. In our assessment, private sector pay levels bottomed out during the first half of 2010.

Sluggish recovery in domestic demand
As expected, domestic demand has remained depressed during the autumn, but there are signs that household

Nordic Outlook – November 2010 | 37

The Baltics

consumption bottomed out this past summer. Labour and residential market stabilisation in the past six months has contributed to this. During the correction, home prices in Latvia fell nearly 70-80 per cent from mid-2007 peak levels. In Estonia, the downturn was 50-60 per cent, while Lithuanian home prices fell 40 per cent. Looking ahead, we also expect consumption to benefit from increased private sector pay, but the recovery in domestic demand will be sluggish. The main reasons are that labour market improvements are expected to be slow and the current unwinding of private debt will continue during 2011. In Estonia, investments may perhaps grow faster than we had anticipated in the wake of euro zone accession on January 1, 2011.

neutral fiscal stance. Overall, we expect budget deficits to shrink from 8 per cent of GDP this year in Latvia and Lithuania to 3-4 per cent in 2012. We expect Estonia, which has had by far the best public finances of the three, to show a slight increase in deficits from 2 to 3 per cent of GDP.

Improved market confidence

Even higher unemployment
Per cent
22.5 20.0 17.5 15.0 12.5 10.0 7.5 5.0 2.5 02 03 04 05 06 07 08 09 10 22.5 20.0 17.5 15.0 12.5 10.0 7.5 5.0 2.5

In the past year, markets have regained their confidence in the Baltic countries and their euro-pegged currencies. This was reinforced after the parliamentary election in Latvia, where the centre-right coalition government moved from minority to majority rule. Late in October, Prime Minister Valdis Dombrovskis formed a two-party coalition (previously three parties) that controls 55 of the 100 seats in Parliament. Pricing of credit default swap (CDS) contracts indicates that after the Latvian election, the market has further lowered the default risk both in Latvia and Lithuania.

Reduced risk of sovereign default
5-year CDS contracts, basis points At present, 600
550 500 450 400 350 300 250 200 150 100 50 Jan Feb Mar Apr May Jun 10 Jul Aug Sep Oct Nov 600 550 500 450 400 350 300 250 200 150 100 50



Source: Local statistical offices

Structural labour market problems
A painful economic policy of dramatic internal devaluation and aggressive fiscal consolidation has wiped out earlier major economic imbalances in the Baltics, in the form of wage inflation and import-driven current account deficits (read more about this in SEB’s Eastern European Outlook). In the past six months, deflation pressure has eased and sharp current account improvements have culminated. During 2011-2012 we expect moderate inflation (however more accentuated in Estonia) in the wake of higher private wages and salaries next year and small current account deficits, due to stronger imports. Remaining imbalances, with accompanying political challenges, include sizeable structural labour market problems and continuing large public budget deficits in Latvia and Lithuania. All three Baltic countries are grappling with labour market matching problems, high youth unemployment and large-scale emigration. Unemployment, which peaked at around 20 per cent in the first half of 2010, will gradually continue to fall and will still average 14-15 per cent during 2012. These labour market problems will lead to persistent fiscal deficits. Latvia will continue to tighten its budget, an assessment based on the unexpected success of the governing coalition in the early October election. In Lithuania and Estonia, we anticipate a relatively



Source: Reuters EcoWin

The political risks appear largest in Lithuania. The conservative-led coalition has been a minority government since last spring, and there are signals that it will ease austerity in the 2011 budget despite the large public sector deficit. Apparently the government will rely on higher GDP growth to shrink deficits. Despite lingering political tensions and the unpopularity of Prime Minister Andrius Kubilius, our assessment is still that the government should be able to stay together until the 2012 parliamentary election. Our main scenario is that Latvia and Lithuania can join the euro zone in 2014. This is also consistent with their official ambitions. But we foresee risks of delay connected to budget developments, since it may be difficult for them to meet the euro zone’s budget criterion. In order to adhere to the timetable, deficits must be brought down to 3 per cent of GDP by 2012 before the EU assesses the Latvian and Lithuanian economies in 2013.

38 | Nordic Outlook – November 2010


Strong growth creating policy dilemma
ƒ ƒ ƒ ƒ ƒ Rapid GDP growth will decelerate Exports can endure a stronger krona Debts and home prices pose a future risk The Riksbank will follow its rate path Neutral fiscal policy in 2011, but challenges ahead
Inflation will remain low, largely due to record-low pay increases during 2010 and 2011, but inflation will rise during 2012 as pay hikes accelerate and resource utilisation normalises. We nevertheless believe that underlying CPIF inflation will remain below 2 per cent throughout our forecast period. In the latest Monetary Policy Report, the Riksbank adjusted its interest rate path downward, so it now matches our August forecast. We expect that partly because of good economic growth and continued rapid credit expansion, the Riksbank will deliver rate hikes approximately in line with our forecast. This will mean a key interest rate of 1.25 per cent at the end of 2010, 2.25 per cent at the end of 2011 and 3.00 at the end of 2012. The recently re-elected Alliance government has chosen a cautious fiscal policy strategy at the beginning of its second four-year term. We estimate that the sum of new programmes, mainly those announced in this autumn’s government budget bill for 2011, is SEK 20-25 billion. But when temporary local government and infrastructure spending from 2010 fade away, fiscal policy for 2011 will be largely neutral. The government has announced that during its term of office there will be limited room for reforms, equivalent to SEK 40 billion. The government’s strategy during the next couple of years is apparently to assert its control of the political mid-field by being more of a caretaker than a reformer, but we expect it to pursue a more aggressive fiscal policy towards the end of its term.

Sweden’s GDP growth has surpassed expectations so far during 2010. We predict GDP growth of a full 5.0 per cent in 2010 (4.7 per cent adjusted for the number of working days). This rapid recovery is broadly based. A favourable export structure and the effects of the previously weak krona have given exports an extra push. The strength of the domestic economy is diverging even more clearly from other countries. An expansionary fiscal policy and low interest rates helped to rapidly reverse the 2009 decline in consumption. Growth will be above trend during the next couple of years, although Sweden will eventually be affected in various ways by the absence of a real overall resurgence in the OECD economies. We expect GDP to grow by 3.5 per cent in 2011 and by 2.5 per cent in 2012 (3.5 and 2.9 per cent adjusted for the number of working days).

GDP growth peaking in 2010
6 4 2 0 -2 -4 -6 -8 Q1 Q3 08 Q1 SEB forecast 6 4 2 0 -2 -4 -6 -8

Policy mix may need to be re-assessed
Because of the international economic policy discourse that is now under way, there will be reason to discuss a suitable policy mix in Sweden. The country can boast a balanced budget, low and falling central government debt and large trade surpluses. The current account balance is well in excess of the 4 per cent of GDP cited as an acceptable level during recent G20 discussions. Meanwhile the absence of a downward adjustment in Swedish home prices diverges from almost all other countries. Instead, the household debt ratio has accelerated and home prices are continuing to climb to new record levels at a rapid pace, posing obvious risks in a longer perspective. Taken together, this may be interpreted as justifying a more expansionary fiscal policy, with more aggressive efforts to resolve important structural issues,

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

Q3 09


Q3 10


Q3 11


Q3 12

Source: Statistics Sweden, SEB

The labour market has improved faster than expected, even taking Sweden’s strong GDP growth into account. Looking ahead, we expect a continued upturn in employment, though at a calmer pace. Resource utilisation is on the rise, but the output gap will not close during our forecast period. At the end of 2012, however, we foresee unemployment of 7.0 per cent, only 0.5-1 per cent above equilibrium level.

Nordic Outlook – November 2010 | 39


especially related to taxes. Combined with a clearer normalisation of interest rates, in order to avert future credit and home price bubbles, from an international perspective this would be a natural policy mix in light of Sweden’s situation.

Strong rebound for exporters
The sharp recovery in manufacturing is largely a result of the sectoral structure of Swedish exports. The global downturn of 2009 had a particularly dramatic impact on such key Swedish exports as intermediate and capital goods. Since then, the recovery has been strongest in these areas. This is illustrated, for example, by the trend of imports in the euro zone, the recipient of more than one third of Swedish merchandise exports.

Meanwhile there are several factors indicating that Swedish exports may continue to increase at a rather healthy pace. Export companies are relatively profitable, largely due to the rapid cost adjustments they implemented during the crisis. The recent appreciation of the krona has not significantly affected the profitability estimates in the National Institute of Economic Research’s Business Tendency Survey. The quarterly reports of industrial companies confirm this. The geographic focus and sectoral structure of Swedish exports are also rather favourable. The fiscal tightening measures being enacted in many European countries will mainly lead to weaker demand for consumer goods, thus hurting sectors of lesser importance to Swedish exports. Another favourable circumstance is that key export markets like Germany and neighbouring Nordic countries are continuing to perform well, while the share of exports destined for the PIIGS countries is small. See the table below. Exports to the expansive Asian market are still relatively limited according to merchandise trade statistics, but company reports indicate a significantly faster eastward shift in export flows. Asia’s role thus seems to be larger than the official statistics show. This divergence may be partly due to a rapid increase in service exports to Asia; information about the distribution of such exports by country is lacking. Increased direct investments in Asia may contribute to higher deliveries of services from Swedish parent companies. Our overall assessment is that despite a stronger krona, exports will grow at the pace of global market expansion. This will result in export growth of 7.4 per cent in 2011 and 5.1 per cent in 2012.

Euro zone: Merchandise imports
Year-on-year percentage change
50 40 30 20 10 0 -10 -20 -30 -40 Jan May Sep 07 Jan May Sep 08 Jan May Sep 09 Jan May 10 50 40 30 20 10 0 -10 -20 -30 -40

Capital goods Consumption goods

Intermediate goods
Source: Eurostat

Swedish merchandise exports have now almost regained their pre-crisis level. This means that the recovery is entering a more mature phase; we thus expect the rate of increase to slow in 2011. Certain factors indicate a clear deceleration. The krona is no longer providing an extra stimulus for exports. This may lead to especially noticeable effects early next year, when a large proportion of the currency hedging contracts at Swedish companies will expire. Global overcapacity exists in certain important Swedish export sectors, and this may also increase sensitivity to currency rate changes.

Merchandise exports, January-August 2010
Per cent Europe EU Euro zone Germany Norway UK Denmark Finland France PIIGS North America US South America Asia China Total
Source: Statistics Sweden, SEB

% of total 72.3 57.6 37.6 10.2 10.1 7.7 6.6 6.2 5.0 6.4 8.3 7.2 2.4 11.8 3.1 100

Merchandise exports
Index 100 = 2008
110 105 100 95 90 85 80 75 05 06 07 08 09 10 110 105 100 95 90 85 80 75

Year-on-year change, % 10.1 10.7 10.0 11.6 7.8 18.2 0.4 9.3 6.0 3.4 26.4 26.1 22.8 8.9 10.5 11.8


Source: Statistics Sweden, Deutsche Bundesbank

40 | Nordic Outlook – November 2010


With a certain time lag, capital spending by Swedish manufacturers has also rebounded from its record low in 2009. Although capacity utilisation has now risen, there is still potential to boost production at many companies without expanding capacity. We thus expect capital spending to enter a calmer phase during 2011. A rapid upswing in residential investments has also occurred during 2010. Continued home price increases indicate that this upward trend will continue in 2011.

chasing power at a rate equivalent to 0.5-1.0 per cent annually. In addition, the stock market upturn and rising home prices will result in an increasingly strong wealth position. Household wealth has increased from 440 per cent of income in 2009 to 500 per cent in 2010.

Household income and consumption
Percentage change 2009 2010 Consumption Income Savings ratio -0.8 0.9 12.6 3.5 1.9 11.3 2011 2.8 3.4 11.7 2012 2.5 2.1 11.3

Gross fixed investment

Percentage change, 2009 level in current prices (SEK bn) 2009 Government sector Housing Business sector Total 103 91 362 555 2009 6.7 -23.4 -20.5 -16.0 2010 -2.0 20.0 6.3 7.0 2011 2012 0.0 12.0 6.2 6.0 0.0 10.0 3.6 4.0

Source: Statistics Sweden, SEB

Lending to households
Year-on-year percentage change
17.5 15.0 12.5 10.0 7.5 17.5 15.0 12.5 10.0 7.5 5.0 2.5 06 07 08 09 10

Source: Statistics Sweden, SEB

Rebound in investments
Index 100 = 2005
105 100 95 90 85 80 75 70 65 Q1 Q3 05 Q1 Q3 06 Q1 Q3 07 Q1 Q3 08 Q1 Q3 09 Q1 10 105 100 95 90 85 80 75 70 65

5.0 2.5

Total Housing Consumption + other purposes
Source: Riksbank



Source: Statistics Sweden

Strong households − risky housing market
An expansionary fiscal policy helped household income continue to increase at a healthy pace during the crisis years, despite weak wage and salary income. Combined with sharply lower mortgage interest rates, this has made room for rising consumption. In the past year, actual consumption figures have also rebounded as the labour market has improved. In particular, auto purchases have increased sharply. The outlook for the next couple of years still looks bright. Household confidence is on a par with previous historical highs. In the retail sector, optimism has admittedly declined a bit, but since actual retail sales nevertheless rose, this downturn is probably temporary. The household savings ratio remains at a historically high level, and stable employment and falling inflation are contributing to stable income increases. Fiscal policy is continuing to contribute positively to pur-

The housing market upturn looks set to continue in the short term. Rising interest rates and the recently enacted loan-to-value ceiling on mortgages will help slow price increases, while rising employment and income will pull in the opposite direction. The latest statistics indicate an unchanged rate of increase in mortgage lending and home prices. Other indicators, such as the SEB housing price index, show a continued upturn.

Households continuing to increase their debts
Per cent of disposable income
11 10 9 8 7 6 5 4 3 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 180 160 140 120 100 80 60

Sweden: Interest burden after taxes (LHS) Sweden: Debts (RHS) US: Debts (RHS)
Source: Riksbank, Federal Reserve, SEB

The long-term trend will depend on whether economic policy can be crafted in a way that prevents a sharp downturn in home prices. In the August issue of Nordic

Nordic Outlook – November 2010 | 41


Outlook, we discussed these questions in more detail. Various underlying factors, for example a continued moderate interest burden, a slow pace of construction and the rule system in the housing market will reduce the risks of a downturn. On the other hand, historical experience show that practically no country has been able to avoid a sharp adjustment after such a dramatic upturn in household debt as is now occurring in Sweden.

Strong labour market recovery
Employment rebounded as early as the end of 2009. More than two thirds of the three per cent downturn in jobs since 2008 has now been regained. Available indicators show that this trend will continue, at least over the next two quarters. Unemployment has recently also shown signs of falling, although the indicator situation is more mixed here. As economic growth gradually decelerates, the labour market recovery will also slow down, but in 2012 GDP will continue to grow at above its long-term trend. This indicates that unemployment will fall throughout our forecast period.

There is no shortage of structural challenges, however. Employment in the manufacturing sector fell very sharply during 2008, and the historical pattern indicates that these jobs will come back only to a limited extent. Expansion will instead occur in the construction sector and in private services. Such a rapid structural change may contribute to an upward shift in equilibrium unemployment from about 6-6.5 per cent, the level that prevailed before the crisis. This means that at the end of 2012, unemployment will not be especially far above its equilibrium level.

Index 100 = 2008, 3 month moving average
107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0 Jan May Sep 08 Jan May Sep 09 Jan May 10 107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0

Labour market
Percentage change Employment Labour supply Unemployment, % Productivity (GDP) 2009 2010 -2.1 0.2 8.3 -2.5 1.0 1.1 8.4 0.7 3.0 2011 1.7 0.7 7.5 -0.6 2.3 2012 0.7 0.3 7.1 -0.1 2.3

Total Manufacturing Construction

Government sector Services Retail
Source: Statistics Sweden, SEB

Average hours worked -0.5

Record-low pay increases
Collective pay agreements for 2010 and 2011 were signed at a time when future expectations were very depressed. The agreements thus ended up being recordlow in terms of pay hikes. Monthly wage and salary statistics show that these low agreements had a strong impact. Pay increases are record-low even taking into account that the preliminary monthly figures are always adjusted upward. Despite the improved labour market, we are thus sticking to our earlier forecast that 2010 and 2011 pay hikes will end up around 2.0 to 2.5 per cent, that is, well below the historical average.

Source: Statistics Sweden, SEB

Structural challenges
Indicators of resource utilisation, such as capacity utilisation in manufacturing and labour shortages according to the NIER Business Tendency Survey, have quickly climbed from the record lows reported in late 2009. Today they stand at about the levels prevailing during the previous recession in 2002-2003. These levels indicate that capacity bottlenecks are not a major obstacle to growth and pose no threat of rising inflation.

Record-low pay increases
Year-on-year percentage change
5.0 4.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 01 02 03 04 05 06 07 08 09 10

Labour shortages in the business sector
Net balance
35 30 25 20 15 10 5 0 00 01 02 03 04 05 06 07 08 09 10 70 60 50 40 30 20 10 0

4.0 3.5 3.0 2.5 2.0 1.5 1.0


Business sector
Source: National Mediation Office

Manufacturing (LHS) Services (LHS)

Retail (LHS) Construction (RHS)
Source: NIER

In 2012, however, we expect pay increases to rise to 3.5-4.0 per cent. The next wage round will occur in a significantly stronger labour market situation. The year-

42 | Nordic Outlook – November 2010


on-year increase figures will also be affected by the fact that the revision date in the earlier agreement will occur relatively late in 2011. Uncertainty about wage formation has also increased because the Employers’ Federation of the Swedish Engineering Industry (Teknikföretagen) has just withdrawn from the 1997 Cooperation Agreement on Industrial Development and Wage Formation.

clear downside risk in this forecast. Producer prices, which ordinarily lead consumer prices by about six months, have so far risen only moderately. Measured in Swedish kronor, broader commodity indices have not risen very much either. In addition, short-term commodity price upturns often do not have time to affect the CPI and PPI trend. Even taking food prices into account, however, CPIF will end up well below the Riksbank’s target throughout our forecast period. But headline CPI will exceed the target, due to rising household mortgage interest costs.

Low inflation
Year-on-year percentage change
5 4 3 2 1 0 -1 -2 08 09 10 11 12 SEB forecast 5 4 3 2 1 0 -1 -2

Riksbank will hike key rate as planned
In its October Monetary Policy Report, the Riksbank adjusted its future rate hike plans downward. It not only revised the rate path in the long term, but also for the bank’s next interest rate policy meetings. The Riksbank is now signalling rate hikes at two of the next three meetings, thus increasing uncertainty in the short term as well. But we are sticking to our forecast and expect the Riksbank to hike its repo rate at the next two meetings, that is, in December and February. In our judgement, third quarter growth will be stronger than the Riksbank had forecasted, while the labour market will strengthen and lending to households will increase.


CPIF excl energy and food


Source: Statistics Sweden, SEB

Low inflation, but food an upside risk
After peaking late in 2009, inflation measured as CPIF (CPI excluding mortgage interest expenses) has fallen. In October it was 1.8 per cent. Low cost pressure will mean continued weak underlying inflation over in the next couple of years. The appreciation of the krona during the past year will help ease inflation during the first half of 2011. Core inflation (CPI excluding food, energy and interest expenses) has also fallen from nearly 3 per cent in late 2009 to less than 1.5 per cent in October. We expect core inflation to continue downward to about one per cent in mid-2011. After that there will be a moderate upturn, especially because krona-related effects will be fading.

Repo rate path
3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 Nov Mar 10 Jul 11 Nov Mar Jul 12 Nov Mar Jul 13 Nov 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00

Food prices
Year-on-year percentage change
15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 97 98 99 00 01 02 03 04 05 06 07 08 09 10 50 40 30 20 10 0 -10 -20 -30

Market pricing SEB forecast

Riksbank Oct 2010

Source: SEB

PPI, food (LHS) CPI, food (LHS)

Commodity prices (RHS)
Source: Statistics Sweden, The Economist

We have adjusted our inflation forecast slightly upward since August, mainly due to rising food prices next year. We expect the upturn in Sweden to be consistent with that in the euro zone, 3-4 per cent, but we foresee a

In our judgement, even in a longer perspective the Riksbank will deliver key rate hikes roughly in line with its latest rate path. Rapid credit growth, rising home prices and gradually increasing resource utilisation all point towards continued interest rate hikes. New regulations, such as the recently introduced loan-to-value ceiling on mortgages, as well as restrictions on bank lending due to the new Basel III capital adequacy rules, will reduce the need for rate hikes. Another argument against larger rate hikes is that in its latest report, the Riksbank explicitly discussed the risks of an excessively rapid krona appreciation as a consequence of the way major central banks in the OECD countries are keeping their key interest rates close to zero. As indicated by our conclusions in the box below, however, we do not regard rate hikes of the magnitude announced by the Riksbank as any major threat to the external balance of

Nordic Outlook – November 2010 | 43


the Swedish economy. Taken together, we expect a repo rate of 2.25 per cent in December 2011 and 3.00 per cent at the end of 2012.

10-year yield spread vs Germany
Basis points
100 75 50 25 0 -25 -50 98 99 00 01 02 03 04 05 06 07 08 09 10 11 100 75 50 25 0 -25 -50

Wider long-term yield spread
The spread between 10-year Swedish government bond yields and their German equivalents has risen to about 30 basis points, the highest level since 2005. The most important reason for this upturn is that strong economic signals have made the Riksbank’s plans to raise its key interest rate more credible, while the ECB’s refi rate will remain unchanged. Our Swedish repo rate forecast for 2011 is above market expectations, indicating that the spread will continue to widen ahead. Offsetting this is Sweden’s strong


Source: SEB

Does the krona risk becoming too strong?
The latest Monetary Policy Report focused on the risk that the krona may become too strong if the Riksbank hikes its repo rate while the ECB and other major central banks in the OECD countries leave their key rates unchanged. Relevant questions are: In what respects, and at what levels, will the strengthening of the krona become a problem? far from the average of the past 10-15 years that it would radically alter Sweden’s competitiveness situation. Estimates of long-term equilibrium exchange rates based on prices and labour costs also indicate that even at these levels, the krona will be undervalued.

Trade balance and current account
Per cent of GDP
10 8 6 4 2 0 -2 94 96 98 00 02 04 06 08 10 10 8 6 4 2 0 -2
5 0 -5 -10 -15 -20 -25 -30 -35 99 00 01

Net external position
Per cent of GDP
5 0 -5 -10 June 2010 -15 -20 -25 -30 -35 02 03 04 05 06 07 08 09 10

Goods and services Goods

Services Current account
Source: Statistics Sweden, Riksbank

Source: Statistics Sweden

For a long time, Sweden has been running large current account surpluses. These have been relatively stable, even at times when the export industry has been in crisis. There may be good reasons to run large current account surpluses, for example to offset earlier periods of deficits and to pay down external debt. The long period of surpluses has gradually improved Sweden’s external position, which has now achieved a balance. It is thus difficult to see any problem if this large current account surplus continues to shrink. For example, the surplus is also well above the 4 per cent of GDP that has been discussed within the G20 as acceptable. According to our forecast, the krona will continue strengthening to about 120 in trade-weighted TCW terms. This implies a somewhat stronger krona than the peaks of the past decade, but a level still not so

Our conclusion is that the rate hikes indicated by the Riksbank’s interest rate path will not lead to a strengthening of the krona that will cause any serious problems to the Swedish economy.

Exchange rates
13 12 11 10 9 8 7 6 5 4 98 00 02 04 06 08 10 160


155 150 145 140 135 130 125


120 115

Source: Reuters EcoWin

44 | Nordic Outlook – November 2010


government finances, which means that the supply of sovereign bonds will be limited. Our model for the yield spread against Germany − which takes into account key rates, economic growth and government finances − indicates that the spread is now close to a reasonable level for 2011, but we expect it to widen by another 15 basis points to 50 towards the end of next year.

ing upturn was 35 per cent of GDP. During our forecast period, we expect Sweden’s gross central government debt to fall to 30 per cent of GDP. If we also take the asset side (for example government owned companies and the pension systems buffer funds) into account, the country’s general government net financial position is already positive at present.

New krona appreciation phase on the way
The krona has regained the entire downturn that occurred during the crisis, and the EUR/SEK exchange rate is now in the middle of the 9-9.50 interval it occupied during 2004-2007. The same is true of the USD/SEK rate, although it has been significantly more volatile. In recent weeks, however, the krona has lost ground. This is due to several factors: 1) The Riksbank’s downward adjustment of its rate path, which was partly intended to blunt the rapid appreciation of the krona. 2) The market has apparently had a long position in Swedish kronor, which SEB’s client survey in the Scandie Views report confirmed. 3) The USD has regained ground, which often drives the krona weaker against the euro as well. 4) The period from mid-November to early December has a negative seasonal pattern for the SEK, probably due to the allocation of PPM Swedish pension fund capital to foreign assets. When this period is over, assuming that the Riksbank is continuing to tighten its monetary policy in accordance with our own forecast, the upward trend for the krona should resume. We estimate that the EUR/SEK exchange rate will be 9.15 at the end of this year and 9.00 at the end of the first quarter of 2011. There are strong reasons to forecast continued krona appreciation in the long term. The relative gap in economic performance is wider than for many years, bolstering arguments for an unusually large difference in monetary policies. At present, the likelihood that the ECB will raise its key interest rate during 2011 is very small. In addition, the krona seems weak in a long-term perspective, despite its appreciation during the past year. In an international environment in which most countries would like to weaken their currency, there is a higher probability that this long-term undervaluation will be important. We expect the EUR/SEK rate to stand at 8.75 late in 2011 and 8.60 late in 2012. The corresponding USD/SEK rates will be 6.73 and 6.77.
80 75 70 65 60 55 50 45 40 35 30 94 96 98 00

Falling debt
Per cent of GDP
80 75 SEB forecast 70 65 60 55 50 45 40 35 30 02 04 06 08 10 12

Maastricht debt

Source: Eurostat, Swedish National Debt Office, SEB


In its autumn budget bill, the government unveiled reforms totalling about SEK 13 billion in 2011. Including programmes outlined in the spring 2010 budget bill and our assumptions about further measures in the 2011 spring budget bill, we reach a total of SEK 20-25 billion in expansionary measures during 2011 (equivalent to 0.7 per cent of GDP). Despite these new measures, overall fiscal policy will be neutral in 2011. This is because temporary crisis aid in the form of local government and infrastructure grants will disappear.

Public finances
Per cent of GDP 2009 2010 Revenue Expenditures Net lending Central gov’t debt 52.3 53.3 -1.2 38.3 51.3 51.8 -0.5 37.9 35.4 3 2011 50.8 50.7 0.1 35.5 32.7 -10 2012 50.9 50.1 0.8 32.8 30.0 -47

Gen. gov’t gross debt 41.7 Borrowing req., SEK bn 176
Source: Statistics Sweden, SEB

Continued strong public finances
Strong public finances at the beginning of the crisis enabled Sweden to pursue an expansionary fiscal policy without jeopardising its credibility. After major budget deterioration between 2007 and 2009, we now expect the budget balance to be relatively close to zero during our forecast period. Central government debt rose by about 4 per cent of GDP between 2008 and 2009 − a very modest upturn compared to the 1990s crisis, when the correspond-

The central government borrowing requirement has continued to provide downside surprises during the past 3-4 months, although not to the same extent as earlier in the year. Once again, tax revenue has been surprisingly high. We are also assuming that the government will sell SEK 25 billion worth of state-owned assets per year, as announced. The parliamentary situation makes approval of new privatisations unlikely, but Parliament has already approved the divestment of the government’s holdings in the telecom group TeliaSonera and

Nordic Outlook – November 2010 | 45


the banking group Nordea. These holdings are sufficient to generate SEK 25 billion per year throughout the government’s current four-year term of office. Overall, we expect a very small budget deficit of SEK 3 billion in 2010 and surpluses of SEK 10 billion in 2011 and SEK 37 billion in 2012. Looking ahead, there should also be a discussion of whether the Riksbank needs its entire extra currency reserve buffer once the crisis has faded. In any case, we estimate that some of the nearly SEK 100 billion (equivalent to about 3 per cent of GDP in 2010) that the National Debt Office borrowed on behalf of the Riksbank will be paid back, but that this will occur after 2012. We also believe that the Swedish government’s lending to Iceland and Latvia, nearly SEK 10 billion, will not be implemented.

that took effect in the mid-1990s makes the situation easier for a minority government, since the opposition must join forces and present a common counterproposal in order to defeat a government budget bill. It is highly unlikely that the Social Democrats, Left Party and Green Party would join with the right-wing populist Sweden Democrats to defeat the government’s budget bill. The Red-Green coalition (Social Democrats, Left Party and Greens) that campaigned jointly against the Alliance in the autumn 2010 election has now collapsed, and the Social Democrats are undergoing their own crisis. However, the government may have problems implementing other bills without negotiating in advance to gain support from one or more opposition parties.

Forecasts of the central government borrowing requirement
SEK billion 2010 SEB 3 National Debt Office, November 5 National Institute of Economic Research (NIER), September 21 National Financial Management Authority (ESV), August 21 Ministry of Finance, October 27 2011 -10 -18 22 0 -6 2012 -47 -78 22 -25 -47

Challenges later in the government’s term
The government’s orderly administration of its finances, despite international instability, has contributed to the strong confidence it enjoys among the voters. For as long as possible, the government will remind them that the crisis is not over and that caution is needed in Sweden’s reform ambitions. Such a policy will make it easier to stay in control of the political mid-field. Yet the government will certainly need to show its cards more clearly later in its four-year term. Given such a strong public sector balance sheet, the debate about what is a suitable level of central government debt will probably reappear. In addition, international discourse about global imbalances includes recommendations that countries like Sweden with large current account surpluses and low national debts should pursue a more expansionary policy. In a situation of persistent high unemployment, it will then be especially difficult for the government to argue that Swedish public finances must show surpluses over an economic cycle. In the budget bill for 2011, Finance Minister Anders Borg presented a number of reforms that will enjoy priority if room for further spending becomes available. This list will serve as a good guide to what may later emerge on the political agenda. It includes corporate tax cuts, removal of a 5 per cent extra income tax on the affluent that was imposed as an austerity measure in the 1990s, lower employer payroll fees and venture capital deductions (a study commission will examine these taxes and give advice on what to prioritise). The government’s choice of strategy will determine the political frontlines for a fairly long time to come. The choice between tax cuts and improvements in the business climate, on the one hand, or a clear commitment to health and welfare issues, on the other, will create tensions. The government will either open itself up to criticism from some elements of the business community or to attacks from the opposition, which argued during the 2010 election campaign that the government had a hidden tax-cutting agenda.

Source: National Debt Office, NIER, ESV, Government Offices, SEB

From reformist government to caretaker
After its 2006 election victory, the Alliance government quickly started pushing through an ambitious reform programme. Its focus was to strengthen the incentives to work, for example by means of earned income tax credits and reforms of unemployment insurance and other transfer payment systems. The Alliance’s promises for its new term of office were noticeably more cautious. In the 2011 budget bill, its reform measures are scattered among many fields, but with some emphasis on funding for local governments and tax cuts for pensioners. During the rest of its four-year term, the government has signalled relatively modest reforms totalling SEK 40 billion, or a bit above 1 per cent of GDP. This will be allocated among various fields, with the most costly reform being additional earned income tax credits, an increase in the breakpoint for paying national income tax and lower VAT on restaurant meals. Compared to the Alliance’s reform ambitions in the run-up to the 2006 election, the list seems limited and defensive; the government is shifting from a reformist role to a caretaker role. The Alliance will be ruling as a minority government during this term, which is one of the reasons behind its more defensive policies. But the importance of this situation should not be exaggerated. The budget law

46 | Nordic Outlook – November 2010


Internal tensions within both the four-party Alliance government and the opposition also play a part. The Moderate Party, which dominates the governing coalition, apparently has the most to gain from a strong focus on fiscal responsibility. If the signature issues of the smaller Alliance parties must constantly be sacrificed because of tight government finances, tensions within the government are likely to increase − especially if there is a continued trend towards growing dominance by the Moderates in public opinion surveys. Meanwhile the deep crisis within the Social Democratic Party makes it difficult to assess how the political opposition will shape its policies. The announced departure of party chair Mona Sahlin and internal conflicts are likely to paralyse the party during the coming months. Yet in our judgement, the process of self-examination after their heavy election losses in September 2010 will persuade the Social Democrats to take a step back towards the middle in order to capture the political mid-

field, thus opening up their left flank to the Left (formerly Communist) Party. The risk in such a strategy may be that more traditional leftist voters will view it as an acceptance of elements of the Alliance’s non-socialist policies. There will also a greater focus on the Green Party. In keeping with its rules, this party will be electing two new spokespersons in 2011. During the current Parliament, the Alliance government will undoubtedly seek support from the Greens on a number of occasions. Will the Greens move towards the middle or the left? The political landscape seems about to be reshaped in a way that has not occurred for many years.

Nordic Outlook – November 2010 | 47


Decent growth despite budget tightening
ƒ ƒ ƒ Growth is reverting to a calmer path Good exports that are more competitive No increase in key rate spread until 2012
Exports will keep growing at a healthy pace in 2011 but somewhat more slowly than in 2010, due to weaker global demand and this autumn’s krone upturn following earlier depreciation. Meanwhile Danish exporters can now tolerate a fair degree of currency appreciation, since wage and salary growth has been brought down to a more modest level in recent years, similar to that of competitor countries in Europe. Demand is also solid in two major export markets, Germany and Sweden.

After an unusually strong second quarter, we are adjusting our 2010 Danish growth forecast upward from 1.8 to 2.2 per cent, but are sticking to our view that growth will remain modest at just above 2 per cent yearly in 2011-2012 − mainly due to fiscal tightening.

Sluggish upturn in domestic demand
Domestic demand has begun to recover this year and will continue rising at a leisurely pace. Consumption will benefit from continued gradual improvement in the labour and housing markets, but wage and salary growth will remain modest. Next year, household spending will be affected by the three-year budget consolidation that the government announced last spring. This overall programme is equivalent to 1.5 per cent of GDP and includes lower indexing of pensions and other transfer payments, as well as cancellation of some previously planned tax cuts. Corporate capital spending is rising, but sentiment surveys and capacity utilisation signal no great needs. The construction industry is also battered after the sharp downturn of recent years. Public sector investments will be postponed due to budget austerity. Headline inflation has recently jumped to about 2.5 per cent, but core inflation has been calm. The upturn is mainly due to base effects and higher energy and food prices. In the short term, food prices will probably continue upward, partly for global reasons, but over time inflation will cool. Consumer price increases will average about 2 per cent annually in 2011-2012. After a rapid, dramatic deterioration, the budget deficit will total about 5 per cent of GDP this year. Austerity, smaller unemployment outlays and other factors will shrink the deficit to 3 per cent in 2012. As expected, the central bank has left its key lending rate unchanged at 1.05 per cent, but this autumn it has adjusted other key rates a bit upward in response to rising European market interest rates. This is aimed at keeping the krone exchange rate stable. Over the next year, the spread against the ECB’s key rate will remain at an extremely low 5 basis points. Continued robust current account surpluses will allow this, without weakening the krone against the euro. Only in 2012, once the ECB starts hiking its repo rate, will there be a gradual normalisation of the spread towards 20 bps.

Slower growth expected after strong Q2
Year-on-year percentage change and index
7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 94 96 98 00 02 04 06 08 10 120 110 100 90 80 70 60

Real GDP, quarterly data (LHS) EU monthly sentiment indicator (RHS)
Source: Statistics Denmark, DG ECFIN

The second quarter GDP increase, 3.7 per cent year-on-year, was largely due to temporary effects. A hard-to-assess inventory contribution accounted for 2.1 percentage points. The second quarter of 2009 was also extremely weak, providing a low base. Declining sentiment indicators this autumn, after an earlier long period of upturns, also signal a slowdown ahead. We expect the GDP growth rate to fall below 3 per cent.

More competitive exports this past year
Real effective exchange rate, index 100 = 2005
107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 94 96 98 00 02 04 06 08 10 107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0

Source: Reuters EcoWin

48 | Nordic Outlook – November 2010


Above-trend growth in 2011
ƒ ƒ ƒ ƒ Growth is accelerating again Broad-based growth in domestic demand Core inflation to trend higher by mid-2011 Norges Bank to pause until next June
6 5 4 3 2 1 0 -1 -2 -3 -4 01 02 03 04 05 06 07 08 09 10 -8.0 4.0 0.0 -4.0

2.0 per cent in October. Moreover, interest rates are still at low levels and Norges Bank now seems intent on keeping policy rates unchanged to mid-2011.

Consumption of goods and home prices
6-month percentage change
12.0 8.0

The outlook for the Norwegian economy is broadly unchanged from the August Nordic Outlook. For 2010 the forecast for 0.5 per cent growth in overall GDP is slightly lower due to a sharp drop in oil and gas production in the third quarter − exaggerated by maintenance at some fields − suggesting a more marked drop in such exports. Overall growth should be 2.3 per cent next year and ease to 2.2 per cent in 2012. Momentum in mainland GDP − excluding oil/gas and shipping − is stronger: while we are leaving our forecast unchanged at 1.6 per cent for the current year, growth should accelerate to 2.9 per cent in 2011 and 2012, approximately 0.5 per cent above trend.

Consumption of goods (LHS) Home prices (RHS)

Source: Statistics Norway, Norwegian Association of Real Estate Agents

Private consumption recovering
Signs of accelerating economic activity have accumulated in recent months. The recovery in domestic demand is becoming more broadly based, in line with our expectations. In particular, private consumption rebounded in the third quarter following a surprisingly soft trajectory over the first half of the year. In the previous Nordic Outlook, we attributed the “consumption conundrum” first and foremost to higher inflation, driven by sharply higher electricity prices over the winter, which squeezed real disposable income. Based on solid fundamentals, we thus expect consumption to regain strength going forward. Momentum accelerated over the summer, as seen in the monthly indicator for consumption of goods, which rose by 1.1 per cent between the second and the third quarter, following a slight decline over the first half of the year. This development mirrors the improvement in consumer confidence, with the quarterly index rising to its highest level since late 2007, slightly above the longterm average. In addition, home prices have regained strength by rising 4.1 per cent in the six months to October, while a slowing in the year-on-year rate to 6.2 per cent was due to base effects. The squeeze on household real income has eased as inflation has moderated, with the year-on-year rate on consumer prices slowing from 3.4 per cent in March to

Growth in private consumption should pick up from 2.8 per cent in 2010 to 3.5 per cent in 2011 and 3.3 per cent in 2012. The forecasts are slightly above the expected increase in households’ real disposable income of approximately 3 per cent on average in 201012. The household savings ratio is thus set to decline slightly, but at 7.9 per cent as of the second quarter, it was well above its long-term average. A possibly larger decline in the savings ratio is an upside risk to our forecast for private consumption. However, household debt remains very elevated compared to income. Although credit growth to households has yet to show acceleration on the back of low interest rates, its year-on-year growth of slightly above 6 per cent is still stronger than that of income. Our forecast thus assumes some debt consolidation when Norges Bank re-starts its rate hiking cycle.

Unemployment about to peak
Unemployment is still at rather low levels, even though the improvement in the labour market situation − which started in late 2009/early 2010 − seems to have tapered off. Registered unemployment increased rather markedly in September and October to 3.0 per cent of the labour force in seasonally adjusted terms, the highest in almost five years. The recent increase does not reflect a similar turn to the worse. Rather, some of the labour market programmes that were added when the financial crisis hit have been scaled back. Including people enrolled in such programmes, overall registered

Nordic Outlook – November 2010 | 49


unemployment has thus been stable recently and is lower than a year ago.

Employment and unemployment
5 4 3 2 1 0 -1 -2 94 96 98 00 02 04 06 08 10 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0

below its long-term average. Positively, the capital spending outlook among manufacturers has become gradually less pessimistic, according to the latest Business Tendency Survey from Statistics Norway. Although the investment intentions indicator is not back in positive territory, it hints that the downturn has come to an end. In contrast, capital spending in the utility sector looks set to grow strongly, as indicated by Statistics Norway’s latest investment survey. Moreover, construction orders have showed a strong improvement over the past few quarters and housing starts have trended higher as well, suggesting that residential investment has turned the corner. The same is the case for capital spending in the private service sector, which accounts for the lion’s share of non-oil business investment.

Employment, year-on-year percentage change (LHS) LFS unemployment rate (RHS)

Source: Statistics Norway

Housing starts and orders
1200 1100 1000 900 800 700 600 500 99 00 01 02 03 04 05 06 07 08 09 10 120 110 100 90 80 70 60 50 40 30 20

Moreover, unemployment according to the Labour Force Survey declined slightly from 3.6 per cent in the second quarter to 3.4 per cent in the third, due to a marginal decline in the labour force. Meanwhile, employment was unchanged for the quarter and up a modest 0.4 per cent over the past year. This rather small gain reflects the fact that employment did not decline much during the downturn, as the public sector added workers and the private sector, except manufacturing and construction, was somewhat reluctant to reduce its workforce. Although we foresee somewhat stronger employment growth, it will broadly match the increase in the labour force, and the LFS unemployment rate should average 3.4 per cent in 2011 and 3.3 per cent in 2012.

Housing starts, 1,000 sqm (LHS) Orders, new residential buildings, 2Q earlier (RHS)

Source: Statistics Norway

Capital spending is turning the corner
Steep declines in non-oil business and residential fixed investment have weighed heavily on growth in the past couple of years, dropping almost 30 per cent from the final quarter of 2007 until the second quarter of 2010.

We expect residential investment to grow by a solid 10 per cent in 2011 and almost as much in 2012, although the level will still be almost 20 per cent below its 2007 peak. Meanwhile, non-oil business investment should be up more than 5 per cent next year. Oil sector investment will probably decline somewhat more in 2010 than previously expected. However, Statistics Norway’s most recent survey saw oil companies expecting record-high investment in 2011, and we still expect a 5 per cent growth rate next year.

Orders have recovered
Index 100 = 2005
175 150 125 100 75 50 99 00 01 02 03 04 05 06 07 08 09 10 175 150 125 100 75 50

Exports have underperformed so far
While domestic demand is on the rise, the volume of exports of non-oil goods has continued to be surprisingly soft. Following an initial strong rebound last summer as the global economy turned, such exports have remained broadly unchanged so far in 2010, according to foreign trade statistics. One might suspect that a somewhat stronger currency is partly to blame, as the Norwegian krone has averaged some four per cent higher in trade-weighted terms than a year earlier. In addition, the fact that wages continue to rise faster than among trading partners − which has been the case for years − adds to the loss of competitiveness.

Manufacturing orders

Construction orders

Source: Statistics Norway

Capital spending in the manufacturing sector is likely to decline further between 2010 and 2011. While manufacturing production on a quarterly basis has risen since mid-2009, reaching 4.1 per cent year-on-year as of the third quarter of 2010, capacity utilisation is still well

50 | Nordic Outlook – November 2010


However, the lacklustre trend in non-oil exports owes a lot to plunging exports of electricity and a decline for refined oil products and non-transportation investment goods. Other than that, exports have risen in line with what one would expect considering the recovery in export markets in general and in manufacturing production, in particular since intermediate goods make up a lot of such exports.

slowing from 2.6 per cent at end-2009 to 2.1 per cent according to our calculation. Meanwhile, core import prices in October were 1.4 per cent lower than a year earlier.

Core inflation very benign
Year-on-year percentage change
6 5 4 3 2 1 0 -1 -2 99 00 01 02 03 04 05 06 07 08 09 10 6 5 4 3 2 1 0 -1 -2

Merchandise exports excluding oil/gas, ships etc.
Per cent of total exports 2000 Europe Sweden Germany UK Denmark France Italy PIGS US Asia China Japan Total * Jan-Aug. 77.3 12.7 11.7 10.7 7.3 6.1 3.0 5.7 8.4 9.8 0.8 3.9 2010* Year-on-year change, %* 66.9 8.4 10.7 15.0 8.5 3.3 8.1 19.0 4.9 -3.3 4.5 12.8 1.7 -3.6 5.2 3.3 9.8 31.0 17.2 -3.8 3.9 -11.1 2.8 22.5 8.5


Source: Statistics Norway

To a large extent, the decline in imported inflation reflects the previous appreciation of the Norwegian krone by more than 10 per cent, using the import-weighted index, between late 2008 and early 2010. The price index for imported goods suggests that the downtrend in core import prices has further to run in the near term, but also that a trough is likely before long. Such a signal is also coming from the fact that the import-weighted NOK index is slightly weaker at present than a year ago.

Source: Statistics Norway, SEB

Strong NOK has dented imported inflation
Year-on-year percentage change
6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5 99 00 01 02 03 04 05 06 07 08 09 10 11 -20 -15 -10 -5 0 5 10 15

Manufacturing export orders were up 15 per cent in the year to the third quarter, but this strong gain was affected by the rise in commodity prices, since orders are measured in nominal terms. Nonetheless, according to the quarterly Business Tendency Survey, which saw manufacturing sentiment rising to a three-year high, exports orders increased in both the second and the third quarter and manufacturers’ expectations were the most optimistic in almost five years. In addition, in a recent report from Norges Bank’s regional network, export firms reported a marked pickup in production and expected output to expand at about the same pace in the near term. In all, real exports of non-oil goods probably expanded 5 per cent from 2009 to 2010, but mostly due to the high entry level going into the current year. Our forecast for 3.5 per cent growth in 2011 thus implies an accelerating trend.

Core CPI, imported prices (LHS) NOK import-weighted, 6-month earlier (RHS)

Source: Statistics Norway, SEB

Core inflation at a trough
Core inflation has been surprisingly soft so far in 2010. The year-on-year rate on the CPI-ATE measure − excluding indirect taxes and energy − slowed from 2.4 per cent last December to a four-year low of 0.9 per cent in September before inching up to 1.0 per cent in October, well below the 2.5 per cent medium-term target. The downshift has been rather broad-based between domestic and import prices, with core domestic inflation

Concerning the downtrend in domestic inflation, some of it reflects markedly slower wage and salary growth in recent years, from more than 6 per cent in 2008 via 4.5 per cent in 2009 to approximately 3.5 per cent in the current year. Other than that and the currency effect, it is hard to pin the downshift in core inflation to any similar weakening in demand, while wage growth is likely to drift higher in the next couple of years.

Norges Bank: It is all about inflation
Since early summer, core inflation has fallen short of Norges Bank’s expectations. The October Monetary Policy Report sent a clear message that the 2.00 per cent deposit rate, raised most recently in May, is unlikely to

Nordic Outlook – November 2010 | 51


be hiked until inflation shows a trough and starts trending higher again. A lower inflation forecast was the key reason why the bank again revised its optimal rate path downward, although less than the substantial revisions in the two previous reports. Norges Bank’s new inflation forecast implies that the inflation target will not be met until the second half of 2013. Accordingly, while the previous Monetary Policy Report implied a hike in the deposit rate around the turn of the year, the new one extends the pause until next summer, with two hikes before the end of 2011 and a 3.50 per cent key rate by end-2012.

the near term has been hampered by weak flows and a dovish Norges Bank. It is very likely, though, that the period of NOK weakness against the euro will soon end. After passing the expected positive EUR/NOK seasonality in late November/early December, a number of factors support our forecast of the EUR/NOK exchange rate returning below 8.00 in the first half of 2011. Firstly, the flow outlook is gradually improving: Norges Bank will refrain from selling NOK in December as usual (due to more illiquid markets). In 2011 on average, we estimate that Norges Bank will only sell NOK 150 million per day (vs. the current NOK 800 million/day), according to the 2011 budget. With regard to flows, we also expect continued foreign interest in buying Norwegian equities, with the foreign ownership rate on the Oslo Stock Exchange gradually increasing towards 36-38 per cent (versus 35.3 per cent at present). Secondly, our expectations of a more broad-based recovery and continuing rate normalisation by Norges Bank should support the NOK in 2011. The fact that Norges Bank will not lift key rates until mid-2011 is fully discounted by markets. Hence, monetary policy will be very neutral for the currency and flows will continue to be the most important factor for the NOK. We reiterate our forecasts of EUR/NOK at 8.00 by end-2010 with a further decline towards 7.80 in the first half of 2011.

Norges Bank's rate path
8 7 6 5 4 3 2 1 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 8 7 6 5 4 3 2 1

Norges Bank's deposit rate Optimal rate path, MPR 3/10 Optimal rate path, MPR 2/10
Source: Norges Bank

SEB’s forecast for the CPI-ATE index is only slightly above that of Norges Bank. The trough is mostly likely behind us, but any accelerating trend in core inflation is unlikely before next summer. However, we do foresee a somewhat stronger pick-up thereafter. Core inflation should average 2.2 per cent in 2012, with core domestic prices rising approximately 3 per cent while imported inflation should be slightly above zero. In addition to still-low core inflation, Norges Bank’s room to manoeuvre on key interest rates will still be constrained by monetary policy elsewhere. Much of the core CPI shortfall relative to the bank’s forecast so far in 2010 has been due to imported deflation, underscoring its focus on the exchange rate. However, by mid-2011 the recovery in the Norwegian economy will be well established and growth abroad firmer as well, while core inflation should have started to trend higher. Hence, we expect the deposit rate to be hiked 25 basis points next June, followed by another hike in October, lifting it to 2.50 per cent by the end of 2011. Moreover, with the output gap closed by early 2012 according to Norges Bank’s projection and with core inflation rising a bit faster in our forecast, the rate hiking cycle should accelerate, with the deposit rate ending 2012 at 3.75 per cent.

Exchange rate, EUR/NOK
10.0 9.5 9.0 8.5 8.0 7.5 7.0 02 03 04 05 06 07 08 09 10 10.0 9.5 9.0 8.5 8.0 7.5 7.0

SEB regression

EUR/NOK spot
Source: SEB

The Norwegian 10-year government bond yield is expected to climb somewhat in the near term, in line with the German bond yield. The spread vs. Germany has tightened from historically high levels lately to 66 bps and is expected to remain stable in the near term. We expect Norges Bank to resume its rate hikes as of mid-2011, resulting in a wider key interest rate spread vs. the ECB. This should lead to a gradually widening of the 10-year spread, reaching 90 bps in 2012.

NOK to regain strength in 2011
The long-term outlook is still strong for the NOK. However, as we concluded in the previous Nordic Outlook,

52 | Nordic Outlook – November 2010


Rapid export rebound, faster economic growth
ƒ ƒ ƒ Leading indicators climbing higher Unemployment will continue downward and pay increases will accelerate by 2012 Budget deficit below 3 per cent in 2011
offs and did not need to terminate these employees. Another important factor is that more people are leaving the labour force than joining it; pensioners make up a rapidly growing share of the population. We expect a continued decline in joblessness to below 8 per cent in December 2010 and just above 7 per cent in December 2011. Measured as annual averages, it will be 8.4 per cent this year, 7.7 per cent in 2011 and 7.4 per cent in 2012, about the same as our August forecast. The labour market improvement has not yet affected wage formation, which was held back by rapidly rising unemployment in 2008-2009. Total pay increases slowed from 3.3 per cent year-on-year in the first quarter of 2010 to 2.3 per cent in the third quarter. We expect a cautious rebound in the first half of 2011, but hourly wage increases will remain below 3 per cent throughout our forecast period. HICP inflation has been relatively stable between 1.3 and 1.6 per cent so far this year (1.4 per cent in September). We expect inflation to accelerate somewhat later in the winter, due in part to high energy and food prices. Inflation will climb a bit more in the first quarter of next year. Measured as annual averages, HICP inflation will reach 2.1 per cent in 2011 and 2.0 per cent in 2012. A favourable pre-crisis economic situation, with low government debt and both budget and current account surpluses, helped keep the Finnish economy stable despite its record 8 per cent GDP slide last year. The fiscal deficit − which will stand at 3.4 per cent of GDP this year, the strongest budget in the whole euro zone − will decrease to 2.5 per cent next year and 2.2 per cent in 2012. Public debt as measured by the Maastricht criteria will grow from 47 per cent of GDP this year to just above 50 per cent in 2012, a cautious increase compared to many other euro zone countries. Despite this improvement, Finland needs a long-term budget consolidation programme and an economic and structural policy plan. This will be the task of the next government after the April 2011 parliamentary election.

The Finnish economy is continuing to recover. GDP rose 3.4 per cent year-on-year in the second quarter, mainly due to a rapid rebound in merchandise and service exports, which rose 6.1 per cent year-on-year (-5 per cent in the first quarter), but also due to a 2.7 per cent rise in private consumption. Capital spending remains lower than one year ago but is now also increasing. The rapid improvement in the economy is reflected by most leading indicators. Retail sales have strengthened rapidly so far in 2010, and the construction, manufacturing and service sectors have all experienced clear improvements. Labour market prospects have also brightened; hiring plans have risen rapidly, and unemployment has continued to fall. Overall economic performance is quite consistent with our August forecast. We expect GDP growth of 2.7 per cent this year, a cautious upward revision of 0.2 percentage point since August, 3.0 per cent in 2011 and 2,8 per cent in 2012. Our growth forecast is well above the prevailing consensus (2.1 per cent in 2010 and 1.8 per cent in 2011) but in line with the Finnish central bank’s latest forecast in November.

Service sector leading the upturn
70 50 30 10 -10 -30 -50 -70 00 01 02 03 04 05 06 07 08 09 10 70 50 30 10 -10 -30 -50 -70

Construction sector Manufacturing sector

Service sector
Source: DG ECFIN

Unemployment has continued downward since peaking at 8.9 per cent early in 2010. In September it stood at 8.1 per cent. Unemployment did not climb higher last year largely because companies used short-term lay-

Nordic Outlook – November 2010 | 53

Economic data
Yearly change in per cent 2009 level, DKK bn 1,660 817 492 312 784 727 2009 -4.7 -4.3 3.4 -14.1 -2.4 -10.2 -13.2 3.6 1.1 3.1 4.2 3.6 41.4 Dec 10 1.05 2.85 15 5.36 7.45 Jun 11 1.05 3.00 15 5.36 7.45 2010 2.2 1.9 0.8 -3.0 1.0 7.0 5.5 4.2 2.2 2.3 3.7 -5.2 44.0 Dec 11 1.05 3.25 15 5.73 7.45 2011 2.2 2.2 0.3 4.0 0.0 5.8 5.7 4.0 2.1 2.1 3.0 -3.5 46.0 Jun 12 1.65 3.50 20 5.87 7.45 2012 2.1 2.6 0.5 5.5 0.0 5.0 6.0 3.5 2.1 3.0 2.5 -3.0 48.0 Dec 12 1.95 3.60 20 5.87 7.45

Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices, harmonised Wage cost Current account, % of GDP Public sector financial balance, % of GDP Public sector debt, % of GDP FINANCIAL FORECASTS Lending rate 10-year bond yield 10-year spread to Germany, bp USD/DKK EUR/DKK

Nov 18 1.05 2.81 11 5.47 7.46

Yearly change in per cent 2009 level, NOK bn Gross domestic product 2,256 Gross domestic product (Mainland Norway) 1,732 Private consumption 956 Public consumption 487 Gross fixed investment 467 Stockbuilding (change as % of GDP) Exports 1,008 Imports 638 Unemployment (%) Consumer prices CPI-ATE Wage cost 2009 -1.4 -1.4 0.2 4.7 -9.1 -4.0 -11.4 3.2 2.1 2.6 4.5 2010 0.5 1.6 2.8 2.8 -5.2 -0.5 6.7 3.5 2.4 1.4 3.5 2011 2.3 2.9 3.5 2.0 4.9 1.1 3.8 3.4 1.4 1.6 3.7 2012 2.2 2.9 3.3 1.9 4.2 2.0 4.5 3.3 2.2 2.2 4.0

FINANCIAL FORECASTS Deposit rate 10-year bond yield 10-year spread to Germany, bp USD/NOK EUR/NOK

Nov 18 2.00 3.33 63 5.98 8.16

Dec 10 2.00 3.40 70 5.76 8.00

Jun 11 2.25 3.65 80 5.65 7.85

Dec 11 2.50 3.95 85 5.96 7.75

Jun 12 3.25 4.20 90 6.02 7.65

Dec 12 3.75 4.30 90 5.91 7.50

54 | Nordic Outlook – November 2010

Nordic key economic data

Yearly change in per cent 2009 level, SEK bn Gross domestic product 3,108 Gross domestic product, working day adjusted Private consumption 1,516 Public consumption 863 Gross fixed investment 555 Stockbuilding (change as % of GDP) -41 Exports 1,507 Imports 1,294 Unemployment (%) Employment Industrial production Consumer prices CPIX Wage cost Household savings ratio (%) Real disposable income Trade balance, % of GDP Current account, % of GDP Central government borrowing, SEK bn Public sector financial balance, % of GDP Public sector debt, % of GDP FINANCIAL FORECASTS Repo rate 3-month interest rate, STIBOR 10-year bond yield 10-year spread to Germany, bp USD/SEK EUR/SEK TCW Nov 18 1.00 1.58 2.95 25 6.87 9.37 126.6 Dec 10 1.25 1.65 3.00 30 6.58 9.15 123.4 2009 -5.1 -5.0 -0.8 1.7 -16.0 -1.5 -12.4 -13.2 8.3 -2.1 -19.1 -0.3 1.9 3.4 12.6 0.9 3.5 7.5 176 -1.2 41.7 Jun 11 1.50 1.90 3.25 40 6.47 9.00 121.1 2010 5.0 4.7 3.5 1.1 7.0 1.7 11.0 12.7 8.4 1.0 10.0 1.2 2.0 2.0 11.3 1.9 2.5 6.5 3 -0.5 37.9 Dec 11 2.25 2.65 3.50 40 6.73 8.75 119.7 2011 3.5 3.5 2.8 0.9 6.0 0.2 7.4 7.2 7.5 1.7 7.0 2.0 2.4 2.3 11.7 3.4 2.8 6.0 -10 0.1 35.5 Jun 12 2.50 2.90 3.75 45 6.81 8.65 118.6 2012 2.5 2.9 2.5 0.9 4.0 0.0 5.1 5.2 7.1 0.7 4.0 2.1 1.6 3.9 11.3 2.1 2.8 5.5 -47 0.8 32.8 Dec 12 3.00 3.40 3.90 50 6.77 8.60 118.1

Yearly change in per cent 2009 level, EUR bn 171 94 43 34 62 57 2009 -8.1 -2.4 1.2 -14.5 -1.2 -20.5 -18.1 8.2 1.6 4.0 2.7 -2.5 43.8 2010 2.7 2.3 0.3 0.9 0.3 5.8 4.2 8.4 1.5 2.8 2.0 -3.4 47.1 2011 3.0 2.4 0.5 6.3 0.1 6.6 6.8 7.7 2.1 2.4 1.5 -2.5 49.7 2012 2.8 2.5 0.8 6.1 0.0 5.3 6.0 7.4 2.0 2.9 1.3 -2.2 51.9

Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices, harmonised Wage cost Current account, % of GDP Public sector financial balance, % of GDP Public sector debt, % of GDP

Nordic Outlook – November 2010 | 55

International key economic data

Yearly change in per cent 2009 level, EUR bn 8,979 5,170 1,975 1,773 3,259 3,140 2009 -4.0 -1.1 2.4 -11.3 -0.7 -13.1 -11.8 9.4 0.3 9.6 2010 1.6 0.6 1.3 0.2 1.0 9.3 9.5 10.0 1.5 9.5 2011 1.7 0.7 0.9 4.2 0.2 5.8 5.9 9.7 1.3 9.3 2012 1.5 1.1 1.1 3.9 0.0 5.3 5.5 9.4 1.4 9.0

Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices, harmonised Household savings ratio (%)

Yearly change in per cent 2009 level, USD bn 14,277 10,132 2,934 1,638 1,690 2,116 2009 -2.6 -1.2 1.6 -18.4 -0.6 -9.5 -13.8 9.3 -0.3 5.9 2010 2.7 1.6 1.1 3.8 1.5 11.5 14.1 9.7 1.6 5.6 2011 2.2 1.8 0.4 8.4 0.1 9.9 9.7 9.5 1.2 5.8 2012 3.4 2.7 -0.3 12.6 0.0 13.7 11.4 8.4 1.6 6.3

Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices Household savings ratio (%)

Yearly change in per cent 2009 GDP United Kingdom Japan Germany France Italy Inflation United Kingdom Japan Germany France Italy Unemployment (%) United Kingdom Japan Germany France Italy
56 | Nordic Outlook – November 2010

2010 1.7 3.1 3.6 1.5 1.0

2011 2.1 1.6 2.5 1.4 0.9

2012 2.1 1.5 1.8 1.5 1.3

-5.0 -5.3 -4.7 -2.5 -5.1

2.2 -1.3 0.2 0.1 0.8

3.2 -0.9 1.1 1.6 1.6

2.6 0.1 1.4 1.7 1.7

1.9 0.3 1.5 1.9 1.9

7.7 5.1 7.5 9.5 7.8

7.9 5.1 7.8 10.1 8.4

7.6 5.2 7.2 9.8 8.1

7.4 5.1 6.9 9.6 7.8

International key economic data

2009 GDP, yearly change in per cent Estonia Latvia Lithuania Poland Russia Ukraine Inflation, yearly change in per cent Estonia Latvia Lithuania Poland Russia Ukraine -13.9 -18.0 -14.7 1.7 -7.9 -15.1 2010 2.5 -0.3 1.0 3.5 3.7 5.2 2011 4.0 4.0 4.0 4.0 4.3 4.4 2012 4.0 5.0 4.5 4.5 5.0 4.2

0.2 3.3 4.2 3.5 11.7 15.9

2.7 -1.2 1.0 2.7 6.8 9.5

3.0 1.3 2.0 2.9 7.5 10.9

4.0 1.5 3.0 2.9 7.4 10.1

Nov18 Official interest rates US Japan Euro zone United Kingdom Bond yields US Japan Germany United Kingdom Exchange rates USD/JPY EUR/USD EUR/JPY GBP/USD EUR/GBP Fed funds Call money rate Refi rate Repo rate 0.25 0.10 1.00 0.50 Dec 10 0.25 0.10 1.00 0.50 Jun 11 0.25 0.10 1.00 0.50 Dec 11 0.25 0.10 1.00 0.75 Jun 12 0.50 0.10 1.50 1.25 Dec 12 1.00 0.50 1.75 2.00

10 years 10 years 10 years 10 years

2.90 1.07 2.70 3.40

2.90 1.10 2.70 3.45

3.10 1.20 2.85 3.60

3.35 1.50 3.10 3.80

3.40 1.70 3.30 3.90

3.60 1.90 3.40 4.00

84 1.36 114 1.60 0.85

81 1.39 113 1.62 0.86

84 1.39 117 1.60 0.87

88 1.30 114 1.57 0.83

95 1.27 121 1.55 0.82

100 1.27 127 1.59 0.80

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

Nordic Outlook – November 2010 | 57

Finland Norway Sweden

St: Petersburg Moskva
Russia Estonia Latvia Lithuania

New York


Beijing Shanghai

London Germany Luxembourg

Poland Warsaw Ukraine Kiev

New Delhi

Geneve Nice


São Paulo

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

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