Nordic Outlook 1008: Economic recovery but higher risks

8/8/2019 Nordic Outlook 1008: Economic recovery but higher risks

1/53

Economic recovery but higherrisks, depressed key rates andbond yields

Nordic countries well equipped forupturn

Nordic OutlookEconomic Research August 2010


2/53

Nordic Outlook August 2010 | 3

Contents

International overview 5

The United States 16

Japan 22

Asia 23

The euro zone 25

The United Kingdom 31

Eastern Europe 32

The Baltics 33

Sweden 35

Denmark 43

Norway 44

Finland 48

Economic data 49

Boxes

Downside risks have increased 7

Stable commodity prices 8

Basel III postponed 9

Moving towards Japanese yields? 12

An unusual recovery 19

Falling unemployment even with slow growth 28

Stress tests dispel uncertainty despite shortcomings 30Why is Sweden doing so well? 36

Major Swedish GDP revisions 38


3/53

4 | Nordic Outlook August 2010

This report was published on August 31, 2010.

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

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

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

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

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

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

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

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

Contributions to this report have been made by Thomas Kbel, Klaus Schrfer, SEB Frankfurt/M andOlle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwegiananalysis.

Economic Research


4/53

International overview


Continued economic recovery but increased risks

US growth below trend for the next year

Strong recovery in Sweden and Germany

Low ination will allow extreme low-interest policies

Dilemmas for Nordic central banks

Japanese-style global long-term yields

In recent months the world economic outlook has dete-

riorated, mainly due to clear signs of weakness in the

American economy. Increased worries about a slowdown

in the United States and Asia, combined with contin-

ued uncertainty about the scal situation in southern

Europe, have led to lower risk appetite in nancial

markets and sharply falling interest rates, among other

things. The growth rate was unexpectedly strong in

many countries during the second quarter, and the

emergency response to the southern European crisis has

been successful, but this has not sufced to offset the

negative news.

Ination has continued downward, and ination expec-

tations have fallen. It is becoming increasingly clear

that the risks of undesirably low ination are the domi-

nant problem for major central banks in the 32 member

countries of the Organisation for Economic Cooperation

and Development (OECD). This is creating room for

continued record-low interest rates in the next couple

of years.

We expect the US Federal Reserve (Fed) and the Euro-

pean Central Bank (ECB) to maintain todays record-

low key interest rates throughout 2011 and to begincautious rate hikes only in 2012. Due to low key rates in

the foreseeable future and diminished growth and ina-

tion expectations in the long term as well, government

bond yields will remain at historically very low levels in

the next couple of years.

There is a renewed focus on the potential for central

banks to stimulate their economies by means of quanti-

tative easing (QE). We expect that because of low long-

term yields, central banks will be satised with keeping

their balance sheets at current levels and thus not

implement new QE programmes. The Basel Committee

on Banking Supervision has presented a proposal whichimplies that tightening of nancial regulations will be

postponed, creating an economic stimulus effect that

will also reduce the need for unconventional monetary

policies.

In our judgement, the deceleration signals in the Ameri-

can economy will have consequences for the recovery

dynamic in the coming year. Renewed weakness in both

the labour and housing markets will block a traditional

recovery dynamic. We have thus adjusted our forecast

downward and expect GDP growth somewhat below

trend in the US during late 2010 and early 2011. This

will mean major economic strains, including persistent-ly high unemployment and continued nancial stress.

At the global level, however, extremely loose monetary

policy and continued good growth capacity in many

parts of the world economy will contribute to decent

growth in the next couple of years. Fast-growing Asian

economies will remain an important driving force,

although some deceleration is on the way. We believe

that Chinese authorities, for example, have sufcient

tools to ensure an economic soft landing.

In the OECD, differences in the underlying balance

situation have become increasingly important. Germany

and Sweden are among countries where the strength of

the upturn has been surprising. A strong German econ-

omy is not enough to keep up the momentum of the

entire euro zone, though. There will thus be wide gaps

within the currency area as the full effects of powerful

austerity programmes are felt in southern Europe.

Global GDP growthYear-on-year percentage change

2009 2010 2011 2012

United States -2.6 2.6 2.2 2,9Japan -5.2 2.5 1.5 1.5

Germany -4.7 3.3 2.1 1.8

China 8.7 10.0 9.0 8.0

United Kingdom -4.9 1.7 2.0 2.2

Euro zone -4.1 1.6 1.3 1.5

Nordic countries -4.4 2.5 2.4 2.4

Baltic countries -15.6 0.4 4.2 4.5

OECD -3.3 2.2 2.0 2.3

Emerging markets 2.4 6.8 6.0 6.4

World, PPP* -0.6 4.4 3.8 4.3

World, nominal -1.3 3.7 3.1 3.6

Source: OECD, SEB * Purchasing power parities


5/53



We are sticking to the main scenario from our economic

analyses of recent years: the after-effects of the deep

crisis will hamper economies for a rather long period.

Debt retirement in both the private and public sectors,

combined with lingering weaknesses in the nancial sys-

tem, will mean slower growth for some time to come.

Low interest rates may ease the adjustment, but theirstimulus effect will be weaker than normal in todays

ravaged economic environment.

Amid a fragile economic situation, international

economic policy makers face major challenges, for

example in restructuring the nancial system, coordi-

nating global scal policies and rebuilding condence in

joint European institutions. Belt-tightening in southern

Europe will put the political system under severe strains

there, but political authority is being questioned even

in leading industrial countries. In the US, for example,

President Obamas popularity has plunged and this

autumns congressional election may lead to furtherrestraints on the governments ability to make and

implement decisions. In Germany, Chancellor Angela

Merkels position has weakened and her governing

coalition is going through a rough patch. In the UK, a

new and inexperienced coalition government is facing

painful spending cuts.

Shifting the emphasis to nal demandThe ongoing slowdown trend in the global economy is

largely due to the fading of stimulus effects from the

inventory cycle and scal policy measures. Inventory

movements have been pivotal to the recovery in themanufacturing sector. Since most merchandise invento-

ries are traded across national boundaries, this means

that exports take off rst.

As a percentage of GDP, current prices

US: Non-residential fixed investments

Source: US Department of Commerce

70 75 80 85 90 95 00 05 10

9.0

9.5

10.0

10.511.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

9.0

9.5

10.0

10.511.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

It is thus not illogical for all parts of the world economy

to begin their recovery with export-led growth. The

trend in net exports, when imports are also included, is

another question. Early in the crisis, the effect of

international trade was to ease global imbalances.

Domestic demand, and thus imports, fell sharply incountries with large domestic imbalances, such as the

US. In recent months, this pattern has reversed to some

extent. For example, net US exports accounted for a

large negative contribution to growth in the second

quarter, among other things due to stimulus measures

and a stronger US dollar.

To ensure a sustainable recovery, it will now be crucial

for nal demand in the form of capital spending and

consumption to take over when the inventory cycle

ceases to serve as an economic engine. The box entitled

Recovery at a crossroads in the November 2009 issue

of Nordic Outlook discussed this take-over. One conclu-

sion was that mid-2010 would be the critical period. But

the outlook is mixed.

Capital spending took off in many countries early in

2010. Growth gures are high, in part because the xed

investment level was exceptionally depressed. But

there are also factors that point towards a sustained

recovery.

Non-residential xed investment is deeply de-

pressed, even in a longer time perspective. Unlike

normal economic expansions, the capital spending

level in the OECD countries remained rather low

during the boom years 2006-07.

Balance sheets, especially in large American corpo-

rations, are much stronger than normal. This will

make larger self-nancing of capital investments

possible, facilitating the upturn while the nancial

system remains relatively fragile.

Historical associations signal that capital spending

growth is more dependent on the change in capac-

ity utilisation than on its actual level. This indicatesthat a recovery in xed investments may begin

relatively soon.

One important factor that may delay an upturn is that

many small businesses are still having difculty obtain-

ing loans. The credit market is performing sub-optimally

in this respect, both in the US and Europe.

Per cent of disposable income

US: Uniform pace of debt retirement

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

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

1

2

3

4

5

6

7

89

10

11

12

60

70

80

90

100

110

120

130

140

On the consumption side, the outlook is gloomier.

There is still a major need for debt retirement. New US

gures point to substantially higher household saving

than previously reported. The adjustment process is

thus occurring faster than expected. Given new labour


6/53



market disappointments and a housing sector that again

seems to be on its way down, the underlying prerequi-

sites for a normal American consumption recovery are

missing. In the UK, southern Europe and elsewhere,

consumption is also being held back by scal tighten-

ing. In Germany and Japan, consumers are cautious

despite their strong balance sheets. In Asian emergingeconomies, there is an impending shift towards greater

emphasis on consumption, as illustrated by accelerat-

ing pay increases, but this is too lengthy a process to

facilitate a decisive shift to nal demand as the main

economic engine.

Our overall conclusion is that, in part because of sub-

dued nal demand, the OECD countries will move into

a slower growth phase during the second half of 2010

and the rst half of 2011. This means that for several

quarters, growth will again end up below trend. The

output gap will thus widen. At present, however, most

indications are that growth will remain well aboverecessionary levels.

Very strong recovery in SwedenThe Nordic economies have generally shown good resil-

ience against the global crisis. In Denmark, Sweden and

especially Finland, GDP indeed fell sharply during 2009,

but the impact on domestic demand was rather minor

and the upturn in unemployment surprisingly small.

Public nances are thus in relatively good shape, and

central government debts are at a low level. Combined

with sizeable current account surpluses, this is creating

a favourable platform for recovery. The weakening ofthe euro is helping to ease competitiveness problems

which have hampered growth in Finland and Denmark

to some extent.

In Sweden, growth has been surprisingly vigorous in re-

cent months, and we expect a 4.7 per cent upturn this

year. Exports have recovered strongly after their sharp

decline. Expansionary scal policy and strong housing

market have beneted domestic demand.

In the other Nordic countries, growth will be far more

moderate. The Danish economy is still being hampered

by the repercussions of the housing market crash.

In Finland there is good potential for an export-led

manufacturing upturn similar to Germany and Swe-

den. So far, the upturn has been modest, but a weaker

euro will contribute to an acceleration over the next

few quarters. In Norway, the economy has also been

held back by an appreciating currency. A strong labour

market and expansionary scal policy have not sufced

to get domestic demand moving. Because of the very

mild downturn in 2008-09, resource utilisation is also

high in Norway compared to other countries, and this

will dampen long-term growth potential from the supply

side.

GDP growth, Nordic and Baltic countriesYear-on-year percentage change

2009 2010 2011 2012

Sweden -5.1 4.7 2.9 2.3

Norway -1.4 0.7 2.1 2.1

Denmark -4.7 1.8 1.8 2.2

Finland -7.8 2.5 2.6 2.7

Nordics -4.4 2.5 2.4 2.4

Estonia -14.1 2.0 5.0 4.0Latvia -18.0 -1.5 4.0 5.0

Lithuania -14.8 1.0 4.0 4.5

Baltics -15.6 0.4 4.2 4.5

Source: OECD, SEB

Downside risks have increasedAs earlier, our main scenario implies a relatively slug-

gish global recovery, with medium-term growth being

held back by scal tightening, continued debt adjust-

ment needs and tighter nancial sector rules.

Since last spring, the risk picture has changed in

some respects. The crisis-ridden countries of southern

Europe continue to face major challenges, but the

overall picture looks less threatening. With a credible

bail-out mechanism in place and after the completion

of stress tests in the European banking system, risks

that southern European problems might cause a global

recession have receded. The International Monetary

Fund (IMF) and euro zone countries have approved

a second emergency loan disbursement to Greece,

another sign that the structural adaptation process has

begun.

Yet the deterioration in the American economy has

increased the overall risks of a global recession. We

now estimate the probability of such a scenario at

around 25 per cent, compared to 15 per cent in the

May issue of Nordic Outlook. Conversely, the prob-

ability of upside surprises has naturally diminished.

Despite signs of strength in such countries as Germany,

a rapid recovery in the world economy is relatively un-likely without support from a more dynamic American

economy.

Index 2000=100

GDP OECD countries

New crisis waveRaprid recovery

SEB's main scenario

Source: OECD, SEB

04 05 06 07 08 09 10 11 12105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

15%

25%

SEB forecast


7/53



Baltic countries slowly on the way upThe Baltic economies have now slowly begun to re-

bound from the deep declines they experienced after

the credit bubble burst. The three countries internal

devaluation policy appears likely to be successful. Their

competitiveness has improved, mainly via pay cuts. Also

making the situation easier is that the euro, to whichtheir currencies are pegged, has weakened and the

currencies in several important competitor countries in

Eastern Europe have appreciated. Their external bal-

ance has improved radically, and the deation process

is coming to an end. They have also shown political

rmness in implementing major scal belt-tightening.

Estonia will join the euro zone on January 1, 2011. This

has also helped restore condence, some of which has

spread to Latvia and Lithuania. But there is a degree

of lingering uncertainty about the political situation in

Latvia connected among other things to this autumns

parliamentary election and to some extent also inLithuania.

Looking ahead, we expect a modest growth rate of 4-5

per cent, well below the previous trend. Continued pri-

vate sector adjustment needs, combined with a less ex-

pansionary credit environment, will contribute to this.

It will also take time to restore condence in Baltic

investment projects among long-term foreign investors.

We expect Latvia and Lithuania to have an opportunity

to join the euro zone in 2014.

New labour market patternsIn recent months, the differences in labour market

trends between various countries have become more

pronounced. In Germany and the Nordic countries, for

example, the labour market situation has begun to

improve, whereas the situation in the US is plagued by

new disappointments.

Index = 100 januari 2008

Divergent employment trends

Sweden US Germany SpainSource: Reuters EcoWin

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

89

90

91

92

93

94

95

96

97

98

99

100

101

89

90

91

92

93

94

95

96

97

98

99

100

101

During the economic downturn phase, the decline in

employment was substantially sharper in the US than,

for example, in Germany and the Nordic countries

despite a milder GDP decline. In part, this followed

traditional patterns coupled to such factors as how easy

it is to hire and re employees. Especially in Germany,

Stable commodity pricesCommodity prices have followed the pattern of theglobal recovery. A turnaround came early in 2009 and

was probably initially strengthened by Chinas need to

ll structural stockpiles. Since last spring, commod-

ity prices have tended to level off at the same time

as global manufacturing has reached a more mature

phase, or somewhat ahead of this.

Index, monthly date, USD

High commodity prices

Agriculture Industrial metals EnergySource: HWWI

00 01 02 03 04 05 06 07 08 09 10

50

100

150

200

250

300

350

400

450

500

50

100

150

200

250

300

350

400

450

500

Given our scenario of continued moderate global

growth, with a slight weakening in the short term,

continued price hikes are also likely to be modest. Inparticular, a calmer growth dynamic in fast-growing

Asian economies points in this direction.

Oil prices will rise somewhat from current levels.

At present, reserve oil production capacity is rela-

tively large. Increases in demand next year will not

be large enough to change this. Saudi Arabias large

production reserves will give it a key inuence on the

future price strategy of the Organisation of Petroleum

Exporting Countries (OPEC). Saudi Arabia can boost

production and squeeze oil prices if it turns out that

global growth is slowing too quickly. Iran and Iraq also

have major potential to increase the oil supply, but

in the prevailing uncertain political situation, it is

hardly likely that any large production changes will be

implemented. We are thus assuming that Brent oil will

continue to trade in the USD 70-90/barrel interval.

Agricultural commodities will level off, but there is

a risk of further upturn in the short term. Extreme

weather in two key wheat-producing countries, Rus-

sia and Ukraine, led to a 70-80 per cent price spike

in July and August. Russia has decided to halt grain

exports during the rest of 2010, aimed at ensuring

domestic supplies and counteracting price increases to

consumers. This will pose risks of a new wave of price

increases and might spread to the maize (corn) and

soya markets. But in our assessment, global wheat and

other grain stockpiles are large enough to avoid price

shocks. This is very different from several few years

ago, when low grain stockpiles led to major price

hikes that affected food prices worldwide.


8/53



employment was also sustained by special economic

policy programmes.

Since employment gures have already begun to

increase in a number of European countries, while

remaining weak in the US, it is clear that other expla-

nations for these labour market trends are needed.

One pattern seems to be that in countries with milder

nancial imbalance problems, the labour market has

rebounded faster. Because the need for restructuring

measures is smaller in these countries, when demand

takes off again, companies can rather easily begin

rehiring.

Ination will remain lowDiscussions of ination have shifted emphasis in recent

months. As long-term bond yields have fallen and

concerns about the economy have mounted, there has

been a focus on worries about undesirably low ination.

Meanwhile fears that ination will be driven by mone-tary expansion have faded. Actual ination gures have

not been especially dramatic. Rising energy and food

prices have caused some upside surprises in Consumer

Price Index (CPI) ination, while core ination has

continued to fall.

For some time, our view has been that disinationary

forces caused by large output gaps will dominate the in-

ation trend. The continuous downturn in core ination

over the past year has conrmed this picture. A new IMF

study also shows that the level of the output gap has

historically been crucial in determining ination pres-

sure. The study provides no support either for ination

being a consequence of rapid growth in individual years

(speed limit ination) or being generated by monetary

expansion, without the presence of underlying condi-

tions related to factors such as capacity utilisation or

wage formation.

Year-on-year percentage change

Core inflation is continuing to fall

Euro zone USSource: Eurostat, BLS, SEB

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

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

forecastSEB

Our forecast is that core ination in the OECD countries

will continue downward in the coming year. Economic

growth is not strong enough to generate any signicant

improvement in the labour market situation. The out-put gap will not close during our forecast period. Pay

increases will thus be low and unit labour costs will also

be pushed down by a recovery in productivity.


Rate of pay increases is stabilising

Euro zone USSource: ECB, BLS

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

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

On the other hand, we see no major risks of a danger-

ous deationary trend either. The rate of wage and sal-

ary increases has stopped falling. This will reduce the

risks of a deationary spiral of falling pay and prices. Atthe same time, there are reasons why the disination-

ary forces of globalisation will lose energy compared to

the previous decade. The level of wages and salaries in

fast-growing emerging economies seems to be rapidly

on the way up, while currency appreciation and produc-

tivity growth potential will help narrow previously wide

gaps in the cost situation.

Basel III postponedDuring the summer, the Basel Committee for Bank-

ing Supervision approved various amendments to the

proposal it submitted late in 2009 for comments byinterested parties. The purpose of the reform package

is to strengthen the resilience of the banking sector by

tightening capital and liquidity requirements, and to

thwart excessive risk-taking, diminish gearing effects

and reduce pro-cyclicality.

The reform package includes denitions of capital and

leverage ratios, liquidity coverage ratios, net stable

funding ratios and management of counterparty risk.

The details will be presented later this year, and a

formal decision is expected in November.

Generally speaking, the standards have been eased,while the deadline for implementing them has been

extended from December 2012 to January 2018. Our

conclusion is that the Committees decision was inu-

enced by last springs sovereign debt crisis, combined

with the picture of a sluggish global economic recov-

ery with downside risks as well as a nancial system

that remains weakened.

All else being equal, these amendments will have a

positive impact on our economic scenario. A slower

adjustment process will substantially reduce risks of

poorer access to capital and higher borrowing costs,

which were inherent in the original proposal. Mean-while, milder capital/credit standards both station-

ary and exible will mean placing greater respon-

sibility on interest rate policy to maintain nancial

stability.


9/53



Central banks will wait until 2012Increased worries about the economy, combined with

falling ination expectations, are giving central banks

strong motives for continuing their extremely low inter-

est rate policies. Due to the economic slowdown in the

US, deationary forces will predominate over the next

couple of years. The crisis-ridden countries of southernEurope will be strongly dependent on low interest rates

for a long time in order to deal successfully with imbal-

ances in competitiveness and government nances.

Asymmetric risks on the growth side will also help

ensure that central banks will be very cautious. The

consequences of interrupting a nascent recovery by

raising interest rates too early may be relatively large

in a situation where room for scal policy manoeuvring

is sharply circumscribed in many countries and the

monetary policy arsenal is also relatively exhausted. We

thus anticipate that the central banks in major OECD

countries will not begin hiking their key interest ratesuntil early 2012.

Per cent

Key interest rates

Euro zone USSource: ECB, Fed, SEB

00 02 04 06 08 10 12

0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB

A long period of extreme low interest rate policy entails

certain potential risks. Asset prices may once again be

pumped up to unsustainable levels. Economic players

may also be given an inaccurate picture of the normal

cost of capital, which may lead to inefcient capital

allocation. In addition, the banking system may become

too dependent on liquidity supplied by central banks,

with a more poorly functioning interbank market as aconsequence. The postponed launch of Basel III com-

plicates the situation of the central banks, eliminating

instruments for controlling credit growth and asset

prices that might have eased the pressure on interest

rate policy.

At present, the potential problems of low interest rate

policy are relatively minor in relation to the macroeco-

nomic risks of raising interest rates.

Policy dilemma in Norway and SwedenThe differences in the conditions surrounding major

OECD central banks and the central banks in Norwayand Sweden are becoming increasingly clear. For a

long time, Norges Bank has had to deal with a situation

where differences in terms of resource utilisation, the

direction of scal policy and the state of the credit and

housing markets have pointed to a substantially higher

key interest rate than that of the ECB. Having begun

its rate hikes as early as October 2009, Norges Bank has

gradually adopted a more cautious strategy. Due to con-

cern about the strong krone and the competitivenessof Norwegian manufacturers, the bank has not wanted

to open up an excessive interest rate spread over the

ECBs re rate.

The Riksbank is now beginning to face a similar dilem-

ma. Resource utilisation in Sweden is admittedly lower

than in Norway, but rapid economic growth is quickly

changing that situation. Unemployment has fallen rap-

idly, while home prices and household borrowing have

continued upward as in Norway.

Per cent

Key interest rates

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

00 02 04 06 08 10 120

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB

In some respects, the Nordic central banks are playing

a pioneering role when it comes to learning from the

mistakes that preceded the crisis and then applying the

new guidelines that are emerging from the international

monetary policy discourse. What the major countries

mainly perceive as problems in the distant future is

starting to be fairly urgent in the Nordic countries.

Minutes of Riksbank policy-making meetings show major

disagreements of principle within the Executive Board,

which the bank does not try to hide either.

Our scenario is that the Riksbank will hike its key inter-

est rate at each monetary policy meeting until Febru-

ary 2011, when the rate will reach 1.50 per cent. After

that, rate hikes will be more cautious. An international

slowdown, continued low spot ination and an ever-

stronger krona may be arguments for a more cautious

strategy. At year-end 2011 the repo rate will be 2.25

per cent, and at the end of 2012 it will be 3.0 per cent.

Our forecast is thus lower than the Riksbanks rate path

but higher than market expectations.

Norges Banks deposit rate will remain at 2.00 per cent

up until the second quarter 2011. A closing output gap

and rising core ination will thereafter lead to furthergradual hikes. At the end of 2011 we see the deposit

rate at 2.75 per cent and at the end of 2012 at 3.75 per

cent.


10/53



Different scal strategiesThe acute crisis in southern Europe last spring led to a

change in view about scal policy. The main approach

in earlier recommendations from the OECD and IMF, for

example, has been to focus on credible medium-term

programmes, but implementation could be delayed

until recovery was on rmer ground. It now becameobvious that many countries lacked such room for

manoeuvre. Large-scale austerity packages became

necessary, especially in southern Europe. In France and

Germany, however, austerity measures are rather small.

As a result, the total dose of austerity in the euro zone

will be no more than about 1 per cent of GDP annually

in 2010-12.

Recent budget gures in a number of countries have

been better than expected.In Germany the decit can

probably be reduced to less than 3 per cent of GDP as

early as 2011. The government had previously aimed at

achieving this level only in 2013. As for the effects ofthe austerity packages in southern Europe, it is too ear-

ly to draw any reliable conclusions. The improvements

in Greece, for example, have been sufcient to per-

suade the IMF and EU institutions to approve a second

disbursement of emergency loans. Most of the success

in stopping the bleeding has been on the expenditure

side, while attempts to improve the efciency of tax

collection have yielded smaller results so far.

Given more pessimistic economic prospects, we are

not likely to see further belt-tightening in the major

OECD countries during the coming year. In the UK, thenew government has admittedly decided to deal with

its large scal decits at an early stage. In the US and

Japan, however, new stimulus measures are the focus

of attention, although in our judgement such measures

will hardly be implemented.

Net lendingPer cent of GDP

2010 2011 2012

United States -10.9 -8.2 -5.9

Japan -9.8 -9.1 -8.5

United Kingdom -11.4 -9.4 -7.6Euro zone -6.2 -5.5 -5.0

OECD -7.8 -6.7 -5.5

Source: OECD, IMF, SEB

At the global level, we expect scal policy to have a

weakly tightening effect in the next couple of years.

This means that decits will only shrink slowly and

that government debt will continue to grow. The sharp

downturn in government bond yields in major countries

indicates that mistrust from nancial markets will not

force belt-tightening either. Not even threats of down-

grading by credit rating agencies are likely to change

the picture. Given continued weak economic condi-

tions, high private saving and supportive central banks

many countries will to a large extent postpone scal

adjustment needs.

Low bond yieldsThe decline in long-term bond yields has been very

sharp, and yields are now exceptionally low. American

10-year government bond yield has fallen from 4.0 percent in April to 2.60 per cent, while equivalent German

bonds have now declined to an exceptionally low level

of 2.25 per cent.

There have been several driving forces behind this

yield trend: concerns about economic growth, falling

ination expectations and promises of continued low

key interest rates. The search for safe investments has

also beneted the xed income market, despite large

and growing government debts on both sides of the

Atlantic. A very rapid increase in private savings dur-

ing the economic crisis, savings in the OECD countries

have risen by about 10 per cent of GDP has offsetthe increased public sector borrowing requirement and

helped squeeze interest rates.

The box below discusses how asymmetric downward

risks both on the growth and ination side will probably

lead to long-term uncertainty about the ability of cen-

tral banks to normalise monetary policy. We expect this

uncertainty to help keep long-term yields depressed,

especially in the coming year. German 10-year yields

will bottom out at about 2.20 per cent around year-end

2010 and remain below 2.50 per cent well into next

year. Only when it begins to be apparent that central

banks can actually begin interest rate hikes do we be-

lieve any signicant upturn will occur. Long-term yields

will remain depressed, however. At the end of 2012,

German 10-year government bond yields will stand at

3.20 per cent and American ones at 3.50 per cent.

Per cent

10-year government bond yields

US GermanySource: Reuters EcoWin, SEB

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

2.0

2.5

3.0

3.5

4.04.5

5.0

5.5

6.0

6.5

7.0

2.0

2.5

3.0

3.5

4.04.5

5.0

5.5

6.0

6.5

7.0

SEBforecast

Cautious stock market valuationsThe stock market has recently reacted negatively tosignals of an American economic slowdown. Surpris-ingly strong company earnings reports have not beenenough to offset this. There are both threats andopportunities ahead. The simple phase when thestock market was driven upward by positive surprises


11/53



Moving towards Japanese yields?The key interest rates set by central banks are at

exceptionally low levels. But bond yields are also

historically very low, with American 10-year Treasuries

yielding 2.6 per cent and equivalent German bonds 2.2

per cent. By way of comparison, a Japanese 10-year

bond is at just below 1 per cent and has uctuated

between 1 and 2 per cent for the past 13 years.

Above we discussed the forces that have pushed down

long-term yields to these levels. One crucial question

is how long they will last, and to what extent todays

interest rates in the Western world are abnormally low

or completely normal. This can be analysed in terms

of normal key interest rates and the normal steepness

of the yield curve.

The level of a normal key interest rate can be based

on the level of the real interest rate plus ination

expectations. A proxy for the real interest rate is

long-term GDP growth. Given the need to adjust

imbalances, there is reason to expect lower growth

potential, which will push down the real interest rate.

In the medium term, ination pressure will remain

low. Given asymmetric negative risks for both growth

and ination, uncertainty will continue as to whether

central banks will actually achieve their ination

targets. Ination expectations may thus fall below

ination targets, which will also push down the normal

interest rate.

Short- and long-term interest rates in US and Japan

Japanese interest rate squeeze

Japan: 10-year government yieldJapan: Key interest rateUS: Key interest rate

US: 10-year government yieldSource: Reuters EcoWin

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

12

34

56

78

910

0

12

34

56

78

910

Given exceptionally low key interest rates during the

next couple of years Japan can serve as an example

the average key interest rate will have been very

low for a rather long time. The markets assessment

of what should be viewed de facto as a normal key

interest rate will probably move downward as the

period of low interest rates is extended. In addition,

it is reasonable to assume that new regulatory toolsfor dealing with such problems as pro-cyclical forces

in the nancial sector will make it easier for central

banks to maintain low interest rates and to instead

devote monetary policy energy to price stability.

Japans average GDP growth since the early 1990s is

1.2 per cent. Even if we assume that growth moves

higher, for example close to 2 per cent, there is still

reason to believe that continued imbalances justify

a lower real interest rate than 2 per cent. If we also

foresee that ination expectations may become lower,

for example 1 per cent, the normal key interest rate

will be pushed down further. In a medium- term per-

spective, the normal key interest rate might be in the

1.5-2.5 per cent interval.

Normal long-term yield is based on the level of the

normal key interest rate. The historical average for

the steepness of the yield curve (10-year yield minus

the key interest rate) has been about 130 basis points.

This applies to most countries the US, Germany and

Japan. This differential also includes an ination risk

premium. Studies of the Fed show that the ination

risk premium is about 50 basis points. A low-ination

environment may justify lowering the risk premium.If in our example we assume that this premium is

halved, the differential between the key interest rate

and the low-term yield will be about 100 basis points

(130 minus 25 basis points).

Based on this reasoning, long-term bond yields would

be at 2.5-3.0 per cent. Arguments that the market

will adjust expectations of a normal key interest rate

downward are relatively strong in a medium-term ve-

year perspective, where the elements of similarities

with the Japanese situation may be clear. What may

be regarded as abnormally low interest rates, viewed

in a historical perspective, may be rather normalinterest rates viewed in a future perspective.

in sales and improved leading indicators is over. Thenext phase will be characterised by a maturing mar-ket for industrial products, with major macroeco-nomic challenges, especially in the US. Companiesmust now deliver good prots driven by sales growth

rather than cost savings, in order for share prices to

continue rising.

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

sons why they may continue to do so. SEB Enskildascompany analyses indicate a 56 per cent increasein prots this year for companies listed in the

Nordic countries and 17 per cent next year. Stronggrowth in key Nordic markets, Germany and Asiawill improve the prot outlook in the next couple

of years. Low company valuations also allow roomfor good share price increases. Shares on the Nordicexchanges are now trading at a price-earnings ratioof 10.5 (based on expected 2012 prots) well be-


12/53



low their historical average. Worth adding is that theratio between share prices of listed companies andtheir book values is 25 per cent below its 10-yearaverage.

Stock market indices, 2010

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

Latvia (OMX)

Estonia (OMX)

Lithuania (OMX)

Iceland (OMX)

Denmark

Finland

Sweden

Germany (DAX)

USA (S&P500)

U.K. (FTSE100)

Norway

Japan (Nikkei 225)

Spain (MadSE)

The yield on listed shares in the Nordic countriesduring the next couple of years looks set to be atalmost 4 per cent, or twice the yield on 5-year go-vernment bonds. This also illustrates the exchangescautious valuations. But valuation analyses arenot better than the forecasts that are used in themodels. The assumption is that next year, prots will

have rebounded above their previous record levelsin 2007/2008. The uncertain macroeconomic envi-ronment raises the question of whether this pace

in improved prots will continue. If investors are tofocus again on fundamental valuations, a number ofbasic questions about future developments must beanswered.

P/E ratios in Nordic exchanges

96 98 00 02 04 06 08 10 120.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Fair valuations, more stable currenciesIn the past year, the foreign exchange market hasundergone a normalisation process after major tur-bulence during the most acute phase of the nancial

crisis. Many currencies have again reached more

neutral levels, based on long-term valuation mod-els. Today the G3 currencies (EUR, USD and JPY) areclose to historical average levels in trade-weighted,ination-adjusted terms (real effective exchange

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

uctuations in the foreign exchange market willcontinue.

The risk aversion evident in the market over the pastfew months has led to heavy demand for defensivecurrencies like the JPY and CHF. Shrinking interestrate spreads against the US and euro zone will leadto continued upward pressure on these currencies,but the Swiss central bank has not repeated itsforeign exchange market interventions of last spring,despite an ever-stronger CHF. Nor do we regard thisas likely in the future. In Japan, the issue of inter-vention is heating up. Our assessment is that if the

USD/JPY exchange rate approaches its historicallow of just under 80 (in 1995), this will be critical indetermining whether the Bank of Japan intervenes inthe foreign exchange market.

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

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

EUR and USD

USD EURSource: Bank of England

1980 1985 1990 1995 2000 2005 2010

70

80

90

100

110

120

130

140

70

80

90

100

110

120

130

140

The question of further quantitative easing by cen-tral banks is a source of uncertainty in the foreignexchange market. If the Fed or Bank of England were

to expand their balance sheets further, it wouldweaken the dollar and pound, but this is not ourmain scenario at present.


13/53


14/53



Policy Committee (FPC) is now being established along-

side the existing Monetary Policy Committee (MPC).

The FPC will oversee economic developments and

identify macro trends that may threaten economic and

nancial stability, then take relevant action.

Our conclusion is that the interesting reform task in the

area of economic-policy is continuing, but that its ambi-

tions and pace seems to have been lowered. A fragile

economic situation, but also the weakened authority of

political leaders in many countries, is contributing to

this.


15/53

The United States


Recovery continuing, but at a slower pace

Faster debt retirement

New labour and housing market slump

Sustained upturn in capital spending

Ination will continue to fall

Fed will not hike its key rate until 2012

The American economic recovery is now becoming

weaker, as scal stimulus measures fade and the growth

contribution from the inventory cycle diminishes.

The improvement in the labour market has slowed in

recent months, and the housing market has become

shaky again now that the federal tax credit for rst-

time home buyers has expired. GDP rose 1.6 per cent

in the second quarter on an annualised basis, a clear

slowdown from 3.7 per cent in the rst quarter. Sharply

higher imports provided a strong negative contribution

to growth and inventory build-up also slowed, compared

to the rst quarter. Capital spending by businesses

showed strong growth, however.

Yet the low Federal Reserve key interest rate is still

propping up the economy. We thus believe that the

recovery will continue, but at a slower pace than esti-

mated in our May forecast. GDP growth will climb 2.6

per cent in 2010 and by 2.2 per cent in 2011. 2012

GDP will grow 2.9 per cent. The risk in this growth

forecast is on the downside. The slowdown has opened

the way for the Fed to provide further economic stimu-

lus by expanding its balance sheet and postponing key

rate hikes until 2012.

Quarterly percentage change, annualisedSlower GDP growth

Source: BEA, SEB

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q309 10 11 12

-5

-4

-3

-2

-1

0

1

2

3

4

5

-5

-4

-3

-2

-1

0

1

2

3

4

5

SEB forecast

Many signs of decelerationAside from slower GDP growth and a lukewarm labour

market, various indicators have weakened in recent

months. Consumer condence has fallen and is now

lower than at the beginning of 2010. The ISM purchasing

managers index for manufacturing has fallen during the

past few months, while the service sector index has lev-

elled off, but both indices remain well above 50, which

indicates growth. Weaker optimism is also reected in

retail sales, which recovered strongly early this year

but have stagnated during the past months.

Index

Small firms are lagging behind

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

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

5

10

15

20

25

30

30

35

40

45

50

55

60

65

There is a persistent condence gap between large and

small businesses. While the ISM, which is dominated

by large companies, continues to show a rather bright

picture of the situation, the National Federation of In-

dependent Business (NFIB) index of small business senti-

ment is at a record low. This may partly reect the fact

that small businesses are still having difculty obtainingloans and that depressed construction companies weigh

heavily in the NFIB index.

Higher saving holds back consumptionThe latest national accounts show substantially weaker

consumption and higher saving than the previously

reported gures. In the second quarter, the household

savings ratio was 6.1 per cent, an upward revision of

several percentage points. A higher level of saving indi-

cates a faster pace of adjustment in household balance

sheets. In the long term this will set the stage for a

sustainable recovery in consumption, but over the next

couple of years we believe that the need to pay down

debts will cause the savings ratio to continue upward a

bit, thereby holding back consumption.


16/53


The United States

Our current assessment is that the savings ratio will

gradually rise to around 8 per cent during 2011, far

above the average of the past 15 years. This is also

consistent with our model projections, which have sig-

nalled for some time that the savings ratio will rise to

a level closer to the average for the past 50 years. We

thus believe that overall consumption will increaseby 1.5 per cent in 2010 and 2.2 per cent in 2011, a

downward revision compared to our assessment in

the last Nordic Outlook.

Per cent of disposable income

Uniform pace of debt retirement

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

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

1

2

3

4

5

6

7

8

9

10

11

12

60

70

80

90

100

110

120

130

140

Housing market unsteady againDespite record-low interest rates, pushed down partly

by the Feds mortgage bond purchases, and a subsidy in

the form of a USD 8,000 federal tax credit to home buy-

ers, the housing market recovery has not really taken

off in earnest. In May 2010, the S&P/Case-Shiller home

price index was only some 5 per cent higher than when

it bottomed out one year earlier. The number of home

sales and housing starts are also at historically very low

levels. In July the number of housing starts was only

546,000, less than one third of the July average from

2003 to 2005. Despite the low number of homes being

built, during 2010 inventory has uctuated around eight

months. In July, inventory rose to 12 months. Such a

high level will help hold prices and new construction

down. Because the home buyer tax credit expired at

the end of April, both residential construction and the

number of contracted home sales have weakened mark-edly during the past few months. Mortgage applications

are at a record low. The National Association of Home

Builders index of construction industry condence has

also declined.

It is difcult to foresee any immediate improvement

in the housing market. We anticipate that the rapid

decline in the number of sales will drive down prices

during the next few months. Housing market activity

will also be hampered by the slow recovery in the la-

bour market, but low mortgage rates should be able to

serve as a oor under the housing market. The 30-year

mortgage rate has decreased from around 5 per centin April to just below 4 per cent. Many households also

accelerated their home purchases to take advantage of

the tax credit. Once this effect has faded, the number

of home sales transactions will stabilise. During 2011 we

thus expect slightly rising home prices.

Index 2004:1 = 100

The housing market recovery decelerates

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

04 05 06 07 08 09 10

90

95

100

105

110

115

120

125

130

135

140

90

95

100

105

110

115

120

125

130

135

140

The July issue of the Feds Beige Book points out that

the commercial real estate market remains weak.

Assessments of future trends ranged from continued

decline in activity to weak growth, but one bright spot

is that corporate capital spending on commercial real

estate appears to have stabilised.

Company capital spending a bright spotOne bright spot during the recovery this year is capital

spending by businesses, which has climbed sharply in

2010. During the second quarter, the annualised in-

crease was 17.6 per cent. This growth in capital spend-

ing focused on machinery and software. Commercial

real estate investments were stable. The sharp increase

during the second quarter was partly a consequence of

earlier very depressed levels. Our assessment is thus

that capital spending growth will slow during the rest

of the year, but in a longer perspective there are fac-

tors that indicate good capital spending growth. In a

historical perspective, the capital spending ratio in the

business sector remains very low. Meanwhile companies

are earning good prots and their balance sheets are far

stronger than during any previous economic downturn.

Per cent

Capacity utilisation and company capital spending

Capacity utilisation (LHS)

Company capital spending, annualised Q growth (RHS)Source: BEA, Federal Reserve

70 75 80 85 90 95 00 05 10

-40

-30

-20

-10

0

10

20

30

40

67.5

70.0

72.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0


17/53


The United States

High imports weaken trade balanceDespite a sharp deterioration in public nances, in the

past few years there has been a trend towards improve-

ment in the US current account balance, due to sharply

higher saving by both businesses and households.

Recently, however, trade imbalances seem to have

widened again. The improvement in the balance oftrade has been replaced by rising decits. In June the

trade decit was nearly USD 50 billion, the largest since

October 2008. The much-publicised decit with China

has increased greatly in recent months and was just

above USD 26 billion in June. If it does not fall during

the autumn, the slow appreciation of the Chinese yuan

may become a hot issue in the campaign leading up to

Novembers congressional elections.

Procent of GDP

Current account and budget balance

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

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

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

Because imports rose far more rapidly than exports,foreign trade made a large negative contribution to GDP

growth during the second quarter. Export growth is ex-

pected to decelerate faster than import growth, which

means that US economic growth seems unlikely to get

any help from foreign trade in the next few quarters.

Labour market disappointmentsAfter a fairly positive trend during the spring, the

labour market has now lost momentum and the most

recent reports have been clearly disappointing. The

recovery is moving slowly, and unemployment remains

very high. From a peak of 10.1 per cent in October

2009, the jobless rate had only fallen to 9.5 per centin July: far from the equilibrium unemployment level,

which is around 5 per cent.

Total employment increased sharply during the spring,

but this was primarily due to the large number of peo-

ple with temporary jobs with the 2010 US Census. For

example, around 410,000 people out of a total increase

of 432,000 jobs in May could be explained by Census

effects. Employment in the private sector is showing a

substantially more subdued trend, although the number

of people with jobs has now risen for seven months

in a row. In the most recent three-month period, job

growth has been only 50,000 people per month, far

lower than the underlying increase in the labour supply.

Actual unemployment has nevertheless continued to fall

slightly, because the increase in the labour force that

was discernible early in 2010 was followed by a decline

during the past three months.

Unemployment and private sector employment

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

Source: BLS

07 08 09 10

107

108

109

110

111

112

113

114

115

116

0

1

2

3

4

5

6

7

8

9

10

Because of their weak nances, state governments can-not contribute to the labour market recovery. In July,

the number of state and local government employees

fell by nearly 50,000. The federal government has ap-

proved a USD 26 billion aid package to ease the scal

plight of state governments, but many of them will

need to continue trimming their payrolls.

One new phenomenon during the latest American eco-

nomic downturn is the scale of chronic unemployment.

The share of unemployed people without a job for 27

weeks or longer is now around 45 per cent. This is the

highest level recorded since such statistics began to be

collected in 1948. In response to this chronic unemploy-ment, the maximum period for benet payments has

been extended.

One positive sign in the labour market is the increase in

the number of hours worked during the past year. This

increase indicates continued expansion in employment.

Forward-looking indicators also hold out some hope of

future improvements in the labour market. The employ-

ment sub-index of the ISM survey clearly indicates that

manufacturing employment will continue to increase.

There is also job creation in the private service sector.

The construction sector, however, remains depressed

and its number of employees has again begun to fall in

recent months. Our overall assessment is that employ-

ment will continue to increase, but at a slow pace.

Unemployment will continue to fall and will be just

above 9 per cent at the end of 2010 and 8.5 per cent

at year-end 2011.

Ination will continue to fallThe slow labour market recovery and high unemploy-

ment are holding down ination pressure. Despite an

increase in manufacturing activity, capacity utilisation

remains well below normal. Unit labour costs have fall-

en rapidly in recent years, and the historical associationbetween unit labour costs and ination is strong. Falling

bank lending and the low rate of increase for M2 money


18/53


The United States

supply reinforce the picture of continued low ination

pressure.


Strong connection between inflation and unitlabour cost

CPI inflation Unit labour costsSource: BLS

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

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

During the last four months core ination has been at

0.9 per cent. Such a low level has not been recordedsince the 1960s. CPI ination has fallen during 2010 and

was at 1.2 per cent in July. Our forecast is that core

ination will fall a bit further, bottoming out at 0.5 per

cent in mid-2011. Then core ination will slowly climb

again, ending up just above 1 per cent at the close of

2012. CPI ination may climb somewhat in the immedi-

ate future, but we also expect it to bottom out dur-

ing 2011 and then slowly rise. Altogether, we expect

ination to end up at 1.6 per cent this year and 0.8

per cent next year. In 2012, ination will rise to 1.2

per cent.


Low inflation pressure

Core inflation Headline inflat ionSource: US Department of Commerce, SEB

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

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

forecastSEB

A dilemma for the FedBecause of large US government debt, the chances of

further scal stimulus are slim. If the recovery con-

tinues to weaken, the Fed will thus be under increas-

An unusual recoveryThe National Bureau of Economic Research (NBER)

is the agency that ofcially establishes the dates of

US economic cycles. Although the agency has not yet

declared that the recession is over, the general per-

ception is that it ended in the summer of 2009. The

recovery has thus lasted four quarters so far. On the

other hand, economic developments have diverged

from the normal cyclical pattern, which is probably

the reason why the NBER is hesitant to declare that

the recession is over.

Since the Second World War, annualised GDP growth

has averaged 6 per cent at this point in the economic

cycle, compared to 1.6 per cent during the second

quarter of 2010. Looking back at more than half a

century of data, two and a half years after a recessionstarted the GDP level has averaged 8 per cent above

the previous peak.

Todays weak labour market also diverges from the

historical pattern. The previous two recessions were

admittedly also characterised by relatively long

periods before job creation began to prevail, but the

latest recession is unique in terms of its combination

of depth and length. And without the support of a

stronger labour market, the American economy will

have a difcult time reverting to its normal recovery

dynamic.

This recovery does not resemble others, due to the

causes of the economic crisis. Short, shallow post-war

recessions have often been caused by excessive inven-

tories and exaggerated optimism among investors. This

time, the recession has instead centred on a severelywounded banking system as well as on household bal-

ance sheets and debt retirement. When the dotcom

(IT) bubble popped in 2001, household balance sheets

experienced a shock, but an expansionary monetary

policy quickly helped the housing market to soar.

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

An unusually sluggish recovery

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

92.5

95.0

97.5

100.0

102.5

92.5

95.0

97.5

100.0

102.51974

1981

1990

2001

Current

The NBER focuses mainly on four variables in assess-

ing economic cycles: sales, employment, industrial

production and income. Of these, the rst two have

fallen in recent months while the latter two have

levelled off at slow speed. In such a situation, it isnatural to be cautious in making assessments.


19/53


The United States

ing pressure to act, but the central bank has limited

potential for increasing its stimulus. The federal funds

rate is in the 0-0.25 per cent interval and cannot be cut

further. As early as March 2009 the Fed also pledged to

keep its key rate at an exceptionally low level for an

extended period. The remaining weapon in the Feds

arsenal is thus to expand its balance sheet by purchas-ing securities.

USD trillion

The Fed's balance sheet

Source: Federal Reserve

07 08 09 10

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

At its interest rate meeting in August, the Fed con-

rmed that the US economic recovery has slowed down

and outlined a new monetary policy strategy. The

central bank decided that it will keep its balance sheet

at the current level, instead of shrinking it over time.

Its interest revenue and the principal it receives back as

its existing stock of mortgage bonds matures will thus

be reinvested in government securities. In itself, this

decision does not signify any new stimulus, but it sends

a clear signal that monetary policy has now become

more dovish and that a key rate hike is very distant.

The Fed has shifted from a situation where it had begun

preparing for normalisation of monetary policy to one

of paving the way for possible further stimulus.

If the recovery should weaken even more, the shift in

Fed strategy has opened the door for further quantita-

tive easing (QE), thereby pushing down market interest

rates. Ination pressure remains very low, and the risk

of deation has not disappeared, but there is reasonfor the Fed to hold off on QE for the time being. To

begin with, interest rates are already falling due to

market forces. Furthermore, ination expectations are

admittedly low, though they have not yet approached

deation levels. By purchasing government securities,

the Fed also risks being criticised for monetising the

US federal budget decit. A more far-reaching ques-

tion is how much stimulus effect the Fed can expect

to achieve by further squeezing interest rates that are

already extremely low.

Our assessment is thus that the Fed will hold off on

further stimulus during the next several months butmay implement such measures later this autumn if the

state of the economy deteriorates substantially. Our

forecast is that the Feds rst key interest rate hike

will occur during the rst quarter of 2012 and that

the federal funds rate will stand at 1.25 per cent by

the end of 2012.

Obama faces uphill political battle

President Barack Obamas public approval rating hasfallen sharply. When he took ofce in January 2009,

a Gallup poll on whether the president was doing a

good job or a bad job gave him a 68-21 per cent score.

Todays polls give him 41-52. Despite the passage of

historic health care and nancial sector reforms, the

new president has not managed to live up to peoples

expectations. High unemployment and last years bank-

ing sector bail-out have soured many voters on the

Obama administration.

This decline in public condence is so large that it is

jeopardising continued Democratic control of the House

of Representatives following the November 2 mid-term election. It is nothing unusual for an incumbent

presidents party to lose seats in Congress, but our

analysis (see chart) shows that the Democrats will only

barely retain control of both houses. With a weakened

president, Washington risks political paralysis until the

autumn 2012 presidential election. This is occurring in a

situation where both the American economy and global

cooperation efforts are in great need of clear US politi-

cal leadership.Democratic control of House of

Representatives in jeopardy

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

01030 35 40 45 50 55 60 65 70

Democratic projectedseat loss

Source: Gallup.com, SEBNumber of seats gained/lost (vertical axis)Presidential approval rating, per cent (horisontal axis)Todays US domestic political scene is dominated by

discord and by Republican attempts to stop or at leaststall reforms. There is also disagreement as to whether

the economy needs further stimulus, or whether belt-

tightening is required. The Republicans oppose further

scal stimulus and question the size of the positive im-

pact from earlier stimulus packages. Even among Demo-

crats and the general public, there are doubts about

the need for further stimulus measures. The pendulum

thus seems to be swinging towards support for greater

austerity. Obamas plan for another large-scale stimulus

package has undergone radical cuts. The extension of

unemployment benets to 99 weeks was pushed through

only with great difculty.


20/53


The United States

Fiscal policy difcult to assessThe political situation has made it more difcult to as-

sess US scal policy. For example, it is unclear whether

the tax cuts implemented by President George W. Bush,

which expire at the end of 2010, will be extended.

The Republicans want to retain the tax cuts, while

the administration and most Democrats only want toretain the cuts for people who earn a maximum of USD

250,000 per year. In August, the independent Congres-

sional Budget Ofce warned that extended tax cuts

for all income groups would seriously worsen the scal

outlook, but our overall assessment of scal policy has

not changed especially much since May. We expect

federal stimulus measures to contribute 1 percentage

point to 2010 growth and -0.5 points in 2011. Given our

US economic forecast, the phase-out of scal stimulus

will put the Fed under additional pressure to continue

pursuing an exceptionally accommodative policy, in-

cluding zero interest rates and a possible expansion of

the central banks balance sheet.

The budget decit during the scal year 2009 ended up

at just above USD 1.4 trillion, equivalent to nearly 10

per cent of GDP. The budget decits in scal 2010 and

2011 will be lower than in our May forecast. The de-

cit will end up around USD 1.4 trillion this year and just

below USD 1 trillion next year. In scal 2012 the decit

will shrink further.


21/53

Japan


Strong currency leads to policy dilemma

Brisk exports, but strong yen an obstacle

Continued deation pressure

BoJ will hike key rate only in 2012

The Japanese economy showed unexpected strength

around year-end and early in 2010, but second quarter

growth was a big disappointment. GDP growth was a

mere 0.1 per cent, raising questions about the strengthof the recovery. The GDP gure should not be over-

interpreted; quarterly statistics are often erratic, and

leading indicators like the Tankan Survey from the Bank

of Japan (BoJ) point to continued decent growth in

the near future. But there are also worrisome signs,

among them that the housing and construction industry

as well as retail sales seem to have lost momentum.

Exports and industrial production have bounced back

after last years dramatic fall. Due to high growth else-

where in Asia, combined with a favourable product mix

in trade with the US, exports will rise by about 20 per

cent this year.

Despite the weak second quarter, we foresee that

consumption will continue to be sustained by govern-

ment stimulus measures totalling about 7 per cent of

GDP over the period 2008-2010. Private consumption

will increase by nearly 2 per cent this year, the fast-

est rate since 1996. We predict GDP growth of 2.5 per

cent this year, the same forecast as in May.

A slight cooling in global demand, the lagging effects

of yen appreciation so far this year and the phase-out

of stimulus measures will lead to a deceleration late

this year and in 2011. Export growth will slow to about5 per cent in 2011, capital spending growth to about

4 per cent and consumption growth to less than 1 per

cent. Overall, GDP growth will fall to 1.5 per cent in

2011 as well as 2012.

Unemployment has risen in recent months (currently

5.3 per cent), which risks blunting the consumption

upturn. We expect GDP growth to be close to or just

above trend during the next couple of years, which

means that unemployment will move sideways.

Ination pressure will remain very low. CPI will decline

by 1.0 per cent this year and end up around zero in2011. A lower ination trend than in other countries is

reected in the long-term strengthening of the yen (in

keeping with the theory of purchasing price parity,

PPP). The euro zone economic crisis, combined with

uncertainty about the American economy, has quickly

resulted in a clear appreciation of the yen. The USD/

JPY exchange rate has moved from over 90 in January

to just above 85 today. The yen has also strengthened

against the euro: from about 130 per EUR in January

2010 to about 112 today. In spite of this, the yen is

not unjustiably expensive at present, but given our

forecast that the USD/JPY will approach 80 (the yens

highest value since 1995), ofcial intervention in theforeign exchange market cannot be ruled out.

USD/JPY rate follows relative prices

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

Source: Reuters EcoWin

75 80 85 90 95 00 05 10

80

105

130

155

180

205

230

255

75

100

125

150

175

200

225

250

275

300

325

Due to the strong yen and the trend towards weaker

global demand, Japanese policy makers will face new

challenges. The government, also confronted by falling

stock prices, will seek to have new stimulus measures

outlined by late August. We expect a budget decit

equivalent to about 8 per cent of GDP this year,

somewhat lower in 2011-2012. Government debt is ap-

proaching 200 per cent of GDP. This difcult situation

must be managed in an uncertain political landscape.The Social Democratic Party recently withdrew from the

governing coalition and in June the former nance min-

ister, Naoto Kan, became Japans fth prime minister

since 2006. The Bank of Japan will raise its key interest

rate to 0.5 in 2012.


22/53

Asia


Slight deceleration in growth

Slowdown from high level

Balanced growth in China

Monetary tightening needed in India

Asias emerging countries have shown good resilience

in the face of global recession, recovering far more

rapidly than the OECD countries. Good central govern-

ment nances have made it possible for them to launchstimulus packages, and their export-driven economies

have beneted from the global trade recovery. Howev-

er, there are signs that the recovery that started during

the second half of 2009 is now slowing a bit. In China,

there was a welcome deceleration in economic activity

during the second quarter of 2010. The latest outcomes

for industrial production, exports and purchasing man-

agers indices also indicate a slowdown in such econo-

mies as Malaysia, South Korea and Taiwan. Despite this

deceleration, we expect good growth in the region

during both 2010 and 2011.


Industrial production

Thailand

South Korea

Taiwan

India Source: Reuters EcoWin

Jan May Sep Jan May Sep Jan May Sep Jan May

07 08 09 10

-40

-30

-20

-10

0

10

20

30

40

50

60

-40

-30

-20

-10

0

10

20

30

40

50

60

Rapid wage increases, partly in response to an increas-

ing number of strikes in various Asian countries, repre-

sent a certain short-term inationary threat. In some

countries, such as India, the authorities will need to

respond with continued monetary policy tightening. In a

longer perspective, rising wages are a natural develop-

mental step in the region that will help reduce global

imbalances, both by narrowing cost differences and by

shifting these economies towards a larger consumption

element.

China: Slowdown but no crash landingGDP gures for the second quarter conrmed our

forecast of a soft landing in China. Year-on-year growth

slowed from 11.9 per cent in the rst quarter to 10.3

per cent. The governments tightening measures during

the spring, including restrictions on bank lending and

regulation of home sales, seem to have had an effect.

Various indicators are also showing continued decelera-

tion. The purchasing managers index has continued

to fall, in July reaching its lowest level since February

2009. Industrial production, retail sales and car sales

have also decelerated. Exports have also slowed, but

the rate of increase remains high; their level is nearly

40 per cent higher than in 2009.

The upturn in CPI ination has slowed, and although

core ination has climbed in recent months it was only

2.4 per cent in June. This will probably mean that the

authorities will be cautious about further tightening

measures.


Inflation in China and India

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

07 08 09 10

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

There is a continued focus on the risks of overheating

in the housing market. A sharp decline in home prices

would impact the real economy mainly through falling

activity in the construction sector. Government-con-

trolled Chinese banks nevertheless have sizeable

reserves, and the home loan-to-value ratio is very low,providing a substantial cushion against falling home

prices and reducing the risks of a broader nancial

crisis.

A certain slowdown in the housing market now seems

to be on the way. Construction investments and the

number of home sales have diminished. The rate of

price increases has also cooled somewhat but remains

above 10 per cent. In our assessment, the risk of a

sharp decline in home prices is fairly small. Chinese

authorities will try to respond to an initial price slide.

Overheating is also largely a local problem. There have

been major price hikes in cities like Shanghai and Shen-zhen, but in the housing market as a whole the increase

is more limited. Looking a little further ahead, there is

also a large underlying demand for housing.


23/53


24/53

The euro zone


Doing better, but increasingly divided

Germanys strong competitive positiondriving rapid growth

Debt reduction tough on southern Europe

Unemployment has peaked low ination

ECB will not hike re rate until 2012

The economic trend in the euro zone has been favour-able in the past few months. GDP growth was strong in

the second quarter, leading indicators have continued

to climb especially in Germany, while nancial market

worries about sovereign debt problems have eased

somewhat.

The next couple of years will be characterised by big

gaps within the euro zone. Germany is beneting from

very strong global competitiveness and comparatively

good balances in its domestic economy. Southern

European countries face continued major challenges

in consolidating their central government nances and

restoring their competitiveness.

Low ination will enable the European Central Bank to

keep its key rate very low to support adjustment proc-

esses in southern Europe. We expect it to begin hiking

the re rate only in 2012.

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

IFO climbs higher

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

Source: Federal Statistics Office, IFO

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

75

80

85

90

95100

105

110

115

120

-7.0

-5.0

-3.0

-1.0

1.0

3.0

5.0

Strong short-term indicatorsSecond quarter GDP gures provided upside surprises,

but also illustrated increasingly obvious gaps betweencountries. Euro zone economic growth totalled 1.0 per

cent quarter-on-quarter, and the upturn in Germany

was a full 2.2 per cent (3.7 per cent year-on-year). In

France, GDP grew by 0.6 per cent and in Italy 0.4 per

cent while other southern European countries lagged

behind: Spanish GDP grew only 0.2 per cent, while the

Greek economy shrank by 1.5 per cent.

Especially in Germany, short-term indicators also sup-

port a scenario of continued strong growth. For exam-

ple, order bookings in the German manufacturing sector

rose by 3.2 per cent in June compared to May, and bya full 24.6 per cent year-on-year. Germanys IFO index

has continued upward at a rapid pace, and its current

level indicates an upside risk to our growth forecast.

The purchasing managers index (PMI) has also pro-

vided upside surprises in most countries and is now

signalling a clearer recovery. The widening gap between

Germany and other parts of the euro zone is especially

apparent from the OECDs leading indicator, which has

continued to climb in Germany but has turned down-

ward in France and the PIIGS countries (Portugal,

Ireland, Italy, Greece and Spain).

Composite leading index

Germany in the lead, PIIGS lagging behind

Germany France PIIGSSource: OECD

00 01 02 03 04 05 06 07 08 09 10

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

Can domestic forces take the lead?As in many other countries, exports have been the

engine of the recovery. For some time, German manu-

facturers have been improving their competitiveness. In

the past six months they have received extra help from

a weak currency. With an EUR/USD exchange rate of

around 1.30, the growth stimulus in 2010 from the euro

is equivalent to about

Nordic Outlook 1008: Economic recovery but higher risks

Documents

Transcript of Nordic Outlook 1008: Economic recovery but higher risks