Central banks cannot fix it all

The economic divide between the US and the eurozone remains. While activity in the US economy is now substantially above levels recorded before the global financial crisis, eurozone real GDP has been treading water. However, after the ECB finally decided to make an all-out effort to stave off deflationary pressures, things seem at least to be heading in the right direction. Nevertheless, given that the Fed is soon about to tighten, further dollar strength looks likely. Among the Nordic countries, Sweden has the strongest economy at present, implying a tendency for the krona to decouple to some extent from the euro.

The US economy remains in expansion mode, although growth stalled temporarily during the first quarter, reflecting harsh weather conditions, labour disputes on the West Coast, and weaker net exports. However, the outlook for the remainder of the year and beyond is solid. Against that backdrop, we expect the labour market to tighten further. The Fed has so far stayed on the sidelines, bewildering analysts to some extent, but the rate hike is now probably not far away. Our view is that the Central Bank will make its first move in June. Subsequent steps will likely be very gradual.

The situation in the eurozone remains starkly different. Following the ECB’s decision to embark on its quantitative easing programme, the euro weakened substantially against the dollar, while credit conditions in the troubled monetary union improved. Things in the real economy also seem to be going in the right direction, as business cycle surveys now point to a gradual recovery in economic activity. However, considering the amount of slack that still characterises large parts of the region, the ECB will have to maintain its policy stance much longer. That makes further dollar strength vis-a-vis the euro likely.

Economic recoveries after the financial crisis have been slower than in the typical cyclical upswing and several European economies have hardly come back at all. But while the US recovery has been weak in terms of GDP, the labour market has bounced back strongly and unemployment has declined much more rapidly than forecast. Even so, wage inflation has remained tame. There has been a similar development in the UK and both the Fed and the Bank of England show uncertainty about when the first rate hike is due. The seeming disconnect between unemployment and wage inflation is one of the factors contributing to this uncertainty. The question is if we can base forecasts on a stable relationship between the tightness of the labour market and wage inflation or if we are in uncharted territory

In China, recent data confirm that growth is decelerating. As this is mostly due to structural factors, conventional fiscal and monetary measures to support the economy may only dampen the slowdown, not stop it. However, while financial risks are present, we think that they can probably be managed, in which case China should still be able to avoid a hard landing scenario and remain an important driver for the world economy. We also continue to have a positive view on India. The Russian situation has improved marginally, mostly due to the slight bounce in oil prices, but the recession scenario is still unfolding and we have seen nothing that would change our rather gloomy take on the longer-term outlook. Similarly, Brazil’s prospects are negative too.

The Nordic countries are a rather mixed bunch. Economic activity in Denmark surprised on the upside during the latter half of last year, raising hopes that conditions were improving after a number of dismal years. However, a significant improvement does not seem to be on the cards for now. Finland is in greater trouble, reflecting cyclical as well as structural factors. While voters strongly signalled their desire for changes in the election on April 19, the likely coalition t headed by the Centre Party will be forced to make quite a few tough decisions to put the struggling economy on a sounder footing. Norway seems to be slowing faster than Norges Bank expected. Another rate cut cannot be excluded.

Sweden has the strongest economy among the Nordic countries. The economy looks quite different from that of the eurozone. In many ways, the cyclical situation seems more similar to that of the UK, for instance, with a limited degree of unused capacity despite nominally rather high unemployment. Nevertheless, following significantly lower inflation than forecast, the Riksbank caved in and adopted a negative policy rate. While we believe it would have been wise to follow more closely in the footsteps of Norges Bank and adopt an expansionary posture earlier, we believe there are good reasons to expect that the Riksbank will prove successful this time in eventually moving inflation closer to the official target.

For further information, please contact:

Jan Häggström, Chief economist, +46-8 701 10 97, +46 70 761 43 66
For more information on Handelsbanken, see: www.handelsbanken.se

(Please see attached PDF file for tables).

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