New macro forecast: Too hot and too cold

Economies have been on diverging growth paths since the recovery started. Prospects have deteriorated in parts of Europe because a lack of credibility has raised rates and forced further fiscal restraint. These economies are at risk becoming too cold. Meanwhile, the economies without these problems, including the economies of many emerging countries, are forging ahead and providing a boost to world market growth. The problem in these economies is that they risk becoming too hot. Both on a global scale and within Europe, the divergence between hot and cold is getting wider.

Fears of a double dip in the US have receded and given way to a new round of worries over the so-called PIGS countries. Their fiscal policies are not yet credible and rising bond yields are forcing governments to enhance budget consolidation efforts, putting additional pressure on these economies. The problems are compounded by the weakness of the banks in these countries. A lack of trust increases the need for capital injections. Further help from EU partners will clearly be needed, perhaps with additional support from the IMF. The ECB also has to get involved. This puts downward pressure on the euro and lends a helping hand to countries that can take advantage of booming overseas markets.

Emerging economies face increasing inflationary pressures but are reluctant to tighten monetary policies because it would put additional upward pressure on their currencies. There is no quick fix to this problem, but we expect a gradual appreciation of the Chinese CNY to make it easier for emerging economies to sustain exchange rate appreciation. Over time, this will help exporters in the US, Japan and Western Europe. Keeping interest rates too low in these economies also risks producing bubbles.

Some of the countries that have so far escaped bubble problems are now expanding rapidly and face looming risks, but their central banks are refraining from rate hikes because of financial problems elsewhere. The German economy in particular is at risk of becoming too hot if the ECB tries to prevent financial collapse elsewhere in the euro zone by keeping rates low. Too hot can imply a tight labour market and rising inflation, but it can also imply a hot property market.

Sweden runs similar risks. The Riksbank will probably not raise rates as much as it should given developments in the housing and credit markets. There are good reasons to tighten but the Riksbank has to take into account the policies of other central banks. The Fed, the ECB and the Bank of England continue to keep rates low to help the weaker parts of their economies. If the Riksbank pursues more aggressive tightening, the krona may appreciate too strongly. On the other hand, if the Riksbank is too soft, Swedish labour and property markets will be heating up fast.

Sweden and Germany have another feature in common: their exporters are heavily geared towards capital goods. As global growth is investment-led, they face much more buoyant demand than the economies that rely on consumer goods production. This is another divide that runs across Europe. The south, where the economic climate is getting colder because of debt problems, is consumer-goods-oriented, while the north, which is heating up, benefits from an investment goods orientation.

Jan Häggström, Chefsekonom

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