Nordic Outlook: A race between interest rate cuts and recession risks

After a late-summer bout of stock market turbulence, falling interest rates and a weaker dollar, markets have calmed down and adapted to US economic deceleration and expected rate cuts from the Federal Reserve. The fight against inflation has been successful, and central banks are on the way to taking clearer steps towards interest rate normalisation. The Fed will start its rate cutting cycle in September with a reduction of at least 25 basis points, and the European Central Bank’s rate cuts will continue during the autumn. Growth gaps are narrowing as the United States and China slow down and the euro area economy accelerates, albeit at a moderate pace. Continued resilient labour markets, rising real wages and lower interest rates will drive growth. In Sweden, lower interest rates and taxes will contribute to a strong recovery. After more than two years of stagnant GDP, the Swedish economy will grow by more than 2.5 per cent next year and nearly 3 per cent in 2026. The Riksbank will lower its policy rate to 2 per cent by the end of next year, and the government will spend SEK 75-80 billion on unfunded reforms in 2025.

“Because of rate cuts, along with lower inflation and the absence of major imbalances, a US recession can be avoided after all. This will benefit the entire global economy. But it will be an uncertain and intense autumn, with several key issues to keep an eye on,” says Jens Magnusson, Chief Economist at SEB, pointing to uncertainties about the pace of the US slowdown and the outcome of the upcoming presidential election, the ongoing geopolitical conflicts in Ukraine and the Middle East, a sputtering German economy, and a European Union that is being squeezed between the US and China.

A soft landing in the US, and a recovery in the euro area after earlier stagnation
The growth picture that we described in the May issue of Nordic Outlook is holding up relatively well. The previously resilient US economy will experience a soft landing. We have left our 2024 GDP growth forecast unchanged at 2.5 per cent but lowered our 2025 forecast to 1.5 per cent. The euro area economies have emerged from last year’s stagnation, with GDP growth of 0.8 per cent this year and 1.6 per cent in 2025. Emerging economies are expanding by over 4 per cent yearly, but Chinese growth is slowing because of weak domestic demand, problems in the real estate sector, half-hearted economic policy stimulus attempts and an export-oriented policy that is encountering more and more headwinds. Overall global growth remains moderate, at just over 3 per cent per year throughout our forecast period. An often-stretched supply side will hold back potential late in the forecast period. An ageing population and tightening migration are reducing the labour supply. Fiscal policy is also contractive, prices are high and real interest rates are slowly falling. There is hope for an AI-driven productivity boost, but before we see more concrete evidence, such a development is an upside risk to our forecasts.

“But throughout our forecast period, global growth will be only slightly below the pre-pandemic average. This demonstrates the ability of households, political leaders and businesses to manage a turbulent world,” says Daniel Bergvall, Head of Economic Forecasting at SEB.

Inflation reverting towards target, key interest rates towards neutral levels 
Inflation is continuing to move in the right direction, and there is good potential for stabilisation at around central bank inflation targets. The Fed will begin its rate cutting cycle in September and rapidly lower its key rate to 3.00 per cent by the end of 2025. The ECB has started from a lower key interest rate and will cut its deposit rate more gradually to 2.00 per cent by the end of next year. During 2026, inflation will be at target, and central bank key rates will be back at a neutral level.           

“Because real interest rates rise when inflation falls, key rates must be lowered so monetary policy does not become more contractive,” says Daniel Bergvall.

Sweden: Clear economic upturn, supported by fiscal and monetary policy
After more than two years of stagnant GDP, many preconditions for a strong recovery of the Swedish economy are in place. Household consumption will be the main driver, underpinned by better real wages, expansionary fiscal policy and lower interest rates. We are sticking to our optimistic growth forecast for 2025, when GDP will increase by 2.6 per cent. Our forecast for 2026 is that growth will pick up further, reaching 2.9 per cent.

Manufacturing remains resilient and housing construction will turn around in 2025
Swedish manufacturers have remained resilient amid weak European conditions and exports have continued to increase, albeit at a slowing pace. Assuming a European rebound in 2025-2026, there is good potential for continued Swedish export growth.

“The difference is striking compared to Germany. A weak Swedish krona is one explanation, and relatively low Swedish energy prices are probably also a contributing factor,” says Daniel Bergvall.

Investments have shown continued resilience. Green investments in northern Sweden are a driving force, but it is hard to quantify their importance for overall capital spending. Growing pains and a generally high level of investments will probably dampen growth in 2025‒2026. Due to weak residential housing investments, overall capital spending has declined in 2023 and 2024, but during 2025 and 2026 rising residential investments will contribute to a rebound.

Interest rates and fiscal policy will improve the mood of households
The share of households with variable interest rate loans has risen to over 70 per cent, which will quickly improve household finances if interest rates are lowered as expected. Real wages are now gradually rising. In 2025‒2026, households will also benefit greatly from expansionary fiscal policy. We expect SEK 20 billion/year, or 0.7 per cent of incomes, in tax cuts and grants aimed at households. Consumption will accelerate during the second half of 2024 ‒ an upturn that will then strengthen in 2025 and 2026. Home prices continue to rise slightly.

Weak labour market for a bit longer
The Swedish labour market has weakened since summer 2023. We believe unemployment will increase to nearly 9 per cent early next year. Due to stronger economic growth, employment will then climb. The jobless rate will gradually fall to 8.0 per cent by the end of 2026. The labour market is now clearly weakening, but its deterioration will not be dramatic compared to historical declines.

Inflation will stabilise at a low level
Swedish inflation has fallen rapidly since summer 2023. CPIF (consumer price index with constant interest rates) was below the Riksbank’s 2 per cent target in July, and CPIF excluding energy was marginally above target. Month-on-month changes over the past 3-6 months suggest that core inflation is currently levelling off broadly, at close to target. Reversals of price increases are unusual, but inflation may tend to remain low for relatively long periods after major cost shocks. We expect total yearly inflation to end up a bit below 2 per cent in 2025 and 2026.

Rapid policy rate normalisation, and cuts of 50 basis points cannot be ruled out
The Riksbank lowered its policy rate by an additional 25 basis points in August ‒ its second cut in this cycle. The Executive Board said it expects to lower the interest rate two or three more times this year. Now that inflation is close to target and unemployment is rising, a likely strategy is for the Riksbank to cut the policy rate relatively fast towards neutral levels. We expect three more rate cuts this year, i.e. cuts at every meeting for the rest of the year. In 2025, the policy rate will be lowered three more times to 2.00 per cent, which is 25 basis points below what we expected in May.

“Our inflation forecast is close to the Riksbank’s, but reduced uncertainty about inflation and larger rate cuts by other central banks are the reasons for the downward revision in our policy rate forecast. Larger-than-usual cuts, by 50 basis points, cannot be ruled out if inflation and inflation expectations clearly surprise on the downside. Higher inflation, on the other hand, would of course delay the process, but there are larger risks on the downside," says Daniel Bergvall.

A sudden shift to expansionary budgets, with fiscal framework reforms expected
At the start of its yearly budget negotiations in August, the government estimated the scope for unfunded reforms in 2025 at SEK 60 billion, equivalent to nearly one per cent of GDP. We expect a further expansion of SEK 15-20 billion in unfunded 2025 spending in the spring budget next April and are thus sticking to our May forecast of an expansion totalling SEK 60-80 billion in 2025. Fiscal policy is likely to remain expansionary in 2026, which is an election year. We have assumed unfunded reforms of an additional SEK 70 billion, equivalent to slightly more than one per cent of GDP, in 2026. This autumn, a commission of inquiry will unveil proposals on how the central government’s fiscal targets should be changed. We expect the existing surplus target in public sector savings ‒ 0.3 per cent of GDP ‒ will be changed to a fiscal balance target, but such a change is not likely to affect central government finances within our current forecast horizon.

“The consolidation of the 1990s, a long-standing policy of budgetary restraint and good economic growth give Sweden a strong fiscal starting point – but also pose challenges. Fiscal policy will now become more expansionary and will stimulate growth, when many other countries must cut back. But policymakers remain cautious. Fiscal austerity has created tensions, and strong finances have a downside. However, it is doubtful how far the politicians want and dare to go," says Jens Magnusson.

Key figures: International & Swedish economy (figures in brackets from Nordic Outlook, May 2024)

For further information, contact:
Jens Magnusson: +46 70 210 2267
Daniel Bergvall: +46 73 523 5287
Robert Bergqvist +46 70 445 1404
Olle Holmgren: +46 70 763 8079
Elisabet Kopelman: +46 70 655 3017
Marcus Widén: +46 70 639 1057

Press contact:
Niklas Magnusson, Head of Media Relations & External Communication
+46 70 763 8243
niklas.x.magnusson@seb.se

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