Nordic Outlook: Effective crisis responses with long-term risks

Nordic Outlook: Effective crisis responses with long-term risks

Sweden: Continued rebound after smaller GDP decline than feared

Despite increased COVID-19 spread, the economic recovery in advanced economies has been faster than expected. We are revising our GDP forecast for the 37 mainly affluent OECD countries upward to a decline of 6.6 per cent this year, compared to an expected fall of 7 per cent in our May issue of Nordic Outlook. However, we are downgrading our forecast for the overall global economy because emerging market (EM) countries have suffered unexpectedly extensive economic damage from the pandemic. Labour markets in the advanced economies have performed better than anticipated, limiting the upturn in their public debt burden; meanwhile low pay increases are holding back inflation. A combination of fiscal and monetary policy programmes can thus continue to provide support for the recovery. But despite strong growth in 2021 and 2022, resource utilisation will remain below normal. In the long term, expansionary economic policies create challenges, including increased inequality and reduced pressure for change in the economy.

Like the other Nordic countries and the Baltics, the Swedish economy has coped with the pandemic better than the other parts of Europe. Because of more lenient pandemic-related restrictions, Sweden’s GDP will fall by only 3.8 per cent this year, less than half of the expected decline in the euro area and the United Kingdom; we have revised our Swedish forecast upward from -6.5 per cent in May. GDP will then increase by just above 4 per cent in 2021 and by 3 per cent in 2022. New crisis responses are likely in the autumn budget. We expect it to include SEK 100 billion worth of stimulus measures for 2021. Unemployment will peak at just over 10 per cent, and inflation will remain below the Riksbank’s 2 per cent target. If further monetary stimulus is needed, the Riksbank will mainly expand its asset purchases, while the bar is high for a return to key interest rates below zero. The krona will gradually strengthen to SEK 9.60 per euro and SEK 7.50 per US dollar at the end of 2022, but the Swedish currency will not reach its long-term equilibrium level.

Positive, but mixed, surprises despite COVID-19 setbacks

After a dramatic spring, the economic picture has become a bit clearer and forecasts a bit more certain. The spread of the virus has in fact unfolded in a more negative direction than assumed in our May forecast. In spite of this, the economic recovery has been slightly faster than previously predicted, especially in terms of consumption and manufacturing. Meanwhile the divergences between countries and regions have been unexpectedly wide. The Nordic and Baltic countries in particular surprised analysts on the upside during the second quarter of 2020, but the spread of COVID-19 in many emerging market (EM) countries has caused more economic damage than expected. This mixed picture of the pandemic’s impact is reflected in SEB’s new Nordic Outlook forecast. In the Nordics and Baltics, our upward revisions are dramatic: in the 5-6 percentage point range. Meanwhile we have revised our global GDP forecast a percentage point lower to a decline of 4.3 per cent, due to the EM countries.

Room for further economic stimulus − long-term challenges

As in May, our forecast includes two alternative scenarios. A faster virus spread during the winter may lead to larger GDP declines, while vaccinations and a bigger impact from stimulus measures may speed up the recovery. Our main scenario is a gradual recovery, with GDP growth well above normal: in the OECD countries 4.8 per cent in 2021 and 2.8 per cent in 2022. In spite of this, the gap compared to earlier trends will not close. At the end of 2022 unemployment in most countries will remain well above pre-crisis levels. The jobless rate has nevertheless fallen faster than expected in the United States and has climbed only moderately in Europe, which is one reason why the burden on public sector finances has been lighter than anticipated. As a result, the public sector debt ratio will climb less than previously feared. This creates future manoeuvring room for more programmes to stimulate growth and make restructuring easier. Meanwhile low pay increases are holding back inflation. This will enable central banks to help shore up economies – and facilitate fiscal stimulus – over a long period, with record-low key interest rates and expanded asset purchases if needed. In the long term, however, expansionary economic policies create challenges in the form of unhealthy risk-taking, low pressure for change in the economy, “zombie” companies and increased wealth gaps.

In financial markets, rapid growth as well as low interest rates and bond yields will result in continued favourable conditions for share prices and risk appetite, as well as supporting historically high asset valuations. The US dollar will continue to weaken as interest rates and bond yields in different countries converge at low levels, and the Swedish krona will regain lost ground. The September issue of Nordic Outlook includes a special theme article on the krona (“Lasting gains for an undervalued currency”). Other theme articles examine globalisation, the US elections and how recessions affect labour markets.

Unexpected resilience in the Nordic and Baltic countries

In our May report, the forecast was that GDP in the Nordic countries as a whole would fall by 8 per cent this year; we are now predicting a downturn of only 3.5 per cent. In Norway, the mainland economy (excluding oil, gas and shipping) will shrink by 3.3 per cent this year, followed by an upturn of 3.6 per cent in 2021. Overall Norwegian GDP will fall by 2.6 per cent this year and then grow by 3.4 per cent in 2021 and 3.1 per cent in 2022. Our forecast was made before official second quarter GDP figures were published. Norway’s recovery is being weighed down by weak activity in the oil sector, but an unprecedented policy response – with the government also using capital from the Government Pension Fund Global (or Oil Fund) – is providing support to the household sector and helping to fuel the upturn in home prices. Late in 2022 Norges Bank will begin to hike its key interest rate. The reopening of the Danish economy has been faster and more extensive than expected. We now believe that the economy will shrink by 4.5 per cent this year, followed by annual upturns of 5.0 and 2.5 per cent, respectively. Finland’s economy has been surprisingly resilient; its second quarter GDP decline was among the smallest in the euro area. Weak international demand has seriously hurt exports, but private consumption has held up. Finnish household optimism is above the level of a year ago. GDP will fall 2.9 per cent this year and then climb by 3.2 per cent in 2021 and 2.2 per cent in 2022.   

In the Baltic countries, Lithuania in particular has weathered the crisis unexpectedly well. The small size of its tourism sector and vigorous fiscal support for households will limit this year’s GDP downturn to 1.3 per cent, followed by annual increases of 3 per cent in 2021 and 2022. Latvia and Estonia are harder hit, but less than previously expected. GDP will fall by about 4.5 per cent in both countries during 2020, followed by an upturn of 4-4.5 per cent in 2021 and 3.5 per cent in 2022.  

Sweden: Continued rebound after smaller GDP decline than expected

Due to more lenient restrictions, the COVID-19 pandemic has not had the same negative impact on the Swedish economy as in the euro area. During the second half of 2020, Sweden will experience a gentler rebound than countries that imposed more far-reaching lockdowns, but its full-year decline in GDP will be only 3.8 per cent, which is less than half the expected downturn in the overall euro area and the United Kingdom. In May, our forecast was a 6.5 per cent decline in 2020. In 2021 Swedish GDP will grow by 4.2 per cent and in 2022 by 3.1 per cent. As in other countries, at the end of 2022 GDP will still fall short of its pre-pandemic growth trend.

 Manufacturing and export recovery, moderate investment downturn

This summer’s recovery has been healthy in most sectors, with the exception of some service sectors that will suffer from low demand for a rather long time. By June, industrial production and merchandise exports had recouped nearly half of their downturn. They are expected to continue growing at a healthy pace during the third quarter of 2020. More resilient industrial production is one important reason why we have revised our 2020 GDP forecast higher since May. During the summer, home prices have climbed to new record levels, but we expect rising unemployment to cool off the housing market this autumn and cause home prices to fall slightly late this year and in 2021. Yet the downturn will be significantly milder than we foresaw in our May report and will not exceed 5 per cent overall.  

Cautious households, despite public stimulus measures

The drop in consumption during March and April was historically large, driven by services. An upturn has now begun. Looking ahead, the pace of the recovery will be determined by how long-lasting the change in household consumption patterns will be – to what extent households will continue to replace cross-border tourism with goods and certain types of domestically oriented services. Fiscal stimulus programmes have propped up purchasing power, largely offsetting the effects of falling employment and weak pay increases. This year’s downturn in real disposable incomes will fall short of 1 per cent. We expect purchasing power to climb by around 2.5 per cent both in 2021 and 2022. Because of high unemployment and the uncertain future outlook, the household savings ratio will climb to record levels this year and remain high throughout our forecast period. After falling by 3.5 per cent this year, private consumption will climb by 3.5 per cent in 2021 and 2.5 per cent in 2022.     

Unemployment will peak at more than 10 per cent

Labour market indicators have greatly improved this summer. Hours worked have fallen many times more than overall employment, as businesses have trimmed working time by using wage subsidies instead of employee lay-offs. Looking ahead, we expect new cutbacks as companies that foresee no near-term improvement begin to terminate employees. Our forecast is that unemployment will climb to 10.5 per cent by year-end, then fall to 8.0 per cent by late 2022. Last spring the rate of pay increases was at its lowest level since such statistics began to be compiled in the early 1990s. We expect the national wage round, which was postponed until this autumn, to result in overall contractual pay increases of about 2 per cent during 2021 and 2022. Total yearly pay increases will be 2-2.5 per cent.

Below-target inflation, high bar for key interest rate cuts

The pandemic has caused big price movements in portions of the Consumer Price Index (CPI) basket, which increases the uncertainty of forecasts. Yet on the whole, inflation risks have downshifted, given a slower rate of pay increases and expectations of a stronger krona. Partly due to higher energy prices, CPIF (CPI minus interest rate changes) will temporary move closer to the Riksbank’s 2 per cent inflation target early in 2021, and then stabilise around 1.5 per cent towards the end of our forecast period. Because of weak economic conditions and below-target inflation, the Riksbank is still under pressure to expand its stimulus measures. Our main scenario is that in the near future the central bank’s Executive Board will bide its time, but if inflation expectations should begin to fall, we believe that its most likely choice will be to extend and/or expand the ongoing bond-buying programme (from its current SEK 500 billion total until mid-2021). The bar for cutting the repo rate back below zero per cent is higher. Negative interest rates are not effective if restrictions, rather than demand, are limiting growth.

 Fiscal framework on hold – SEK 100 billion stimulus in autumn budget

Given Sweden’s strong underlying government finances, and because some stimulus programmes have turned out to be ”cheaper” than expected, fiscal policy makers will have more manoeuvring room ahead. We expect the budget bill for 2021 to include a mix of extended crisis responses and more traditional stimulus measures such as tax cuts, municipal and regional programmes, infrastructure, education and housing. In all, we expect SEK 100 billion worth of extra stimulus in 2021. The net lending deficit will be about 5 per cent of GDP this year, followed by deficits of 4 per cent in 2021 and 3 per cent in 2022.

Key figures: International & Swedish economy (figures in brackets are from the May 2020 issue of Nordic Outlook)

SEB is a leading Nordic financial services group with a strong belief that entrepreneurial minds and innovative companies are key in creating a better world. SEB takes a long term perspective and supports its customers in good times and bad. In Sweden and the Baltic countries, SEB offers financial advice and a wide range of financial services. In Denmark, Finland, Norway, Germany and the United Kingdom, the bank's operations have a strong focus on corporate and investment banking based on a full-service offering to corporate and institutional clients. The international nature of SEB's business is reflected in its presence in some 20 countries worldwide. On June 30, 2020, the Group's total assets amounted to SEK 3,218 billion while its assets under management totalled SEK 1,909 billion. The Group has around 15,000 employees. Read more about SEB at sebgroup.com.