Nordic Outlook: Soft landing due to Fed easing and trade talks

Nordic Outlook: Soft landing due to Fed easing and trade talks

Sweden: Riksbank abandoning negative rate despite rising joblessness

US Federal Reserve (Fed) key interest rate cuts and progress in international trade negotiations have boosted global confidence. We are still lowering our GDP growth forecast for 2019 and 2020, but recession risks have diminished and in 2021 global GDP will accelerate again. Lingering political uncertainty and resource restrictions will limit the upside, though. Given continued low inflation, the burden of stimulus will remain on central banks, despite the disadvantages of unconventional monetary policies. Fiscal policy measures are being blocked by strong labour markets late in the economic cycle and by rigid regulations, but climate change is among reasons that strengthen the arguments for public sector intervention. The Swedish economy will slow markedly, and unemployment will climb throughout 2020. Because of stronger international conditions and a gradual recovery in residential construction, growth will rebound during the second half of 2020 and unemployment will stabilise in 2021. Inflation will end up below target, despite a weak krona. The Riksbank will still hike its repo rate to zero this December, but the key interest rate will then remain unchanged until the end of 2021.     

Monetary policy will continue to bear the burden of stimulus despite increased disadvantages

Progress in resolving trade conflicts and Brexit (British withdrawal from the European Union), signs of stabilisation in industrial activity – especially in Asia – and the Fed’s three rate cuts this year have created stronger confidence in the world economy, yet SEB economists are lowering their forecast of global GDP growth by two tenths of a percentage point for 2019 and 2020 due to weaker near-term performance in emerging market (EM) countries and in the United States after this autumn’s decline in sentiment indicators. World economic growth will slow from more than 3.5 per cent last year to about 3 per cent this year and next. But recession risks have diminished and in 2021 GDP growth is expected to speed up again. EM economies are showing early signs of stabilisation and turnaround, and we expect improved export potential to help the euro area economies slowly emerge from their current slump. Global inflation rates will converge at a low level, in spite of tight labour markets, giving central banks room to continue supporting growth. The Fed will deliver a final “insurance” rate cut early next year and will be prepared to do more, and the European Central Bank (ECB) will stimulate the euro zone by means of bond purchases and a negative key rate. Classical imbalance risks − such as high household debts and excessive business investments − are also conspicuously absent. Our forecast is thus a cautiously optimistic soft landing scenario, even though soft landings have been historically unusual.  

Unemployment is at a 40-year low in the 36 mainly affluent OECD countries, making a rapid acceleration in economic growth unlikely. Lingering uncertainty about trade negotiations and Brexit also impose a ceiling on the growth outlook. A combination of low inflation and low unemployment is also making it harder to strike a balance in economic policies. Fiscal policy will probably remain passive, although climate change and other issues provide new arguments for public sector intervention. Political gridlock and regulations, plus a general reluctance to shift budget policies late in the economic cycle, are among the reasons. Instead the burden of stimulus will continue to rest with overburdened monetary policymakers, despite increased disadvantages. Three theme articles in this issue of Nordic Outlook discuss the challenges facing the global trade system (which are not only about US President Donald Trump), signs of improvement in the EM sphere and the “dark sides” of unconventional monetary policy.  

Roller coaster for rates and yields, weaker USD, better risk climate

Bond yields have rebounded as recession risks have diminished. Because central banks are not entirely finished with their stimulus measures, international long-term yields may fall again until mid-2020. After that they will resume their upward movement, but downward structural forces due to low inflation risk premiums and low real interest rates will continue to operate. At the end of our forecast period, yields on 10-year US Treasuries will be at 2.00 per cent and on their German counterparts at zero. Further Fed rate cuts will help the EUR/USD exchange rate gradually climb to 1.20 by the end of 2021. The USD will also enjoy less support from its defensive qualities as global economic growth recovers, but higher US interest rates and bond yields than in other countries will slow the depreciation of the dollar. Stock markets will be supported by historically low interest rates and yields, as well as by the combined effects of dividends and share buy-backs, but low expectations about corporate earnings increases as well as valuations close to historical peaks will limit the potential of equities and generate volatility risks.     

Mainland Norway slowing as oil activity shrinks; muted Baltic exports  

Unlike many other developed countries, Norway will see accelerating overall growth this year, but the positive contagious effects of high oil investments will fade. Although domestic demand will remain healthy, growth in the mainland economy (excluding oil, gas and shipping) will slow from 2.5 per cent this year to 2.1 percent in 2020 and 1.9 per cent in 2021. Because of the weak Norwegian krone, inflation will remain above target, but global uncertainty will keep the key interest rate at 1.50 per cent after four hikes. A sharp upward revision of 2018 figures is making it hard to assess the growth dynamic in the Danish economy. After a strong start to 2019, data are now showing signs of slowdown, probably connected to weaker conditions in major export markets. The housing market is providing support, while the economy is still far from hitting its capacity ceiling. GDP growth in Denmark will slow from just over 2 per cent this year to around 1.5 per cent in 2020 and 2021. Finnish households are unexpectedly cautious despite a strong labour market. Finland’s manufacturing sector has performed decently this year, but international weakness is expected to weigh down the economy. Growth will be only 1.2 per cent this year, followed by an acceleration to 1.6 per cent in both 2020 and 2021.  

So far, the three Baltic economies have been resilient to global headwinds, but they will now decelerate as exports contribute less to their economic growth. Lithuanian GDP will grow by more than 3.5 per cent this year, followed by around 2.5 per cent in 2020 and 2021. Lower capital spending will help cool growth in Latvia from 2.4 per cent this year to 2.0 per cent in 2020, followed by a new acceleration to 2.5 per cent in 2021. Estonia will also see an export-driven slump, but a pension reform will help sustain consumption in 2021. GDP will grow by 3.2 per cent this year, followed by 2.0 and 2.6 per cent in 2020 and 2021, respectively.

Sweden: No more negative key rates, despite growth slump and higher unemployment

Sentiment indicators have fallen in recent months, and the Swedish economy is obviously losing momentum. Statistics Sweden’s downward revision of first half output contributed to the adjustment of our 2019 GDP growth forecast from 1.5 to 1.2 per cent. 2020 GDP growth is revised from 1.3 to 1.2 per cent. Due to modest growth in the coming year, unemployment will climb throughout 2020 and resource utilisation will fall below its historical average. After that, stronger international economic conditions and a gradual recovery in Swedish residential construction will enable growth to recover in the latter part of 2020, helping unemployment to stabilise in 2021. GDP will grow by 1.7 per cent in 2021, an unchanged forecast from the last Nordic Outlook. Strong central government finances will limit downside risks. Supply side restrictions are further away than in other countries, creating upside potential a bit further ahead.

For a long time Swedish manufacturing was resilient to weaker conditions elsewhere, especially in Germany, but in recent months the purchasing managers’ index (PMI) has fallen well below the expansion threshold. During the next few quarters, industrial production and merchandise exports are expected to weaken and even decline, but recovery tendencies in international manufacturing activity suggest that any downturn will be brief. Another sign of weakness in Swedish manufacturing is a downturn in machinery investments after several strong years, but the construction sector is showing clear signs of levelling off. Late in 2020 a cautious upturn in housing starts is expected, resulting in slightly higher residential investments in 2021. Public sector investments will continue to grow, though at a slower pace, which will limit the downturn in overall capital spending this year and next. In 2021, capital spending will again increase somewhat. 

Household consumption began a slight falling trend in mid-2018. This was partly explained by changes in tax rules for auto purchases, but other consumption was also weak. Periods of falling consumption are unusual, however, except during recessions and periods of steeply falling employment. During the second quarter of 2019, consumption rebounded. This positive trend seems to have strengthened during the autumn. The strong expansion of public sector activity in recent years seems to have slowed, which probably reflects a tighter fiscal situation in the local government sector. A theme article in this Nordic Outlook discusses Swedish municipal and regional government finances in detail.

Dramatically higher unemployment figures for Q3 2019 turned out to be due to errors in the official statistics, but it is clear that the labour market has cooled. Indicators suggest that employment is close to stagnating. Given Sweden’s rapid population growth, job growth will not be enough to prevent a gradual increase in unemployment to 7.4 per cent by the end of 2020. The cooling labour market will affect wage formation, but signs of a somewhat less orderly collective bargaining environment, slightly higher initial union pay hike demands and somewhat larger wage and salary increases in other countries, we still believe that contractual pay hikes will end up a little higher than in the last national wage round in 2017. Total pay increases will end up at 2.6 per cent in 2020 and 3.0 per cent in 2021, one tenth of a point below the forecast in the last Nordic Outlook. 

Because of modest pay hikes and low international prices, inflation will end up below the Riksbank’s target, despite a weak krona. In October the central bank sent a clear signal that it intends to hike its key interest rate in December. The Executive Board is sticking to its plan despite weaker economic conditions, with both actual inflation and inflation expectations below target. This represents a shift in the bank’s reaction function away from the inflation focus of recent years. The drawbacks of long periods of negative interest rates, a decreased desire to push up inflation via exchange rates and Sweden’s stronger housing market are three conceivable explanations. In light of this, we believe it would take a lot to persuade the Riksbank to cut its key rate to below zero again. On the other hand, we believe that the bank is again overestimating inflation in its forecast. At present, we therefore see no strong reasons to believe that the central bank will act more aggressively in 2020 and 2021 than it is now signalling. We are thus forecasting that the Riksbank will hike its repo rate to zero in December and then leave it there until the end of 2021.

Key figures: International & Swedish economy (figures in brackets are from the September 2019 issue of Nordic Outlook)

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