SEB: Nordic Outlook: Short-term relief but long-term risks

Nordic Outlook: Short-term relief but long-term risks 

Sweden: Below-trend growth, rising unemployment and key rate pause

The world economy seems to have emerged from last year’s manufacturing slump. Growth is accelerating cautiously, but lingering political uncertainty and supply-side constraints are diminishing the power of the upturn. Central bank signals of low key interest rates for a lengthy period will provide support, but they also raise questions about long-term risks of debt build-up and spiralling asset prices. Fiscal policymakers can play an increased role, but because of rigid fiscal frameworks and weak government finances, the dose of stimulus will still be cautious. In Sweden, sentiment indicators point to weak or even falling GDP in late 2019 and early 2020, but a recovery in household consumption and a turnaround in residential construction suggest that the economy will keep expanding in 2020. Growth will speed up in 2021 as Sweden joins in the international upswing. Continued strong population growth is one reason why unemployment will keep rising during the coming year. The Riksbank will keep the Swedish key interest rate unchanged, even though inflation will fall further below the central bank’s 2 per cent target.  

Global growth is accelerating cautiously, after bottoming out in 2019

The US Federal Reserve’s key interest rate cuts and decreased trade risks due to progress in US-Chinese negotiations have led to a resurgence of optimism in financial markets. Manufacturing activity is showing signs of having bottomed out, with small hints of recovery in sentiment indicators. Domestic demand has remained resilient in most countries, sustained by strong labour markets. This has laid a more stable foundation for future growth. SEB economists predict that global GDP growth will increase from 3.0 per cent in 2019 to 3.1 per cent this year and 3.3 per cent in 2021 – marginally better than our forecast in November’s Nordic Outlook. A recovery in emerging market (EM) economies is the main reason for the acceleration, as large countries like India, Russia, Brazil and Turkey gain momentum while China’s economy continues to decelerate. Improved world trade will also help to sustain exports in Europe and elsewhere during 2021, but for various reasons global growth looks set to be lower than the average during recent decades. Many EM economies have reached a degree of maturity that makes it difficult for them to maintain their earlier rapid trend growth. In advanced economies, the lowest unemployment levels in 40-50 years are shifting the focus of attention to supply-side constraints, as downside risks to demand fade. Yet the potential for a further upturn in US labour force participation and a lower equilibrium unemployment rate in the euro area – including reforms in France, Spain and elsewhere – will make it possible to prolong the economic expansion further. Political uncertainty factors also remain, with question marks about US-Chinese trade after their success in reaching a Phase 1 agreement, as well as about trade between the European Union and both the United States and the United Kingdom. Another source of uncertainty is increased tensions between the US and Iran. In all these cases, however, the parties involved have powerful reasons to avoid an escalation.         

Extended period of low interest rates and yields raises new questions

Central banks will continue to support their economies in the prevailing low-inflation environment, but there is not much room for new initiatives. An increased awareness of the drawbacks of negative rates and yields has raised the bar for further stimulus measures in the euro area, for example. Signals from leading central banks that they will accept a degree of inflation overshooting − after a long period of below-target inflation rates − meanwhile imply that the threshold to rate hikes will be high. In this environment, fiscal policymakers are expected to play an increased role, for example through public sector investments in infrastructure, climate-related projects and education. Yet in practice, the dose of fiscal stimulus is expected to be limited, given already high US federal budget deficits and rigid fiscal frameworks in Europe. An extended period of low interest rates and bond yields meanwhile raises questions about the long-term risks of debt build-up and spiralling asset prices starting on the day that there may be changes in underlying conditions affecting inflation, interest rates, bond yields and other variables. Special theme articles in this February Nordic Outlook explore the scope of fiscal policy, the high debt levels in China and the US, share valuations and the need for sustainable energy innovations.

Steeper yield curves, weaker USD, better risk climate and share prices

Bond yields have stabilised a bit above their previous lows. In the prevailing low-inflation environment, central banks have an asymmetric reaction function: key interest rate cuts are closer at hand than rate hikes. This pushes down short-term yields and leads to a steepening of yield curves. Our forecast of one more Federal Reserve rate cut this coming autumn will nevertheless contribute to a temporary downturn in long-term Treasury yields. By the end of 2021, 10-year US Treasury securities will yield just over 2.00 per cent, while long-term German government bond yields will be slightly above zero. An improved risk climate, including positive economic growth signals and successful trade negotiations, will cause USD-positive drivers to fade. Because the US dollar is overvalued in the long term, it will gradually depreciate, with the EUR/USD exchange rate climbing to 1.20 by the end of 2021. Slightly better growth and ultra-low bond yields will help to sustain high share price valuations. Our main scenario is slightly positive stock market returns and good performance for both cyclical industrials and structurally favoured growth companies in digitisation and sustainability.     

Decelerating Nordic growth, delayed Baltic impact of global slowdown

The Norwegian economy appears to have peaked in autumn 2019. The mainland economy (excluding oil, gas and shipping) will slow towards its trend growth rate as oil investments fall and demand from this sector shrinks. Mainland GDP growth will decelerate from 2.5 per cent last year to 2.0 per cent in 2020 and 1.8 per cent in 2021. The weak krone will push inflation above target this year, but because of increased international risks, slower domestic economic growth and less risk to financial stability, Norges Bank will leave its key interest rate unchanged at 1.50 per cent. Denmark will show faster economic expansion than the euro area, sustained by strong job growth and decent private consumption, yet it will decelerate gradually from more than 2 per cent last year to 1.5 per cent in 2021. Improved consumption and service exports sustained Finnish economic growth last year; it will level off at around 1.5 per cent, supported by somewhat better global economic conditions.      

After a lag, the three Baltic economies are now beginning to be affected by last year’s global slowdown. This includes lower industrial production and weaker demand for transport services. Despite slower growth, labour markets remain tight and pay increases are high. Lithuania’s GDP growth will slow from more than 3.5 per cent last year to around 2.5 per cent in both 2020 and 2021. In Latvia, a temporary slump to 2.0 per cent growth this year will be followed by a new acceleration to 2.5 per cent in 2021. Estonia will see a slowdown from last year’s 3.8 per cent growth to 2.0 per cent in 2020, then a rebound to 2.6 per cent in 2021.   

Sweden: Below-trend growth, rising unemployment and key rate pause

Despite certain signs of stabilisation, sentiment indicators point to weak or even falling Swedish GDP in late 2019 and early 2020. This weakness is clearest in manufacturing, while domestically oriented sectors are showing signs of some recovery: most apparent in the retail and construction sectors. Progress in US-Chinese trade negotiations suggests that manufacturing sentiment will rebound during the next few months. This is one reason why we have only adjusted our 2020 GDP forecast marginally lower, to 1.1 per cent (November: 1.2 per cent). Our 2021 forecast of 1.7 per cent GDP growth is unchanged. A bit further ahead, there is upside potential. Supply-side restrictions in the labour market are further away than in comparable countries. The krona is weak, and strong government finances will allow room for increased fiscal stimulus measures. There are many indications that higher central government grants to local governments will be part of the upcoming spring budget, but a strict interpretation of Sweden’s official fiscal framework and the gridlock created by the government’s January Agreement on budget cooperation with two opposition parties will have a restraining effect.

For a long time the Swedish manufacturing sector was resilient to weaker conditions elsewhere, especially in Germany. After plunging last September, the purchasing managers’ index (PMI) is now well below the expansion threshold of 50. This was reflected in clear downturns for industrial production and merchandise exports during the autumn, but recovery tendencies in international manufacturing activity suggest that the Swedish downturn in the sector will be brief. As early as the second quarter of 2020 we believe exports will start growing again. 

Machinery investments have declined, while residential investments are close to bottoming out. During 2020 we expect a cautious upturn in housing starts, resulting in slightly rising residential investments during 2021. Due to high demand for health care, social services and schooling, the upturn in public sector investments will continue, though at a somewhat slower pace. This is one reason why the downturn in overall capital spending will be only 2.0 per cent in 2019 and 1.0 per cent this year, followed by a 2 per cent increase in 2021.

Household consumption began a slight falling trend in mid-2018 but rebounded starting in Q2 2019. The future outlook is mixed. Job growth and higher real wages and − to some extent − tax cuts have provided support. The same is true of the record-high savings ratio and increasing asset prices, including home prices. A clearly weaker labour market has shaken household confidence, but what worries consumers is mainly the general economic situation, whereas confidence in their own finances has recovered. We expect a gradual upturn in consumption: by 1.3 per cent during 2020 and 1.7 per cent next year. Public sector consumption is decelerating but will be sustained by strong demand for public services and the forecasted higher central government grants.

The Swedish labour market has cooled noticeably. Job growth is continuing, but not fast enough to match an increasing labour supply due to both rising labour force participation and rapid population growth. Our forecast is that job growth will be less than half a percentage point this year and that unemployment will climb to 7.4 per cent by late 2020 and then stabilise at that level. Swedish wage and salary growth has diverged from the international pattern, remaining at a very even rate of about 2.5 per cent yearly. We expect total pay increases to accelerate only moderately to 2.6 per cent in 2020 and 3 per cent in 2021. The ongoing national wage round is expected to result in a slight higher pay hikes than the previous wage round in 2017.

Inflation is below the Riksbank’s 2 per cent target despite a weak krona. Falling electricity prices  as well as lower electrical network charges are expected to push CPIF inflation (the consumer price index minus interest rate changes) down towards 1 per cent during the coming six months, before it rebounds to a bit above 1.5 per cent during 2021. CPIF excluding energy will remain just below 2 per cent during the next few months and then fall towards 1.5 per cent as exchange rate effects fade. After hiking the repo rate to zero per cent in December 2019, a majority of the Riksbank’s Executive Board members are signalling an unchanged key rate until mid-2022. The central bank’s increased acceptance of overshooting above its inflation target suggests that very large upside inflation surprises will be required for a rate hike to occur. The December rate hike, which occurred in spite of rising unemployment and below-target inflation, meanwhile suggests that the threshold for a return to negative key rates is high. We see a higher probability of more stimulus measures than normalisation, but our main scenario is a lengthy pause for the repo rate at zero. The Riskbank’s December rate hike removed another negative factor for the krona. A somewhat more positive international environment suggests that the krona can continue to appreciate, with the EUR/SEK exchange rate falling to 10.00 by the end of 2021. 

Key figures: International & Swedish economy (figures in brackets are from the November 2019 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 September 30, 2019, the Group's total assets amounted to SEK 3,046 billion while its assets under management totalled SEK 1,943 billion. The Group has around 15,000 employees. Read more about SEB at https://www.sebgroup.com