Economic recovery but higher

risks, depressed key rates and

Nordic Outlook
bond yields
Nordic countries well equipped for
Economic Research – August 2010 upturn
 Contents

International overview 5

The United States 16

Japan 22

Asia 23

The euro zone 25

The United Kingdom 31

Eastern Europe 32

The Baltics 33

Sweden 35

Denmark 43

Norway 44

Finland 48

Economic data 49

Boxes

Downside risks have increased 7

Stable commodity prices 8

Basel III postponed 9

Moving towards Japanese yields? 12

An unusual recovery 19

Falling unemployment even with slow growth 28

Stress tests dispel uncertainty despite shortcomings 30

Why is Sweden doing so well? 36

Major Swedish GDP revisions 38

Nordic Outlook – August 2010  |  3

 Economic Research

This report was published on August 31, 2010.

Cut-off date for calculations and forecasts was August 27, 2010.

Robert Bergqvist Håkan Frisén

Chief Economist Head of Economic Research
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Daniel Bergvall Mattias Bruér

Economist Economist
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Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist
+ 46 8 763 80 77 + 46 8 763 80 93

Andreas Johnson Tomas Lindström

Economist Economist
+46 8 763 80 32 + 46 8 763 80 28

Gunilla Nyström Ingela Hemming

Global Head of Personal Finance Research Global Head of Small Business Research
+ 46 8 763 65 81 + 46 8 763 82 97

Susanne Eliasson Johanna Wahlsten

Personal Finance Analyst Small Business Analyst
+ 46 8 763 65 88 + 46 8 763 80 72

SEB Economic Research, K-A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Köbel, Klaus Schrüfer, SEB Frankfurt/M and
Olle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwegian
analysis.

4   |  Nordic Outlook – August 2010


Continued economic recovery but increased risks
ƒƒ US growth below trend for the next year
ƒƒ Strong recovery in Sweden and Germany
ƒƒ Low inflation will allow extreme low-
interest policies
ƒƒ Dilemmas for Nordic central banks
ƒƒ Japanese-style global long-term yields
In recent months the world economic outlook has dete-
riorated, mainly due to clear signs of weakness in the
American economy. Increased worries about a slowdown
in the United States and Asia, combined with contin-
ued uncertainty about the fiscal situation in southern
Europe, have led to lower risk appetite in financial
markets and sharply falling interest rates, among other
things. The growth rate was unexpectedly strong in
many countries during the second quarter, and the
emergency response to the southern European crisis has
been successful, but this has not sufficed to offset the
negative news.
Inflation has continued downward, and inflation expec-
tations have fallen. It is becoming increasingly clear
that the risks of undesirably low inflation are the domi-
nant problem for major central banks in the 32 member
countries of the Organisation for Economic Cooperation
and Development (OECD). This is creating room for
continued record-low interest rates in the next couple
of years.
We expect the US Federal Reserve (Fed) and the Euro-
pean Central Bank (ECB) to maintain today’s record-
low key interest rates throughout 2011 and to begin
cautious rate hikes only in 2012. Due to low key rates in
the foreseeable future and diminished growth and infla-
tion expectations in the long term as well, government
bond yields will remain at historically very low levels in
the next couple of years.
There is a renewed focus on the potential for central
banks to stimulate their economies by means of quanti-
tative easing (QE). We expect that because of low long-
term yields, central banks will be satisfied with keeping
their balance sheets at current levels and thus not
implement new QE programmes. The Basel Committee
on Banking Supervision has presented a proposal which
implies that tightening of financial regulations will be
postponed, creating an economic stimulus effect that
International overview
will also reduce the need for unconventional monetary
policies.
In our judgement, the deceleration signals in the Ameri-
can economy will have consequences for the recovery
dynamic in the coming year. Renewed weakness in both
the labour and housing markets will block a traditional
recovery dynamic. We have thus adjusted our forecast
downward and expect GDP growth somewhat below
trend in the US during late 2010 and early 2011. This
will mean major economic strains, including persistent-
ly high unemployment and continued financial stress.
At the global level, however, extremely loose monetary
policy and continued good growth capacity in many
parts of the world economy will contribute to decent
growth in the next couple of years. Fast-growing Asian
economies will remain an important driving force,
although some deceleration is on the way. We believe
that Chinese authorities, for example, have sufficient
tools to ensure an economic soft landing.
In the OECD, differences in the underlying balance
situation have become increasingly important. Germany
and Sweden are among countries where the strength of
the upturn has been surprising. A strong German econ-
omy is not enough to keep up the momentum of the
entire euro zone, though. There will thus be wide gaps
within the currency area as the full effects of powerful
austerity programmes are felt in southern Europe.
Global GDP growth
Year-on-year percentage change
2009 2010 2011 2012
United States -2.6 2.6 2.2 2,9
Japan -5.2 2.5 1.5 1.5
Germany -4.7 3.3 2.1 1.8
China 8.7 10.0 9.0 8.0
United Kingdom -4.9 1.7 2.0 2.2
Euro zone -4.1 1.6 1.3 1.5
Nordic countries -4.4 2.5 2.4 2.4
Baltic countries -15.6 0.4 4.2 4.5
OECD -3.3 2.2 2.0 2.3
Emerging markets 2.4 6.8 6.0 6.4
World, PPP* -0.6 4.4 3.8 4.3
World, nominal -1.3 3.7 3.1 3.6
Source: OECD, SEB­ * Purchasing power parities
Nordic Outlook – August 2010  |  5
 International overview

We are sticking to the main scenario from our economic large negative contribution to growth in the second
analyses of recent years: the after-effects of the deep quarter, among other things due to stimulus measures
crisis will hamper economies for a rather long period. and a stronger US dollar.
Debt retirement in both the private and public sectors,
combined with lingering weaknesses in the financial sys- To ensure a sustainable recovery, it will now be crucial
tem, will mean slower growth for some time to come. for final demand in the form of capital spending and
Low interest rates may ease the adjustment, but their consumption to take over when the inventory cycle
stimulus effect will be weaker than normal in today’s ceases to serve as an economic engine. The box entitled
ravaged economic environment. “Recovery at a crossroads” in the November 2009 issue
of Nordic Outlook discussed this take-over. One conclu-
Amid a fragile economic situation, international sion was that mid-2010 would be the critical period. But
economic policy makers face major challenges, for the outlook is mixed.
example in restructuring the financial system, coordi-
nating global fiscal policies and rebuilding confidence in Capital spending took off in many countries early in
joint European institutions. Belt-tightening in southern 2010. Growth figures are high, in part because the fixed
Europe will put the political system under severe strains investment level was exceptionally depressed. But
there, but political authority is being questioned even there are also factors that point towards a sustained
in leading industrial countries. In the US, for example, recovery.
President Obama’s popularity has plunged and this
ƒƒ Non-residential fixed investment is deeply de-
autumn’s congressional election may lead to further
pressed, even in a longer time perspective. Unlike
restraints on the government’s ability to make and
normal economic expansions, the capital spending
implement decisions. In Germany, Chancellor Angela
level in the OECD countries remained rather low
Merkel’s position has weakened and her governing
during the boom years 2006-07.
coalition is going through a rough patch. In the UK, a
new and inexperienced coalition government is facing ƒƒ Balance sheets, especially in large American corpo-
painful spending cuts. rations, are much stronger than normal. This will
make larger self-financing of capital investments
Shifting the emphasis to final demand possible, facilitating the upturn while the financial
The ongoing slowdown trend in the global economy is system remains relatively fragile.
largely due to the fading of stimulus effects from the
ƒƒ Historical associations signal that capital spending
inventory cycle and fiscal policy measures. Inventory
growth is more dependent on the change in capac-
movements have been pivotal to the recovery in the
ity utilisation than on its actual level. This indicates
manufacturing sector. Since most merchandise invento-
that a recovery in fixed investments may begin
ries are traded across national boundaries, this means
relatively soon.
that exports take off first.
One important factor that may delay an upturn is that
US: Non-residential fixed investments
many small businesses are still having difficulty obtain-
As a percentage of GDP, current prices
14.5 14.5
ing loans. The credit market is performing sub-optimally
14.0 14.0 in this respect, both in the US and Europe.
13.5 13.5
US: Uniform pace of debt retirement
13.0 13.0
Per cent of disposable income
12.5 12.5
140 12
12.0 12.0
11
11.5 11.5 130
10
11.0 11.0 120 9
10.5 10.5 8
110
10.0 10.0 7
100
9.5 9.5 6
9.0 9.0 90 5
70 75 80 85 90 95 00 05 10 80 4
3
Source: US Department of Commerce 70
2
60 1
It is thus not illogical for all parts of the world economy
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
to begin their recovery with export-led growth. The
trend in net exports, when imports are also included, is Household debts (LHS) Household saving (RHS)
Source: Federal Reserve
another question. Early in the crisis, the effect of
international trade was to ease global imbalances. On the consumption side, the outlook is gloomier.
Domestic demand, and thus imports, fell sharply in There is still a major need for debt retirement. New US
countries with large domestic imbalances, such as the figures point to substantially higher household saving
US. In recent months, this pattern has reversed to some than previously reported. The adjustment process is
extent. For example, net US exports accounted for a thus occurring faster than expected. Given new labour

6   |  Nordic Outlook – August 2010

 International overview

market disappointments and a housing sector that again
seems to be on its way down, the underlying prerequi-
sites for a normal American consumption recovery are
missing. In the UK, southern Europe and elsewhere,
consumption is also being held back by fiscal tighten-
ing. In Germany and Japan, consumers are cautious
despite their strong balance sheets. In Asian emerging
economies, there is an impending shift towards greater
emphasis on consumption, as illustrated by accelerat-
ing pay increases, but this is too lengthy a process to
facilitate a decisive shift to final demand as the main
economic engine.
Our overall conclusion is that, in part because of sub-
dued final demand, the OECD countries will move into
a slower growth phase during the second half of 2010
and the first half of 2011. This means that for several
quarters, growth will again end up below trend. The
output gap will thus widen. At present, however, most
indications are that growth will remain well above
recessionary levels.
Very strong recovery in Sweden
The Nordic economies have generally shown good resil-
ience against the global crisis. In Denmark, Sweden and
especially Finland, GDP indeed fell sharply during 2009,
but the impact on domestic demand was rather minor
and the upturn in unemployment surprisingly small.
Public finances are thus in relatively good shape, and
central government debts are at a low level. Combined
with sizeable current account surpluses, this is creating
a favourable platform for recovery. The weakening of
the euro is helping to ease competitiveness problems
which have hampered growth in Finland and Denmark
to some extent.
In Sweden, growth has been surprisingly vigorous in re-
cent months, and we expect a 4.7 per cent upturn this
year. Exports have recovered strongly after their sharp
decline. Expansionary fiscal policy and strong housing
market have benefited domestic demand.
In the other Nordic countries, growth will be far more
moderate. The Danish economy is still being hampered
by the repercussions of the housing market crash.
In Finland there is good potential for an export-led
manufacturing upturn similar to Germany and Swe-
den. So far, the upturn has been modest, but a weaker
euro will contribute to an acceleration over the next
few quarters. In Norway, the economy has also been
held back by an appreciating currency. A strong labour
market and expansionary fiscal policy have not sufficed
to get domestic demand moving. Because of the very
mild downturn in 2008-09, resource utilisation is also
high in Norway compared to other countries, and this
will dampen long-term growth potential from the supply
side.
GDP growth, Nordic and Baltic countries
Year-on-year percentage change
2009 2010 2011 2012
Sweden -5.1 4.7 2.9 2.3
Norway -1.4 0.7 2.1 2.1
Denmark -4.7 1.8 1.8 2.2
Finland -7.8 2.5 2.6 2.7
Nordics -4.4 2.5 2.4 2.4
Estonia -14.1 2.0 5.0 4.0
Latvia -18.0 -1.5 4.0 5.0
Lithuania -14.8 1.0 4.0 4.5
Baltics -15.6 0.4 4.2 4.5
Source: OECD, SEB­

Downside risks have increased

As earlier, our main scenario implies a relatively slug-
gish global recovery, with medium-term growth being
held back by fiscal tightening, continued debt adjust-
ment needs and tighter financial sector rules.
Since last spring, the risk picture has changed in
some respects. The crisis-ridden countries of southern
Europe continue to face major challenges, but the
overall picture looks less threatening. With a credible
bail-out mechanism in place and after the completion
around 25 per cent, compared to 15 per cent in the
May issue of Nordic Outlook. Conversely, the prob-
ability of upside surprises has naturally diminished.
Despite signs of strength in such countries as Germany,
a rapid recovery in the world economy is relatively un-
likely without support from a more dynamic American
economy.
GDP OECD countries
Index 2000=100
127.5 127.5

of stress tests in the European banking system, risks 125.0

15% 125.0
122.5 122.5
that southern European problems might cause a global
120.0 120.0
recession have receded. The International Monetary
117.5 117.5
Fund (IMF) and euro zone countries have approved
115.0 25% 115.0
a second emergency loan disbursement to Greece, 112.5 112.5
another sign that the structural adaptation process has 110.0 SEB forecast 110.0
begun. 107.5 107.5
105.0 105.0
Yet the deterioration in the American economy has 04 05 06 07 08 09 10 11 12
increased the overall risks of a global recession. We
New crisis wave SEB's main scenario
now estimate the probability of such a scenario at Raprid recovery
Source: OECD, SEB

Nordic Outlook – August 2010  |  7

 International overview

Baltic countries slowly on the way up New labour market patterns

The Baltic economies have now slowly begun to re- In recent months, the differences in labour market
bound from the deep declines they experienced after trends between various countries have become more
the credit bubble burst. The three countries’ internal pronounced. In Germany and the Nordic countries, for
devaluation policy appears likely to be successful. Their example, the labour market situation has begun to
competitiveness has improved, mainly via pay cuts. Also improve, whereas the situation in the US is plagued by
making the situation easier is that the euro, to which new disappointments.
their currencies are pegged, has weakened and the
Divergent employment trends
currencies in several important competitor countries in Index = 100 januari 2008
Eastern Europe have appreciated. Their external bal- 101 101
ance has improved radically, and the deflation process 100 100
99 99
is coming to an end. They have also shown political
98 98
firmness in implementing major fiscal belt-tightening. 97 97
Estonia will join the euro zone on January 1, 2011. This 96 96
95 95
has also helped restore confidence, some of which has
94 94
spread to Latvia and Lithuania. But there is a degree 93 93
of lingering uncertainty about the political situation in 92 92
Latvia − connected among other things to this autumn’s 91 91
90 90
parliamentary election − and to some extent also in 89 89
Lithuania. Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
08 09 10
Looking ahead, we expect a modest growth rate of 4-5 Sweden US Germany Spain
Source: Reuters EcoWin
per cent, well below the previous trend. Continued pri-
vate sector adjustment needs, combined with a less ex- During the economic downturn phase, the decline in
pansionary credit environment, will contribute to this. employment was substantially sharper in the US than,
It will also take time to restore confidence in Baltic for example, in Germany and the Nordic countries
investment projects among long-term foreign investors. despite a milder GDP decline. In part, this followed
We expect Latvia and Lithuania to have an opportunity traditional patterns coupled to such factors as how easy
to join the euro zone in 2014. it is to hire and fire employees. Especially in Germany,

Stable commodity prices Oil prices will rise somewhat from current levels.
Commodity prices have followed the pattern of the At present, reserve oil production capacity is rela-
global recovery. A turnaround came early in 2009 and tively large. Increases in demand next year will not
was probably initially strengthened by China’s need to be large enough to change this. Saudi Arabia’s large
fill structural stockpiles. Since last spring, commod- production reserves will give it a key influence on the
ity prices have tended to level off at the same time future price strategy of the Organisation of Petroleum
as global manufacturing has reached a more mature Exporting Countries (OPEC). Saudi Arabia can boost
phase, or somewhat ahead of this. production and squeeze oil prices if it turns out that
global growth is slowing too quickly. Iran and Iraq also
High commodity prices have major potential to increase the oil supply, but
Index, monthly date, USD
in the prevailing uncertain political situation, it is
500 500
hardly likely that any large production changes will be
450 450
implemented. We are thus assuming that Brent oil will
400 400
350 350
continue to trade in the USD 70-90/barrel interval.
300 300
Agricultural commodities will level off, but there is
250 250
a risk of further upturn in the short term. Extreme
200 200
weather in two key wheat-producing countries, Rus-
150 150
sia and Ukraine, led to a 70-80 per cent price spike
100 100
in July and August. Russia has decided to halt grain
50 50
00 01 02 03 04 05 06 07 08 09 10
exports during the rest of 2010, aimed at ensuring
domestic supplies and counteracting price increases to
Agriculture Industrial metals Energy
Source: HWWI consumers. This will pose risks of a new wave of price
increases and might spread to the maize (corn) and
Given our scenario of continued moderate global soya markets. But in our assessment, global wheat and
growth, with a slight weakening in the short term, other grain stockpiles are large enough to avoid price
continued price hikes are also likely to be modest. In shocks. This is very different from several few years
particular, a calmer growth dynamic in fast-growing ago, when low grain stockpiles led to major price
Asian economies points in this direction. hikes that affected food prices worldwide.

8   |  Nordic Outlook – August 2010

 International overview

employment was also sustained by special economic Rate of pay increases is stabilising
policy programmes. Year-on-year percentage change
4.5 4.5
Since employment figures have already begun to
4.0 4.0
increase in a number of European countries, while
remaining weak in the US, it is clear that other expla- 3.5 3.5

nations for these labour market trends are needed. 3.0 3.0
One pattern seems to be that in countries with milder
2.5 2.5
financial imbalance problems, the labour market has
rebounded faster. Because the need for restructuring 2.0 2.0

measures is smaller in these countries, when demand 1.5 1.5

takes off again, companies can rather easily begin 1.0 1.0
rehiring. 98 99 00 01 02 03 04 05 06 07 08 09

Euro zone US
Inflation will remain low Source: ECB, BLS

Discussions of inflation have shifted emphasis in recent

months. As long-term bond yields have fallen and
concerns about the economy have mounted, there has
been a focus on worries about undesirably low inflation.
Meanwhile fears that inflation will be driven by mone-
tary expansion have faded. Actual inflation figures have
not been especially dramatic. Rising energy and food
prices have caused some upside surprises in Consumer
Price Index (CPI) inflation, while core inflation has
continued to fall.
For some time, our view has been that disinflationary
forces caused by large output gaps will dominate the in-
flation trend. The continuous downturn in core inflation
over the past year has confirmed this picture. A new IMF
study also shows that the level of the output gap has
historically been crucial in determining inflation pres-
sure. The study provides no support either for inflation
being a consequence of rapid growth in individual years
(speed limit inflation) or being generated by monetary
expansion, without the presence of underlying condi-
tions related to factors such as capacity utilisation or
wage formation.
Core inflation is continuing to fall
Year-on-year percentage change
3.0
SEB
2.5
forecast
2.0
1.5
1.0
0.5
0.0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Euro zone US
Source: Eurostat, BLS, SEB
Our forecast is that core inflation in the OECD countries
will continue downward in the coming year. Economic
growth is not strong enough to generate any significant
improvement in the labour market situation. The out-
put gap will not close during our forecast period. Pay
increases will thus be low and unit labour costs will also
be pushed down by a recovery in productivity.
On the other hand, we see no major risks of a danger-
ous deflationary trend either. The rate of wage and sal-
ary increases has stopped falling. This will reduce the
risks of a deflationary spiral of falling pay and prices. At
the same time, there are reasons why the disinflation-
ary forces of globalisation will lose energy compared to
the previous decade. The level of wages and salaries in
fast-growing emerging economies seems to be rapidly
on the way up, while currency appreciation and produc-
tivity growth potential will help narrow previously wide
gaps in the cost situation.
Basel III postponed
During the summer, the Basel Committee for Bank-
ing Supervision approved various amendments to the
proposal it submitted late in 2009 for comments by
interested parties. The purpose of the reform package
is to strengthen the resilience of the banking sector by
tightening capital and liquidity requirements, and to
thwart excessive risk-taking, diminish gearing effects
and reduce pro-cyclicality.
The reform package includes definitions of capital and
leverage ratios, liquidity coverage ratios, net stable
3.0 funding ratios and management of counterparty risk.
The details will be presented later this year, and a
2.5
formal decision is expected in November.
2.0
Generally speaking, the standards have been eased,
1.5 while the deadline for implementing them has been
extended from December 2012 to January 2018. Our
1.0
conclusion is that the Committee’s decision was influ-
0.5 enced by last spring’s sovereign debt crisis, combined
with the picture of a sluggish global economic recov-
0.0
ery with downside risks as well as a financial system
that remains weakened.
All else being equal, these amendments will have a
positive impact on our economic scenario. A slower
adjustment process will substantially reduce risks of
poorer access to capital and higher borrowing costs,
which were inherent in the original proposal. Mean-
while, milder capital/credit standards − both station-
ary and flexible − will mean placing greater respon-
sibility on interest rate policy to maintain financial
stability.

Nordic Outlook – August 2010  |  9

 International overview
Central banks will wait until 2012
Increased worries about the economy, combined with
falling inflation expectations, are giving central banks
strong motives for continuing their extremely low inter-
est rate policies. Due to the economic slowdown in the
US, deflationary forces will predominate over the next
couple of years. The crisis-ridden countries of southern
Europe will be strongly dependent on low interest rates
for a long time in order to deal successfully with imbal-
ances in competitiveness and government finances.
Asymmetric risks on the growth side will also help
ensure that central banks will be very cautious. The
consequences of interrupting a nascent recovery by
raising interest rates too early may be relatively large
in a situation where room for fiscal policy manoeuvring
is sharply circumscribed in many countries and the
monetary policy arsenal is also relatively exhausted. We
thus anticipate that the central banks in major OECD
countries will not begin hiking their key interest rates
until early 2012.
Key interest rates
Per cent
7 7
6 SEB 6 3
forecast
5 5
4 4
3 3
2 2
1 1
0 0
00 02 04 06 08 10 12
Euro zone US
Source: ECB, Fed, SEB
A long period of extreme low interest rate policy entails
certain potential risks. Asset prices may once again be
pumped up to unsustainable levels. Economic players
may also be given an inaccurate picture of the normal
cost of capital, which may lead to inefficient capital
allocation. In addition, the banking system may become
too dependent on liquidity supplied by central banks,
with a more poorly functioning interbank market as a
consequence. The postponed launch of Basel III com-
plicates the situation of the central banks, eliminating
instruments for controlling credit growth and asset
prices that might have eased the pressure on interest
rate policy.
At present, the potential problems of low interest rate
policy are relatively minor in relation to the macroeco-
nomic risks of raising interest rates.
Policy dilemma in Norway and Sweden
The differences in the conditions surrounding major
OECD central banks and the central banks in Norway
and Sweden are becoming increasingly clear. For a
long time, Norges Bank has had to deal with a situation
10   |  Nordic Outlook – August 2010
where differences in terms of resource utilisation, the
direction of fiscal policy and the state of the credit and
housing markets have pointed to a substantially higher
key interest rate than that of the ECB. Having begun
its rate hikes as early as October 2009, Norges Bank has
gradually adopted a more cautious strategy. Due to con-
cern about the strong krone and the competitiveness
of Norwegian manufacturers, the bank has not wanted
to open up an excessive interest rate spread over the
ECB’s refi rate.
The Riksbank is now beginning to face a similar dilem-
ma. Resource utilisation in Sweden is admittedly lower
than in Norway, but rapid economic growth is quickly
changing that situation. Unemployment has fallen rap-
idly, while home prices and household borrowing have
continued upward as in Norway.
Key interest rates
Per cent
7 7
6 SEB 6
forecast
5 5
4 4
3
2 2
1 1
0 0
00 02 04 06 08 10 12
Euro zone Norway Sweden
Source: ECB, Norges Bank, Riksbank, SEB
In some respects, the Nordic central banks are playing
a pioneering role when it comes to learning from the
mistakes that preceded the crisis and then applying the
new guidelines that are emerging from the international
monetary policy discourse. What the major countries
mainly perceive as problems in the distant future is
starting to be fairly urgent in the Nordic countries.
Minutes of Riksbank policy-making meetings show major
disagreements of principle within the Executive Board,
which the bank does not try to hide either.
Our scenario is that the Riksbank will hike its key inter-
est rate at each monetary policy meeting until Febru-
ary 2011, when the rate will reach 1.50 per cent. After
that, rate hikes will be more cautious. An international
slowdown, continued low spot inflation and an ever-
stronger krona may be arguments for a more cautious
strategy. At year-end 2011 the repo rate will be 2.25
per cent, and at the end of 2012 it will be 3.0 per cent.
Our forecast is thus lower than the Riksbank’s rate path
but higher than market expectations.
Norges Banks deposit rate will remain at 2.00 per cent
up until the second quarter 2011. A closing output gap
and rising core inflation will thereafter lead to further
gradual hikes. At the end of 2011 we see the deposit
rate at 2.75 per cent and at the end of 2012 at 3.75 per
cent.
 International overview

Different fiscal strategies
The acute crisis in southern Europe last spring led to a
change in view about fiscal policy. The main approach
in earlier recommendations from the OECD and IMF, for
example, has been to focus on credible medium-term
programmes, but implementation could be delayed
until recovery was on firmer ground. It now became
obvious that many countries lacked such room for
manoeuvre. Large-scale austerity packages became
necessary, especially in southern Europe. In France and
Germany, however, austerity measures are rather small.
As a result, the total dose of austerity in the euro zone
will be no more than about 1 per cent of GDP annually
in 2010-12.
Recent budget figures in a number of countries have
been better than expected. In Germany the deficit can
probably be reduced to less than 3 per cent of GDP as
early as 2011. The government had previously aimed at
achieving this level only in 2013. As for the effects of
the austerity packages in southern Europe, it is too ear-
ly to draw any reliable conclusions. The improvements
in Greece, for example, have been sufficient to per-
suade the IMF and EU institutions to approve a second
disbursement of emergency loans. Most of the success
in stopping the bleeding has been on the expenditure
side, while attempts to improve the efficiency of tax
collection have yielded smaller results so far.
Given more pessimistic economic prospects, we are
not likely to see further belt-tightening in the major
OECD countries during the coming year. In the UK, the
new government has admittedly decided to deal with
its large fiscal deficits at an early stage. In the US and
Japan, however, new stimulus measures are the focus
of attention, although in our judgement such measures
will hardly be implemented.
many countries will to a large extent postpone fiscal
adjustment needs.
Low bond yields
The decline in long-term bond yields has been very
sharp, and yields are now exceptionally low. American
10-year government bond yield has fallen from 4.0 per
cent in April to 2.60 per cent, while equivalent German
bonds have now declined to an exceptionally low level
of 2.25 per cent.
There have been several driving forces behind this
yield trend: concerns about economic growth, falling
inflation expectations and “promises” of continued low
key interest rates. The search for safe investments has
also benefited the fixed income market, despite large
and growing government debts on both sides of the
Atlantic. A very rapid increase in private savings − dur-
ing the economic crisis, savings in the OECD countries
have risen by about 10 per cent of GDP − has offset
the increased public sector borrowing requirement and
helped squeeze interest rates.
The box below discusses how asymmetric downward
risks both on the growth and inflation side will probably
lead to long-term uncertainty about the ability of cen-
tral banks to normalise monetary policy. We expect this
uncertainty to help keep long-term yields depressed,
especially in the coming year. German 10-year yields
will bottom out at about 2.20 per cent around year-end
2010 and remain below 2.50 per cent well into next
year. Only when it begins to be apparent that central
banks can actually begin interest rate hikes do we be-
lieve any significant upturn will occur. Long-term yields
will remain depressed, however. At the end of 2012,
German 10-year government bond yields will stand at
3.20 per cent and American ones at 3.50 per cent.

10-year government bond yields

Net lending Per cent
Per cent of GDP 7.0 7.0
2010 2011 2012
6.5 6.5
SEB
United States -10.9 -8.2 -5.9 6.0 forecast 6.0

Japan -9.8 -9.1 -8.5 5.5 5.5

5.0 5.0
United Kingdom -11.4 -9.4 -7.6 4.5 4.5
Euro zone -6.2 -5.5 -5.0 4.0 4.0
3.5 3.5
OECD -7.8 -6.7 -5.5
3.0 3.0
2.5 2.5
Source: OECD, IMF, SEB
2.0 2.0
99 00 01 02 03 04 05 06 07 08 09 10 11 12
At the global level, we expect fiscal policy to have a
weakly tightening effect in the next couple of years. US Germany
Source: Reuters EcoWin, SEB
This means that deficits will only shrink slowly and
that government debt will continue to grow. The sharp Cautious stock market valuations
downturn in government bond yields in major countries The stock market has recently reacted negatively to
indicates that mistrust from financial markets will not signals of an American economic slowdown. Surpris-
force belt-tightening either. Not even threats of down- ingly strong company earnings reports have not been
grading by credit rating agencies are likely to change enough to offset this. There are both threats and
the picture. Given continued weak economic condi- opportunities ahead. The ‘simple’ phase when the
tions, high private saving and supportive central banks stock market was driven upward by positive surprises

Nordic Outlook – August 2010  |  11

 International overview
in sales and improved leading indicators is over. The
next phase will be characterised by a maturing mar-
ket for industrial products, with major macroeco-
nomic challenges, especially in the US. Companies
must now deliver good profits driven by sales growth
rather than cost savings, in order for share prices to
continue rising.
So far the stock exchanges in the Nordic and Baltic
countries have generally performed better than ex-
changes elsewhere this year. There are several rea-
Moving towards Japanese yields?
The key interest rates set by central banks are at
exceptionally low levels. But bond yields are also
historically very low, with American 10-year Treasuries
yielding 2.6 per cent and equivalent German bonds 2.2
per cent. By way of comparison, a Japanese 10-year
bond is at just below 1 per cent and has fluctuated
between 1 and 2 per cent for the past 13 years.
Above we discussed the forces that have pushed down
long-term yields to these levels. One crucial question
is how long they will last, and to what extent today’s
interest rates in the Western world are abnormally low
or completely normal. This can be analysed in terms
of normal key interest rates and the normal steepness
of the yield curve.
The level of a normal key interest rate can be based
on the level of the real interest rate plus inflation
expectations. A proxy for the real interest rate is
long-term GDP growth. Given the need to adjust
imbalances, there is reason to expect lower growth
potential, which will push down the real interest rate.
In the medium term, inflation pressure will remain
low. Given asymmetric negative risks for both growth
and inflation, uncertainty will continue as to whether
central banks will actually achieve their inflation
targets. Inflation expectations may thus fall below
inflation targets, which will also push down the normal
interest rate.
Japanese interest rate squeeze
Short- and long-term interest rates in US and Japan
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
88 90 92 94 96 98 00 02 04 06 08 10
Japan: 10-year government yield
Japan: Key interest rate
US: Key interest rate
US: 10-year government yield
Source: Reuters EcoWin
Given exceptionally low key interest rates during the
next couple of years − Japan can serve as an example
12   |  Nordic Outlook – August 2010
sons why they may continue to do so. SEB Enskilda’s
company analyses indicate a 56 per cent increase
in profits this year for companies listed in the
Nordic countries and 17 per cent next year. Strong
growth in key Nordic markets, Germany and Asia
will improve the profit outlook in the next couple
of years. Low company valuations also allow room
for good share price increases. Shares on the Nordic
exchanges are now trading at a price-earnings ratio
of 10.5 (based on expected 2012 profits) − well be-
− the average key interest rate will have been very
low for a rather long time. The market’s assessment
of what should be viewed de facto as a normal key
interest rate will probably move downward as the
period of low interest rates is extended. In addition,
it is reasonable to assume that new regulatory tools
for dealing with such problems as pro-cyclical forces
in the financial sector will make it easier for central
banks to maintain low interest rates and to instead
devote monetary policy energy to price stability.
Japan’s average GDP growth since the early 1990s is
1.2 per cent. Even if we assume that growth moves
higher, for example close to 2 per cent, there is still
reason to believe that continued imbalances justify
a lower real interest rate than 2 per cent. If we also
foresee that inflation expectations may become lower,
for example 1 per cent, the normal key interest rate
will be pushed down further. In a medium- term per-
spective, the normal key interest rate might be in the
1.5-2.5 per cent interval.
Normal long-term yield is based on the level of the
normal key interest rate. The historical average for
the steepness of the yield curve (10-year yield minus
the key interest rate) has been about 130 basis points.
This applies to most countries − the US, Germany and
Japan. This differential also includes an inflation risk
premium. Studies of the Fed show that the inflation
risk premium is about 50 basis points. A low-inflation
environment may justify lowering the risk premium.
If in our example we assume that this premium is
halved, the differential between the key interest rate
and the low-term yield will be about 100 basis points
(130 minus 25 basis points).
Based on this reasoning, long-term bond yields would
be at 2.5-3.0 per cent. Arguments that the market
will adjust expectations of a normal key interest rate
downward are relatively strong in a medium-term five-
year perspective, where the elements of similarities
with the Japanese situation may be clear. What may
be regarded as abnormally low interest rates, viewed
in a historical perspective, may be rather normal
interest rates viewed in a future perspective.
 International overview

low their historical average. Worth adding is that the rates). In the short term, uncertainty about the
ratio between share prices of listed companies and global economic recovery will dominate the for-
their book values is 25 per cent below its 10-year eign exchange market, but we believe that market
average. positioning is now more neutral than for a long time,
which will restrain movements in the future. We thus
Stock market indices, 2010 see various reasons why the trend towards smaller
Spain (MadSE)
fluctuations in the foreign exchange market will
Japan (Nikkei 225) continue.
Norway
U.K. (FTSE100) The risk aversion evident in the market over the past
USA (S&P500) few months has led to heavy demand for defensive
Germany (DAX) currencies like the JPY and CHF. Shrinking interest
Sweden
rate spreads against the US and euro zone will lead
Finland
to continued upward pressure on these currencies,
Denmark
Iceland (OMX) but the Swiss central bank has not repeated its
Lithuania (OMX) foreign exchange market interventions of last spring,
Estonia (OMX) despite an ever-stronger CHF. Nor do we regard this
Latvia (OMX) as likely in the future. In Japan, the issue of inter-
-30 -20 -10 0 10 20 30 40 50 vention is heating up. Our assessment is that if the
USD/JPY exchange rate approaches its historical
low of just under 80 (in 1995), this will be critical in
The yield on listed shares in the Nordic countries determining whether the Bank of Japan intervenes in
during the next couple of years looks set to be at the foreign exchange market.
almost 4 per cent, or twice the yield on 5-year go-
vernment bonds. This also illustrates the exchange’s Overall, our forecast implies small movements in
cautious valuations. But valuation analyses are leading currencies during the coming year. The EUR/
not better than the forecasts that are used in the USD exchange rate may again fall below 1.20 in the
models. The assumption is that next year, profits will next six months, driven by continued low risk ap-
have rebounded above their previous record levels petite in the world economy, then rise somewhat.
in 2007/2008. The uncertain macroeconomic envi- In the long term we expect the EUR/USD rate to be
ronment raises the question of whether this pace at levels around 1.20-1.30. The US economy will
in improved profits will continue. If investors are to admittedly remain weak and continue to show ex-
focus again on fundamental valuations, a number of ternal trade imbalances, but on the other hand the
basic questions about future developments must be euro system is facing long-lasting uncertainties and
answered. quandaries. The yen will gain some strength against
P/E ratios in Nordic exchanges the USD in the short term but will then decline as
35.0 35.0
the interest rate spread between Japan and other
countries widens again in the future.
30.0 30.0
EUR and USD
25.0 25.0 Real effective exchange rates. Index 100 = average 1980-2010
140 140
20.0 20.0
130 130
15.0 15.0
120 120

10.0 10.0 110 110

100 100
5.0 5.0
90 90
0.0 0.0
96 98 00 02 04 06 08 10 12 80 80

70 70
1980 1985 1990 1995 2000 2005 2010
Fair valuations, more stable currencies
In the past year, the foreign exchange market has USD EUR
Source: Bank of England
undergone a normalisation process after major tur-
The question of further quantitative easing by cen-
bulence during the most acute phase of the financial
tral banks is a source of uncertainty in the foreign
crisis. Many currencies have again reached more
exchange market. If the Fed or Bank of England were
neutral levels, based on long-term valuation mod-
to expand their balance sheets further, it would
els. Today the G3 currencies (EUR, USD and JPY) are
weaken the dollar and pound, but this is not our
close to historical average levels in trade-weighted,
main scenario at present.
inflation-adjusted terms (real effective exchange

Nordic Outlook – August 2010  |  13

 International overview
Commodity-producer currencies with relatively high
valuations are extra sensitive to the global slow-
down. Yet the trend towards appreciating currencies
in emerging economies will continue, driven by such
factors as the search for higher returns.
Since June, when China’s central bank resumed
the appreciation of the yuan against the USD, the
Chinese currency has strengthened by less than 1 per
cent. Worries about speculative currency inflows
have contributed to this caution. In addition, the
CNY has strengthened by more than 5 per cent in the
past year in trade-weighted terms as a consequence
of the USD recovery. However, we expect an increase
in the pace of appreciation to about 5 per cent,
resulting in a USD/CNY exchange rate of 6.00 by the
end of 2012. This forecast is nevertheless dependent
on the movements of the USD against other curren-
cies; Chinese authorities are very likely to keep close
track of the yuan’s movements in terms of a trade-
weighted basket. Adjustments to the imbalances
in real exchange rates will also occur by means of
rapid wage increases in China. The ongoing internal
revaluation process will thus determine the size of
nominal changes in the exchange rate.
SEB EUR/SEK model
12.0
11.5
11.0
10.5
10.0
9.5
9.0
07 08 09 10
Regression Actual
Source: Reuters EcoWin, SEB
The Swedish krona and the Norwegian krone have
recently demonstrated great stability. Underlying
economic strength and rising key interest rates have
prevented the weakening that normally occurs in
troubled times. Looking ahead, we expect the two
currencies to continue trending higher. By year-end
2012 the EUR/NOK exchange rate will be 7.80. In
the short term, however, we see reasons for a slight
weakening of the krone to 8.20 per euro at the close
of 2010, among other things because Norges Bank is
continuing its cautious strategy of emphasising the
risks of an excessively strong currency.
The strengthening of the Swedish krona also risks
being halted by international worries, as well as
by increased political uncertainty related to the
September 19 parliamentary election. We neverthe-
less expect such effects to be very short-lived, and
we are sticking to our forecast that the EUR/SEK
14   |  Nordic Outlook – August 2010
exchange rate will reach 9.00 at the end of 2010.
After that, we foresee room for a slight further ap-
preciation, with the EUR/SEK rate standing at 8.75
by late 2011.
The economic policy framework
Both the European Union (EU) and the Group of 20
(G20) countries are continuing their efforts to improve
the stability and credibility of public finances. As a
reaction to the severe fiscal crisis this past spring, the
European Commission presented a proposal on June
30 for strengthening economic policy coordination. Its
overall purpose is to strengthen budget discipline in the
EU. The proposal includes five areas:
1. Macroeconomic surveillance (warning system: score-
board) 2. Stronger fiscal frameworks 3. Greater focus
on debt levels 4. Wider sanctions 5. Economic policy
coordination
The final point will include the launch of a new yearly
process in 2011, aimed at increased fiscal policy inte-
gration. The basic idea is to enable the Commission
and other EU institutions to influence national decision
making in a way that does not challenge the sovereignty
of national parliaments on budget policy issues: by
means of collaboration in the form of problem analysis,
12.0 consistency tests and recommendations.
11.5 Already under way is an equivalent Mutual Assessment
Process (MAP) for the G20 countries, which will be
11.0
coordinated by the IMF. MAP is a key element of the G20
10.5 countries’ efforts to find a framework that will promote
sustainable and balanced economic growth at global
10.0 level. The G20 meeting in Seoul on November 11-12 will
provide an important opportunity to gauge the level of
9.5
potential coordination and the pace of reform.
9.0
The economic crises have also fuelled an intensive
international debate concerning the role of central
banks. This debate is being pursued within the G20 and
other forums under IMF leadership. There seems to be
a consensus that price stability will remain the overall
goal of monetary policy, but that financial trends and
risks should be integrated into goal formulation to a
greater extent.
The main responsibility for financial stability will
continue to lie outside of interest rate policy. This will
require new instruments with a clearer macroeconomic
connection. These will mainly consist of regulations and
standards for the financial sector aimed at preventing
systemic crises and reducing pro-cyclical elements in
lending. Concrete examples are capital requirements
that are both constant and variable over time, forward-
looking reserves for loan losses and liquidity ratios.
The UK has taken a major step by placing its regula-
tory authority under the umbrella of the central bank.
Within the Bank of England, an independent Financial
 International overview

Policy Committee (FPC) is now being established along-

side the existing Monetary Policy Committee (MPC).
The FPC will oversee economic developments and
identify macro trends that may threaten economic and
financial stability, then take relevant action.

Our conclusion is that the interesting reform task in the

area of economic-policy is continuing, but that its ambi-
tions and pace seems to have been lowered. A fragile
economic situation, but also the weakened authority of
political leaders in many countries, is contributing to
this.

Nordic Outlook – August 2010  |  15

The United States

Recovery continuing, but at a slower pace

ƒƒ Faster debt retirement Many signs of deceleration

Aside from slower GDP growth and a lukewarm labour
ƒƒ New labour and housing market slump
market, various indicators have weakened in recent
ƒƒ Sustained upturn in capital spending months. Consumer confidence has fallen and is now
ƒƒ Inflation will continue to fall lower than at the beginning of 2010. The ISM purchasing
managers’ index for manufacturing has fallen during the
ƒƒ Fed will not hike its key rate until 2012 past few months, while the service sector index has lev-
elled off, but both indices remain well above 50, which
indicates growth. Weaker optimism is also reflected in
The American economic recovery is now becoming retail sales, which recovered strongly early this year
weaker, as fiscal stimulus measures fade and the growth but have stagnated during the past months.
contribution from the inventory cycle diminishes.
The improvement in the labour market has slowed in Small firms are lagging behind
Index
recent months, and the housing market has become
65 30
shaky again now that the federal tax credit for first-
time home buyers has expired. GDP rose 1.6 per cent 60 25
in the second quarter on an annualised basis, a clear 55
20
slowdown from 3.7 per cent in the first quarter. Sharply
50
higher imports provided a strong negative contribution 15
45
to growth and inventory build-up also slowed, compared
10
to the first quarter. Capital spending by businesses 40
showed strong growth, however. 35 5

Yet the low Federal Reserve key interest rate is still 30 0

86 88 90 92 94 96 98 00 02 04 06 08 10
propping up the economy. We thus believe that the
recovery will continue, but at a slower pace than esti- ISM Manufacturing (LHS) NFIB (RHS)
Source: ISM, NFIB
mated in our May forecast. GDP growth will climb 2.6
per cent in 2010 and by 2.2 per cent in 2011. 2012
GDP will grow 2.9 per cent. The risk in this growth There is a persistent confidence gap between large and
forecast is on the downside. The slowdown has opened small businesses. While the ISM, which is dominated
the way for the Fed to provide further economic stimu- by large companies, continues to show a rather bright
lus by expanding its balance sheet and postponing key picture of the situation, the National Federation of In-
rate hikes until 2012. dependent Business (NFIB) index of small business senti-
ment is at a record low. This may partly reflect the fact
Slower GDP growth that small businesses are still having difficulty obtaining
Quarterly percentage change, annualised loans and that depressed construction companies weigh
5 5 heavily in the NFIB index.
4 4
3 3 Higher saving holds back consumption
2 2 The latest national accounts show substantially weaker
1 1 consumption and higher saving than the previously
0 0 reported figures. In the second quarter, the household
-1 -1 savings ratio was 6.1 per cent, an upward revision of
SEB forecast
-2 -2 several percentage points. A higher level of saving indi-
-3 -3 cates a faster pace of adjustment in household balance
-4 -4 sheets. In the long term this will set the stage for a
-5 -5 sustainable recovery in consumption, but over the next
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
couple of years we believe that the need to pay down
09 10 11 12
Source: BEA, SEB debts will cause the savings ratio to continue upward a
bit, thereby holding back consumption.

16   |  Nordic Outlook – August 2010

 The United States

Our current assessment is that the savings ratio will accelerated their home purchases to take advantage of
gradually rise to around 8 per cent during 2011, far the tax credit. Once this effect has faded, the number
above the average of the past 15 years. This is also of home sales transactions will stabilise. During 2011 we
consistent with our model projections, which have sig- thus expect slightly rising home prices.
nalled for some time that the savings ratio will rise to
The housing market recovery decelerates
a level closer to the average for the past 50 years. We
Index 2004:1 = 100
thus believe that overall consumption will increase 140 140
by 1.5 per cent in 2010 and 2.2 per cent in 2011, a 135 135
downward revision compared to our assessment in 130 130
the last Nordic Outlook. 125 125
120 120

Uniform pace of debt retirement 115 115

110 110
Per cent of disposable income
140 12 105 105

11 100 100
130
10 95 95
120 9 90 90
110 8 04 05 06 07 08 09 10
7
100 S&P Case-Shiller 20 FHFA
6 Source: OFHEO, Standard & Poor's
90 5
80 4 The July issue of the Fed’s Beige Book points out that
3 the commercial real estate market remains weak.
70
2
Assessments of future trends ranged from continued
60 1
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
decline in activity to weak growth, but one bright spot
is that corporate capital spending on commercial real
Household debts (LHS) Household saving (RHS) estate appears to have stabilised.
Source: Federal Reserve

Housing market unsteady again Company capital spending a bright spot

Despite record-low interest rates, pushed down partly One bright spot during the recovery this year is capital
by the Fed’s mortgage bond purchases, and a subsidy in spending by businesses, which has climbed sharply in
the form of a USD 8,000 federal tax credit to home buy- 2010. During the second quarter, the annualised in-
ers, the housing market recovery has not really taken crease was 17.6 per cent. This growth in capital spend-
off in earnest. In May 2010, the S&P/Case-Shiller home ing focused on machinery and software. Commercial
price index was only some 5 per cent higher than when real estate investments were stable. The sharp increase
it bottomed out one year earlier. The number of home during the second quarter was partly a consequence of
sales and housing starts are also at historically very low earlier very depressed levels. Our assessment is thus
levels. In July the number of housing starts was only that capital spending growth will slow during the rest
546,000, less than one third of the July average from of the year, but in a longer perspective there are fac-
2003 to 2005. Despite the low number of homes being tors that indicate good capital spending growth. In a
built, during 2010 inventory has fluctuated around eight historical perspective, the capital spending ratio in the
months. In July, inventory rose to 12 months. Such a business sector remains very low. Meanwhile companies
high level will help hold prices and new construction are earning good profits and their balance sheets are far
down. Because the home buyer tax credit expired at stronger than during any previous economic downturn.
the end of April, both residential construction and the Capacity utilisation and company capital spending
number of contracted home sales have weakened mark- Per cent
edly during the past few months. Mortgage applications 90.0 40
are at a record low. The National Association of Home 87.5 30
Builders index of construction industry confidence has 85.0 20
also declined. 82.5
10
80.0
0
It is difficult to foresee any immediate improvement 77.5
in the housing market. We anticipate that the rapid -10
75.0
decline in the number of sales will drive down prices 72.5 -20

during the next few months. Housing market activity 70.0 -30

will also be hampered by the slow recovery in the la- 67.5 -40
70 75 80 85 90 95 00 05 10
bour market, but low mortgage rates should be able to
serve as a floor under the housing market. The 30-year Capacity utilisation (LHS)
mortgage rate has decreased from around 5 per cent Company capital spending, annualised Q growth (RHS)
Source: BEA, Federal Reserve
in April to just below 4 per cent. Many households also

Nordic Outlook – August 2010  |  17

 The United States
High imports weaken trade balance
Despite a sharp deterioration in public finances, in the
past few years there has been a trend towards improve-
ment in the US current account balance, due to sharply
higher saving by both businesses and households.
Recently, however, trade imbalances seem to have
widened again. The improvement in the balance of
trade has been replaced by rising deficits. In June the
trade deficit was nearly USD 50 billion, the largest since
October 2008. The much-publicised deficit with China
has increased greatly in recent months and was just
above USD 26 billion in June. If it does not fall during
the autumn, the slow appreciation of the Chinese yuan
may become a hot issue in the campaign leading up to
November’s congressional elections.
Current account and budget balance
Procent of GDP
5.0
2.5
0.0
-2.5
-5.0
-7.5
-10.0
-12.5
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Current account Federal budget balance
Source: BEA, US Department of the Treasury
Because imports rose far more rapidly than exports,
foreign trade made a large negative contribution to GDP
growth during the second quarter. Export growth is ex-
pected to decelerate faster than import growth, which
means that US economic growth seems unlikely to get
any help from foreign trade in the next few quarters.
Labour market disappointments
After a fairly positive trend during the spring, the
labour market has now lost momentum and the most
recent reports have been clearly disappointing. The
recovery is moving slowly, and unemployment remains
very high. From a peak of 10.1 per cent in October
2009, the jobless rate had only fallen to 9.5 per cent
in July: far from the equilibrium unemployment level,
which is around 5 per cent.
Total employment increased sharply during the spring,
but this was primarily due to the large number of peo-
ple with temporary jobs with the 2010 US Census. For
example, around 410,000 people out of a total increase
of 432,000 jobs in May could be explained by Census
effects. Employment in the private sector is showing a
substantially more subdued trend, although the number
of people with jobs has now risen for seven months
in a row. In the most recent three-month period, job
growth has been only 50,000 people per month, far
lower than the underlying increase in the labour supply.
Actual unemployment has nevertheless continued to fall
18   |  Nordic Outlook – August 2010
slightly, because the increase in the labour force that
was discernible early in 2010 was followed by a decline
during the past three months.
Unemployment and private sector employment
10 116
9 115
8 114
7 113
6
112
5
111
4
110
3
109
2
1 108
0 107
07 08 09 10
Unemployment, per cent (LHS)
Private sector employment, millions of individuals (RHS)
Source: BLS
5.0
Because of their weak finances, state governments can-
2.5
not contribute to the labour market recovery. In July,
0.0 the number of state and local government employees
-2.5 fell by nearly 50,000. The federal government has ap-
-5.0
proved a USD 26 billion aid package to ease the fiscal
plight of state governments, but many of them will
-7.5
need to continue trimming their payrolls.
-10.0
One new phenomenon during the latest American eco-
-12.5
nomic downturn is the scale of chronic unemployment.
The share of unemployed people without a job for 27
weeks or longer is now around 45 per cent. This is the
highest level recorded since such statistics began to be
collected in 1948. In response to this chronic unemploy-
ment, the maximum period for benefit payments has
been extended.
One positive sign in the labour market is the increase in
the number of hours worked during the past year. This
increase indicates continued expansion in employment.
Forward-looking indicators also hold out some hope of
future improvements in the labour market. The employ-
ment sub-index of the ISM survey clearly indicates that
manufacturing employment will continue to increase.
There is also job creation in the private service sector.
The construction sector, however, remains depressed
and its number of employees has again begun to fall in
recent months. Our overall assessment is that employ-
ment will continue to increase, but at a slow pace.
Unemployment will continue to fall and will be just
above 9 per cent at the end of 2010 and 8.5 per cent
at year-end 2011.
Inflation will continue to fall
The slow labour market recovery and high unemploy-
ment are holding down inflation pressure. Despite an
increase in manufacturing activity, capacity utilisation
remains well below normal. Unit labour costs have fall-
en rapidly in recent years, and the historical association
between unit labour costs and inflation is strong. Falling
bank lending and the low rate of increase for M2 money
 The United States

supply reinforce the picture of continued low inflation ate future, but we also expect it to bottom out dur-
pressure. ing 2011 and then slowly rise. Altogether, we expect
inflation to end up at 1.6 per cent this year and 0.8
Strong connection between inflation and unit
per cent next year. In 2012, inflation will rise to 1.2
labour cost
per cent.
Year-on-year percentage change
15.0 15.0 Low inflation pressure
12.5 12.5 Year-on-year percentage change
6 6
10.0 10.0
5 SEB 5
7.5 7.5 forecast
5.0 5.0 4 4
2.5 2.5 3 3
0.0 0.0 2 2
-2.5 -2.5
1 1
-5.0 -5.0
0 0
50 55 60 65 70 75 80 85 90 95 00 05 10
-1 -1
CPI inflation Unit labour costs
Source: BLS -2 -2
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
During the last four months core inflation has been at
0.9 per cent. Such a low level has not been recorded Core inflation Headline inflation
Source: US Department of Commerce, SEB
since the 1960s. CPI inflation has fallen during 2010 and
was at 1.2 per cent in July. Our forecast is that core
inflation will fall a bit further, bottoming out at 0.5 per A dilemma for the Fed
cent in mid-2011. Then core inflation will slowly climb Because of large US government debt, the chances of
again, ending up just above 1 per cent at the close of further fiscal stimulus are slim. If the recovery con-
2012. CPI inflation may climb somewhat in the immedi- tinues to weaken, the Fed will thus be under increas-

An unusual recovery
The National Bureau of Economic Research (NBER)
is the agency that officially establishes the dates of
US economic cycles. Although the agency has not yet
declared that the recession is over, the general per-
ception is that it ended in the summer of 2009. The
recovery has thus lasted four quarters so far. On the
other hand, economic developments have diverged
from the “normal” cyclical pattern, which is probably
the reason why the NBER is hesitant to declare that
the recession is over.
Since the Second World War, annualised GDP growth
has averaged 6 per cent at this point in the economic
cycle, compared to 1.6 per cent during the second
quarter of 2010. Looking back at more than half a
recessions have often been caused by excessive inven-
tories and exaggerated optimism among investors. This
time, the recession has instead centred on a severely
wounded banking system as well as on household bal-
ance sheets and debt retirement. When the dotcom
(IT) bubble popped in 2001, household balance sheets
experienced a shock, but an expansionary monetary
policy quickly helped the housing market to soar.
An unusually sluggish recovery
Total number of employed, index=100 in the quarter
preceding the beginning of the recession
102.5 102.5
1974 1990
1981
100.0 2001 100.0

century of data, two and a half years after a recession

started the GDP level has averaged 8 per cent above 97.5 97.5
the previous peak.

Today’s weak labour market also diverges from the 95.0 Current 95.0

historical pattern. The previous two recessions were

admittedly also characterised by relatively long 92.5 92.5
periods before job creation began to prevail, but the 0 5 10 15 20 25 30 35 40 45
Source: BLS
latest recession is unique in terms of its combination
of depth and length. And without the support of a The NBER focuses mainly on four variables in assess-
stronger labour market, the American economy will ing economic cycles: sales, employment, industrial
have a difficult time reverting to its normal recovery production and income. Of these, the first two have
dynamic. fallen in recent months while the latter two have
levelled off at slow speed. In such a situation, it is
This recovery does not resemble others, due to the natural to be cautious in making assessments.
causes of the economic crisis. Short, shallow post-war

Nordic Outlook – August 2010  |  19

 The United States
ing pressure to act, but the central bank has limited
potential for increasing its stimulus. The federal funds
rate is in the 0-0.25 per cent interval and cannot be cut
further. As early as March 2009 the Fed also pledged to
keep its key rate at an exceptionally low level for an
“extended period”. The remaining weapon in the Fed’s
arsenal is thus to expand its balance sheet by purchas-
ing securities.
The Fed's balance sheet
USD trillion
2.50
2.25
2.00
1.75
1.50
1.25
1.00
0.75
07 08 09 10
Source: Federal Reserve
At its interest rate meeting in August, the Fed con-
firmed that the US economic recovery has slowed down
and outlined a new monetary policy strategy. The
central bank decided that it will keep its balance sheet
at the current level, instead of shrinking it over time.
Its interest revenue and the principal it receives back as
its existing stock of mortgage bonds matures will thus
be reinvested in government securities. In itself, this
decision does not signify any new stimulus, but it sends
a clear signal that monetary policy has now become
more dovish and that a key rate hike is very distant.
The Fed has shifted from a situation where it had begun
preparing for normalisation of monetary policy to one
of paving the way for possible further stimulus.
If the recovery should weaken even more, the shift in
Fed strategy has opened the door for further quantita-
tive easing (QE), thereby pushing down market interest
rates. Inflation pressure remains very low, and the risk
of deflation has not disappeared, but there is reason
for the Fed to hold off on QE for the time being. To
begin with, interest rates are already falling due to
market forces. Furthermore, inflation expectations are
admittedly low, though they have not yet approached
deflation levels. By purchasing government securities,
the Fed also risks being criticised for monetising the
US federal budget deficit. A more far-reaching ques-
tion is how much stimulus effect the Fed can expect
to achieve by further squeezing interest rates that are
already extremely low.
Our assessment is thus that the Fed will hold off on
further stimulus during the next several months but
may implement such measures later this autumn if the
state of the economy deteriorates substantially. Our
20   |  Nordic Outlook – August 2010
forecast is that the Fed’s first key interest rate hike
will occur during the first quarter of 2012 and that
the federal funds rate will stand at 1.25 per cent by
the end of 2012.
Obama faces uphill political battle
President Barack Obama’s public approval rating has
fallen sharply. When he took office in January 2009,
a Gallup poll on whether the president was doing a
good job or a bad job gave him a 68-21 per cent score.
Today’s polls give him 41-52. Despite the passage of
2.50
historic health care and financial sector reforms, the
2.25 new president has not managed to live up to people’s
expectations. High unemployment and last year’s bank-
2.00
ing sector bail-out have soured many voters on the
1.75 Obama administration.
1.50
This decline in public confidence is so large that it is
1.25 jeopardising continued Democratic control of the House
1.00
of Representatives following the November 2 mid-
term election. It is nothing unusual for an incumbent
0.75 president’s party to lose seats in Congress, but our
analysis (see chart) shows that the Democrats will only
barely retain control of both houses. With a weakened
president, Washington risks political paralysis until the
autumn 2012 presidential election. This is occurring in a
situation where both the American economy and global
cooperation efforts are in great need of clear US politi-
cal leadership.
Democratic control of House of
Representatives in jeopardy
10
0
30 35 40 45 50 55 60 65 70
-10
-20
-30
Democratic projected
-40
seat loss
-50
-60
Number of seats gained/lost (vertical axis)
Presidential approval rating, per cent (horisontal axis)
Source: Gallup.com, SEB
Today’s US domestic political scene is dominated by
discord and by Republican attempts to stop or at least
stall reforms. There is also disagreement as to whether
the economy needs further stimulus, or whether belt-
tightening is required. The Republicans oppose further
fiscal stimulus and question the size of the positive im-
pact from earlier stimulus packages. Even among Demo-
crats and the general public, there are doubts about
the need for further stimulus measures. The pendulum
thus seems to be swinging towards support for greater
austerity. Obama’s plan for another large-scale stimulus
package has undergone radical cuts. The extension of
unemployment benefits to 99 weeks was pushed through
only with great difficulty.
 The United States

Fiscal policy difficult to assess pursuing an exceptionally accommodative policy, in-

The political situation has made it more difficult to as- cluding zero interest rates and a possible expansion of
sess US fiscal policy. For example, it is unclear whether the central bank’s balance sheet.
the tax cuts implemented by President George W. Bush,
The budget deficit during the fiscal year 2009 ended up
which expire at the end of 2010, will be extended.
at just above USD 1.4 trillion, equivalent to nearly 10
The Republicans want to retain the tax cuts, while
per cent of GDP. The budget deficits in fiscal 2010 and
the administration and most Democrats only want to
2011 will be lower than in our May forecast. The defi-
retain the cuts for people who earn a maximum of USD
cit will end up around USD 1.4 trillion this year and just
250,000 per year. In August, the independent Congres-
below USD 1 trillion next year. In fiscal 2012 the deficit
sional Budget Office warned that extended tax cuts
will shrink further.
for all income groups would seriously worsen the fiscal
outlook, but our overall assessment of fiscal policy has
not changed especially much since May. We expect
federal stimulus measures to contribute 1 percentage
point to 2010 growth and -0.5 points in 2011. Given our
US economic forecast, the phase-out of fiscal stimulus
will put the Fed under additional pressure to continue

Nordic Outlook – August 2010  |  21

Japan

Strong currency leads to policy dilemma

ƒƒ Brisk exports, but strong yen an obstacle
ƒƒ Continued deflation pressure
ƒƒ BoJ will hike key rate only in 2012
The Japanese economy showed unexpected strength
around year-end and early in 2010, but second quarter
growth was a big disappointment. GDP growth was a
mere 0.1 per cent, raising questions about the strength
of the recovery. The GDP figure should not be over-
interpreted; quarterly statistics are often erratic, and
leading indicators like the Tankan Survey from the Bank
of Japan (BoJ) point to continued decent growth in
the near future. But there are also worrisome signs,
among them that the housing and construction industry
as well as retail sales seem to have lost momentum.
PPP). The euro zone economic crisis, combined with
uncertainty about the American economy, has quickly
resulted in a clear appreciation of the yen. The USD/
JPY exchange rate has moved from over 90 in January
to just above 85 today. The yen has also strengthened
against the euro: from about 130 per EUR in January
2010 to about 112 today. In spite of this, the yen is
not unjustifiably expensive at present, but given our
forecast that the USD/JPY will approach 80 (the yen’s
highest value since 1995), official intervention in the
foreign exchange market cannot be ruled out.
USD/JPY rate follows relative prices
325
300 255
275
230
250
225
205

200 180
Exports and industrial production have bounced back 175 155
after last year’s dramatic fall. Due to high growth else- 150
130
where in Asia, combined with a favourable product mix 125
in trade with the US, exports will rise by about 20 per 100 105

cent this year. 75 80

75 80 85 90 95 00 05 10
Despite the weak second quarter, we foresee that
USD/JPY, Yen per dollar (LHS)
consumption will continue to be sustained by govern- Relative prices, Japan compared to US, Jan. 2010=100 (RHS)
ment stimulus measures totalling about 7 per cent of Source: Reuters EcoWin

GDP over the period 2008-2010. Private consumption
will increase by nearly 2 per cent this year, the fast-
est rate since 1996. We predict GDP growth of 2.5 per
cent this year, the same forecast as in May.
A slight cooling in global demand, the lagging effects
of yen appreciation so far this year and the phase-out
of stimulus measures will lead to a deceleration late
this year and in 2011. Export growth will slow to about
5 per cent in 2011, capital spending growth to about
4 per cent and consumption growth to less than 1 per
cent. Overall, GDP growth will fall to 1.5 per cent in
2011 as well as 2012.
Unemployment has risen in recent months (currently
5.3 per cent), which risks blunting the consumption
upturn. We expect GDP growth to be close to or just
above trend during the next couple of years, which
means that unemployment will move sideways.
Due to the strong yen and the trend towards weaker
global demand, Japanese policy makers will face new
challenges. The government, also confronted by falling
stock prices, will seek to have new stimulus measures
outlined by late August. We expect a budget deficit
equivalent to about 8 per cent of GDP this year,
somewhat lower in 2011-2012. Government debt is ap-
proaching 200 per cent of GDP. This difficult situation
must be managed in an uncertain political landscape.
The Social Democratic Party recently withdrew from the
governing coalition and in June the former finance min-
ister, Naoto Kan, became Japan’s fifth prime minister
since 2006. The Bank of Japan will raise its key interest
rate to 0.5 in 2012.

Inflation pressure will remain very low. CPI will decline

by 1.0 per cent this year and end up around zero in
2011. A lower inflation trend than in other countries is
reflected in the long-term strengthening of the yen (in
keeping with the theory of purchasing price parity,

22   |  Nordic Outlook – August 2010

 Asia

Slight deceleration in growth

ƒƒ Slowdown from high level
ƒƒ Balanced growth in China
ƒƒ Monetary tightening needed in India
Asia’s emerging countries have shown good resilience
in the face of global recession, recovering far more
rapidly than the OECD countries. Good central govern-
ment finances have made it possible for them to launch
stimulus packages, and their export-driven economies
have benefited from the global trade recovery. Howev-
er, there are signs that the recovery that started during
the second half of 2009 is now slowing a bit. In China,
there was a welcome deceleration in economic activity
during the second quarter of 2010. The latest outcomes
for industrial production, exports and purchasing man-
agers’ indices also indicate a slowdown in such econo-
regulation of home sales, seem to have had an effect.
Various indicators are also showing continued decelera-
tion. The purchasing managers’ index has continued
to fall, in July reaching its lowest level since February
2009. Industrial production, retail sales and car sales
have also decelerated. Exports have also slowed, but
the rate of increase remains high; their level is nearly
40 per cent higher than in 2009.
The upturn in CPI inflation has slowed, and although
core inflation has climbed in recent months it was only
2.4 per cent in June. This will probably mean that the
authorities will be cautious about further tightening
measures.
Inflation in China and India
Year-on-year percentage change
15.0 15.0
12.5 12.5

mies as Malaysia, South Korea and Taiwan. Despite this 10.0 10.0
deceleration, we expect good growth in the region
7.5 7.5
during both 2010 and 2011.
5.0 5.0
Industrial production
Year-on-year percentage change 2.5 2.5
60 60 0.0 0.0
50 50
40 40 -2.5 -2.5
30 30 07 08 09 10
20 20
China India
10 10 Source: National Bureau of Statistics of China, Ministry of Commerce and Industry, India
0 0
-10 -10
-20 -20
There is a continued focus on the risks of overheating
-30 -30 in the housing market. A sharp decline in home prices
-40 -40 would impact the real economy mainly through falling
Jan May Sep Jan May Sep Jan May Sep Jan May
activity in the construction sector. Government-con-
07 08 09 10
Thailand Taiwan trolled Chinese banks nevertheless have sizeable
South Korea India reserves, and the home loan-to-value ratio is very low,
Source: Reuters EcoWin
providing a substantial cushion against falling home
Rapid wage increases, partly in response to an increas-
prices and reducing the risks of a broader financial
ing number of strikes in various Asian countries, repre-
crisis.
sent a certain short-term inflationary threat. In some
countries, such as India, the authorities will need to A certain slowdown in the housing market now seems
respond with continued monetary policy tightening. In a to be on the way. Construction investments and the
longer perspective, rising wages are a natural develop- number of home sales have diminished. The rate of
mental step in the region that will help reduce global price increases has also cooled somewhat but remains
imbalances, both by narrowing cost differences and by above 10 per cent. In our assessment, the risk of a
shifting these economies towards a larger consumption sharp decline in home prices is fairly small. Chinese
element. authorities will try to respond to an initial price slide.
Overheating is also largely a local problem. There have
China: Slowdown but no crash landing been major price hikes in cities like Shanghai and Shen-
GDP figures for the second quarter confirmed our
zhen, but in the housing market as a whole the increase
forecast of a soft landing in China. Year-on-year growth
is more limited. Looking a little further ahead, there is
slowed from 11.9 per cent in the first quarter to 10.3
also a large underlying demand for housing.
per cent. The government’s tightening measures during
the spring, including restrictions on bank lending and
Nordic Outlook – August 2010  |  23
 Asia
China: Home prices
Year-on-year percentage change
15.0
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
07 08 09
Source: National Bureau of Statistics of China
Since China’s central bank resumed the appreciation of
the yuan against the US dollar in June, the currency has
strengthened very moderately: less than one per cent.
Because of official concerns about speculative curren-
cy inflows, appreciation is likely to continue occurring
relatively slowly. A continued low-interest policy in the
West will increase the risks of speculative inflows and
may raise the question of introducing capital controls
similar to those used in countries like Brazil. Further-
more, due to the general USD upturn over the past
year, China’s currency has strengthened by more than
5 per cent in trade-weighted terms, also contributing
to caution in adjusting the USD/CNY exchange rate. We
expect the USD/CNY rate to stand at 6.40 by mid-2011
and then continue downward to 6.00 by late 2012, but
these levels will depend greatly on the performance of
the USD against other currencies. The Chinese authori-
ties are likely to pay close attention to the trend of the
yuan in terms of a trade-weighted currency basket.
China's effective exchange rate
Monthly averages. Index = 100, Janaury 2005
125
120
115
110
105
100
95
05 06 07 08 09
This increased flexibility has eased currency policy
tensions with the US. In light of the yuan’s slow
appreciation,and because China’s trade surplus against
the US is on its way up ( in July it reached USD 28.7
billion), the issue is likely to heat up again this autumn,
America’s trade deficit against China may thus influence
the US stance towards Chinese currency policy.
Looking further ahead, however, other forces besides
currency rates will also lead to a better trade balance.
The recent increase in the number of strikes is a sign
24   |  Nordic Outlook – August 2010
that Chinese labour market conditions are changing.
The share of younger people in the population is shrink-
15.0 ing, which will eventually hamper the geographic mobil-
12.5
ity in the labour force. This will help push up wages
in regions where demand for labour is largest. Rising
10.0
wages and disposable incomes will then help narrow
7.5 cost differentials with other countries, while strength-
5.0 ening domestic demand. China’s imports will thus rise.
2.5 Chinese authorities have repeatedly shown their ability
0.0 to craft economic policies in such a way that growth
ends up in the interval they regard as compatible with
-2.5
10
economic and social balance. This is one reason why we
predict that the economy will decelerate in a controlled
fashion. Our forecast is that GDP will increase by 10.0
per cent in 2010 and growth will then slow to 9.0 per
cent in 2011 and 8.0 per cent in 2012.
Monetary tightening in India
The Indian economy is characterised both by high growth
and high inflation. In the first quarter of 2010, GDP rose
by 8.6 per cent year-on-year. The upturn was mainly
driven by exports and industrial production, but the rate
of increase in manufacturing is decelerating from the
high figures reported in late 2009 and early 2010.
India: Inflation and key interest rate
Per cent
9.0
14
8.5
12
8.0
10
7.5
8
7.0
6 6.5
4 6.0
2 5.5
0 5.0
-2 4.5
125 07 08 09 10
Inflation (LHS) Key interest rate (RHS)
120 Source: Reserve Bank of India
115 The agricultural sector accounts for between 15 and 20
per cent of the overall economy. The monsoon season
110
runs from June to September and is of key importance
105 to agricultural production. This year’s monsoon ap-
pears likely to result in a somewhat better harvest than
100
normal. Since the 2009 season was much worse than
95 normal, the shift in agricultural production, and the
10 impact on GDP, will be relatively large. We expect that
Source: BIS GDP will grow 9.0 per cent in 2010, slowing to 8.0
per cent in 2011 and 7.0 per cent in 2012.
Rising food prices have pushed up inflation. The good
domestic harvest may contribute to slower price
increases, but we still expect India’s central bank to
express concern about the situation. Since March 2010
it has raised its key interest rate by one percentage
point to 5.75 per cent. Further hikes to 6.50 per cent
continuing into 2011 are expected but these hikes will
not occur as frequently as they have so far. Key inter-
est rate hikes help to strengthen the currency and the
rupee will stand at 43.5 per USD one year from now.
 The euro zone

Doing better, but increasingly divided

ƒƒ Germany’s strong competitive position was a full 2.2 per cent (3.7 per cent year-on-year). In
driving rapid growth France, GDP grew by 0.6 per cent and in Italy 0.4 per
cent while other southern European countries lagged
ƒƒ Debt reduction tough on southern Europe
behind: Spanish GDP grew only 0.2 per cent, while the
ƒƒ Unemployment has peaked − low inflation Greek economy shrank by 1.5 per cent.
ƒƒ ECB will not hike refi rate until 2012 Especially in Germany, short-term indicators also sup-
port a scenario of continued strong growth. For exam-
ple, order bookings in the German manufacturing sector
The economic trend in the euro zone has been favour- rose by 3.2 per cent in June compared to May, and by
able in the past few months. GDP growth was strong in a full 24.6 per cent year-on-year. Germany’s IFO index
the second quarter, leading indicators have continued has continued upward at a rapid pace, and its current
to climb especially in Germany, while financial market level indicates an upside risk to our growth forecast.
worries about sovereign debt problems have eased The purchasing managers´ index (PMI) has also pro-
somewhat. vided upside surprises in most countries and is now
signalling a clearer recovery. The widening gap between
The next couple of years will be characterised by big
Germany and other parts of the euro zone is especially
gaps within the euro zone. Germany is benefiting from
apparent from the OECD’s leading indicator, which has
very strong global competitiveness and comparatively
continued to climb in Germany but has turned down-
good balances in its domestic economy. Southern
ward in France and the “PIIGS” countries (Portugal,
European countries face continued major challenges
Ireland, Italy, Greece and Spain).
in consolidating their central government finances and
restoring their competitiveness. Germany in the lead, PIIGS lagging behind
Composite leading index
Low inflation will enable the European Central Bank to 112.5 112.5
keep its key rate very low to support adjustment proc- 110.0 110.0
esses in southern Europe. We expect it to begin hiking 107.5 107.5
the refi rate only in 2012. 105.0 105.0
102.5 102.5
IFO climbs higher 100.0 100.0
Year-on-year percentage change (GDP), IFO index 2000=100 97.5 97.5
5.0 120 95.0 95.0
115 92.5 92.5
3.0
110 90.0 90.0

1.0 105 87.5 87.5

85.0 85.0
100
-1.0 00 01 02 03 04 05 06 07 08 09 10
95
-3.0 90 Germany France PIIGS
Source: OECD
85
-5.0
80
-7.0 75 Can domestic forces take the lead?
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 As in many other countries, exports have been the
GDP, Germany (LHS) engine of the recovery. For some time, German manu-
Business conditions, IFO (RHS) facturers have been improving their competitiveness. In
Expectations, IFO (RHS)
Source: Federal Statistics Office, IFO the past six months they have received extra help from
a weak currency. With an EUR/USD exchange rate of
Strong short-term indicators around 1.30, the growth stimulus in 2010 from the euro
Second quarter GDP figures provided upside surprises, is equivalent to about 0.7 per cent of GDP. Now that the
but also illustrated increasingly obvious gaps between global industrial cycle is entering a more mature phase,
countries. Euro zone economic growth totalled 1.0 per while the American economy moves into a slowdown
cent quarter-on-quarter, and the upturn in Germany phase, exports will become a less important driving
force. The historical association between America’s ISM

Nordic Outlook – August 2010  |  25

 The euro zone

purchasing managers’ index and the IFO index indicates
a slight deceleration in the euro zone early next
year.
At present, there are mixed signals as to whether do-
mestic demand can take over as a growth engine. Vari-
ous indicators, among them rising capacity utilisation in
manufacturing, show that we are approaching a period
of stronger capital spending.
German households are an uncertainty factor a bit
further ahead, despite lower unemployment and rising
consumer confidence. In particular, this has been under-
scored by Germany’s rather weak retail sales so far in
2010, but June sales rose by 4.7 per cent year-on-year
according to revised statistics. This was stronger than
expected. We anticipate that private consumption will
German GDP will climb by 3.3 per cent this year,
thanks to rising exports and capital spending. In the
near future, the German economy will also expand
relatively fast; we expect GDP to rise 2.1 per cent in
2011 and somewhat more slowly in 2012. France will
grow by about 1.5 per cent a year, Italy 1-1.5 per cent.
Countries with the biggest austerity programmes will
continue to perform very weakly. For example, the
Greek economy will shrink by about 4 per cent this
year and a further 2 per cent in 2011. Spanish GDP will
fall 0.5 per cent this year, then grow by some 0.5 per
cent in 2011.
Decent growth in spite of everything
Percentage change
5.0 5.0
2.5 2.5

decrease by about 0.5 per cent in Germany this year 0.0 0.0
(nearly unchanged in the euro zone as a whole), speed- -2.5
SEB
-2.5
forecast
ing up a bit in 2011 and 2012.
-5.0 -5.0
Sharp increase in investments
Year-on-year percentage change and per cent -7.5 -7.5

10 85.0 -10.0 -10.0

82.5 04 05 06 07 08 09 10 11 12
5
80.0 Quarter-on-quarter, annualised
0 Year-on-year percentage change
77.5 Growth indicator (Euroframe)
-5 Source: Euroframe, Eurostat, SEB
75.0
-10
72.5
Large austerity packages
-15 70.0 During the spring and summer, various euro zone coun-
-20 67.5 tries announced fiscal austerity packages in response to
00 01 02 03 04 05 06 07 08 09 10 the severe crisis of confidence. In the PIIGS countries,
Gross capital formation (LHS) these programmes include very large doses of budget-
Capacity utilisation, manufacturing (RHS) tightening. In Greece, such cutbacks are equivalent
Source: Eurostat, DG ECFIN
to about 12 per cent of GDP in 2010-2012. Spain and
Euro zone growth will not bottom out until the first Portugal have also pushed through major austerity pack-
quarter of next year (0.2 per cent, quarter-on-quarter), ages. In the core countries of the euro zone, austerity
two quarters after the US, then slowly recover in the measures are far more modest. The German govern-
course of 2011 and 2012. GDP growth will end up at ment plans fiscal tightening efforts totalling about EUR
1.6 per cent this year in the euro zone as a whole − a 80 billion until the end of 2014. This is equivalent to
cautious upward revision since our May forecast and 3.4 per cent of GDP in all, but the annual effects will
well above the consensus. Growth will then remain at be moderate over the next couple of years. As early as
around 1.5 per cent in 2011 and 2012. January, the French government announced austerity
measures amounting to EUR 11 billion (0.6 per cent of
Consumption recovers slowly
Year-on-year percentage change GDP), spread over several years. Further cutbacks are
5 4.0 planned, but no formal decisions will be made before
0 September.
3.0
-5
2.0 The table below shows fiscal consolidation measures
-10
as a percentage of GDP. The figures for 2010 and 2011
-15 1.0
are largely based on decisions that have already been
-20
0.0 made, while those for 2012 are largely based on esti-
-25
mates of what is reasonable. At present, these meas-
-1.0
-30 ures total less than 1 per cent of euro zone GDP, and
-35 -2.0 up to some 4 per cent of GDP in the PIIGS countries.
00 01 02 03 04 05 06 07 08 09 10
Further austerity measures may follow.
Consumer confidence (LHS)
Private consumption (RHS)
Source: DG Ecfin, Eurostat, SEB

26   |  Nordic Outlook – August 2010

 The euro zone

with its austerity package. The accumulated Greek

Austerity measures announced so far deficit was EUR 12 billion in July, or EUR 3 billion less
Per cent of GDP
2010 2011 2012 Total than the government’s own target. This means that
the country will qualify for its second round of bail-
Greece 4.2 4.2 4.0 12.4
out funds from the European Commission, euro zone
Ireland 3.7 0.0 0.0 3.7 countries and IMF. But although the pace of reform
Spain 2.3 2.3 2.0 6.6 has been faster than expected during the summer,
major challenges and risks remain. The market still
Portugal 2.0 2.2 2.0 6.2
mistrusts the ability of the PIIGS countries to tighten
Italy 0.8 0.8 1.5 3.1 up their economies. This is clear from their continued
France 0.3 0.1 0.5 0.9 high interest rate spreads against Germany. The rapid
Germany 0.0 0.5 0.8 1.3 upturn in CDS spreads over the past few weeks, espe-
cially for Ireland and Italy but also for the other PIIGS
Euro zone 0.8 0.9 1.1 2.8 countries, is another sign of mistrust.
Source: SEB Yield spreads against Germany
 Percentage points
10 10
The direct effect of these austerity programmes will
9 9
be to dampen growth, especially via weaker consump-
8 8
tion. But there is also a neutralising effect, since 7 7
confidence in the ability of problem economies to 6 6
extricate themselves from their current crisis may 5 5
improve. This will benefit capital spending and con- 4 4
3 3
sumption (“expansionary fiscal contraction”). A weaker
2 2
euro because of the debt problem will also contribute 1
1
to stronger growth. 0 0
Oct Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug
Such indicators as data on sovereign borrowing require- 08 09 10
France Ireland Portugal
ments show that the combination of austerity measures Greece Italy Spain
and growth recovery has already had some impact on Source: Reuters EcoWin

government finances. In Germany, this is occurring
mainly via increased tax revenue as the economic
situation has strengthened. The federal budget deficit
appears likely to drop below 3 per cent of GDP as early
as 2011; last spring the government declared that its
ambition was to achieve this by 2013.
Budget balance, selected countries
Per cent of GDP
2009 2010 2011 2012
Ireland -14.3 -11.7 -12.1 -10.6
Greece -13.6 -9.1 -8.6 -8.0
Spain -11.2 -9.8 -8.5 -7.0
Portugal -9.4 -8.3 -7.6 -6.1
This mistrust may have various causes. To date, budget
improvements seem to have been the result of slashing
expenditures. In the long term, improving the efficien-
cy of tax collection will be the most important meas-
ure, and initial signals from Greece indicate certain
disappointments in this regard. Angry reactions among
employees and trade unions also indicate that countries
face major challenges when it comes to creating con-
sensus and understanding about their austerity policies.
This summer, for example, Greek lorry drivers struck in
protest against deregulation of the haulage trade, and
public transport in both Spain and Portugal have been
hard hit. So far, however, governments have responded
with toughness: in Greece with emergency legislation
forcing the lorry drivers back to work.

France -7.5 -7.6 -7.1 -5.6 Growing debt levels

Belgium -6.0 -5.0 -5.0 -3.5 Per cent of GDP

Italy -5.3 -5.3 -4.7 -3.2 140 140

Netherlands -5.3 -6.0 -5.0 -3.5 120 120

Austria -3.4 -4.7 -4.5 -3.0 100 100

Germany -3.3 -4.0 -3.0 -2.5 80 80

Finland -2.2 -3.5 -2.9 -2.2 60

SEB
60
forecast
Euro zone -6.3 -6.2 -5.5 -5.0 40 40

Source: European Commission, SEB 20 20

01 02 03 04 05 06 07 08 09 10 11 12
According to the European Commission, the ECB and Euro zone France Spain Greece
the IMF, Greece in particular has made great progress Germany Italy Ireland
Source: Eurostat, SEB

Nordic Outlook – August 2010  |  27

 The euro zone
Fundamentally, however, market mistrust is due to
uncertainty as to whether the escalation of sovereign
debt can be halted and whether some form of debt re-
structuring is unavoidable. According to the calculations
on which its bail-out programmes are based, Greek
government debt will reach about 140 per cent of GDP
in 2013, the highest level in the whole euro zone. Italy’s
debt will end up at about 130 per cent, Portugal and
Ireland just below 100 per cent and Spain just below 80
per cent.
Unemployment has peaked
The decline in German unemployment in July (20,000
fewer people without jobs) raises hopes that today’s
upturn in export and industrial production will also
spread to the household sector. According to national
statistics, unemployment ended up at 7.6 per cent, the
lowest jobless level in 20 months.
Falling unemployment even with slow
growth
The positive effect of the German government’s anti-
unemployment programme can be analysed with the
aid of “Okun’s Law”, which relates unemployment to
GDP growth and the output gap (i.e. the difference
between actual and potential GDP). According to the
historical association, unemployment in the euro zone
should have risen faster late in 2008 and in 2009, also
remaining at a higher level in 2010-2012 (see chart).
According to Okun’s Law, when the GDP gap narrows
by 1 percentage point, unemployment falls by 0.5
percentage points.
Unemployment has peaked
Per cent
11.0
10.5
10.0
9.5
9.0
8.5
8.0
7.5
7.0
6.5
6.0
00 01 02 03 04 05 06 07 08 09
Classical Okun Unemployment
Source: Eurostat, OECD, SEB
We have also analysed how the level of GDP growth
compatible with constant unemployment has changed
over time. One result that is evident from the table
below is that this growth requirement has decreased
sharply in the euro zone over the past decade.
During the period 2000-2010, for example, Germany
has required a GDP growth rate of only 0.8 per cent
and France 1.2 per cent to keep unemployment un-
changed. In Italy the figure is as low as -0.7 per cent,
reflecting very special labour market mechanisms.
28   |  Nordic Outlook – August 2010
However, there are major differences in employment
trends between euro zone countries. The strong Ger-
man employment trend is partly due to a system of
government allowances (“Kurzarbeit”) which result in
a form of job-sharing. When these subsidies are phased
out, there is admittedly a risk that unemployment
will rebound, but the lack of large underlying imbal-
ances has also benefited the German labour market.
The economy can now take advantage of the upturn in
international demand without needing to implement
far-reaching structural changes. In various respects,
Spain is the opposite of Germany. Spain faces a long
period of structural adjustment, for example when it
comes to cutting down the size of the construction sec-
tor, reforming the labour market and streamlining the
public sector.
In Spain the level is nearly 3 per cent, among other
things due to high productivity growth over the past
decade. In the euro zone as a whole, GDP growth of
0.9 per cent is sufficient for unemployment to level
off.
GDP growth required for unchanged
unemployment
Year-on-year percentage growth
1980-10 80-90 90-00 00-10
Germany 2.5 2.6 2.6 0.8
France 2.2 3.2 2.1 1.2
11.0 Italy 1.8 0.4 2.1 -0.7
10.5
Spain 2.9 3.8 2.6 2.8
10.0
9.5 Euro zone 2.3 2.5 2.3 0.9
9.0
US 2.9 2.9 2.8 2.7
8.5
8.0 UK 2.4 3.1 1.9 2.3
SEB
forecast 7.5 Japan 2.8 4.0 3.5 1.0
7.0
Nordics 2.5 2.3 2.3 2.4
6.5
6.0 Source: IMF data, SEB estimates
10 11 12
In an international comparison, we can note that
NAIRU
this required GDP growth rate in the United States,
the United Kingdom and the Nordic countries has not
fallen in the same way as in the euro zone and Japan.
This can be explained by a higher underlying produc-
tivity growth trend, as well as a more favourable trend
of labour supply for demographic and other reasons.
 The euro zone

Divergent employment trends pay squeeze throughout the economy. In Germany, we

Index, January 2008=100 discern the opposite trend. Rapidly increasing industrial
101 101 production and a strong labour market have resulted
100 100 in demands from IG Metall and other trade unions for
99 99
98 98
higher pay increases.
97 97
96 96 Continued low inflation
95 95
Inflation in the euro zone, as measured by the Harmo-
94 94
93 93 nised Index of Consumer Prices (HICP), rose to 1.7 per
92 92 cent in July from 1.4 per cent the month before. This
91 91 upturn was expected and was largely driven by tempo-
90 90
89 89
rarily higher energy and food prices, which contributed
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr about 0.7 percentage points. According to our forecast,
08 09 10 however, the price of oil will fall towards USD 75 per
Italy France Germany Spain
Source: Deutsche Bundesbank, INE, INSEE, Istat barrel this autumn and winter, which means that the
contribution to inflation from energy will decline. Food
We expect unemployment in the euro zone as a whole,
prices will also show a more subdued trend. HICP infla-
which stayed at 10 per cent in June for the fourth
tion will thus decelerate to 1.2 per cent by December
straight month, to peak in August and then slowly
2010. Measured in terms of annual averages, the infla-
decline. Joblessness will be slightly below 10 per cent
tion rate will end up at 1.4 per cent this year, 0.8 per
in December this year, then gradually fall to 9.0 per
cent in 2011 and 1.2 per cent in 2012, in other words
cent in December 2012 − a slow downturn, yet better
well below the ECB’s target.
than today’s consensus forecast of 10.1 per cent both
this year and in 2011. Unemployment will continue to Euro zone core inflation has been at a stable 1 per cent
fall in Germany and France, level off in Italy but rate all year. As earlier, we expect underlying inflation
continue upward in Spain. to fall further this autumn and winter, bottoming out
at 0.3 per cent in the first quarter of next year. As the
Pay squeeze in southern Europe output gap slowly begins to close, core inflation will
The upturn in unemployment over the past few years
cautiously climb in the course of 2011 and 2012. Meas-
is continuing to squeeze wages and salaries. Last year
ured as annual averages, core inflation will end up at
total hourly wage costs in the euro zone rose by 4 per
0.9 per cent this year, 0.5 per cent next year and 0.9
cent, but this year and in 2011 they are unlikely to
per cent in 2012.
increase by more than about 1.5 per cent. The associa-
tion between wages and unemployment indicates that No ECB rate hike until 2012
the risks may even be on the downside. The ECB’s interest rate policy has been relatively simple
Core inflation will continue downward since the central bank cut its refi rate to 1 per cent in
Per cent May last year. The sharp slide in the world economy,
4.5 4.5 with falling HICP and core inflation, low inflation ex-
4.0 4.0 pectations and extremely restrictive credit and money
3.5 3.5
supply growth, are unambiguous arguments for excep-
3.0 3.0
2.5
SEB
2.5
tionally low interest rates. The ECB may also continue
forecast
2.0 2.0 to provide loans on favourable terms to commercial
1.5 1.5 banks in problem countries − for the time being to
1.0 1.0 Greek banks. However, it cannot be ruled out that
0.5 0.5
banks in other countries may also need support − and
0.0 0.0
-0.5 -0.5
that the ECB will accept government securities as col-
-1.0 -1.0 lateral despite poor sovereign credit ratings.
01 02 03 04 05 06 07 08 09 10 11 12
Our estimates of the optimal refi rate, using the “Taylor
Core inflation HICP inflation
Source: Eurostat, SEB rule” − which can explain about 80 per cent of the vari-
ation in refi rates with the help of unemployment and
In the May issue of Nordic Outlook, we analysed the
inflation data − indicate that the key interest rate could
large differentials in the cost increase situation mainly
easily be even lower (see chart). The ECB is appar-
between Germany and the PIIGS countries. Our conclu-
ently making a similar assessment, since the European
sion was that the need for internal devaluations in the
Overnight Index Average of interbank interest rates
PIIGS countries is in the 20-30 per cent range. Some
(EONIA) has been about 50 basis points below the refi
adjustments in the cost situation have now begun. Cuts
rate since last summer.
in public sector pay in various countries have mainly
been implemented on the basis of fiscal arguments. Because of major fiscal belt-tightening and a growing
But in the same way as occurred in the Baltic coun- mountain of debt, the countries of southern Europe are
tries, for example, these measures will also lead to a in need of exceptionally low interest rates for a long

Nordic Outlook – August 2010  |  29

 The euro zone
period. We now expect the initial refi rate hike to be
delayed until March 2012: the refi and EONIA rate will
then be raised to 1.25 per cent. This hike will then be
followed by another two the same year, bringing the
refi rate up to 1.75 per cent in December 2012. The
rate hiking cycle is roughly coniststent with what the
Taylor rule recommends. In the short term, the di-
lemma of divergent growth dynamics in the euro zone
is not so large. German inflation pressure remains low,
and the ECB also has reasons to try to get German
consumers moving. In the long term, however, diver-
gent growth prospects, especially between Germany
and southern Europe, will lead to difficult economic and
political trade-offs for the ECB.
Another difficulty is uncertainty about the global eco-
nomic cycle and the sustainability of euro zone recov-
ery in general. If the euro zone should suffer a double
dip, in the sense that the GDP level again begins to fall
Stress tests dispel uncertainty despite
shortcomings
As a result of the EU’s tests of the European banking
system, which examined the financial stamina of 91
banks during 2010 and 2011, seven banks − five Span-
ish, one German, one Greek − fell below the estab-
lished minimum Tier 1 capital of 6 per cent. According
to the hypothetical scenarios, the EU banking system
would need to be capable of managing losses totalling
EUR 566 billion.
Many of the 91 banks ended up close to the minimum,
however. This confirms the view that there are still
weaknesses in the financial system in the form of vul-
nerable balance sheets, overcapacity and poor profit-
ability. Euro zone banks play an especially important
role in the economic recovery, since they account for
some 80 per cent of the total credit supply. Meanwhile
these banks have a very large need for refinancing
over the next 2-3 years. Continued recapitalisation
(through capital injections or earnings) is needed in
order to preserve financial stability and keep borrow-
ing costs down.
30   |  Nordic Outlook – August 2010
− which we estimate as having a 20 per cent probability
− the game plan will change. The Taylor rule indicates
that a scenario in which unemployment rises to 11 per
cent and remains at that level until mid-year 2011
would have to be met by interest rate cuts of about 75
basis points.
ECB starts to hike in March 2012
Per cent
5 5
4 SEB 4
forecast
3 3
2 2
1 1
0 0
-1 -1
00 02 04 06 08 10 12
Refi rate
Taylor rule, main scenario
Taylor rule, "double dip" scenario
Source: ECB, Eurostat, SEB
The tests have not escaped criticism. Their assump-
tions have been described as too easy. There was no
scenario in which an EU country defaults on its sover-
eign debts. There was also a lack of clarity about the
way German banks reported their exposure to various
government securities. Of the 14 German banks that
participated in the stress tests, six chose not to report
details related to their holdings of government bonds
and treasury bills.
The criticism is partly deserved. Nevertheless, the test
fulfils a number of purposes. It took place in all coun-
tries simultaneously, giving the risk picture a systemic
dimension. Because it strengthened dialogue among
financial institutions and regulatory authorities, it
helped to increase transparency and reduce uncertain-
ty. In particular, the stress tests eased the uncertainty
about the status of the Spanish banking system, with
all the country’s banks participating.

Emergency budget will slow economic growth
ƒƒ Belt-tightening will squeeze households
ƒƒ Housing market will cool off again
ƒƒ Bank of England will hike rate in late 2011
Rising exports and industrial production have contrib-
uted to a recovery in the battered British economy.
During the second quarter of 2010, GDP grew by 1.2 per
cent compared to the preceding quarter, or well above
expectations. This expansion will probably slow during
the second half, and over the next couple of years we
foresee growth somewhat below trend. GDP will climb
1.7 per cent in 2010 and by 2.0 per cent in 2011. In
2012, GDP will increase by 2.2 per cent.
Future economic performance will be greatly affected
by the emergency budget that the new coalition gov-
ernment unveiled in June. This budget represents total
fiscal tightening of 7-8 per cent of GDP until 2013. At
least for the time being, such austerity will help the UK
avoid a downgrading of its AAA credit rating. A spend-
ing review will be unveiled in October, but it is already
known that 80 per cent of tightening will consist of
spending reductions, the remaining 20 per cent of tax
increases. Cutbacks in the various departments will be
around 25 per cent, but the National Health Service
(NHS) has been exempted.
Tougher international regulation of financial markets
(Basel III) may have a major impact on the UK’s impor-
tant financial sector, but standards have been eased
and in practice the implementation of Basel III has been
postponed. This also postpones the risks to the British
economy that poorer access to capital and higher bor-
rowing costs may later imply.
Exports recovered strongly from their 2009 lows.
However, looking ahead exports will be squeezed as the
pound regains some of its earlier decline against the
euro. Private consumption has so far held up but will
show weakness because government austerity measures
will restrain income growth, but if these measures are
perceived as credible they may have a positive impact
on consumer confidence.
The housing market now seems to be weakening, after
having recovered from its nadir early in 2009. Recent
transactions indicate stagnating or even falling home
prices. Weak growth in disposable household income
will hamper activity in the housing market ahead. We
foresee that the recovery in home prices will slow dur-
The United Kingdom
ing the second half of 2010 and that prices will stagnate
in 2011 and 2012.
The labour market has improved clearly since the turn
of the year; in April, unemployment was 7.8 per cent.
Employment increased during the first quarter. How-
ever, labour market performance will be adversely
affected by the expected staffing cutbacks in the public
sector. The newly established Office for Budget Respon-
sibility (OBR) estimates that around 600,000 people, 2
per cent of all employees, will lose their jobs. Overall,
we expect unemployment to increase slightly during the
coming year.
Headline and core inflation in the UK
Per cent
5.5 5.5
5.0 5.0
4.5 4.5
4.0 4.0
3.5 3.5
3.0 3.0
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
07 08 09 10
Headline inflation Core inflation
Source: ONS
Headline inflation has fallen slightly, and core inflation
declined to 2.6 per cent in July. Our forecast indicates
that headline inflation will fall to 2.5 per cent by the
end of 2010, resulting in 3.1 per cent inflation for
the full year. This deceleration will continue during
2011 and 2012, when inflation will be 2.1 and 1.3
per cent, respectively. We expect a similar trend for
core inflation. The effect of the value-added tax hike
in January 2011 will be neutralised by other austerity
effects. Reduced risks that inflation will again take off
will enable the Bank of England to keep its key inter-
est rate low and thereby continue to stimulate the
economy and counteract the effects of the emergency
budget. We believe the BoE will wait until the last
quarter of 2011 before hiking its repo rate. In De-
cember 2012 this rate will be 2.0 per cent.
We expect the pound to continue regaining some of its
earlier decline against the euro. The pound is still fun-
damentally undervalued, and higher UK inflation means
that interest rate hikes are somewhat more imminent.
We expect the EUR/GBP exchange rate to be 0.80 at
year-end, then remain around the same level.
Nordic Outlook – August 2010  |  31
Eastern Europe
Gradual economic upturn
ƒƒ Domestic demand slowly reawakening
ƒƒ Improved macroeconomic balance
ƒƒ Currencies once again appreciating
The economic upturn in Eastern Europe will soon
broaden. In the autumn of 2009, exports and industrial
production began to recover. In some places, growth
has been stronger than in the West. The upturn oc-
curred from a low level, however; Eastern Europe was
the region hardest hit by the global credit crisis, due
to its large foreign loans. The manufacturing sector
is now moving into a more mature phase. Meanwhile
we are seeing the first signs that household consump-
tion has begun to join the recovery. Households are
being sustained by stabilisation in the labour market
and resumption of real wage growth. The outlook
for corporate capital spending has also brightened
somewhat. But we are continuing to predict a rather
sluggish upturn in domestic demand. The main reasons
are moderate fiscal tightening in various countries, as
well as a credit situation that is only slowly thawing.
Taken together, this implies decent GDP growth in the
next few years, which in the most cases will reach just
below potential rate.
In terms of economic fundamentals, Poland and Russia
are in the best shape, except for large budget deficits.
In Poland − the only EU country with positive GDP
growth last year − economic expansion will accelerate
from 3.5 per cent this year to 4.5 per cent in 2012. The
government’s target of trimming its budget deficit from
7.1 per cent of GDP last year to 3 per cent in 2013 − in
preparation for possible euro zone accession in 2015 −
appears realistic. A recently adopted four-year plan in-
cludes a boost in value-added tax, a ceiling on spending
increases and faster privatisations of state enterprises.
Russia’s growth accelerated during the second quarter
to a year-on-year rate of 5.2 per cent. Extreme weather
and fires, which have wiped out one fourth of Russia’s
grain production, will hamper growth in the short term.
Overall, agriculture accounts for no more than 4 per
cent of GDP, but other disruptions in production will
also slow expansion. We are lowering our GDP growth
forecast by half a percentage point to 4.5 per cent but
believe it will then rise to 5.5 per cent in 2012. The
economy is benefiting from relatively high commodity
prices and in 2010 continued loose fiscal policy.
32   |  Nordic Outlook – August 2010
Ukraine has recovered unexpectedly fast after last
year’s 15 per cent GDP slide. The economy grew by
6 per cent in the first half. Steel exports and a weak
currency have driven the upturn. A new loan agreement
with the IMF has helped boost investor confidence but
is also tied to austerity requirements and reforms. Bank
lending is recovering slowly. We predict GDP growth of
4-5 per cent annually during the next couple of years.
Declining inflation
CPI, year-on-year percentage change
35 35
30 30
25 25
20 20
15 15
10 10
5 5
0 0
06 07 08 09 10
Russia Ukraine Poland
Source: Local statistical offices
The underlying balance situation in Eastern Europe
has improved. Current account deficits are now rela-
tively low in several countries; Russia, Hungary and the
Baltics are showing surpluses. The large budget deficits
that arose during the crisis are gradually shrinking, and
this is helping to keep government debt levels relatively
low. The inflation rate has fallen in recent years, in
Russia to a record-low 5 per cent in July. This downturn
has been driven by large resource gaps and pressure
on wages. But inflation is now close to bottoming out.
Poor grain harvests as well as administrative increases
will boost inflation. Given our modest growth scenario,
however, underlying price increases will be sedate.
Central banks can hold off on key interest rate hikes.
Poland, and the Czech Republic will be the first to hike
key rates in the spring of 2011. Many Eastern European
currencies have weakened since May, thus tending to
reverse a long-term appreciation trend. This can largely
be explained by shrinking global risk appetite, but also
concerns about Hungary’s loose fiscal policy. Relatively
stronger growth in Eastern Europe, as well as capital
flows, will lead to renewed currency appreciation this
autumn. But this appreciation will not be rapid, since
worries about the US economy are likely to hamper risk
appetite. The forint may be under pressure again in the
run-up to Hungary’s local elections this autumn.
 The Baltics

Moderate growth after difficult adjustments

ƒƒ Export surge − sluggish domestic upturn month basis and in current prices, is around 30 per
cent in Estonia and Latvia and nearly 40 per cent in
ƒƒ Deflation pressure will fade this year
Lithuania. Behind this upswing is greater international
ƒƒ Greater financial stability demand, but the Baltic countries also regained market
share in 2009 (Lithuania in 2008 as well). They have im-
proved their competitiveness partly due to this year’s
The three Baltic economies have once again begun to decline in the euro, but mainly because of their internal
grow, sustained by strong exports. The brutal adjust- devaluations. This is clear from real effective exchange
ment process following their previous severe external rates; see the chart, which shows their inflation-adjust-
and internal imbalances, which led to GDP declines of ed exchange rate trend compared to 58 economies.
around 30 per cent from peak to trough, is now ap-
Real effective exchange rates
proaching its end. Growth will not, however, reach our
Index 100 = 2005
previous estimate of its potential rate, about 6-7 per 135 135
cent. A tighter lending environment and more cautious 130 130
investment behaviour compared to the earlier boom 125 125
will hold back growth. In addition, the crisis triggered 120 120
new emigration trends in the labour force. We thus 115 115
expect a gradual economic recovery to a growth of 110 110

around 4-5 per cent over the next two years. 105 105
100 100
The European Commission’s composite business and 95 95

household survey, which began rebounding in the spring 90 90

of 2009, has continued upward in recent months,
though at a calmer pace. Household optimism has clear-
ly returned in Estonia during the past year, while still
remaining at low levels in Latvia and Lithuania. One
reason may be positive expectations about Estonia’s
euro zone accession in 2011, but also that at an early
stage the Estonian government managed to generate
confidence in its fiscal policies by means of measures
that prevented the budget deficit from spinning out of
control.
The improvement in sentiment indicators has also be-
gun to show up in GDP data. In the second quarter, Es-
tonia’s GDP rose 3.5 per cent year-on-year and Lithua-
nia’s by 1.3 per cent − the first positive growth rates
since the fourth quarter of 2007 and the third quarter
of 2008, respectively. We expect Latvia’s growth rate to
turn positive no later than the fourth quarter. Outcomes
have been in line with expectations: Our 2010 GDP fore-
casts for Estonia (2.0 per cent) and Lithuania (1.0 per
cent) are thus unchanged from the May issue of Nordic
Outlook. However, for Latvia we have made an upward
adjustment, from -2.8 to -1.5 per cent.
Improved competitiveness
Exports will remain the clearly dominant economic
engine this year, although we expect the growth rate
to slow due to fading positive base effects. The year-
on-year rate of increase in exports, on a rolling three
85 85
00 01 02 03 04 05 06 07 08 09 10
Estonia Lithuania Latvia
Source: BIS
Wages and salaries have been pushed down sharply,
especially in Latvia, where the need for adjustment
was also the largest. The official decline in Latvian pay
levels from their peak late in 2008 has been 15 per
cent so far (until the end of the first quarter), but in
practice the cuts have probably been far bigger than
this. Public sector salaries have been lowered by about
25 per cent. The private sector has also strengthened
its competitiveness via efficiency-raising measures.
There will probably be some further downward pressure
on pay in yearly terms this year in all countries. After
that, we expect the adjustment process to end, and we
are predicting certain pay increases next year. This
means, in turn, that underlying deflation pressure in
consumer prices will vanish; in Estonia and Lithuania,
the downturn in year-on-year HICP inflation ended last
spring. However, price increases to date are largely due
to administrative increases (taxes and fees) as well as
higher energy costs. Inflation will resume at a moderate
pace. We expect price increases to average 2-3 per cent
(highest in Estonia) in 2011.
Meanwhile internal devaluations have dampened import
demand and contributed to a sharp swing in current
account balances. Earlier exceptionally large deficits

Nordic Outlook – August 2010  |  33

 The Baltics
were replaced by sizeable surpluses during 2009. A
shift in capital flows from foreign-owned banks also
strengthened current account balances. Our assessment
is that these surpluses will shrink or turn into moderate
deficits in the near future as domestic demand gradu-
ally strengthens.
Current account
Per cent of GDP
15 15
10 10
5 5
0 0
-5 -5
-10 -10
-15 -15
-20 -20
-25 -25
-30 -30
01 02 03 04 05 06 07 08 09 10
Estonia Latvia Lithuania
Source: Bank of Estonia, Bank of Latvia, Bank of Lithuania
Domestic demand is still being squeezed, but there is
evidence that household consumption has bottomed
out. A stabilisation in the labour and housing markets
has contributed to this. Looking ahead, consumption
will also be sustained by rising wages and salaries. In
our assessment, Estonia domestic demand will slowly
begin to recover late in 2010, with a certain extra
impetus for investments as the euro transition ap-
proaches. In Latvia and Lithuania, domestically oriented
portions of the economy will not gain momentum until
early 2011.
A number of factors indicate that the recovery in do-
mestic demand will be sluggish, however. GDP growth
will not be strong enough to allow any significant labour
market improvement; unemployment of 15-20 per cent
will fall slowly in the near future. In addition, fiscal
policies will remain tight in Latvia and Lithuania next
year. The ongoing phase-down of private debt is also
likely to continue in 2011.
Budget consolidation, but risks remain
Public sector budget consolidation has largely been
completed in Estonia, while it is continuing in Latvia
and Lithuania. We anticipate that Latvia will thus con-
tinue to live up to the targets established by its interna-
tional lenders, the IMF and the EU. We expect Latvia’s
budget deficit to be somewhat below 8.5 per cent of
GDP this year and 6 per cent in 2011. Lithuania’s budget
deficit will shrink to 8 and 5 per cent, respectively.
Public sector debt will stop growing during 2011-2012.
Its levels are moderate: around 40 per cent of GDP in
Lithuania and 60 per cent in Latvia. Estonia’s public
sector debt is well below 10 per cent.
Certain political risks remain in Latvia and Lithuania.
These countries have been led by minority governments
since last spring, which could make it more difficult
to push through the remaining austerity measures that
34   |  Nordic Outlook – August 2010
will be needed. The October parliamentary election in
Latvia represents a further source of uncertainty, but in
our assessment there is sufficient parliamentary support
to allow the implementation of the main features of
the country’s economic policy, although some proposals
may be eliminated or adjusted. Because an economic
recovery is on the way, political risks are generally also
diminishing.
A brighter economic outlook, determined fiscal con-
solidation policies and effective internal devaluation
policies have helped the Baltic countries regain the
confidence of financial markets. During the spring and
summer, Estonia received the green light to join the
euro zone in 2011. This has also contributed to greater
market stability in Latvia and Lithuania. In addition,
Latvia’s discussions with its creditors, the IMF and the
EU, have become far less dramatic. Since February-
March, the Latvian government has signalled the need
to use international loans has decreased substantially.
Three-month interbank rates
Per cent
30 30
25 25
20 20
15 15
10 10
5 5
0 0
Jan May Sep Jan May Sep Jan May Sep Jan May Sep
07 08 09 10
Estonia: TALIBOR Lithuania: VILIBOR
Latvia: RIGIBOR Euro zone: EURIBOR
Source: Reuters EcoWin
In this environment, interbank rates have fallen sharply
since late 2009; during the summer, three-month rates
were less than one percentage point above the equiva-
lent euro rates (in Latvia the margin was only 40 basis
points). Fundamentally, this is an indication of greater
market confidence that Latvia and Lithuania’s fixed
currency pegs against the euro will also survive; this has
been our main scenario all along.
As expected, in July the EU formally approved Esto-
nia’s transition to the euro on January 1, 2011 without
any exchange rate adjustment. Our main scenario is
that Latvia and Lithuania will also become euro zone
members in 2014. This is also the official target of the
Latvian government and the ambition of the Lithuanian
government. The budget deficit will be the trickiest of
the five Maastricht criteria to fulfil. In order to adhere
to this timetable, the deficit must be brought down to 3
per cent of GDP by 2012, which may prove quite tough.
 Sweden

Very fast recovery

Other statistics also indicate that total resource utilisa-
ƒƒ Highest 2010 growth in the West tion has rebounded from crisis levels and is now at
ƒƒ Unemployment will fall rapidly this about the same level as during the mild downturn of
autumn 2001. A stronger krona, low collective pay agreements
and a recovery in productivity nevertheless indicate
ƒƒ Inflation will remain low that inflation will be low throughout our forecast pe-
ƒƒ Front-loaded key interest rate hikes by riod.
the Riksbank
The situation of the Riksbank has changed to some ex-
ƒƒ Expansionary fiscal policy in 2011 tent in recent months. The recovery is occurring faster
than expected. Meanwhile Basel III regulations have
been softened and postponed. We expect the Riksbank
The Swedish economy is now growing considerably to raise its key interest rate at every monetary policy
faster than comparable countries. Second quarter GDP meeting this autumn. The key rate will reach 1.5 per
was stronger than expected and the outlook for the rest cent in February 2011. After that, low inflation pres-
of 2010 appears favourable. This is why we have raised sure and slower growth will help slow the pace of these
our GDP forecast for 2010 and expect growth of 4.7 per hikes. There is also a risk that the krona will be exces-
cent (calendar adjusted: 4.4 per cent). Looking ahead, sively strong as a consequence of a wider short-term
however, world economic deceleration will also result in interest rate spread against other countries. We expect
slower Swedish growth. Due to high household savings a repo rate of 2.25 per cent at the end of 2011 and 3.00
and continued expansionary fiscal policy, GDP growth per cent at the end of 2012.
will remain higher than in other countries, though. We
expect 2.9 per cent growth in 2011 and 2.3 per cent in Sweden will continue to demonstrate strong public
2012. finances, and the central government budget will be
close to balance as early as 2010. This will allow room
Strong recovery for GDP 2010 for a continued expansionary fiscal policy after the
6 6 September 19 election, and both governing alternatives
5 SEB 5
forecast (the incumbent non-socialist Alliance and the Red-
4 4
3 3 Green opposition) have also announced more and more
2 2 election promises. Regardless of which block forms
1 1
0 0 a government after the election, we expect reforms
-1 -1 equivalent to about SEK 25 billion during 2011 (0.8 per
-2 -2
-3 -3
cent of GDP), primarily in the form of lower taxes for
-4 -4 pensioners and higher state grants to the local govern-
-5 -5 ment sector. In 2011, economic policy will be more
-6 -6
-7 -7 demand- than supply-side oriented regardless of who
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 wins the election.
07 08 09 10 11 12
Quarter-on-quarter percentage change
Year-on-year percentage change
Our main forecast assumes a continued Moderate Party-
Source: Statistics Sweden, SEB led Alliance government. The results of public opinion
surveys vary, but it is not unlikely that the right-wing
Reflecting this strong GDP growth, unemployment has populist Sweden Democrats, who now have no seats
declined in recent months. When growth slows, the in Parliament, will gain a kingmaker role there. In
labour market improvement will also enter a calmer the short term, a minority government may lead to a
phase, but the jobless rate will continue downward somewhat higher risk premium in the fixed income and
throughout our forecast period. At the end of 2012, we foreign exchange markets. Further ahead, such a parlia-
expect unemployment of just above 7 per cent. This is mentary situation may also lead to agreements spanning
about one percentage point above the low of the pre- the divide between the Alliance and Red-Green blocks
ceding boom period and is very close to our estimate of that would help stabilise government policies. The
equilibrium unemployment. strong position of the existing fiscal policy framework
will help ensure a stable economic policy in the short
and long term.

Nordic Outlook – August 2010  |  35

 Sweden

Why is Sweden doing so well?
We expect Swedish growth in 2010 to be about twice
the OECD average, and no other mature industrialised
country seems close to Sweden’s growth rate. One
explanation for this is that the downturn in 2008 and
2009 was deeper than in most other countries; the po-
tential for recovery is thus larger. These large swings
are due to the major role of exports in the Swedish
economy (50 per cent), but the structure of the export
sector has also resulted in extra large fluctuations.
This is not the most important explanation, however;
even in terms of levels, output and employment have
expanded more strongly in Sweden. Over the past
year, for example, Sweden has regained about half the
downturn in employment, whereas the euro zone job
market remains depressed.
Employment
Index 100=2007
102.5
102.0
101.5
101.0
100.5
100.0
99.5
finances. Another important factor is that Sweden was
not hit by a housing market crisis, with large price de-
clines, as was the case in a number of other countries.
This preserved the strong wealth position of Swedish
households, while the downturn in the residential sec-
tor was milder. The housing market was stable partly
because cuts in key interest rates had a larger impact
on mortgage loan rates, but also because of the low
level of residential construction for many years. A con-
tinued rise in home prices has led to a strong wealth
position, which in turn has helped stimulate consump-
tion.
Mortgage lending rates
Short-term, per cent
8 8
7 7
6 6
5 5
4 4
102.5
3 3
102.0
2 2
101.5
1 1
101.0 05 06 07 08 09 10
100.5
US, Freddie Mac 1 year
100.0 United Kingdom, standard variable rate
Sweden, 3-month
99.5 Source: Reuters EcoWin

99.0 99.0

98.5 98.5 As a whole, the Swedish economy is thus characterised

Q1 Q3 Q1 Q3 Q1 Q3 Q1 by rapid, broad growth in demand and has managed to
07 08 09 10
Sweden Euro zone avoid major structural crises in specific economic
Source: Eurostat, Statistics Sweden
sectors. But at the same time, many of the factors
Various factors can explain why the slump in domes- behind this favourable trend may also be interpreted
tic demand − both consumption and capital spend- as potential future risks. The section below on
ing − was more short-lived in Sweden than in other consumption discusses the risks that rapid credit
countries. Consumption has been sustained by high expansion and large home price increases may lead to
initial household savings and good income growth. This problems ahead. The section on exports analyses the
is largely attributable to an expansionary fiscal policy large international dependence of the Swedish
that was made possible by robust central government economy.

Broad upturn in exports fades in the course of 2010, exports will enter a calmer
The recovery in merchandise exports began later than phase.
in many other countries, but the upturn of the past
Strongest merchandise exports since 1995
4-5 months has been correspondingly stronger. The
20 275
year-on-year change in merchandise exports is now the
15
highest since 1994-95. The National Institute of Eco- 250
10
nomic Research’s Economic Tendency Survey indicates 225
5
that exports will continue to grow strongly in the near 200
0
future. The average increase between 2009 and 2010
-5 175
will be around 11 per cent.
-10
150
The export upturn is broadly based, with large upturns -15
125
especially in the sectors that fell the most during 2009, -20

for example the automotive industry. The recovery for -25 100
the metal and mining industries has also been very 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

strong. This year’s vigorous upturn in exports is largely Year-on-year percentage change (LHS)
driven by a reversal of the international inventory Level (RHS)
Source: Statistics Sweden, SEB
draw-down during 2009. When this process gradually

36   |  Nordic Outlook – August 2010

 Sweden

Despite the appreciation of the krona, the manufactur-
ing sector is relatively competitive. Sweden’s export
structure is also well suited to respond to the upturn
in international demand that we foresee in a longer
perspective. The growth rate of Swedish exports will
nevertheless slow somewhat over the next couple of
years as the global market for industrial goods enters a
less expansive period.
Gross fixed investments
Percentage change, 2009 level in current prices (SEK bn)
2009 2009 2010 2011 2012
Government
sector 103 7 2 -1 -1
Housing 91 -23 17 12 8

High correlation with other countries Business

GDP, year-on-year percentage change sector 362 -19 6 5 5
7.5 7.5

US
Sweden Total 555 -16 7 5 4
5.0 5.0
Source: Statistics Sweden, SEB
2.5 2.5

Euro zone Room for higher consumption

0.0
Correlation:
-2.5 Sweden - US: 0.82
Sweden - Euro zone: 0.91
-5.0
-7.5
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters Ecowin
But if the international economic situation should
deteriorate dramatically, Sweden will inevitably be af-
fected. A deep downturn in international trade, driven
for example by the emergence of new problems in the
financial sector, would have major consequences. The
historical correlation with US and euro zone growth is
high. In such crisis situations, Sweden is extra vulner-
able in its role as a small open economy.
0.0
Private consumption will be sustained by income growth
-2.5 averaging more than 2 per cent annually in 2010-12.
Because of low inflation, real hourly wages are rising in
-5.0 spite of record-low nominal pay increases. Combined
with rising employment, this will lead to a solid upturn
-7.5
in total real wages and salaries. In addition, Sweden’s
expansionary fiscal policy will boost income growth by
nearly one percentage point annually during 2010-2012.
Household income and consumption
Year-on-year percentage change
2009 2010 2011 2012
Consumption -0.8 2.9 2.6 2.2
Income 0.9 1.8 2.9 2.2
Savings ratio 12.6 11.6 11.8 11.8

Higher resource utilisation means Source: Statistics Sweden, SEB

capital spending During the economic crisis, Sweden’s household savings
Because of the steep deceleration in manufactur-
ratio reached record-high levels. A gradual decline in
ing during 2008-2009, capacity utilisation plunged to
unemployment and a strong wealth position, with home
record-low levels, with a sharp fall in capital spending
prices at record levels, mean that households could
as a consequence. Capacity utilisation has now rapidly
now reduce their saving. We thus expect the savings
rebounded and is back at levels more consistent with a
ratio to fall by one percentage point this year. In 2011
normal recession.
and 2012, our forecast is that consumption will largely
Capital spending in the business sector began climb- follow the trend of income, but the uncertainty risks in
ing early in 2010 from very low levels. The recovery is our consumption forecast is on the upside.
continuing, according to the Statistics Sweden business
Home prices
investment survey. The upturn is relatively broad-based, Index 2000 = 100
with higher activity both in manufacturing and in many 250 250
domestically oriented sectors. The upturn will continue 225 225
during the next couple of years, but the level of capital 200 200
spending in 2012 will remain lower than before the
175 175
economic crisis. Residential construction in Sweden has
150 150
also rebounded sharply in recent months. As a percent-
125 125
age of GDP, it has been lower than in nearly all other EU
100 100
countries for some time, and it is now benefiting from
rising home prices. 75 75
00 01 02 03 04 05 06 07 08 09 10

United Kingdom Denmark Sweden

Norway Spain
US Germany
Source: Reuters EcoWin

Nordic Outlook – August 2010  |  37

 Sweden

Imbalances are being postponed Households continuing to increase their debts

In a longer perspective, however, there is reason for Per cent of disposable income
greater concern. Due to the strong transmission mecha- 11 180
nism in Swedish monetary policy, household borrowing 10
160
is continuing to increase far faster than income. This 9
140
diverges sharply from the pattern in other countries. 8

Home prices have rebounded after a brief slump and 7 120

6
have thus doubled over the past ten years. In an inter- 100
5
national comparison only Spain − despite the downturn 80
4
of recent years − shows a larger price increase for the
3 60
decade as a whole.
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

There are, of course, various reassuring special features Sweden: Interest rate burden after taxes (LHS)
Sweden: Debts (RHS)
in the Swedish housing market, such as high household
US: Debts (RHS)
saving, low residential construction and fewer specu- Source: Riksbank, Federal Reserve, SEB

lative elements in the housing market. Yet the gap

between Sweden and other countries is sizeable. The The experiences of other countries show that a build-
process of de-leveraging and adjustment of home prices up of debt as rapid as in Sweden usually ends rather
that is now quite typical of other countries has thus not abruptly. This is often associated with a negative spiral
begun in Sweden. in which falling home prices lead to increased sav-

Major Swedish GDP revisions

In recent months, revisions in the Swedish GDP growth cussed in detail the discrepancy that existed between
forecast have been larger than in other countries. a strong labour market, rising optimism and upside
Until the end of May 2010, the consensus forecast surprises for public finances, on the one hand, and
was around 2 per cent. Then it rose to 3.5 per cent in GDP figures that indicated falling output throughout
August, and we expect the upward trend to continue 2009, on the other hand.
in the coming months in line with our own forecast.
There are similar trends in other countries whose GDP bottomed in Q1 2009, revised figure show
cyclical patterns are strongly dependent on interna- Index Q1 2008 = 100
101 101
tional trade and the market for manufactured goods.
For example, GDP growth in Japan was revised sharply 100 100

upward during the spring, but weak second quarter 99 99

GDP makes a new downswing in the consensus forecast 98 98
likely. As for Germany, the strong data of recent Aug 2010
97 97
months has not yet been fully reflected by the consen-
96 96
sus forecast.
95 95
GDP growth 2010
94 94
Per cent according to Consensus Forecasts Feb 2010
3.5 3.5 93 93
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
3.0 3.0
08 09 10
Source: SCB
2.5 2.5

2.0 2.0 When second quarter figures were published, this

picture changed. The new data indicate that GDP
1.5 1.5
bottomed out in the first quarter of 2009. This was
1.0 1.0
far more consistent with other economic information.
0.5 0.5 Technically speaking, this greatly changed the basis
0.0 0.0 for the full-year 2010 forecast. In our box in May,
Jan Mar May Jul Sep Nov Jan Mar May Jul
09 10
we implicitly assumed that such a revision would be
US Euro zone Germany unavoidable, but we could naturally not draw the full
Japan Sweden
Source: Consensus Economics consequences of this revision. The major adjustments
in Swedish GDP forecasts for 2010 can thus be viewed
The change in the Swedish forecast is also partly due as reflecting the greater dependence of a small open
to revisions in the national accounts. In the May is- economy on shifts in the global economic situation,
sue of Nordic Outlook, we predicted GDP growth of but also as showing that revisions in the statistics may
3.0 per cent in Sweden during 2010, well above the be more arbitrary in small countries.
consensus forecast at that time. In the box entitled
“Large gap between GDP and labour market”, we dis-

38   |  Nordic Outlook – August 2010

 Sweden

ing, declining consumption and rising unemployment. Statistics on new job vacancies and lay-off announce-
Economic policy makers in Sweden − both in fiscal and ments do not provide quite as bright a picture of
monetary policy − face the challenge of ensuring a soft developments but still indicate that the employment
landing for credit growth and home prices, which so upturn is continuing to gain strength. Looking a bit
many countries have failed to achieve. further ahead, the recovery in GDP nevertheless points
Expansive hiring plans in the business sector to a moderate upturn in employment. There is major
30 4 potential for productivity improvements after the large
20 SEB 3
declines of recent years, and this will reduce the need
forecast for new hiring.
10 2

0 1
Low pay hikes in 2010 and 2011
-10 0 The 2010 wage round is now largely completed. Ac-
-20 -1 cording to estimates by the National Mediation Office,
-30 -2 average contractual pay increases appear likely to end
up at 1.9 per cent during 2010 and 1.7 per cent in 2011.
-40 -3
These collective agreements were largely signed during
-50 -4
a period when there were fears that unemployment
02 03 04 05 06 07 08 09 10 11 12
would climb far above today’s levels. Now that the la-
Companies intending to boost employee numbers, net index (LHS)
Employment, year-on-year percentage change (RHS) bour market is strengthening, it is reasonable to assume
Source: NIER, Statistics Sweden, SEB that total pay increases will be somewhat higher than
the agreed levels. Our forecast is that pay increases
Falling unemployment will total 2.0 per cent in 2010 and 2.3 per cent in 2011.
Seasonally adjusted unemployment has decreased rap- Monthly statistics (according to the National Mediation
idly in recent months. Although official monthly figures Office) confirm a clear deceleration in the rate of wage
are often volatile, especially during the summer, most and salary increases, even after taking into account the
signs are that unemployment will now trend downward. normal downward adjustment in preliminary figures.
Short-term indicators show that the downturn may
Slower wage and salary increases
occur quite rapidly in the near future. According to
Year-on-year percentage change
the NIER Economic Tendency Survey, for example, the 5.0 5.0
percentage of companies stating that they intend to
4.5 4.5
hire new employees payrolls is higher than at any time
during 2007, when the number of jobs expanded by 4.0 4.0

more than 2.5 per cent. 3.5 3.5

3.0 3.0
Labour market, percentage change
2.5 2.5
2009 2010 2011 2012 2.0 2.0
Employment -2.1 0.9 1.2 0.5 1.5 1.5
Labour supply 0.2 1.0 0.5 0.3 01 02 03 04 05 06 07 08 09 10

Unemployment, % 8.3 8.5 7.9 7.6 Business sector Total

Source: National Mediation Office
Average hours
worked -0.5 0.3 -0.4 0.0 The new collective agreements expire at the end of
Productivity (GDP) -2.5 3.2 2.1 2.1 2011 or early in 2012. In the next wage round, trade
unions will probably try to compensate for having
Source: Statistics Sweden, SEB
concluded agreements in 2010 under the influence
of an excessively pessimistic picture of the economic
Productivity and GDP/hours
situation and the labour market. Yet we believe that
Index 2003 = 100
the strong support enjoyed by the Riksbank’s inflation
117.5 117.5
target, along with the fact that real wages rose in 2010
115.0 115.0
and 2011 despite low nominal increases, will help keep
112.5 112.5 wage formation problems from becoming too large.
15-year trend
110.0 110.0 We thus estimate that pay increases will accelerate
107.5
Productivity
107.5 to about 3.5 per cent during 2012, consistent with the
SEB forecast
average in recent decades.
105.0 105.0

102.5 102.5 Core inflation to keep falling

100.0 100.0 There are several reasons for believing that inflation
97.5 97.5 will be low in the next couple of years. The krona has
03 04 05 06 07 08 09 10 11 12 appreciated greatly, following its sharp decline dur-
Source: Statistics Sweden, SEB

Nordic Outlook – August 2010  |  39

 Sweden

ing 2008-09. Prices of imported goods in Sweden rose
sharply in 2009 − unlike the euro zone, for example.
Now that the krona is strengthening, much of the price
upturn is likely to be reversed. This effect will help
ease inflation pressure during the coming year.
Low inflation
Year-on-year percentage change
5 5
Regardless of the election outcome, fiscal policy is also
expected to remain expansionary.
In the next few months, we expect the Riksbank to
carry out the interest rate hikes it has announced, rais-
ing its key rate at each monetary policy meeting until
February. The repo rate will thus reach 1.5 per cent in
February 2011.

4 SEB forecast 4 Indicators for capacity utilisation

45 90.0
3 3
40 87.5
2 2
35 85.0
1 1
30 82.5
0 0 25 80.0

-1 -1 20 77.5

-2 -2 15 75.0
08 09 10 11 12 10 72.5

CPIF CPIF excl energy and food CPI 5 70.0

Source: Statistics Sweden, SEB
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

The sharp deceleration in wage inflation, combined
with a recovery in productivity, will also lead to a de-
cline in unit labour cost both in 2010 and 2011. We also
expect international price increases on imported goods
in general to be low.
Core inflation − defined as CPIF (CPI with a fixed
interest rate) excluding energy and food − fell gradu-
ally from nearly 3 per cent at the end of 2009 to just
above 1.5 per cent in July. We expect this downturn to
continue until mid-2011, when the effects of krona ap-
preciation culminate. After that there will be a gradual
upturn, but CPIF will remain below the Riksbank’s 2 per
cent target throughout our forecast period. CPI inflation
will climb gradually to just above 2 per cent in 2011
due to the Riksbank’s key rate hikes, which will boost
the interest costs for home mortgages.
Rapidly climbing resource utilisation will represent
an inflationary threat in a longer perspective, but the
historical pattern is that inflation gains momentum only
when a period of economic expansion is about to culmi-
nate. That is presumably beyond our forecast horizon.
Labour shortage, share of firms (LHS)
Capacity utilisation, manufacturing, per cent (RHS)
Source: NIER
After that, we expect the rate hiking cycle to shift to
a slower pace. The recovery will lose momentum and
meanwhile there will be increasing focus on Sweden’s
low actual inflation pressure. Continued very low key
interest rates in other countries will indirectly affect
the Riksbank, among other things because the krona
will be appreciating. Since a large majority of Swed-
ish households have adjustable mortgage rates, home
prices and lending are also likely to be very sensitive
to higher short-term interest rates. To some extent,
the housing market will also cool as a result of the new
mortgage loan ceiling. The change in funding for mort-
gage institutions − a shift towards longer-term funding
− will also contribute to a larger increase in short-term
lending rates than will be justified by repo rate hikes.
The Riksbank’s estimates of a neutral key rate may also
continue to be adjusted downward. Taking all factors
into account, we expect the repo rate to stand at 2.25
per cent late in 2011 and 3.0 per cent late in 2012.

Front-loaded key rate hikes Spread vs Germany

The Riksbank now faces an ever-clearer dilemma. Very Basis points
1.5 0.7
strong Swedish GDP and labour market data imply a
need for major revisions in forecasts. On the other 1.0
0.5
hand, the Riksbank must weigh this against downward 0.3
revisions in the international picture and increasing 0.5

risks of a more significant downturn, for example in the 0.1

0.0
US. -0.1

-0.5
In the short term, domestic factors will predomi- -0.3

nate. Based on revisions of output and labour market -1.0 -0.5

gaps, the Riksbank will probably continue to draw the 99 00 01 02 03 04 05 06 07 08 09 10 11 12
conclusion that current interest rates are too low. In Repo rate spread (LHS)
addition, home prices and lending are expected to 10 year government yield (RHS)
Source: Reuters EcoWin
continue climbing faster than underlying factors justify.

40   |  Nordic Outlook – August 2010


Wider spread against Germany
The differential between Swedish and ECB key interest
rates is the most important explanatory variable behind
divergences in long-term yields against Germany. We
expect Sweden’s repo rate at the end of 2011 to be
around 100 basis points above the ECB’s refi rate. This
will be reflected in a wider differential in long-term
yields, but strong Swedish government finances will
keep the yield spread narrower. Overall, we anticipate
that the spread will widen to 30 basis points by mid-
2011, from around 0 points today. Swedish bond yields
will thus climb slowly from today’s very depressed lev-
els. This forecast implies that the Swedish yield curve
will be very flat in the future.
Normalised krona exchange rate
The krona has regained most of the ground it lost dur-
ing the economic crisis years. In trade-weighted TCW
terms, it is now only 3-4 per cent weaker that before
the crisis broke out in 2007. The EUR/SEK exchange
rate is now back in the upper part of the relatively
stable 9.00-9.40 interval that prevailed during 2002-07.
Economic and interest rate forecasts unambiguously
indicate that the krona will continue to strength against
the euro. Our forecast that the EUR/SEK rate will be
9.00 at the end of 2010 remains unchanged.
Underlying fundamentals such as labour costs and cur-
rent account point towards a further strengthening of
the krona in a longer perspective. These fundamentals
were previously difficult to see, but given the linger-
ing problems of the euro zone, we expect the krona to
strengthen past the 9.00 mark, reaching an exchange
rate of SEK 8.75 per euro at the end of 2011. Given our
EUR/USD forecast, the krona will end up at 6.89 per
dollar at the end of 2011.
The risks in our forecast of a continued apprecia-
tion of the krona lie mainly in a clear deterioration in
risk appetite ahead. In the short term, an uncertain
parliamentary situation may also lead to a temporary
weakening of the currency.
Surprising public finances
Our forecast for Swedish public finances has continued
to improve. This is due to brighter economic prospects,
but also to unexpectedly strong tax revenue. Sweden
weathered the crisis without large deficits − meanwhile
managing to carry out expansionary measures aimed at
easing the impact of the crisis − mainly due to its strong
fiscal position at the outset. In 2007, Swedish public
finances showed a surplus of 3.6 per cent of GDP, while
both Germany and the euro zone as a whole posted def-
icits despite several years of strong economic growth.
Nor was the historical pattern of greater cyclical sensi-
tivity in Swedish public finances repeated in this phase.
This was mainly due to a relatively moderate downturn
in the labour market as well as stable private consump-
tion, which kept up value-added tax revenue.
Sweden
Deficits in public sector budgets
Per cent of GDP
Sweden Euro zone Germany
2007 balance 3.5 -0.7 -0.2
Change since 2007 -4.5 -5.6 -3.5
GDP, change 08/09 -5.5 -3.6 -3.7
Source: Eurostat, Statistics Sweden
We expect Sweden’s central government debt to fall
to 31.7 per cent of GDP in 2012: lower than before the
economic crisis. This still includes more than SEK 100
billion in onward lending by the National Debt Office,
mainly in the form of a loan to the Riksbank aimed at
strengthening its foreign exchange reserve. If the re-
serve reverted to normal size, this would reduce central
government debt by nearly 3 per cent of GDP. In our
calculations, we have not taken into account the incum-
bent Alliance government’s declaration that it intends
to carry out divestments of state-owned companies
averaging SEK 25 billion (0.8 per cent of GDP) annually.
The graph below shows central government debt and
the effect on central government debt of a repayment
of the SEK 100 billion loan to the Riksbank and sales
revenue of SEK 25 billion a year 2011 and 2012.
Falling central government debt
Per cent of GDP
75 75
70 70
65 65
60 60
55 55
50 50
45 45
40 40
35 35
30 30
25 25
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Forecast
Forecast with privatisation and loan repayment
Source: Statistics Sweden, SEB
Continued fiscal expansion
Unlike most other OECD countries, Sweden will pursue
an expansionary fiscal policy in 2011 as well. We expect
the total dose of fiscal stimulus to be equivalent to
about SEK 25 billion (0.8 per cent of GDP). The shape
of this stimulus will naturally depend on the election
outcome, but tax cuts for pensioners totalling SEK 5-10
billion and additional billions to the local government
sector will be important elements of economic policy,
regardless of the election outcome.
There is further room for reforms in the years after
2011. The government’s latest estimate is a total of SEK
30-40 for the four-year parliamentary term of office as
a whole (of which SEK 10 billion in 2011), beyond what
had already been announced. In our assessment, this
is a cautious forecast which includes safety margins
Nordic Outlook – August 2010  |  41
 Sweden

beyond the surplus targets that are part of the existing
fiscal framework.
During the election campaign, the battle for centrist
voters has escalated. As a result, the two blocks have
moved closer to each other, among other things be-
cause the government has made its election programme
more demand-oriented and toned down its emphasis on
creating incentives to join the labour market. Yet there
are still important differences between the two govern-
ing alternatives when it comes to economic policy. An
Alliance government would continue its current policy
of strengthening the driving forces behind working, by
enacting further earned income deductions and social
insurance reforms. If the Red-Green block takes office,
it will restore earlier cuts in compensation levels in the
transfer payment system. The Red-Green block has also
proposed tax increases of about SEK 10 billion in the
form of energy, payroll and wealth taxes. This kind of
more demand-oriented and perhaps more expansionary
policy will lead to a somewhat greater need for interest
rate hikes.
Public finances
Per cent of GDP
2009 2010 2011 2012
Revenue 52.4 51.7 50.7 50.7
Expenditures 53.4 52.1 51.2 50.3
Net lending -1.0 -0.5 -0.6 0.3
General gov’t
gross debt 41.7 41.3 40.1 38.2
Central gov’t debt 37.0 34.8 33.6 31.7
with the Green Party and the Left Party has probably
also created greater uncertainty about the Red-Green
coalition’s ability to govern.
In spite of this, the election outcome is far from
decided. Public opinion surveys in August have shown
a very even race, though with a lead for the Alliance.
Most surveys have nevertheless shown a narrower gap
between the blocks than at the same point before the
2002 and 2006 parliamentary elections. In both these
elections, the gaps between the blocks narrowed in the
final days of the campaign. Yet at present, the most
likely election outcome is that the Alliance will win
more seats than the Red-Green block.
In most surveys, the right-wing populist Sweden Demo-
crats have fluctuated around the 4 per cent national
minimum of voter support required to win any seats at
all. The party is relatively likely to make it into Parlia-
ment. An Alliance government without a majority of
its own would be forced to seek support from one or
more other parties on various issues. Such an election
outcome might create short-term concerns and lead to
an extra Swedish risk premium in the fixed income in
foreign exchange markets. Looking further ahead, how-
ever, it is difficult to foresee any major risks to Swed-
ish economy policy. The fiscal policy framework enjoys
strong support, and in the long term such a parliamen-
tary situation may lead to agreements across the divide
between the two main blocks, which would contribute
to political stability.

Central gov’t
borrowing
Requirement, SEK bn 176 12 24 -7
Source: Statistics Sweden, SEB

A new minority government?

In the course of 2010 the Alliance government has grad-
ually increased its support in voter opinion polls and
has moved ahead of the Red-Green block. The improved
Swedish economy, in clear contrast to the problems of
other countries, has contributed to this improvement.
The Alliance government has shown that it can steer
the country through an economic crisis while sticking to
the existing fiscal policy framework. This has neutral-
ised such traditional Social Democratic arguments as
proven leadership skills and fiscal responsibility, based
on the party’s earlier decades-long tenure in govern-
ment. The Social Democrats’ new formal collaboration

42   |  Nordic Outlook – August 2010


Modest growth but better balance
ƒƒ The labour market is stabilising
ƒƒ Large foreign trade surpluses
ƒƒ Budget tightening will shrink big deficit
The Danish economy is climbing at a modest pace. First
quarter GDP was 0.6 per cent higher than in the fourth
quarter of 2009. This third straight quarter of growth
was somewhat stronger than expected. Sentiment
indicators are signalling a continued gradual recovery.
Both manufacturing and service sector surveys have
trended upward for more than a year. After a minor
slowdown last spring, the purchasing managers’ index in
manufacturing has strengthened, again climbing above
the expansion level of 50. The service sector indica-
tor has shown a similar pattern, while expectations at
construction companies remain cautious.
Exports, inventory build-up and public sector consump-
tion have initially driven the economic turnaround, but
private consumption has also started to rebound this
year. The upturn in domestic demand will be sluggish,
however. Restraining factors are tighter fiscal policy,
higher savings ambitions among households and much
calmer construction and housing markets than during
the overheating of 3-5 years ago. Home prices have
climbed weakly for three straight quarters. We expect a
continued weak upturn in prices.
Big trade surpluses are back
DKK billion, moving three month average
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
04 05 06 07 08 09 10
Current account Trade balance
Source: Reuters EcoWin
Positive growth surprises in Sweden and Germany, and
well as currency depreciation, are providing an extra
impetus for exports this year. This is the main reason
why we are revising our 2010 GDP forecast to 1.8 per
cent, compared to 1.5 per cent in May. The 2011
growth outlook remains at 1.8 per cent. We foresee
growth of 2.2 per cent in 2012.
Denmark
Because of the upswing in exports, the trade and cur-
rent account balances have again shown large surpluses
during the past year. These will shrink somewhat as
imports gradually strengthen.
After an upturn from a very low 1.7 per cent in the
summer of 2008, unemployment has levelled off at
4-4.5 per cent in the past six months. We predict a
slow downturn to an average of 3.5 per cent in 2012.
The jobless rate can fall at least one percentage point
from today’s level without triggering a surge in pay and
prices. Our pay forecast is continued slow increases
of slightly above 2 per cent this year and next. The
deceleration in wage pressure over the past few years,
combined with this year’s weakening of the Danish
krone, has strengthened competitiveness. Pay growth
exceeding that of competitor countries has previously
been a structural problem, but the implementation of
reforms aimed at creating a more flexible labour mar-
ket appears to have had a favourable impact.
The inflation rate has hovered around 2 per cent, fol-
lowing a brisk upturn last winter, but core inflation has
trended downward to 1 per cent. Using the broad HICP
measure, we expect inflation to average less than 2
per cent in 2011 and just above 2 per cent in 2012.
The public sector budget deficit looks set to end up
above 5 per cent of GDP this year. Partly because of
this large deficit, late in May the government presented
a three-year austerity programme totalling DKK 24
billion. This package came unexpectedly early, consid-
ering that the economic upturn has just begun, but the
government probably wants to avoid announcing belt-
tightening close to next year’s election. The measures
include lower public sector investments, deceleration
of automatic indexing of pensions and other transfer
payments plus cancellation of certain planned tax cuts.
We foresee that these measures will help shrink the
budget deficit to 3 per cent in 2012.
Given robust surpluses in Denmark’s external balance,
the central bank can leave its low 5 basis point spread
above the ECB’s refi rate remain unchanged into next
year. However, we believe that Denmark will begin
interest rate normalisation one–two quarters before
the ECB, which will carry out its first rate in March in
2012. Looking ahead a year or two, the spread vs the
ECB will gradually widen to 20 basis points, which has
historically been more normal.
Nordic Outlook – August 2010  |  43
Norway

More broad-based recovery

ƒƒ Mainland GDP back at previous peak level
ƒƒ Unexpectedly weak H1 consumption
ƒƒ Norges Bank constrained by ECB
ƒƒ Weaker NOK in the near term
The recovery in the Norwegian economy has been sub-
par so far, but activity accelerated towards mid-year as
sequential growth in mainland GDP (excluding oil, gas
and shipping) picked up from 0.2 per cent in the first
quarter to 0.5 per cent in the second quarter − up 1.5
per cent from the year-earlier period. Moreover, under-
lying momentum was somewhat better as a sharp drop
in electricity production subtracted 0.2 points from
the quarterly growth rate in mainland GDP: excluding
this, growth accelerated more markedly and the level
surpassed the previous peak.
Meanwhile, overall GDP inched up only 0.1 per cent on
the quarter in Q2 and a sub-par 0.9 per cent year-on-
year, among other things due to another drop in exports
of oil and gas and a substantial drag from higher net
imports of ships and oil platforms.
An uneven recovery so far
Year-on-year percentage change
12.5
10.0
7.5
5.0
2.5
0.0
The consumption conundrum
The turn around mid-2009 was spurred by private
consumption as households reacted to sharply lower
interest rates and fiscal stimuli lifting overall public
demand. However, while private consumption was up
more than 4 per cent from the first to the fourth quar-
ter of 2009, it declined by 0.2 per cent during the first
half of 2010.
The weakening has been surprising considering that fun-
damentals − real income growth, still-low interest rates
and some improvement in labour markets − are rather
supportive. One reason might be that the considerable
boost to disposable income from Norges Bank’s deep
rate cuts up until June 2009 was seen by households as
a one-off.
Moreover, Norwegian households’ gross debt has
risen from some 150 per cent of disposable income
at the start of 2004 to slightly above 190 per cent by
end-2009. Part of the reason for a higher debt-to-in-
come ratio than among peers reflects structural dif-
ferences (such as more saving for pensions through
taxes) and high public savings. In particular, assets in
the Government Pension Fund Global − formerly the
national petroleum fund − have increased sharply to
some 145 per cent of mainland GDP as of mid-2010.
20.0
15.0
Households have made correction
Per cent of disposable income
10.0
12.0 225
5.0
10.0
0.0 200
8.0

-2.5 -5.0 6.0 175

-5.0 -10.0 4.0
2.0 150
-7.5 -15.0
99 00 01 02 03 04 05 06 07 08 09 0.0
125
-2.0
Final non-oil private domestic demand (LHS)
Public demand (LHS) -4.0 100
Exports traditional goods (RHS) 90 92 94 96 98 00 02 04 06 08 10
Source: Statistics Norway
Household saving ratio, 4Q moving average (LHS)
The 2010 forecast for growth in mainland GDP has Household savings ratio excl share dividends, 4Q mov. av. (LHS)
Household gross debt (RHS)
been nudged down to 1.6 per cent because of the slow Source: Norges Bank, Statistics Norway

start of the year, while 2011 should see acceleration
to 2.7 per cent. The downward revision is mainly due
to lacklustre private consumption. However, non-oil
investment shows signs of bottoming out and is likely
to add to overall growth going forward. Moreover, oil
companies expect markedly higher investment in 2011.
Growth in overall GDP should be a modest 0.7 per cent
in 2010 but somewhat stronger at 2.1 per cent in 2011.
Nonetheless, a period of debt consolidation might be
likely, but it is uncertain whether the relative level will
start falling. This has happened before: gross debt fell
from 148 per cent of disposable income in 1990 to 117
per cent in 1995. During that period, average annual
growth in private consumption was broadly in line with
that of real disposable income. It should be noted,
though, that interest expenses as a share of disposable

44   |  Nordic Outlook – August 2010


income at the start of that period were approximately
twice as high as today. So far, available data do not
indicate that households have started to reduce their
debts to any large extent.
However, the household savings ratio shows a sizeable
correction from slightly negative at the start of 2008
to 8.4 per cent by the final quarter of 2009. The more
stable savings measure which excludes share dividends
shows a similar trend and is far above its long-term
average.
One more factor behind the soft patch in private con-
sumption was the 50 per cent spike in electricity prices
over the six months to March due to unusually cold
winter weather. History shows that sharp movements in
such prices, whether up or down, often have a rather
immediate effect on consumption. This is not surpris-
ing, as electricity makes up a sizeable part of monthly
household expenses. In fact, the subsequent jump in
overall inflation was instrumental for the decline in real
disposable income in the first quarter of the year.
Private consumption and inflation
Percentage change over two quarters
6 -2.0
5
4
3 0.0
2
1
0 2.0
-1
-2
-3
99 00 01 02 03 04 05 06 07 08
Private consumption (LHS)
Inflation, lagged 1Q (RHS)
Source: Statistics Norway
Signs of a broadening recovery
We expect fundamentals to reassert themselves and
private consumption to re-accelerate over the re-
mainder of the year. The correction in the household
savings ratio has likely ended and consumption should
be somewhat stronger than growth in real disposable in-
come (about 2.5 per cent this year and next). In recent
months, inflation pressure has eased as well, which
should help consumption to recover.
In addition, the labour market shows signs of a modest
improvement, but there is a discrepancy in unemploy-
ment measures. The unemployment rate according to
the Labour Force Survey inched up from 3.3 per cent at
end-2009 to 3.5 per cent on average in May-July. How-
ever, overall registered unemployment − including those
in government-financed labour market schemes − de-
clined to a level well below that at the end of last year.
Of the two measures, the latter has tended to be more
reliable in the past. In addition, employment shows
tentative signs of accelerating, rising 0.5 per cent in
May-July from six months earlier.
Norway
Our forecast for private consumption growth in 2010 has
been cut markedly to 2.7 per cent, but growth should
accelerate to 3.3 per cent in 2011. In addition, signs
of the expected broadening in domestic demand are
emerging, and growth in mainland GDP should acceler-
ate somewhat over the second half of 2010 and in 2011.
In particular, private non-oil investments seem to have
bottomed out. Residential investments, which fell by
a third between mid-2007 and end-2009, show signs
of stabilising and new orders for dwellings have risen.
Moreover, business investments outside manufacturing
saw a very marked rebound in the second quarter. Such
investments tend to be very volatile, but they were up
during the first half following a slump of 25 per cent
from end-2007 and until the first quarter of 2010.
Other indicators also suggest an improving outlook.
Firstly, Norges Bank’s latest lending survey reported
rising loan demand from businesses, and lending to the
sector has turned around. Secondly, producers of invest-
ment goods expect rising domestic demand according
to Statistics Norway’s Business Tendency Survey, and
orders for such goods increased markedly in the second
quarter from the year-earlier period.
-1.0 Investments in the manufacturing sector dropped 23 per
cent in the year to the second quarter of 2010. Manu-
facturing output was up 4.3 per cent over the same pe-
1.0 riod, and capacity utilisation increased somewhat. The
level remains well below its long-term average, which
will put a lid on future investment, although manufac-
3.0
turers reported higher planned investments in the Q2
4.0 Business Tendency Survey. This suggests a slow improve-
09 10 ment. Nonetheless, other business sectors will account
for all of the expected pickup in investment, averaging
4.6 per cent in 2011.
The outlook has improved for oil sector investments as
well. Oil companies reported surprisingly high invest-
ment plans for 2011 in the second-quarter survey − 7-8
per cent higher in nominal terms than the expected
level in 2010 − and orders from the sector to domestic
manufacturers have shot up. We expect investments in
the oil sector to be up 5.0 per cent in 2011 following a
slight decline in 2010, providing stimuli to the rest of
the economy, manufacturing in particular.
Core inflation to remain benign
Inflation has trended markedly lower so far in 2010 with
the annual rate for the core CPI-ATE measure (excluding
taxes and energy) slowing more than one percentage
point from last December to 1.3 per cent as of July,
while overall inflation dropped from 3.4 per cent in
March to 1.9 per cent. Part of the slowing in headline
CPI is due to a marked turn in electricity prices fol-
lowing the surge until spring. In addition, the decline
in import prices has accelerated, reflecting a stronger
Norwegian krone. This effect is likely to continue in the
near term but will wane in due time.
Nordic Outlook – August 2010  |  45
 Norway

Core inflation at a three-year low
Year-on-year percentage change
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
-4 -4
-5 -5
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
CPI, excluding taxes and energy
Core inflation, domestic goods and services
Core inflation, imported consumer goods
Source: Statistics Norway, SEB
Core domestic inflation has moderated as well to
slightly above 2 per cent at present. Domestic inflation-
ary pressure is likely to remain muted. Wage growth is
expected to moderate from 4.5 per cent in 2009 to 3.5
per cent in 2010. Productivity has staged a recovery,
resulting in markedly slower growth in unit labour costs
compared with the rather strong rise seen previously.
Overall, we now see a slightly more benign outlook
with core inflation only marginally higher by early next
year, averaging 1.9 per cent in 2011 and close to Norges
Bank’s 2.5 per cent medium-term target late in 2012.
Even slower interest rate hikes
Norges Bank’s monetary policy meeting in August con-
firmed the dovish impression left from June’s Monetary
Policy Report, in which the bank once again cut its
optimal rate path quite markedly: the rate path shows
a 50/50 chance for a hike in the 2.00 per cent deposit
rate before end-2010, while the report lowered the
level in the final quarter of 2011 by almost 60 basis
points to 2.74 per cent on average.
Norges Bank's rate path
8 8
7 7
order to guard against the risk of future financial im-
balances. Taking into account our new forecasts for
domestic growth and inflation and the expected soft
patch in growth abroad, we now expect the deposit
rate to remain at 2.00 per cent until year-end, with
the next hike in the first quarter of 2011.
We see several reasons for Norges Bank to continue
hiking the deposit rate gradually thereafter. The output
gap is expected to be closed by early 2012 and core
inflation will also start trending upward. However, the
bank’s room to manoeuvre will still be constrained by
monetary policy elsewhere, as it will want to avoid a
markedly stronger NOK.
As the ECB and the Fed is now expected to keep their
key interest rates unchanged until 2012, Norges Bank
will move more slowly as well: we foresee the deposit
rate ending 2011 at 2.75 per cent. Such a level implies
a continued stimulative monetary policy as the real
deposit rate − adjusted for core inflation − at that time
will be less than ¾ percentage point according to our
forecast, well below what Norges Bank regards as a
“normal” level of some 2 per cent.
Tighter yield spread vs. Germany
As indicated above, Norges Bank will continue to nor-
malise its key rate at a faster pace than the ECB. Our
forecast implies that the interest rate spread will be
175 basis points by the end of 2011. While this normally
means that the 10-year government bond yield spread
against Germany should rise, we expect it to remain
unchanged or even decline somewhat from current high
levels. The current low global bond yield environment
makes Norwegian government bonds attractive from a
yield pick-up perspective. We thus believe that the 10-
year government bond yield will be unchanged at 2.95
per cent at the end of 2010, rising to 3.50 per cent by
end-2011 and 3.95 per cent at the end of 2012.

6 6

5 5 Short-term krone weakening

4 4 The Norwegian krone remains a central element of
Norwegian monetary policy. Although Norges Bank has
3 3
focused more on the European debt crisis in recent
2 2
months, the central bank continues to express concern
1 1 about the relatively strong currency. At today’s levels,
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
the NOK is pushing down imported inflation. This is the
Norges Bank deposit rate main reason why Norges Bank would prefer − and is also
Optimal rate path, MPR 2/10 forecasting − a somewhat weaker currency. We now also
Optimal rate path, MPR 1/10
Source: Norges Bank foresee a weaker krone, at least in the short term. The
Domestic economic developments have been in line Norges Bank deposit rate will probably remain at 2 per
with Norges Bank’s expectations and suggest that the cent until early 2011, and although expectations are set
bank should continue hiking its key rate as planned. very low, we will not see hawkish surprises during the
Among other things, the bank regards a gradual rise next few months.
“closer to a more normal level” as warranted, in

46   |  Nordic Outlook – August 2010

 Norway

Exchange rate EUR/NOK

10.0 10.0

9.5 9.5

9.0 9.0

8.5 8.5

8.0 8.0

7.5 7.5

7.0 7.0
02 03 04 05 06 07 08 09 10

EUR/NOK spot SEB regression

Source: Reuters EcoWin, SEB

Foreign interest in buying Norwegian equities has also

cooled somewhat, although we saw a slight increase in
the summer. Still, there is a risk that the global eco-
nomic slowdown will reduce foreign investors’ purchas-
es of Norwegian company shares and that capital will
be repatriated, which would have a big impact on the
NOK. Norges Bank has also announced that it will begin
buying foreign currencies for the Government Pension
Fund Global. This adds to the weaker flow outlook. To
top it off, the NOK looks expensive in real trade-weight-
ed terms. Our internal EUR/NOK model (including oil
prices, interest rate spreads and risk appetite) points at
an equilibrium exchange rate close to 8.60. At the end
of 2010, the EUR/NOK rate will be 8.20. In a slightly
longer perspective, we expect the krone to strengthen
as Norges Bank continues to raise its key interest rate
and the global economic outlook improves. The EUR/
NOK exchange rate will be 7.90 at the end of 2011.

Nordic Outlook – August 2010  |  47

Finland
Strong autumn and winter
ƒƒ Leading indicators climbing, GDP taking
off
ƒƒ Higher inflation than euro zone average
ƒƒ Budget deficit below 3 per cent in 2011
The Finnish economy was very hard hit by last year’s
global slowdown and early 2010 was unexpectedly
weak. GDP fell by 8 per cent in 2009 − the largest de-
cline in the OECD − and continued downward by 0.4 per
cent in the first quarter of 2010 compared to the fourth
quarter of last year. However, the downturn was largely
due to the protracted dock workers’ strike, which para-
lysed a large percentage of exports, hurting the paper
and forest product industry in particular.
Yet leading indicators are still pointing upward.
Surveys show that the service sector is leading the up-
turn, but the manufacturing sector − and recently the
construction industry − are also recovering. Industrial
production rose 2.1 per cent month-to-month in June,
equivalent to a year-on-year increase of nearly 15 per
cent. Today retail sales are also rebounding, with a
year-on-year increase of more than 4 per cent in June.
Exports are benefiting from substantially stronger
growth in a number of important countries, especially
Germany and Sweden, which each buy 10 per cent of
Finnish exports. Continued strong growth in Russia and
China (together accounting for 15 per cent of exports)
is also having a positive impact. Altogether, exports will
increase by about 6 per cent this year and in 2011.
Service sector leading the upturn
Index
70
50
30
10
-10
-30
-50
-70
00 01 02 03 04 05 06 07 08
Construction sector Service sector
Manufacturing sector
Capital spending will grow by 2 per cent this year,
among other things due to rapidly rising capacity uti-
lisation (about 80 per cent today). Households, which
48   |  Nordic Outlook – August 2010
cut back on consumption last year, are being stimulated
by low interest rates and have already begun to spend;
private consumption will climb by around 2 per cent
both this year and in 2011. The household savings
ratio will decline somewhat.
Altogether, GDP growth will end up at 2.5 per cent
this year, 2.6 per cent in 2011 and somewhat higher
in 2012 − roughly the same forecast as in May and still
well above consensus. The risks in the immediate future
are on the upside. Given Finland’s export structure, the
economy could take off even more strongly, thus follow-
ing the pattern in Sweden and Germany.
The negative labour market trend following the crisis
has ended. In the second quarter, the number of job
vacancies was nearly 30 per cent higher than a year
earlier. Unemployment peaked at 8.9 per cent in Janu-
ary and has now fallen to 8.2 per cent. We expect the
jobless rate to continue downward towards 7.5 per cent
in mid-2011, then to 7 per cent at the end of 2012,
somewhat below the OECD’s measure of non-accelerat-
ing inflation rate of unemployment (NAIRU).
Wage and price formation are affected by the labour
market with a certain time lag, and last year’s upturn
in unemployment and collective agreements point
towards low increase in hourly wages both this year and
next. In the economy as a whole, wages and salaries
will climb by 2.8 per cent this year and just below 2.5
per cent in 2011. In 2012, the rate of pay increases
will accelerate due to a tighter labour market situa-
tion.
According to Finland’s national measure, CPI inflation
has gradually climbed this year: from -0.2 per cent
70 year-on-year in January to 1 per cent in July. This sum-
50 mer’s value-added tax hike will result in a continued
30 upturn this autumn and winter. CPI inflation will end
up averaging 1 per cent this year, just over 2 per cent
10
in 2011 and even higher in 2012. Eurostat’s harmonised
-10
inflation measure (HICP), which excludes interest pay-
-30 ments on loans, will be somewhat higher: HICP inflation
-50 will average 1.5 per cent this year, then climb gradually
-70 to somewhat above 2 per cent in 2011 and 2012.
09 10
Decent growth and falling unemployment will con-
tribute to a moderate budget deficit of about 3.5 per
Source: DG ECFIN cent of GDP this year and less than 3 per cent in 2011.
Sovereign debt will stabilise at around 50 per cent of
GDP. Finnish public finances are thus in substantially
better shape than the euro zone average.
 Economic data

DENMARK
Yearly change in per cent
2009 level,
DKK bn 2009 2010 2011 2012
Gross domestic product 1,660 -4.7 1.8 1.8 2.2
Private consumption 817 -4.3 1.9 2.2 2.7
Public consumption 492 3.4 0.8 0.3 0.5
Gross fixed investment 312 -14.1 -3.5 3.0 5.5
Stockbuilding (change as % of GDP) -2.4 0.7 0.0 0.0
Exports 784 -10.2 6.0 5.5 5.0
Imports 727 -13.2 4.5 5.7 6.0

Unemployment (%) 3.6 4.4 4.0 3.5

Consumer prices, harmonised 1.1 2.1 1.9 2.1
Wage cost 3.1 2.3 2.1 3.0
Current account, % of GDP 4.0 3.5 3.0 2.5
Public sector financial balance, % of GDP 3.6 -5.5 -4.0 -3.0
Public sector debt, % of GDP 39.0 45.0 47.0 48.0

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Deposit rate 1.05 1.05 1.05 1.10 1.65 1.95
10-year bond yield 2.21 2.30 2.55 2.95 3.15 3.35
10-year spread to Germany, bp 6 10 15 15 15 15
USD/DKK 5.85 6.11 5.96 5.87 5.73 5.73
EUR/DKK 7.45 7.45 7.45 7.45 7.45 7.45

NORWAY
Yearly change in per cent
2009 level,
NOK bn 2009 2010 2011 2012
Gross domestic product 2,256 -1.4 0.7 2.1 2.1
Gross domestic product (Mainland Norway) 1,732 -1.4 1.6 2.7 2.9
Private consumption 956 0.2 2.7 3.3 3.1
Public consumption 487 4.7 3.0 2.4 1.8
Gross fixed investment 467 -9.1 -4.5 4.3 4.1
Stockbuilding (change as % of GDP) -2.2 1.7 0.0 0.0
Exports 1,008 -4.0 -0.1 0.7 1.9
Imports 638 -11.5 6.7 3.4 4.2

Unemployment (%) 3.2 3.6 3.6 3.4

Consumer prices 2.1 2.4 1.6 2.4
CPI-ATE 2.6 1.5 1.8 2.3
Wage cost 4.5 3.5 3.7 4.0

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Deposit rate 2.00 2.00 2.25 2.75 3.25 3.75
10-year bond yield 2.97 2.95 3.00 3.50 3.75 3.95
10-year spread to Germany, bp 82 75 60 70 75 75
USD/NOK 6.29 6.72 6.40 6.22 6.00 6.00
EUR/NOK 8.01 8.20 8.00 7.90 7.80 7.80

Nordic Outlook – August 2010  |  49

 Nordic key economic data

SWEDEN
Yearly change in per cent
2009 level,
SEK bn 2009 2010 2011 2012
Gross domestic product 3,108 -5.1 4.7 2.9 2.3
Gross domestic product, working day adjusted -5.0 4.4 2.9 2.7
Private consumption 1,516 -0.8 2.9 2.6 2.2
Public consumption 863 1.7 1.0 0.9 0.9
Gross fixed investment 555 -16.0 7.0 5.0 4.0
Stockbuilding (change as % of GDP) -41 -1.4 0.7 0.2 0.2
Exports 1,507 -12.4 11.3 6.7 5.1
Imports 1,294 -13.2 12.4 6.9 5.1

Unemployment, (%) 8.3 8.5 7.8 7.6

Employment -2.1 0.9 1.2 0.5
Industrial production -19.1 10.0 5.0 4.0
Consumer prices -0.3 1.2 1.7 2.2
CPIX 1.9 2.0 1.1 1.6
Wage cost 3.4 2.0 2.3 3.5
Household savings ratio (%) 12.6 11.6 11.8 11.8
Real disposable income 0.9 1.8 2.9 2.2
Trade balance, % of GDP 4.0 3.3 2.5 2.5
Current account, % of GDP 7.5 6.0 5.5 5.5
Central government borrowing, SEK bn 176 12 24 -7
Public sector financial balance, % of GDP -1.0 -0.5 -0.6 0.3
Public sector debt, % of GDP 42 41 40 38

FINANCIAL FORECASTS Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12

Repo rate 0.50 1.25 1.50 2.25 2.75 3.00
3-month interest rate, STIBOR 1.03 1.78 1.85 2.65 3.15 3.40
10-year bond yield 2.25 2.30 2.70 3.20 3.40 3.60
10-year spread to Germany, bp 10 10 30 40 40 40
USD/SEK 7.41 7.38 7.20 6.89 6.73 6.77
EUR/SEK 9.43 9.00 9.00 8.75 8.75 8.80
TCW 129.6 124.6 123.5 120.4 120.0 120.7

FINLAND
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 171 -7.8 2.5 2.6 2.7
Private consumption 94 -1.8 2.0 2.2 2.0
Public consumption 43 0.8 0.5 0.7 1.1
Gross fixed investment 34 -13.4 2.0 4.0 4.3
Stockbuilding (change as % of GDP) -0.9 0.3 0.1 0.0
Exports 62 -24.4 6.6 6.0 5.5
Imports 57 -22.3 6.0 5.9 5.0

Unemployment (%) 8.2 8.4 7.7 7.1

Consumer prices, harmonised 1.6 1.5 2.2 2.5
Wage cost 3.9 2.8 2.4 2.9
Current account, % of GDP 1.3 1.8 2.1 2.3
Public sector financial balance, % of GDP -2.2 -3.5 -2.9 -2.2
Public sector debt, % of GDP 44.0 47.1 49.7 51.9

50   |  Nordic Outlook – August 2010

 International key economic data

EURO ZONE
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 8,979 -4.1 1.6 1.3 1.5
Private consumption 5,170 -1.2 0.2 0.7 1.1
Public consumption 1,975 2.7 1.5 1.4 1.6
Gross fixed investment 1,773 -10.8 0.0 4.6 4.1
Stockbuilding (change as % of GDP) -0.8 0.7 0.2 0.0
Exports 3,259 -13.2 7.6 4.7 4.5
Imports 3,140 -11.9 6.6 6.0 5.1

Unemployment (%) 9.4 10.0 9.7 9.2

Consumer prices, harmonised 0.3 1.4 0.8 1.2
Household savings ratio (%) 9.6 9.5 9.3 9.0

US
Yearly change in per cent
2009 level,
USD bn 2009 2010 2011 2012
Gross domestic product 14,119 -2.6 2.6 2.2 2.9
Private consumption 10,001 -1.2 1.5 2.2 2.4
Public consumption 2,915 1.6 1.1 2.2 2.0
Gross fixed investment 1,716 -18.3 5.4 9.7 9.0
Stockbuilding (change as % of GDP) -0.6 1.4 0.1 0.0
Exports 1,578 -9.5 12.0 8.2 6.6
Imports 1,965 -13.8 14.8 13.4 7.4

Unemployment (%) 9.3 9.5 9.0 7.8

Consumer prices -0.3 1.6 0.8 1.2
Household savings ratio (%) 5.9 6.5 7.9 7.6

LARGE INDUSTRIAL COUNTRIES

Yearly change in percent
2009 2010 2011 2012
GDP
United Kingdom -4.9 1.7 2.0 2.2
Japan -5.2 2.5 1.5 1.5
Germany -4.7 3.3 2.1 1.8
France -2.5 1.5 1.5 1.7
Italy -5.1 1.0 1.1 1.5

Inflation
United Kingdom 2.2 3.1 2.1 1.3
Japan -1.3 -1.0 0.0 0.3
Germany 0.2 0.9 1.2 1.5
France 0.1 1.6 1.7 1.9
Italy 0.8 1.6 1.7 1.9

Unemployment (%)
United Kingdom 7.6 7.9 8.2 7.9
Japan 5.1 5.2 5.2 5.3
Germany 7.5 7.8 7.2 6.9
France 9.4 10.1 9.8 9.5
Italy 7.8 8.4 8.1 7.8

Nordic Outlook – August 2010  |  51

 International key economic data

EASTERN EUROPE

2009 2010 2011 2012

GDP, yearly change in per cent
Estonia -14.1 2.0 5.0 4.0
Latvia -18.0 -1.5 4.0 5.0
Lithuania -14.8 1.0 4.0 4.5
Poland 1.7 3.5 4.0 4.5
Russia -7.9 4.5 5.0 5.5
Ukraine -15.1 5.0 4.0 4.5

Inflation, yearly change in per cent

Estonia 0.2 2.5 3.0 2.0
Latvia 3.3 -1.0 1.9 1.8
Lithuania 4.2 1.0 2.0 3.0
Poland 3.4 2.5 2.7 2.9
Russia 11.7 7.0 7.5 8.5
Ukraine 15.9 9.5 11.0 10.0

FINANCIAL FORECASTS

Aug 26 Dec 10 Jun 11 Dec 11 Jun 12 Dec12
Official interest rates
US Fed funds 0.25 0.25 0.25 0.25 0.75 1.25
Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50
Euro zone Refi rate 1.00 1.00 1.00 1.00 1.50 1.75
United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 2.00

Bond yields
US 10 years 2.48 2.45 2.50 3.00 3.20 3.50
Japan 10 years 0.95 1.00 1.20 1.50 1.70 1.90
Germany 10 years 2.15 2.20 2.40 2.80 3.00 3.20
United Kingdom 10 years 2.89 2.90 3.00 3.40 3.60 3.80

Exchange rates
USD/JPY 84 82 85 85 90 95
EUR/USD 1.27 1.22 1.25 1.27 1.30 1.30
EUR/JPY 107 100 106 108 117 124
GBP/USD 1.55 1.49 1.47 1.55 1.63 1.67
EUR/GBP 0.82 0.82 0.85 0.82 0.80 0.78

GLOBAL KEY INDICATORS

Yearly percentage change
2009 2010 2011 2012
GDP OECD -3.3 2.2 2.0 2.3
GDP world -0.6 4.4 3.8 4.3
CPI OECD 0.1 1.4 0.9 1.2
Export market OECD -11.5 7.7 5.7 7.8
Oil price, Brent (USD/barrel) 61.9 76.2 80.0 80.0

52   |  Nordic Outlook – August 2010

International Cash &
Treasury Management
Conference in ­Geneva
2010
Take the opportunity to network with colleagues in
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Programme and registration on Eurofinance website:

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Time October 6–8, 2010

Place  eneva Palexpo

G
Geneva, Switzerland

We hope to see you in Geneva at the SEB stand!

SEB
 Finland
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Sweden
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Latvia
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London New Delhi
Poland
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SEB is a North European financial group serving some 400,000 corporate

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Germany and a global presence through its international network in major
financial centres. On 30 June 2010, the Group’s total assets amounted to SEK
2,318bn while its assets under management totalled SEK 1,328bn. The Group
has about 19,000 employees. Read more about SEB at www.sebgroup.com.
With capital, knowledge and experience, we generate value for our customers −
a task in which our research activities are highly beneficial.
Macroeconomic assessments are provided by our Economic Research unit.
Based on current conditions, official policies and the long-term performance of
the financial market, the Bank presents its views on the economic situation −
locally, regionally and globally.
One of the key publications from the Economic Research unit is the quarterly
Nordic Outlook, which presents analyses covering the economic situation in the
world as well as Europe and Sweden. Another publication is Eastern European
Outlook, which deals with the Baltics, Poland, Russia and Ukraine and appears
twice a year.
SEMB0041 2010.08

www.sebgroup.com