Nordic Outlook

Recovery becoming more

self-sustaining
Economic Research – February 2011 Faster Nordic key rate hikes
 Contents

International overview 5

Theme: A model for long-term equilibrium

exhange rates (SEBEER) 15

The United States 16

Japan 22

Asia 23

The euro zone 26

The United Kingdom 32

Eastern Europe 33

The Baltics 34

Sweden 36

Denmark 45

Norway 46

Finland 50

Economic data 51

Boxes

Risk and opportunities in North Africa 6

“United Debt of Europe” 8
Continued high commodity prices 10
Falling private sector savings boosts GDP 17
Home price drop jeopardises recovery 18
Little risk of 1970s-style stagflation 20
Obama rebounding 21
China’s twelfth five-year plan, 2011-2015 25
ECB questioning core inflation as an indicator 31
The Riksbank and macro supervisory rules 41
Fiscal policy has an expansionary bias 47

Nordic Outlook – February 2011  |  3

 Economic Research

This report was published on February 8, 2011.

Cut-off date for calculations and foreasts was February 3, 2011.

Robert Bergqvist Håkan Frisén

Chief Economist Head of Economic Research
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Daniel Bergvall Mattias Bruér

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Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist
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Andreas Johnson Tomas Lindström

Economist Economist
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Gunilla Nyström Ingela Hemming

Global Head of Personal Finance Research Global Head of Small Business Research
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Susanne Eliasson Johanna Wahlsten

Personal Finance Analyst Small Business Analyst
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SEB Economic Research, K-A3, SE-106 40 Stockholm

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

4   |  Nordic Outlook – February 2011


The recovery is becoming more self-sustaining
ƒƒ Stronger momentum as the US accelerates
ƒƒ Inflation will fall − increasing focus on
resource utilisation
ƒƒ ECB hike in September, Fed only in 2012
ƒƒ The Riksbank will speed up its rate hikes
ƒƒ Long-term yields sideways next 6 months
ƒƒ Nordic currencies will keep appreciating
In recent months, the global economic outlook has
improved. US growth expectations have risen. Fiscal
policy will be more expansionary in 2011, now that
Congress has resolved important taxation issues. In
addition, the American recovery is entering a more
self-sustaining phase, despite lingering problems in
the labour and housing markets. Emerging economies,
especially in Asia, are continuing their strong expan-
sion although tighter economic policies will now lead
to a slight deceleration. In Europe, economic signals
are more mixed. In Germany and the Nordic countries,
2011 growth will be stronger than we had previously
expected. The United Kingdom is now beginning to feel
the impact of tight fiscal policy. In southern Europe and
Ireland, growth will be hampered by continued financial
turmoil and necessary budget consolidation measures.
Overall, we foresee above-trend GDP growth in the 34
countries of the Organisation for Economic Cooperation
and Development (OECD). We expect GDP increases of
2.8 per cent both in 2011 and 2012, representing an
upward revision of 0.5 and 0.3 percentage points.
The world economy still faces a number of challenges.
Sovereign debts continue to grow, and acute crises in
several euro zone countries have still not been re-
solved. Global imbalances remain large and a restruc-
turing of the financial system is under way, yet the
world economy seems to be entering a new phase. In
the corporate sector, optimism is record-high. Strong
balance sheets, expansionary policies and large global
growth potential dominate the picture. Given a more
self-sustaining economic upturn, the focus of financial
markets and economic policy makers is shifting towards
more traditional economic variables such as growth,
inflation and the labour market.
This shift has occurred only after the American econo-
my reached slightly firmer ground, yet the world that is
now taking shape has changed in many ways. The role
of the US has weakened, while China and other emerg-
International overview
ing economies have increased both their economic and
political clout. Germany’s pivotal role in Europe has
been further confirmed by the euro zone debt crisis and
its financial consequences. The Nordic economies have
also emerged stronger from the crisis, and Swedish GDP
growth stands out in an international perspective. The
Nordic model is again a focus of international debate.
Global GDP growth
Year-on-year percentage change
2009 2010 2011 2012
United States -2.6 2.9 3.6 4.0
Japan -6.3 4.0 1.6 1.6
Germany -4.7 3.6 3.1 2.5
China 9.2 10.3 9.5 8.5
United Kingdom -4.9 1.4 1.5 2.5
Euro zone -4.0 1.7 1.9 1.8
Nordic countries -4.6 2.9 3.4 2.6
Baltic countries -15.6 1.2 4.1 4.7
OECD -3.5 2.7 2.8 2.8
Emerging markets 2.6 7.1 6.5 6.5
World, PPP* -0.6 5.0 4.5 4.6
World, nominal -1.3 4.3 3.8 3.9
*Purchasing power parties
Source: OECD, SEB­
In recent months, rising commodity prices have fuelled
inflation worries. Our assessment is that these fears
are somewhat exaggerated. Even if commodity prices
remain high, inflation will fall in the course of 2011.
Inflation expectations are under control, and underlying
cost pressure is low in the US and Western Europe. This
will help keep down inflation in the OECD countries dur-
ing the next couple of years, especially in the US.
In spite of this, key interest rate hikes are fast ap-
proaching. Output gaps are on their way towards
closing. Financial conditions continue to normalise,
including the beginnings of growth in the money supply.
This indicates that central banks in the major OECD
countries must soon start normalising their monetary
policies to keep inflation expectations under control.
We expect the European Central Bank (ECB) to begin
hiking its key interest rate in September this year. A
relatively small output gap, combined with the ECB’s
less intensive focus on core inflation compared to vari-
Nordic Outlook – February 2011  |  5
 International overview
ous other central banks, will contribute to earlier rate
hikes. To some extent, the expansion of the European
financial stability mechanism (ESFS/ESM) is also taking
pressure off the ECB, enabling the bank to focus to a
greater extent on its main task: ensuring price stabil-
ity. High inflation figures will also help to persuade the
Bank of England (BoE) to begin key rate hikes before
the end of 2011. Because of high unemployment and
a continued decline in core inflation, the US Federal
Reserve (Fed) will hold off until April 2012 before begin-
ning its rate hikes.
The Nordic central banks will continue raising their key
interest rates. Partly due to rapidly climbing resource
utilisation, Sweden’s Riksbank will adopt a more aggres-
sive stance during 2011. We expect it to hike the repo
rate to 2.75 per cent by year-end. Norges Bank, too,
will find it easier to raise its deposit rate in response to
Norwegian domestic conditions once the ECB and BoE
also begin hiking their key rates.
The US: Private saving now falling again
American economic signals have gradually become more
optimistic since worries about a double dip recession
culminated in August 2010. At first, the Fed’s quantita-
tive easing (QE) helped restore confidence. The fiscal
policy agreements reached in December were also
important to the 2011 growth outlook, not least by
blunting the sharp conflicts that dominated Congress
last autumn. This is among the reasons why we have
revised our GDP forecast for 2011 upward from 2.2 to
3.6 per cent.
The change in our scenario is not only due to economic
stimulus policies. Changes in private sector financial
saving are normally a reliable signal that a shift is im-
minent, mainly in capital spending. Historical experi-
ence indicates that a downward adjustment in saving
happens relatively fast once the curve has changed
direction. Our forecast assumes that the downward
adjustment in private saving will occur more slowly
Risks and opportunities in North Africa
In recent weeks, political unrest in North Africa has
increased global uncertainty. One reason behind the
unrest is a rapid rise in food prices. This is having
an extra impact because food subsidies have been
removed in many places. Other factors, such as high
youth unemployment and widespread corruption, also
play a part.
Right now the situation is worst in Egypt, with its large
population. The country has only limited oil produc-
tion but has a pivotal security policy role as a major
US ally in the Middle East. Since 1980 Egypt has had a
peace treaty with Israel and has played a major role
as a mediator in the Israeli-Palestinian conflict.
The greatest risk ahead is consequently that the
unrest will threaten to disrupt security policy stabil-
ity in the region. In financial markets, North African
6   |  Nordic Outlook – February 2011
than usual (see the chart). There is still a great need
for financial consolidation, especially in the household
sector and especially due to lingering weaknesses in the
housing and labour markets. Our forecast implies that
the household savings ratio will remain at the level of
some 5-6 per cent it has now reached, which is compat-
ible with a continued draw-down in the debt ratio. In
spite of this, the saving downturn in the corporate sec-
tor is sufficient to generate significant growth stimulus
in the form of capital spending over the next couple of
years. We thus expect GDP growth to hold up well in
2012, too, in spite of tighter economic policies.
US: Financial saving in private sector
Per cent of GDP
10.0 10.0
7.5 7.5
5.0 5.0
2.5 2.5
0.0 0.0
-2.5 -2.5
-5.0 -5.0
-7.5 -7.5
60 65 70 75 80 85 90 95 00 05 10 15
Normal adjustment Mean (1960-95)
NO scenario
Source: SEB
Emerging Asia: Growth despite
tightening
The Asian emerging economies will continue to drive
the world economy. Accounting for nearly one fourth
of global GDP, their growth is increasingly important.
Partly due to their resilience during the financial crisis,
emerging markets are rather far ahead of the OECD
countries in the economic cycle. One expression of this
is that inflation is now climbing relatively fast, mainly
due to higher food and energy prices. But core inflation
has also risen in such countries as China, India and Indo-
nesia. There is a clear trend towards higher key interest
countries have been affected via rising risk premiums
and falling share prices. The crisis has also pushed up
oil and wheat prices. Disruptions in vital oil shipments
through the Suez Canal would have major consequenc-
es. If the protests spread to Saudi Arabia, Kuwait and
the United Arab Emirates, there would be a big impact
on oil prices, at least in the short term.
On the other hand, experience shows that revolts and
upheavals often do not necessarily result in major
financial consequences. Pakistan in 1999 and Thailand
in 2006 and 2010 are examples of upheavals where
economic crises were avoided. There is thus a possibil-
ity that developments in Egypt might lead to democra-
tisation and greater stability. However, no quick solu-
tion seem likely, which is one reason why the current
uncertainty will continue for another while.

rates. In India, for example, the real key rate is well
into negative territory, while economic growth is nearly
9 per cent a year. Many Asian central banks seem more
and more uncomfortable with excessively accommoda-
tive monetary policies. We can thus expect continued
key interest rate hikes during 2011.
Real key rates in selected countries
Per cent
Key rate Inflation Real SEB
key rate forecast
GDP 2011 -25
India 6.5 8.4 -1.9 8.5
Indonesia 6.5 7.0 -0.5 6.3
China 5.8 4.6 1.2 9.5
Euro zone 1.0 2.2 -1.2 1.9
Japan 0.1 0.0 0.1 1.6
United States 0.25 1.5 -1.2 3.6
Source: National statistical offices, OECD, SEB
Because of their higher trend growth and earlier posi-
tion in the economic cycle, the differences between
nominal emerging market interest rates and those in
the OECD countries will increase this year. This may ex-
acerbate the problems connected to speculative capital
inflows, including bubble tendencies in asset markets.
But to a greater extent than before, many countries
seem to accept currency appreciation as an element
of inflation-fighting. One reason is that greater risks of
rising food prices might lead to social unrest.
We still foresee an Asian soft landing as the most likely
scenario. Tighter economic policies will decelerate
growth to more sustainable levels, which in the long
term are around 6 per cent. Inflation will peak during
the first half of 2011 and then decline.
Western Europe: Out of step
The euro zone continues to be characterised by a two-
speed economy. The recovery in Germany is progress-
ing at a rapid pace. Optimism is at record-high levels,
according to the IFO sentiment index. Unemployment
has fallen to its lowest level since 1992. We expect
German GDP to climb by 3.1 per cent in 2011, a bit
less than last year’s 3.6 per cent. Meanwhile powerful
austerity programmes in southern Europe will hamper
growth in the euro zone as a whole. This year, GDP will
fall in Greece and Portugal and will be close to zero in
Spain and Ireland. In France and Italy, growth will end
up around 1½ per cent, both this year and next. Due to
structural deficits in both countries, however they also
have a major need for fiscal austerity measures. Overall
euro zone growth will end up at 1.9 per cent this
year and 1.8 per cent in 2012, somewhat higher than
we believed in November.
During 2011, the British economy will be hampered by
fiscal tightening and by high inflation that will under-
mine purchasing power. The weak British pound and
International overview
strong international demand will nevertheless prop up
economic growth. GDP will increase by 1.5 per cent
this year and 2.5 per cent in 2012.
Diverging levels of optimism
Consumer confidence, net balance
15 15
10 10
5 5
0 0
-5 -5
-10 -10
-15 -15
-20 -20
-25
-30 -30
-35 -35
-40 -40
90 92 94 96 98 00 02 04 06 08 10
United Kingdom Germany
Source: DG ECFIN
Swedish growth in a class by itself
The Nordic countries are continuing their strong growth.
These countries are benefiting from export sectors that
are well positioned to meet rising global demand for
investment and intermediate goods. In additional, such
fundamental factors as public finances and current ac-
count balances are in very good shape.
GDP growth, Nordic and Baltic countries
Year-on-year percentage change
2009 2010 2011 2012
Sweden -5.3 5.7 4.7 2.6
Norway -1.4 0.1 2.7 2.5
Denmark -4.7 2.3 2.6 2.3
Finland -8.1 2.7 3.5 3.0
Nordics -4.6 2.9 3.4 2.6
Estonia -13.9 2.7 4.5 4.0
Latvia -18.0 -0.3 4.0 5.0
Lithuania -14.7 1.0 4.0 4.5
Baltics -15.6 1.2 4.1 4.7
Source: OECD, SEB­
The Swedish economy is now expanding very fast. We
have revised our GDP growth forecast upward to 4.5
per cent in 2011, after an increase of no less than 5.7
per cent in 2010. Other Nordic countries will show more
modest growth figures. Danish growth will be 2.6 per
cent in 2011 and 2.2 per cent in 2012, despite a degree
of fiscal tightening. In Finland, too, exports are the
main driving force. GDP growth will accelerate a bit,
reaching 3.5 per cent in 2011 and 3.0 per cent in 2012,
among other things due to improved competitiveness.
In Norway, supply-side restrictions are already starting
to hamper expansion; GDP growth will thus be only 2.7
per cent in 2011 and 2.5 per cent in 2012.
Rising resource utilisation in both Sweden and Norway
has led to early key rate hikes and sharply appreciating
Nordic Outlook – February 2011  |  7
 International overview
currencies. This will slow export growth over the next
couple of years, although our calculations indicate that
their currencies are still undervalued against the euro.
On the other hand, competitiveness in Finland and Den-
mark will benefit from the appreciation of the SEK and
NOK from their previously extremely low levels.
Gradual recovery in the Baltics
The three Baltic countries rebounded weakly last year
after their depression-like downturn in 2008-2009. In
2011 and 2012 we expect GDP growth of 4-5 per cent,
which is still above consensus. We have revised our
“United Debt of Europe”
Monetary cooperation in Europe is moving into a new
phase. The temporary European Financial Stability
Facility (EFSF), which will be replaced in 2013 by
the permanent European Stability Mechanism (ESM),
serves as a supranational lender of last resort. It will
play a key role in dealing with the short- and medium-
term liquidity and refinancing needs of problem coun-
tries. Also of central importance is that the EFSF/ESM
is re-establishing a clear delineation between euro
zone sovereign debt policy and monetary policy.
At their summit in late March, the European Union
heads of state and government are expected to decide
what powers the EFSF/ESM will have. We foresee the
following decisions:
1) The lending amount guaranteed by the euro zone
countries will more than double from today’s EUR
440 billion to EUR 1 trillion. That will reduce the EU’s
dependence on the advice of the International Mon-
etary Fund (IMF), but even so the IMF is still expected
to play an important role for economic policy advice.
2) The EFSF/ESM will be allowed to buy government
bonds in the secondary market. This will take over the
role the ECB has been forced to assume to stabilise
the situation. The EFSF/ESM is also expected to buy
up the approximately EUR 80 billion in government
securities now in the ECB’s balance sheet.
3) The EFSF/ESM will become a tool for long-term
debt consolidation in crisis-hit countries with solven-
cy problems; EFSF/ESM loans can be used to enable
crisis countries to repurchase outstanding bonds that
are trading today at prices sharply below face value.
EU fiscal policy coordination will also intensify this
year as a result of the “European semester”, a recur-
ring process in which the fiscal positions and policies
of EU countries will be reviewed before their national
budget process is completed. In June, the EU summit
is also expected to approve tougher standards and
sanctions for the now-toothless Stability and Growth
Pact.
This signifies that euro zone government debt and
fiscal policies will be taking a major step towards
8   |  Nordic Outlook – February 2011
forecast for Estonia upward by half a percentage point
to 4.5 per cent both in 2011 as well as 2012. This
implies that Estonia will have the fastest growth in the
Baltics during both years. With its relatively high ex-
ports as a percentage of GDP, the Estonian economy is
best positioned to benefit from good external demand,
especially from Sweden and Finland.
Growth will continue to be driven by strong, com-
petitive exports. Domestic demand will recover
slowly. Households and businesses are still feeling the
after-effects of internal devaluation and tough public
greater coordination. The new system represents
something of a break with the principle that previous-
ly dominated the work of the EU: that each country
should be able to pursue government debt policies
that do not adversely impact other countries (in terms
of interest rate effects/credibility). However, this
seems to be the price that must be paid to ensure
the survival of the euro. It is also consistent with the
fundamental concept that the euro zone should serve
as one step in the evolution of a political union.
Increased oversight and demands on fiscal policy − and
clearer distinctions between different policy areas −
will have an impact on monetary policy. Government
debt problems will be referred to national govern-
ments. Since the ECB will no longer be buying govern-
ment bonds, this will increase the pressure to pursue
responsible fiscal policies.
The ECB can thus increasingly focus on its main
task, ensuring price stability, which will strengthen
its credibility. Our assessment is that on the margin,
this opens the door to an earlier ECB interest rate
hike. Looking ahead, confirming the ECB’s independ-
ence may also diminish the risk of rising inflation ex-
pectations and long-term yields. Such a development
would be especially beneficial to such debt-burdened
countries as Greece, Ireland, Portugal and Spain.
But even if the EFSF/ESM gains an enlarged mandate
and stronger financial muscle, the underlying problems
are fundamentally national. An economy’s competi-
tiveness and fiscal credibility must be regained by
means of a sustainable structural policy and stable
policy frameworks. Before this is ensured, the risks of
financial volatility will persist.
During the spring, we expect that both Greece and
Ireland will be offered “soft” debt renegotiations
in the form of lower interest rates on borrowing and
extended loan maturities. Meanwhile these countries
can implement a write-down of debts by repurchasing
some of their outstanding debt. We also believe that
Portugal and Spain will show an interest in borrow-
ing money from EFSF/ESM. These countries must be
taken care of in resolute fashion, to avoid a resur-
gence of mistrust.
 International overview

budget consolidation; in Latvia, budget austerity meas-
ures will continue. Unemployment will fall slowly, and
at the end of 2012 it will remain far higher than before
the crisis. Inflation is being pushed up by international
energy and food price increases. Underlying price pres-
sures remain low but will climb gradually.
Big labour market differences
During the downturn phase in 2008-2009, labour market
trends diverged from what could be expected on the
basis of GDP developments. For example, employment
in the US fell significantly more sharply than in Germa-
ny, Sweden and Finland despite a milder GDP decline.
In the recovery phase, this trend has become even
clearer; those countries that were mainly affected by
the crisis in the form of the international trade collapse
have coped better than countries with more profound
financial adjustment problems. One explanation is that
the need for restructuring is smaller in these countries;
when demand takes off again, their companies can
rather easily begin to rehire. The UK is a clear excep-
tion. Despite its deep financial crisis, the downturn in
the labour market has been comparatively mild.
fear of deflation caused by low resource utilisation
and lack of confidence in the future. For some time,
our inflation forecast has been below consensus, based
on our assessment that large output gaps have domi-
nated inflation processes. At the same time, we have
deemed the deflation risk to be relatively small, since
central banks seem to have retained credibility for
their medium-term inflation ambitions. This has been
reflected, for example, in inflation expectations and
wage formation. In recent months, the risk picture has
changed to some extent. Rising energy and food prices
as well as tax increases in a number of countries have
pushed up actual inflation. This has also contributed to
a certain increase in inflation expectations.
Headline inflation will fall back in the euro zone
CPI, year-on-year percentage change
6 6
5 5
SEB
forecast
4 4
3 3
2 2
1 1

0 0
Actual unemployment vs NAIRU
Per cent -1 -1

11 11 -2 -2
10 10 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

9 9 Euro zone US
Source: Eurostat, BLS, SEB
8 8
7 SEB 7 Our forecast implies that Consumer Price Index (CPI)
forecast
6 6 inflation will fall somewhat in the course of 2011.
5 5 Although commodity prices will remain at high levels,
4 4 or even continue climbing somewhat, the inflation rate
3 3 will slow as the effects of the rapid price increase dur-
92 94 96 98 00 02 04 06 08 10 12 ing 2010 disappear from the 12-month figures. In addi-
US, actual Euro zone, actual tion, underlying price pressures remain low. Because of
US, NAIRU Euro zone, NAIRU the cyclical recovery in productivity, unit labour costs
Source: OECD, SEB
are still falling. We thus expect core inflation to keep
These differences in the labour market situation will declining in 2011, especially in the US.
be increasingly important for inflation analysis and thus
Unit labour costs
central bank action ahead. Because of the sharp upturn Year-on-year percentage change
in US unemployment during the crisis, the gap between 9 9
actual unemployment and established measures of 8 8
equilibrium unemployment (such as non-accelerating 7 7
6 6
inflation unemployment rate, NAIRU) is significantly 5 5
larger than in Europe. On the other hand, there is a risk 4 4
that the period of high unemployment in the US will be- 3 3
2 2
come so lengthy that structural damage to the economy 1 1
will be unavoidable and that equilibrium unemployment 0 0
will end up climbing even faster than traditional esti- -1 -1
-2 -2
mates indicate. For example, the slide in home prices
-3 -3
may have made it more difficult for many people to 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
move out of homes whose mortgage loans exceed their
Europe (OECD countries) US
market value. The geographic mobility that has been so Source: OECD

important to the flexibility of the US labour market may

In the long term, however, we foresee growing risks of a
thereby have diminished.
cyclically driven acceleration in inflation:
More symmetrical inflation risks ƒƒ The output gap is on its way towards closing, al-
In recent years, discourse has alternated between two
though the situation looks different, for example, in
extremes: worries about monetary-driven inflation or

Nordic Outlook – February 2011  |  9

 International overview

Germany and the Nordic countries, on the one hand,
and the UK and the US on the other. This means that
the rate of pay increases will probably accelerate
next year in the OECD countries as a whole.
ƒƒ Robust expansion in emerging economies will con-
tribute to a continued upward trend in commodity
prices, although certain temporary driving forces
(such as the weather) will weaken in the short term.
Real-term appreciation in the currencies of emerg-
ing market countries, for example due to faster
pay increases, will also help reduce the strength of
disinflationary globalisation forces.
ƒƒ The situation in financial markets will gradually
normalise. This will be reflected by resumption in
the growth of broad money supply measures. The
credit multiplier also seems to have turned upward.
These levels remain low and are primarily signalling
a reduced deflation risk.
We have revised our overall inflation forecast a bit
upward and view the risk picture as more symmetrical

Continued high commodity prices limit of the USD 70-80/barrel price range it had previ-
Commodity price increases have regained momentum. ously indicated as a suitable benchmark. In the near
These price upturns have been driven by a number of future, we expect a downward correction towards USD
factors. The global recovery is creating an underlying 90, since several of the short-term driving forces are
demand for commodities. Prices are also being stimu- fading. Looking a bit further ahead, we expect good
lated by the weak dollar, which is connected to the global economic growth to help maintain oil prices at
Fed’s quantitative easing, as well as weather-related a high level around USD 90-100/barrel.
disruptions. Speculative trading may also have had a
certain impact. We expect this price pressure to last Today’s situation with regard to commodity prices
for the rest of 2011, but the upturn will be significant- has certain similarities with the 1970s. At that time,
ly more gentle than in late 2010. an oil price shock occurred soon after the economic
policy framework that had prevailed for decades (the
Commodity prices have continued upward
Index, monthly data, USD Bretton Woods system) had collapsed. This oil price
550 550 upturn was driven by a change in price strategy by the
500 500 dominant oil producers (OPEC). This time around, the
450 450 commodity price upturn is mainly a consequence of
400 400 rapid growth and the increasing importance of emerg-
350 350
ing economies. For the OECD countries, however, the
300 300
consequence is similar. The commodity price upturn is
250 250
serving as an external shock and comes at a sensitive
200 200
150 150
cyclical phase.
100 100 OECD: Inflation
50 50 Year-on-year percentage change
00 01 02 03 04 05 06 07 08 09 10 17.5 17.5

Agriculture Industrial metals Energy 15.0 15.0

Source: HWWI
12.5 12.5

The La Niña weather phenomenon is continuing to 10.0 10.0

drive agricultural commodity prices, with widespread 7.5 7.5
weather-related disruptions since mid-2010. Late in 5.0 5.0
2010, such disruptions mainly affected Australia and 2.5 2.5
South America. Agricultural prices are now around 10
0.0 0.0
per cent higher than their previous peak during the
-2.5 -2.5
2008 crisis. A degree of price stabilisation now seems 75 80 85 90 95 00 05 10
to be occurring, among other things as an effect of
Total Core inflation
the probable fading of La Niña during the first half of Source: OECD
2011. Looking further ahead, most indications are that
agricultural prices will remain high, since demand for But there are major differences, especially when it
food is increasing at a rapid pace. comes to economic policy preparedness. The 1970s
were characterised by uncertainty and confusion in
Oil prices have continued to climb, and today they are that area. In the absence of a credible inflation strate-
around USD 100/barrel. Cold weather in the northern gy, the oil price upturn soon spread to wage and salary
hemisphere, combined with greater optimism about increases and broad-based inflation. In the past 7-8
the global economic recovery, has pushed up prices. years, the association between commodity prices and
Production disruptions and the recently unfolding cri- core inflation has been much weaker. The credibility
sis in North Africa have also contributed to the upturn. of inflation targets seems to have served as an effec-
So far, the Organisation of Petroleum Exporting Coun- tive obstacle, preventing upturns in commodity prices
tries (OPEC) has not done much to defend the upper from getting a foothold in expectation scenarios.

10   |  Nordic Outlook – February 2011


than before. Inflation will probably fall somewhat in
2011, but a little further ahead the cyclical forces of
inflation will gain strength. The period when inflation
threats could be dismissed by pointing to large output
gaps seems to be on its way towards ending.
Money supply
Year-on-year percentage change
15.0
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
90 92 94 96 98 00 02 04 06 08
US, M2 Euro zone, M3
Source: Federal Reserve
“Exit policy” discussion is reawakened
The global recovery is highly dependent on how mon-
etary policies are crafted in the world’s five largest
economies: the US, the euro zone, China, Japan and
the UK. Central banks, in turn, must take into account
developments related to fiscal tightening and new
macro supervisory regulation, areas that enjoy priority
in Group of 20 cooperative efforts during 2011.
Monetary policy makers also face challenges when it
comes to managing various risk factors and dilemmas.
The commodity price upturn is pushing up inflation,
but at the same time it is weakening the recovery and
adding to political risks in many countries. Crises of
confidence in sovereign finances and banks still have a
troublingly high probability, among other things weak-
ening the effectiveness of interest rate policy.
Meanwhile the crisis policies of recent years have
opened up new issues. In order to maintain long-term
credibility, the allocation of responsibility among
different fields of policy must be made clearer. In
such a situation, inflation expectations are especially
important to keep track of. Despite earlier enormous
loosening of monetary policy and growing government
debts, inflation expectations have remained at a rather
stable level. The trend of money supply and credit ag-
gregates is generally showing continued low growth fig-
ures. These are, however, expected to increase as the
credit multiplier normalises, due to a better economic
outlook and stronger banking systems.
Given a more stable economic outlook, a more normally
functioning financial system and a crisis mechanism
taking shape in Europe, the question of suitable “exit
policy” is becoming more topical. This issue was, in
principle, removed from the agenda nearly a year ago.
Later in 2011, we expect the ECB and the Bank of Eng-
land to begin moving cautiously towards a normalisation
International overview
of interest rates, with reference to increased inflation
risks. The ECB will raise its key interest rate in Septem-
ber and then once more in December, while the BoE will
hold off until December. The Fed and the Bank of Japan
will wait until 2012 before hiking their key rates.
Key interest rates
Per cent
7 7
15.0
6 SEB 6
12.5 forecast
5 5
10.0
4 4
7.5
3 3
5.0
2 2
2.5
1 1
0.0
0 0
-2.5 00 02 04 06 08 10 12
10
Euro zone US
Source: ECB, Fed, SEB
We expect the Fed to complete its programme of pur-
chasing USD 600 billion worth of government securities
by the end of the second quarter of 2011 in order to
ensure the functionality of the financial market and to
preserve continued low mortgage interest rates. The
Bank of Japan will also continue its unconventional
monetary policies. In the euro zone, the EFSF will
take over the current role of the ECB in stabilising the
government securities market. The Bank of England will
remain inactive, however. Because of growing govern-
ment debts and the need for long-term funding in the
banking system, there will be very limited room for
central banks to reduce their holdings of securities dur-
ing the next couple of years.
Key interest rates
Per cent
7 7
6 SEB 6
forecast
5 5
4 4
3 3
2 2
1 1
0 0
00 02 04 06 08 10 12
Euro zone Norway Sweden
Source: ECB, Riksbank, Norges Bank, SEB
Rapidly rising resource utilisation combined with higher
home prices and household debt make it likely that
there will be relatively rapid key interest rate hikes in
Norway and Sweden. For some time, however, Norges
Bank has slowed the pace, mindful of the risks of an
excessively strong Norwegian currency. Last autumn,
Sweden’s Riksbank lowered its repo rate path after tak-
ing into account the international situation.
Rapidly climbing resource utilisation − combined with
higher home prices and rapidly growing household debt
Nordic Outlook – February 2011  |  11
 International overview
− throw a spotlight on risks to both price stability and
financial stability. This is an argument in favour of rela-
tively fast key interest rate hikes in Norway and Swe-
den. For some time, however, Norges Bank has slowed
its pace, mindful that an excessively strong Norwegian
currency would weaken exports and push down inflation
undesirably far. Last autumn, Sweden’s Riksbank also
lowered its repo rate path, among other things because
of the international situation.
Our forecast that the European Central Bank will begin
its key rate hikes as early as September 2011 will ease
the Nordic central banks’ dilemma related to excessive
currency appreciation. Our assessment is that this will
help bring about an upward revision in Norges Bank’s
deposit rate path at its monetary policy meeting in
March. We expect the bank to raise its key rate three
times during 2011, which will mean a deposit rate of
2.75 per cent at year-end. After five additional hikes
during 2012 rate will stand at 4.00 per cent, a level
that would be relatively close to normal.
Due to short-term upward revisions in our inflation fore-
casts and a substantially changed resource utilisation
picture, we believe that Sweden’s Riksbank will raise
its key interest rate at a faster pace than previously
announced. We expect the bank to hike its repo rate
at every monetary policy meeting during 2011; the key
rate will thus be 2.75 per cent at year-end in Sweden
as well. During 2012 the hikes will continue, though at
a somewhat slower pace, bringing the repo rate up to
3.75 per cent at year-end. This means that the key rate
will be close to what can be regarded as a neutral level.
To ease the pressure on interest rate policy, additional
measures are being carried out to slow household credit
expansion. For example, in 2010 both countries imposed
a ceiling on the loan-to-value ratio for mortgages. The
two central banks have also pointed to the possibility
of accelerating their implementation of the new Basel
III international banking regulations. In a speech during
February, Riksbank Governor Stefan Ingves stated that
Sweden may either need to take extra steps or move
ahead faster than other countries on the matter of
macro supervisory regulations in particular.
Different fiscal strategies
Government debts are continuing to grow, and there
is a great need for continued fiscal tightening in many
countries, but these needs vary considerably between
countries. Simplifying a bit, we can distinguish four
categories of countries with different fiscal directions
and strategies:
1) Countries that have now approved very large fiscal
austerity programmes in the range of 5-10 per cent of
GDP. In most cases, this has occurred after heavy mar-
ket pressure (Greece, Ireland, Portugal, Spain, UK).
2) Countries that have relatively large deficits but have
only implemented small and probably inadequate cut-
backs (France, Italy and Belgium).
12   |  Nordic Outlook – February 2011
3) Countries that are implementing further stimulus
measures in 2011 and are thus postponing their prob-
lems (Japan and the US).
4) Countries with strong public finances that have the
potential for expansionary fiscal policies (Norway, Swe-
den, many emerging economies including China).
Net lending
Per cent of GDP
2010 2011 2012 2012
Gross debt
United States* 8.8 9.9 -7.4 101.5
Japan -9.4 -8.8 -7.6 230.0
United Kingdom -9.7 -8.0 -6.5 95.0
Euro zone -6.2 -4.5 -3.5 93.5
OECD -7.5 -6.0 -4.6 102.8
* Federal deficit.
Source: European Commission, OECD, SEB
Partly due to the new stimulus measures in the US and
Japan, the tightening effect in the OECD now looks
likely to be only 0.25 per cent of GDP. Our previous
estimate was 1 per cent. Next year tightening measures
will be more powerful, nearly 1.5 per cent of GDP.
Continued large deficits mean that problems are being
postponed and that fiscal tightening will hamper the
recovery for a rather long period. At the same time,
we can see that incoming budget statistics often bring
upside surprises in countries that have progressed rela-
tively far in their recovery. Looking ahead, the cyclical
improvement may also prove larger than expected.
Bond yield rise will slow after rebound
In recent months, global long-term yields have re-
bounded after their dramatic downturn in April-October
2010. American and German 10-year yields have risen
by 1.5 and more than 1.0 percentage points, respec-
tively, from their lows last autumn of 2.4 and 2.1 per
cent, respectively. These upturns were driven by higher
inflation expectations and a stronger growth outlook.
Recent expectations of earlier key interest rate hikes
in major OECD countries have also contributed. This is
especially true of the ECB, which has been clearest in
signalling its concern that rising commodity prices could
spread, causing a broader upturn in inflation.
The yield curve has been very steep during the past
year. One year ago, the differential between 10- and
2-year US government bond yields was the widest for
at least 35 years. Given the recent upturn in long-term
yields, record levels are within reach again. A steep
yield curve is normally an indicator of improved eco-
nomic conditions; it reflects a situation in which a lin-
gering expansionary monetary policy is combined with
rising optimism and risk appetite. This interpretation
is more relevant today than a year ago. At that time,
 International overview

comparatively high long-term yields reflected − to a key interest rate hikes. This is due, among other things,
greater extent than today − a fundamental uncertainty to expectations of a limited supply of Swedish govern-
about the sustainability of economic policies. ment bonds (because of the balanced budget and pri-
10-year government bond yields vatisations of state-owned companies). Looking ahead,
Per cent we nevertheless believe that a widening gap in key
7.0 7.0 interest rates will enlarge the spread from today’s 20
6.5 6.5 or so basis points to 50 points by late 2012.
SEB
6.0 forecast 6.0
5.5 5.5 For Norwegian bonds, too, wider differentials in short-
5.0 5.0 term interest rates compared to those of the ECB will
4.5 4.5 mean upward pressure on the 10-year yield spread
4.0 4.0 against Germany. Our forecast is that Norway’s key rate
3.5 3.5 spread against the ECB will increase by 50 basis points
3.0 3.0 in the next couple of years. As a result, the 10-year
2.5 2.5
yield spread against Germany will climb towards 75
2.0 2.0
points by late 2012.
99 00 01 02 03 04 05 06 07 08 09 10 11 12

US Germany
Source: Reuters EcoWin, SEB
Calmer trend in Nordic stock markets
In recent months, the correlation between the world’s
One of the most important tasks of central banks during various stock markets has weakened. One new trend
the next couple of years will be to ensure that key rate has been that US stock exchanges in particular have
hikes do not lead to a significant upturn in long-term performed strongly, while stock markets in many de-
yields. Such a parallel upward shift in the yield curve veloping countries have lost momentum and, in some
might jeopardise the recovery. To many central banks, cases, also fallen significantly. For example, the stock
the reaction when the Fed began its rate hiking cycle in market rallies in India and Indonesia during 2010 have
1994 is still regarded as a textbook example of what to been followed by downturns of more than 10 per cent
avoid. In light of our inflation forecasts and other data, so far this year. In China, too, stock exchange perform-
however, such a development seems rather unlikely. ance has been weak. The political unrest in North Africa
Instead, well-justified key rate hikes may help improve has reinforced the stock market downturn in emerging
the credibility of central banks and stabilise inflation economies, while the impact on US and euro zone stock
expectations in a somewhat longer perspective. exchanges has been minor so far. Looking ahead, we
Steep yield curves believe there will be a cautious global stock market
Government bonds: 10-year minus 2-year yield upturn. Because emerging economies are much further
3 3 ahead in the economic cycle, and their currencies will
2 2 continue to strengthen, leading stock exchanges in the
US and Western Europe are likely to continue doing
1 1
comparatively well.
0 0
Stock market slowdown in the EM sphere
-1 -1 Index 100 = juni 2007
120 120
-2 -2
110 110
-3 -3 100 100
-4 -4 90 90
86 88 90 92 94 96 98 00 02 04 06 08 10 80 80
70 70
US Germany Sweden
Source: Reuters EcoWin 60 60
50 50
Our assessment is thus that the yield curve will 40 40
eventually become flatter. This means that we believe 30 30

that international 10-year bond yields will move Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov
07 08 09 10 11
upward at a moderate pace. The upward pressure on US Emerging markets
long-term yields will be restrained, among other things, Euro zone Sweden
Source: Reuters EcoWin, SEB
by CPI figures that will ease inflation worries ahead.
Towards the end of 2012, German long-term yields will The Nordic stock exchanges are also entering a more
stand at 4.00 per cent and American ones at 4.30, an mature phase. Valuations (measured as share price/
upward adjustment of 60 and 70 basis points, respec- equity) have now reached their average for the past
tively, since our last Nordic Outlook. decade. For example, market capitalisation on the OMX
Stockholm exchange has doubled in the past two years.
The spread between German and Swedish 10-year In 2010, operating margins of many Nordic listed com-
government bond yields has been rather stable at 15- panies reached historical peaks. This limits the room
35 basis points in recent months, despite the Riksbank’s

Nordic Outlook – February 2011  |  13

 International overview
for new positive surprises. For Swedish companies, and
to some extent also Norwegian ones, the strength of
the currency is also starting to become a greater chal-
lenge. This will make it harder for the OMX Stockholm
to continue outperforming exchanges in other countries
during the next couple of years.
Several factors nevertheless point towards a fairly
strong Nordic stock market trend this year. Because
of low debt, corporate transactions will increase after
several years of modest merger and acquisition volume.
Dividends will also be raised. The relationship between
interest rates and the yields on equities will also allow
room for rising share prices. We estimate that total
yield on Nordic stock exchanges will be 3.6 per cent,
which is higher than today’s yields on 10-year govern-
ment bonds in all Nordic countries but Iceland.
Continued Nordic currency appreciation
Differences in macroeconomic fundamentals, includ-
ing economic growth and government finances, will
remain key driving forces in the foreign exchange mar-
ket. Short-term interest rate spreads will also grow in
importance, as the volatility of the FX market subsides.
An increasingly vigorous world economy will continue to
push up the currencies of emerging market countries. In
many cases, rising commodity prices will help improve
terms-of-trade, making more room for continued ap-
preciation. This also applies to such OECD currencies as
the AUD, CAD and NOK.
Cyclically sensitive currencies will thus appreciate,
though earlier weakening trends have been reversed in
many cases. Central banks in many emerging economies
have intervened forcefully to slow the appreciation of
their currencies. However, we believe that many coun-
tries will, to a greater extent, accept future strength-
ening of their currencies as a means of keeping inflation
down. This is one way of taking the edge off rising food
prices and the related risks of social unrest.
China’s currency policy remains cautious. Since late
June 2010, when appreciation against the US dollar was
resumed, the yuan has gained about 3.5 per cent. Real
effective appreciation totalled about 5 per cent during
2010. We believe that the pace of appreciation against
the USD will increase somewhat during 2011 in order
to counter inflation and contribute to more balanced
economic growth. Our assessment is that the USD/CNY
exchange rate will be 6.30 at the end of 2011.
As for the trend of G4 currencies, we anticipate that
the euro will continue to strengthen against the USD
in the immediate future. Among factors supporting
the euro will be that the ECB will start its key interest
rate hikes earlier than other major central banks. We
also expect the strengthening of the EFSF/ESM stability
mechanism to help reduce the political risk premium.
This has been manifested, for example, in narrowing
euro zone yield spreads. Our forecast is thus that the
EUR/USD exchange rate will continue to climb, peaking
14   |  Nordic Outlook – February 2011
at 1.45 during the third quarter of 2011. Next year
the USD will regain ground as the American economic
recovery progresses and as the Fed begins its key rate
hikes. Towards year-end 2012, the EUR/USD rate will
stand at 1.30: still a bit above our estimated long-term
equilibrium exchange rate (fair value) of around 1.20.
Long-term fair values according to SEBEER
Current Fair value 2010
EUR/USD 1.36 1.19
EUR/SEK 8.82 8.27
EUR/NOK 7.82 7.39
USD/SEK 6.47 6.93
USD/NOK 5.73 6.19
USD/JPY 82 120
EUR/GBP 0.84 0.71
EUR/CHF 1.29 1.44
GBP/USD 1.61 1.68
USD/CHF 0.95 1.20
Source: Reuters, SEB
The Japanese and Swiss currencies (JPY and CHF) are
among the most overvalued according to our model. As
the world economic situation stabilises and the ECB and
Fed begin their rate hikes, we expect the JPY and CHF
to fall towards levels more justified by fundamentals.
The USD/JPY rate will be 90 at the end of 2011 and 98
at the end of 2012.
The Swedish and Norwegian currencies will continue
to strengthen. Rapid rate hikes by the Riksbank will
open a key rate gap against the ECB. The Norwegian
krone will also move higher due to a widening key rate
spread against the ECB. We thus expect its appreciation
to continue during 2011, and the EUR/NOK rate will
reach 7.60 at the end of this year.
The flow situation will also push up the SEK. Strong
government finances are one reason why the krona
may gain a larger weighting in the foreign exchange
reserves of central banks. We believe that the EUR/
SEK exchange rate will stand at 8.50 towards the end
of 2011 and 8.40 towards the end of 2012. This is close
to our fair value estimate of about 8.30. The large cur-
rent account surplus and Sweden’s strong net external
financial position support our forecast that the krona
may appreciate further.
On the other hand, company reports from the fourth
quarter of 2010 are showing that profits are beginning
to be affected by the strong currency.
 Theme

SEBEER: A model for long-term equilibrium

exchange rates
ƒƒ EUR/USD equilibrium at 1.20 inflow of capital that helps strengthen its exchange rate
in the short and medium term.
ƒƒ JPY and CHF the most overvalued
The usual way of estimating fair values is to use tradi-
ƒƒ NOK and SEK undervalued against the
euro tional time series analysis on individual currencies. One
way of carrying the analysis further is to estimate fair
values for a panel of exchange rates simultaneously.
The economic literature includes many approaches to The number of observations − and the precision of
calculating equilibrium exchange rates (fair values). the estimates − is larger, without having to extend the
Purchasing Power Parity (PPP) emphasises the associa- estimate period as far back in time. The panel approach
tion between relative price levels in different countries also makes it possible to estimate several fair values
and exchange rate. Other methods focus on internal simultaneously, so the approach is internally consistent.
and external balance conditions − with the situation
related to resource utilisation and inflation rate, on the Deviation from Fair Value 2010
Deviation, per cent, vs. USD
one hand, and current account balance and net exter-
nal financial position, on the other, providing the basis GBP -8%
for estimating equilibrium exchange rates.
NOK 0%
In addition to these more fundamental, theoretical
approaches, there are more empirical methods based SEK 0%
on actual historical exchange rate trends. SEB Research AUD 8%
recently estimated such equilibrium rates (Behavioural
Equilibrium Exchange Rate, BEER). The variables that EUR 8%
proved to have the largest impact on fair values in the
NZD 14%
model that we have named SEBEER are the following:
DKK 14%
Relative prices: Long-term fair value is affected by
relative price levels between countries, in keeping with CAD 22%
the above-mentioned PPP theory. A low domestic price
CHF 22%
level relative to other countries indicates that the cur-
rency is undervalued. JPY 36%
Undervalued Overvalued
Terms-of-trade: Differences in world market price Source: SEB
trends between a country’s exports and imports influ-
ence fair value. A favourable trend with faster-rising The chart shows selected results from our latest panel
export prices strengthens a country’s fair value. data estimate of nominal fair values from 1980 through
2010, stating deviations from fair value against the US
Relative productivity: Differences in productivity
dollar for the average exchange rate in 2010 (for more
growth influence fair value. A country with higher pro-
details, see FX Ringside, January 2011). The hard cur-
ductivity growth than its peers can maintain a gradually
rencies of Japan and Switzerland are the most over-
appreciating currency without seeing its competitive-
valued, while the British pound is the only currency in
ness undermined.
the list that is undervalued against the USD. The euro
Current account: In the long term, the current account exchange rate is above its fundamental valuation; the
balance affects the exchange rate. A surplus leads to latest estimate indicates that EUR/USD fair value is
greater demand for the currency, thereby strengthening 1.20.
its exchange rate.
The SEK and NOK were in balance against the USD in
Interest-rate differentials: Differences in interest rates 2010 (SEK 6.93 and NOK 6.19) but were fundamen-
generate capital flows, which influence the exchange tally undervalued against other currencies, except the
rate. A country with higher interest rates receives an pound. Estimated EUR/SEK fair value in 2010 was 8.30
and EUR/NOK fair value was 7.39.

Nordic Outlook – February 2011  |  15

The United States
The US economy gears up above trend
ƒƒ The labour market is improving
ƒƒ Corporate profits will continue upward
ƒƒ The housing market is stumbling
ƒƒ The Fed will hike its key rate in April 2012
The US economic outlook has improved. A combination
of the Federal Reserve’s ultra-loose monetary policy
and a new fiscal stimulus has bolstered optimism. GDP
growth in the fourth quarter of 2010 was significantly
stronger than we expected in the last Nordic Outlook,
and there are many indications of continued good
growth figures early in 2011. Private sector financial
saving has now started falling, which is usually an
important signal that a recovery is becoming self-
sustaining. Measured as annual averages, we foresee
GDP growth of 3.6 per cent this year and 4.0 per cent
in 2012, which is above consensus and a sharp upward
revision for 2011. Housing market reversals and poor
state government finances will nevertheless keep the
recovery a few percentage points weaker than histori-
cal averages during the corresponding cyclical phase.
Employment will increase by an average of about
180,000 per month this year, despite public sector
cutbacks. Unemployment will fall but will remain at
a high 7.8 per cent at the end of our forecast period.
Large output and labour market gaps will lead to low
core inflation; our inflation forecasts are below consen-
sus. We thus anticipate that the Fed will hike its key
interest rate in April 2012, later than market pricing
indicates.
Composite ISM and GDP growth
Index, year-on-year percentage change
62,5
60,0
57,5
55,0
SEB
52,5
forecast
50,0
47,5
45,0
42,5
40,0
37,5
35,0
02 03 04 05 06 07 08 09 10 11
ISM Composite index (LHS) Real GDP (RHS)
Source: ISM, SEB
16   |  Nordic Outlook – February 2011
Continued strong company profit growth
Capacity utilisation has risen at a brisk pace since it
bottomed out a year and a half ago, but remains at low
levels. Capital spending by businesses is now increas-
ing 10 per cent year-on-year but is still at a histori-
cally very low level as a percentage of GDP. Meanwhile
current market values relative to the replacement
costs are giving companies good incentives for invest-
ments. (Tobin’s Q has continued to climb). Add strong
corporate balance sheets and great optimism, both
in manufacturing and service sectors. Our composite
ISM purchasing managers’ index is compatible with
5 per cent GDP growth. The manufacturing ISM index
currently is close to 25-year highs. In a shorter perspec-
tive, however, weaker order bookings for capital goods
in recent months are evidence against an acceleration
in capital spending activity.
Good profitability is also helping to stimulate capital
spending activity. Corporate after-tax profits are at 5.6
per cent of GDP, slightly above the historical average
but far below previous peaks. A combination of ris-
ing labour costs and higher taxes will eventually push
down profits. But 2011 will probably be another year of
double-digit profit growth. The gap between inflation
and labour costs has historically been a good indicator
of which way profits are headed. This indicator points
towards an increase in profits 2-3 times higher than
GDP growth in current prices during 2011. Profits as a
percentage of GDP will continue upward.
Strong profit growth in 2011 as well
Difference, year-on-year percentage change
8 80
7 70
6 60
5 50
4 40
6 3 30
Percent
5 2 20
4 1 10
0 0
3
-1 -10
2
-2 -20
1 -3 -30
0 -4 -40
-1 90 92 94 96 98 00 02 04 06 08 10
-2
Headline inflation less unit labor cost inflation (LHS)
-3
Net profits after tax (RHS)
-4 Source: BLS, BEA, SEB
-5
12
Our overall forecast is that corporate capital spending
will grow by 13 per cent in 2011 and 15 per cent in
2012. Its contribution to GDP growth will average 1.6
 The United States

percentage points during our forecast period, compared compatible with a continued decline in household debt
to 2.1 per cent for private consumption. in relation to income. The debt-to-income ratio is now
at 122 per cent, according to the latest Fed statistics,
Exports will climb in first half of 2011 a clear downturn from its peak (135 per cent in 2007).
The weakening of the US dollar will lift exports dur- The adjustment has thus progressed quite far, and the
ing the next six months, while import figures will be debt service ratio has also fallen to its long-term mean.
kept down because an inventory build-up has already But the debt-to-income ratio is still high. Together with
occurred. We foresee increases in exports averaging further home price declines, this indicates that debt
11 per cent in 2011-12. Foreign trade will contribute retirement will continue. In the years before the home
positively to GDP growth during the first half of 2011, price boom, the debt ratio was below 100 per cent.
followed by a shift to a negative contribution in the
second half and in 2012. The 2010 US current account Household deleveraging
Per cent of disposable income
balance, which stood at -3.2 per cent of GDP in 2010, is
140 15.5
expected to approach -4 per cent of GDP by the end of 130 15.0
2012. 120
Mean, debt service ratio
14.5
110 14.0
100 13.5
Consumers getting bolder 90 13.0
A strong Christmas shopping season helped lift consump- 80 12.5
70 12.0
tion by 4.4 per cent annualised in the fourth quarter of 60 11.5
2010, the strongest figure since 2006. Several factors 50 11.0
40 10.5
indicate that this positive trend will persist. Extend- 30 10.0
ing the Bush-era tax cuts for another two years as well 20 9.5
as cutting the employees’ federal payroll tax in 2011 45 55 60 65 70 75 80 85 90 95 00 05 10

will increase room for consumption. Meanwhile the
consumer confidence surveys look a bit brighter; for
example the Conference Board indicator posted a heavy
gain in January. We foresee a gradual return to normal
confidence levels as the labour market and incomes
strengthen.
Looking further ahead, a stronger labour market will
also help bolster household income. Given the large
role of private consumption in GDP (71 per cent), this
is one key explanation for our brighter economic view.
Household savings adjustment has also come a long way.
According to our calculations, household savings levels
are close to the equilibrium justified by such factors as
wealth position. We are thus expecting only a marginal
additional upturn in household savings ratios during
the next couple of years. Such savings behaviour is also
Household debt-to-income ratio (LHS)
Household debt service ratio (RHS)
Source: Federal Reserve, SEB
Overall, we foresee an increase in consumption of
3.2 per cent this year and 3 per cent next year:
more than half a percentage point below the 1994-
2007 average. Rising petrol prices pose a downside risk
for our consumption forecast, however. The upturn in
oil prices does not appear to have been driven by US
consumers, since the demand for oil-related products
is currently falling at a 2.4 per cent year-on-year rate.
Petrol has climbed from an average of USD 2.70/gal-
lon (September) to USD 3.15/gallon today. One rule of
thumb is that for every cent that petrol prices rise,
household buying power shrinks by USD 1.5 billion. In
other words, rising petrol prices are blunting the impact
of the tax cut extension. Nevertheless, we expect that

Falling private sector savings boosts GDP is slow compared to historical experience, but still
The difference between total private sector income compatible with above-trend GDP growth according to
and expenditures, as a percentage of GDP, was record- our estimates.
high last year. Since then, the percentage has begun
to fall. Expenditures are again increasing faster than Private sector balance boosts growth
Per cent of GDP
income. According to the historical pattern, the pri-
10.0 10.0
vate sector balance will continue falling towards the
7.5 7.5
long-term average, making strong GDP growth likely
over the next few years. 5.0 5.0

2.5 2.5
If this adjustment continues over a four-year period
(the risk scenario in the chart), our calculations indi- 0.0 0.0

cate that GDP growth measured as annual averages -2.5 -2.5

will exceed 4 per cent during the next three years. -5.0 -5.0
But continued need for financial consolidation in the
-7.5 -7.5
household sector as well as lingering weaknesses in 60 65 70 75 80 85 90 95 00 05 10 15
the housing and labour markets implies that the ad-
Risk scenario Main scenario
justment may take longer than this. Our main scenario Source: SEB

is that the adjustment will take eight years, which

Nordic Outlook – February 2011  |  17

 The United States

real disposable income will rise at an annualised rate
of 5-6 per cent in the first quarter, compared to slightly
below 2 per cent in the fourth quarter. Some of the
boost will be saved, thus reversing the recent drop in
the savings ratio. Even so, we expect impressive con-
sumption growth in the current quarter as well.
this year. Higher mortgage interest rates will contrib-
ute to the downturn, but their effect should not be
exaggerated: a 60 basis point increase in 30-year mort-
gage rates from their bottom level will lower prices by
about 1 per cent in a one-year time frame, according to
our estimates.

The housing market is stumbling The steeper yield curve is positive for bank earnings,
Housing investments as a share of GDP are at a deeply which would mean a gradual easing of credit condi-
depressed 2.2 per cent. There is thus little risk of a fur- tions and increased new lending. But bad commercial
ther decline, but no upswing will occur until the market property loans will pull down the banking system, es-
catches up with the oversupply of homes. Housing pecially the regional banks. These problems have been
investments will grow by 2 per cent in 2011, accel- relegated to the future, since banks have postponed
erating to a 14 per cent rate in 2012, which will still loan maturity dates and thus avoided taking losses on
provide a relatively small contribution to GDP growth their balance sheets. Commercial property loans worth
(0.4 percentage points in 2012). USD 1.5 trillion will reportedly fall due in the next four
years. About half of this volume is related to loans
Huge investment swings exceeding current property value.
Per cent of GDP
9 15
The labour market is gaining strength
8 14 According to the Fed’s latest Beige Book, stronger
7 13 employment growth is occurring in most parts of the
United States, although the improvement is rather slow.
6 12
New unemployment benefit claims have also fallen
5 11 noticeably since August, which is usually a good indica-
4 10 tor that a clear increase in employment is imminent.
A cyclical slowdown in the productivity upturn is also
3 9
helping increase the need for new hiring. We expect
2 8 productivity to rise by 1.3 per cent this year and 2 per
50 55 60 65 70 75 80 85 90 95 00 05 10
cent in 2012, compared to 3.5 per cent in both 2009
Residential (LHS) Nonresidential (RHS) and 2010.
Source: Reuters EcoWin, SEB

According to the Case-Shiller index, home prices have Our overall assessment is that employment will in-
fallen for five months in a row, and our assessment is crease by an average of 180,000 a month this year
that home prices will fall by an additional 5 per cent and by 200,000 next year, or double the 2010 level.

Home price drop jeopardises recovery

The downward trend in home prices reversed during Real home prices well above the mean
the second half of 2009, which can be explained by Index 1890 = 100
several factors: the Fed’s mortgage bond purchases 225 225

helped push mortgage rates to record lows, while 200 200

mortgage modification plans and temporary morato-
175 175
riums on home foreclosures reduced supply. But the +85% -33%

market was still too weak to sustain itself, as illustrat- 150 150
ed by the renewed price declines following the expira- +1 std dev
125 125
tion of temporary tax credits for home purchases. -23%
100 100
The supply of available homes is still large: 3.6 mil-
75 -1 std dev 75
lion, or 65 per cent above the historical average.
Meanwhile the “shadow supply” is significantly larger 50 50
90 00 10 20 30 40 50 60 70 80 90 00 10
than the 8 month inventory that official figures indi-
cate. According to Fed estimates, the actual inventory Source: Robert Shiller, SEB

of available homes is around 24 months. In addition,

every fifth household with a mortgage owes more
money than its home is worth, and nearly half of bank
assets are tied to the housing market. Sharper home
price declines than we are expecting in our main sce-
nario are thus the biggest risk to US economic recov-
ery. Although home prices in real terms have fallen by
one third from their 2006 peak, there is quite a way
left down to the historical average.
What may prevent such sharp home price declines is
that a stronger labour market will help prop up the
housing market. In addition, new support measures
will probably be launched if conditions get much
worse.

18   |  Nordic Outlook – February 2011


The tough public budget situation at the state and local
levels − which account for 15 per cent of all employees
− will prevent an even stronger rebound in the number
of jobs. Unemployment will fall to 8 per cent by the
end of 2012, in line with the Fed’s latest forecasts.
Diverging employment trends
Year-on-year percentage change
4 4
3 3
2 2
1 1
0 0
-1
-2
-3
-4
-5
-6
90 92 94 96 98 00 02 04 06 08
Total employment State & local employment
Source: BLS, SEB
Yet it will be a long time before the labour market is
back at a normal situation. Some 13.8 million Ameri-
cans, or 9 per cent of the labour force, are unem-
ployed. This can be compared to our estimate of
equilibrium unemployment, which is 5.5 per cent.
Another 11 million people are underemployed; the
jobless rate is as high as 16.1 per cent according to the
broadest measure (U6). Youth unemployment stands
at 25.7 per cent, compared to 14 per cent in 2006.
The employment-population ratio is stuck close to
its 28-year low (58.4 per cent), which means that 11
million jobs will be needed in order to reach the 2007
peak. Meanwhile, among the G7 economies the US and
Canada are the only two where GDP has reached fresh
highs.
Our conclusion is that despite faster GDP and employ-
ment growth, the labour market gap will remain large
during our forecast period. In light of this, Fed Chair-
man Ben Bernanke recently warned that it may take
4-5 years before unemployment is back at historically
normal levels.
Large output gap means low inflation
For a long time, our take on inflation has been that the
resource situation in the US economy is the most impor-
tant determining factor and that both the output gap
and the labour market gap are large. The trend towards
low, falling core inflation will thus continue for an-
other while. Broad measures of monetary growth have
rebounded, but year-on-year rates of increase remain
far below historical averages. The credit multiplier
bottomed out a year ago, but the upturn since then has
been modest.
According to our forecasts, core inflation will bottom
out at a record-low 0.5 per cent rate later this spring
and then gradually accelerate. Measured as annual
averages, core inflation will amount to 0.7 per cent in
2011 and 1.0 per cent in 2012. But historical experi-
The United States
ence shows that core inflation has never risen when
there has been such high unemployment. It is thus too
early to write off the deflation risk completely, a view
that also is supported by the low wage pressure.
Private sector capital stock drops
Year-on-year percentage change
25 25
20 20
15 15
10 10
-1
5 5
-2
-3 0 0
-4
-5 -5
-5
-6 -10 -10
10 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10
Source: BEA, SEB
Risks of long-term supply side disruptions
Our inflation and labour market analysis is based on a
relatively optimistic picture of the American economy’s
supply side in the medium term. But there are various
risks that the deep recession has harmed the economy
in a more lasting way. This might lead to a substantial
downshift in potential growth and permanent exclusion
from the labour market, for example in the form of
higher equilibrium unemployment. One alarming fact
is that in 2009, US capital stock decreased for the
first time since the 1930s depression, indicating lower
productivity growth a bit further ahead.
Another potential threat has to do with rising long-
term unemployment. Since many jobless people were
close to the end of their benefit period, unemployment
benefits were extended for another 13 months just
before the end of 2010. Long-term unemployment − 6.2
million people have been out of work for at least 6
months − has both economic and social dimensions: a
Congressional Budget Office (CBO) study shows that one
fourth of the long-term unemployed do not return to
the labour force. Those who manage to return often do
not achieve their earlier productivity level, which is one
reason why those who return average 20 per cent lower
pay.
The continued decline in home prices is another fac-
tor that may affect the supply side of the economy.
Geographic mobility is one important reason why output
and employment recoveries have historically been so
dynamic in the US. Many households have now lost a
large percentage of their residential capital. In many
cases they are stuck in homes worth less than their
mortgages. This will probably reduce mobility and thus
slightly push up the non-accelerating inflation rate of
unemployment (NAIRU).
Such supply side questions will become more acute
further along in the recovery. In some respects, these
problems may have time to correct themselves, provid-
Nordic Outlook – February 2011  |  19
 The United States

ed that the US economy enters a more positive recovery federal expenditures will total 25 per cent of 2011 GDP,
dynamic. Otherwise fresh economic policy thinking may with revenue at around 15 per cent. For every dollar
be required to avoid long-term damage. that flows into the Treasury, the US government thus
spends USD 1.60-1.70. During the post-war period, this
Government spending for each USD of
figure has rarely exceeded USD 1.30.
revenues
Ratio
Next year we expect a slight fiscal tightening, and the
1.8 1.8
budget deficit will then fall to USD 1.2 trillion, yet pub-
1.7 1.7
1.6 1.6
lic sector debt will continue climbing during the next
1.5 1.5 couple of years. We expect the 2012 national debt to be
1.4 1.4 slightly over 100 per cent of GDP. Although credit rating
1.3 1.3 agencies are beginning to show their displeasure, we
1.2 1.2 do not believe that the consequences will be particu-
1.1 1.1 larly large during the next couple of years. The dol-
1.0 1.0 lar’s status as a reserve currency provides a degree
0.9 0.9
of freedom to increase debt without incurring higher
0.8 0.8
55 60 65 70 75 80 85 90 95 00 05 10
borrowing costs. But there is a limit, and further ahead
the politicians will be forced to make decisions that
Source: US Department of the Treasury, SEB
will bolster confidence in a long-term balance, not least
National debt approaching new heights because more than half this public debt is in foreign
The contractive economic effect of private sector debt hands.
reduction has been offset by explosive growth in public
sector debt. Federal debt has risen from 65 per cent of US hitting debt ceiling again
GDP in 2007 to nearly 95 per cent today. In 2010, the This spring the risks associated with the “debt ceiling”
budget deficit was nearly USD 1.3 trillion. This year will be in focus. US national debt now totals USD 14.004
it will exceed USD 1.5 trillion or 9.9 per cent of GDP, trillion: a mere USD 290 billion below the legal ceiling
due among other things to further tax cuts. This year’s of USD 14.294 trillion. Most indications are that the US

Little risk of 1970s-style stagflation

The Fed’s decision to implement quantitative easing
has been both praised and reviled. The most critical
voices argue that stagflation − weak growth combined
with high inflation, as in the 1970s − may be the
outcome. In our assessment, that risk is small; our
forecasts instead point towards continued very low
inflation over the next couple of years. In addition,
the situation today is different from that of 35 years
ago in several respects:
We can also note that upturns in commodity prices
quickly spread to core inflation in the 1970s, as
evidenced by the high correlation between core and
headline measures. In recent years, core inflation
has trended downward and has not been affected by
commodity-driven variations in headline inflation. The
trend of underlying inflation thus seems to be driven to
a greater extent by such factors as resource utilisation
and long-term inflation expectations.

ƒƒ Most measures indicate plenty of idle resources in

Core inflation heading down
the economy today, which was not the case in the
Year-on-year percentage change
1970s. 15.0 15.0

ƒƒ The purpose of quantitative easing is to boost infla- 12.5 12.5

tion to levels consistent with price stability; in the 10.0 10.0

1970s inflation was significantly higher at the outset. 7.5 7.5

ƒƒ Unit labour cost (ULC) is the most important factor 5.0 5.0
in the inflation process in developed countries. At 2.5 2.5
present, ULC is still falling year-on-year. But 30
0.0 0.0
years ago, wages and salaries were rising at a faster
-2.5 -2.5
pace than productivity justified, among other things
70 75 80 85 90 95 00 05 10
because the labour union movement was stronger in
All items All items less food and energy
those days. Source: Reuters EcoWin, SEB

ƒƒ Mechanical monetary policy rules such as the Taylor

rule indicate that, if anything, monetary policy is
too tight today. During the 1970s, in contrast, mon-
etary policy was too accommodative.

20   |  Nordic Outlook – February 2011


Treasury will hit the debt ceiling in April or May. Raising
this ceiling is not exactly unusual: it has been raised
74 times since 1962, and 10 times since 2001. The last
time was a year ago. But occasionally this issue has led
to political conflicts, including this time around.
When the Treasury reaches the federal debt ceiling, it
is prohibited from issuing further debt securities before
Congress has approved an increase in the ceiling. This
will apparently become an important tool in efforts to
push through other reforms; this may include taking a
closer look at the proposals of President Obama’s deficit
commission. House Republicans are now reportedly also
pushing for USD 50 billion in budget cuts this year. The
pension reform issue may also come up.
Debt ceiling will soon be reached
Per cent of GDP, USD trillion
95
Current debt ceiling
90
85
80
75
70
65
60
55
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Federal debt, percent of GDP (LHS)
Federal debt, trillion (RHS)
Source: US Department of the Treasury, BEA, SEB
The Fed will hike its key rate in a year
In our assessment, after the Fed completes the USD 600
billion in bond purchases it has announced, it will stop
making such purchases. What may disrupt this scenario
is if core inflation approaches zero, or if economic
growth turns out to be much weaker than we believe;
Obama rebounding
With less than two years left until the 2012 presiden-
tial election, our assessment is that Barack Obama’s
chances of being re-elected are relatively good. His
approval rating is admittedly still rather weak; only
around 50 per cent of the population thought the
president was doing a good job in mid-January. But
the experience of recent decades indicates that public
opinion figures can shift rapidly. Bill Clinton was in a
similar position in the spring of 1995 yet still managed
to be re-elected by a wide margin in 1996. Ronald
Reagan had very weak public approval ratings early in
1983, but won a landslide victory in the 1984 election.
George Bush, both father and son, enjoyed far better
support in the 1991 and 2003 opinion polls respec-
The United States
in that case, further stimulus may be called for. New
estimates from the Fed indicate that quantitative eas-
ing is effective: its bond purchases in recent years will
boost inflation by one percentage point and generate
3 million jobs by 2012, according to the Fed’s models.
Measures aimed at actively shrinking the Fed’s balance
sheet − reversing quantitative easing − will probably
not be launched during our forecast period. Leaving QE
in place for a few years is a cornerstone of the Fed’s
calculations.
To summarise, our assessment is that the US central
bank will hold off before making its first interest rate
hike in April 2012 and that the federal funds rate will
stand at 1.75 at the end of our forecast period. This
implies that the Fed will hold off somewhat longer than
the market has now priced in, but normalise rates more
15 rapidly.
14
13 Changes in the Fed’s voting system may have an effect
12
on the detailed formulation of US monetary policy. Each
11
10 year five regional Fed presidents are entitled to vote,
9 according to a rotating timetable, with the head of the
8 New York Fed always included. Judging from recent
7
6
speeches, this year’s Federal Open Market Committee
5 is slightly more hawkish than last year, since Richard
4 Fisher (Dallas Fed) and Charles Plosser (Philadelphia
Fed) will vote on the FOMC while Thomas Hoenig (Kan-
sas City Fed) has left. But although interest rate hawks
get a lot of media coverage, they are a clear minor-
ity and do not set the tone of the FOMC. Instead we
believe that possible shifts in the positions of Chairman
Ben Bernanke, the New York Fed’s William Dudley and
Vice Chair Janet Yellen will be decisive.
tively, but George H.W. lost and George W. won by
the narrowest possible margin. Early in 1979, Jimmy
Carter was roughly where Obama is today, but he
failed to be re-elected.
Our conclusion is that the economic situation in
the period leading up to the election decides the
matter. If our forecasts of decent growth and falling
unemployment prove correct, Obama is likely to be
re-elected in 2012. The economy helped both Reagan
and Clinton but sank Carter and the elder Bush.
Obama has also shown considerable willingness to
compromise and has taken various steps towards the
political centre, which appear to be smart moves.
Nordic Outlook – February 2011  |  21
Japan

Recovery losing momentum

ƒƒ Clear deceleration in growth this year Headline CPI inflation has crept up to zero in recent
months, but core inflation remains negative. There are
ƒƒ Exports gaining traction, but weak domes- no signs that the inflation rate will start climbing to any
tic demand
great extent. We expect CPI inflation to be weakly
ƒƒ Fiscal weakness requires tax reform positive both in 2011 and 2012.

Continued deflation pressure

A sharp recovery in exports and industrial production in 2.5 2.5

the first half of 2010 lifted Japan’s GDP by around 4 per 2.0 2.0

cent for the full year, but the fourth quarter as well as 1.5 1.5

early 2011 appear to have been weak. We predict GDP 1.0 1.0

growth of 1.6 per cent both in 2011 and 2012. 0.5 0.5
0.0 0.0
The purchasing managers’ index in the manufacturing -0.5 -0.5
industry is just above 50, and leading indicators are -1.0 -1.0
faltering. Consumer confidence is at its lowest level -1.5 -1.5
for nearly two years, which is also reflected in weak -2.0 -2.0
retail sales. We expect consumption growth to average -2.5 -2.5
around 1 per cent in 2011-2012. 00 01 02 03 04 05 06 07 08 09 10

CPI Core inflation

Industrial production has risen in the past two months, Source: Statistics Bureau, Ministry of Internal Affairs and Communication

but only after it had fallen for five straight months. Government efforts to highlight public debt prob-
According to the Bank of Japan’s latest Tankan survey, lems and Japan’s need for tax reform have dominated
the competitive position of the manufacturing sector domestic policy. The newly appointed economic and
deteriorated during the fourth quarter of 2010. Weak fiscal policy minister, Kaoru Yosano, wants to launch
order bookings indicate a continued decline in capital quick improvements in government finances. The issue
spending. Residential construction remains at a low gained new urgency when Standard & Poors downgraded
level, but rents for office space have rebounded. Japanese sovereign debt to AA-. Prime Minister Naoto
Exports are taking off again Kan continues to underscore the need to reform the tax
Index 100 = 2000 system; high government debt and budget deficits make
190 190 change vital. In December, the government approved a
180 180
cut in corporate tax to 35 per cent. It has invited the
170 170
160 160 opposition for talks on raising the sales tax from the
150 150 current 5 per cent. This would risk hurting already weak
140 140 retail sales. Making all reform efforts more difficult is
130 130
120 120
the record-low public confidence in the government.
110 110
100 100 The Bank of Japan will keep its key interest rate
90 90 unchanged in the 0.00-0.10 per cent interval until the
80 80
third quarter of 2012, while retaining its credit facility
70 70
00 01 02 03 04 05 06 07 08 09 10 and asset purchase fund.

Industrial production Exports
Source: Ministry of Finance, METI
After a slump, exports have clearly recovered in recent
months. The negative impact of yen appreciation during
2010 (4 per cent in effective terms) is being offset by
stronger demand in China and the US. Annual export
growth will average around 5 per cent in 2011-12.
The government has also made clear its willingness to
intervene again in the foreign exchange market if the
yen continues to appreciate. We expect the USD/JPY
rate to stand at 90 at the end of 2011 and 98 at the
end of 2012.

The labour market improvement last summer and early

autumn has slowed. Unemployment will remain at
around 5 per cent during the next couple of years.

22   |  Nordic Outlook – February 2011


Good growth but rising inflation
ƒƒ More acceptance of currency appreciation
ƒƒ Continued monetary tightening in China
ƒƒ Risk of overheating in India
GDP growth in Asian emerging countries decelerated
during the third quarter of 2010, but there are many
indications of stabilisation in the fourth quarter. Exports
and industrial production show continued good growth
in most of these economies, despite noticeable ap-
preciation in many currencies. During 2011 and 2012
we expect continued strong growth, but it will slow
somewhat because rising inflation and large capital
inflows will force governments to keep tightening their
economic policies.
Inflation pressure in the region has increased in recent
months. Rising food prices play a crucial role, since
food accounts for a very large share of CPI in develop-
ing economies. There are major risks of discontent and
protests against high food prices, not least in China. So
far, however, there are few signs of a broad inflation
upturn in the region, although core inflation has begun
rising in China, Indonesia and elsewhere.
Inflation is rising in Asia
Per cent
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
07 08 09
China South Korea Thailand
Indonesia Malaysia India
Source: National statistical offices
Many Asian countries have begun taking steps to prevent
inflation expectations from soaring. We expect China
to continue tightening monetary policy in 2011. India
will be forced to hike interest rates further to tackle
inflation, which has taken off again. South Korea raised
its key rate in January. Indonesian inflation is now well
above target and core inflation has also climbed signifi-
cantly. Key rate hikes are being supplemented by other
actions. For example, Indonesia and China have raised
their bank reserve requirements to slow credit expan-
sion. Steps have been taken to increase food supply,
while food price controls are being considered.
Asia
Differences in interest rates and growth outlook com-
pared to the US and Western Europe are continuing to
generate large capital flows into the region. This risks
causing macroeconomic imbalances and price bub-
bles for assets like real estate and equities, which in
turn may threaten financial stability. To counter such
tendencies, Asian countries have intervened in foreign
exchange markets. Rising inflation seems to be making
countries willing to allow more currency appreciation
than before. Rapid pay increases in many countries are
also speeding the pace of real appreciation.
China: Continued strong growth
During the fourth quarter of 2010, GDP rose by 9.8 per
cent, which was somewhat higher than expected. For
2010 as a whole, growth ended up at 10.3 per cent. We
are revising our 2011 growth forecast slightly upward
to 9.5 per cent and expect growth of 8.5 per cent in
2012.
The purchasing managers’ index in manufacturing fell
somewhat in December but still indicates good growth.
Industrial production has stabilised at year-on-year
growth of around 13 per cent. Retail sales have been
strong, and in December the increase was around 19
per cent. Export growth decelerated in the second half
of 2010; in December the year-on-year rate of increase
12.5
was 18 per cent, the lowest since December 2009.
10.0
Export and import growth is slowing
7.5
Year-on-year percentage change
5.0 100 100
2.5
75 75
0.0
50 50
-2.5
-5.0 25 25
10
0 0
-25 -25
-50 -50
00 01 02 03 04 05 06 07 08 09 10
Exports Imports
Source: National Bureau of Statistics
Import growth has also decelerated, but in the past
months the rate of increase in imports has been higher
than that of exports. We expect this trend to persist. It
reflects the increasing importance of domestic con-
sumption and is shrinking China’s large trade surplus.
This surplus fell from USD 196 billion in 2009 to USD
183 billion in 2010, but the politically sensitive trade
Nordic Outlook – February 2011  |  23
 Asia
surplus against the US remains at a high level. It was
USD 25.6 billion in November. Chinese authorities have
expressed a desire to see the surplus continue shrinking
in 2011.
Calmer housing market trend
As expected, home price increases have continued to
slow. In December the year-on-year increase in the
70 largest cities of China was 6.4 per cent, or half
the growth rate of last spring. The measures that the
authorities have undertaken to cool down the market
thus seem to have had an effect. Sharply increased
construction will probably lead to a further slowdown.
A property tax has been launched on a trial basis in
Chongqing and Shanghai. According to the new five-year
plan, more than 15 million residential units will be com-
pleted before the end of 2012. Overall, we thus believe
that home prices will level off during the latter part
of 2011.
Tightening in response to rising inflation
Inflation is continuing upward. In November, CPI infla-
tion reached 5.1 per cent, its highest level since July
2008, but in December inflation slowed to 4.6 per cent.
Higher inflation was mainly caused by rising food prices;
food inflation reached 9.6 per cent in December. Core
inflation, which excludes food and energy, also climbed
and was 1.5 per cent in November. Inflation expecta-
tions rose significantly in the fourth quarter of 2010.
The December inflation rate decline is largely explained
by base effects, and we expect inflation to remain high
in the next few months.
Food prices driving up inflation
Per cent
25
20
15
10
5 5
0 0
-5
05 06 07 08 09
CPI Core inflation Food prices
Source: National Bureau of Statistics
China is now tightening its monetary policy to counter
the inflation upturn. On Christmas day, the central bank
raised its key interest rate by 25 basis points to 5.81
per cent − the second such hike in 2010. Several other
tightening measures have been implemented. The bank
reserve requirement was raised six times during 2010
and once again in January 2011 and now stands at 19
per cent for most banks. The new 2011 lending target
for banks has also been lowered compared to 2010.
We expect China to continue its monetary tighten-
ing during the first half of 2011. The central bank has
24   |  Nordic Outlook – February 2011
communicated clearly that monetary policy needs to
be normalised. The current key interest rate of 5.81
per cent is still well below the long-term average of
7.5 per cent. For example, a deposit rate of 2.75 per
cent means that real interest on household bank sav-
ings is clearly negative. This indicates significant room
for further rate hikes. On the other hand, excessively
aggressive rate hikes risk worsening the problem of
speculative foreign exchange inflows. Our assessment
is thus that the Chinese authorities will need to use
different tools in their tightening policy. Key interest
rate hikes will be combined with increases in reserve
requirements and stricter controls on currency inflows.
We predict three additional interest rate hikes during
the first half of 2011, bringing the key rate to around
6.5 per cent. While monetary policy is being tightened,
fiscal policy will be less expansionary.
China’s currency appreciation will contribute to eco-
nomic policy tightening. Since late June, when the
appreciation of the yuan against the US dollar was
resumed, the yuan has strengthened by around 3.5 per
cent. Real effective appreciation totalled around 5 per
cent during 2010. Although appreciation has acceler-
ated early in 2011, China rejects the demands of other
countries for a radically faster appreciation rate, and
we expect this cautious policy to continue. However,
we expect the appreciation rate to increase somewhat
in 2011 in order to counter inflation, help slow export
growth and support domestic consumption by making
imports cheaper. Our assessment is that the USD/CNY
rate will be 6.30 by the end of 2011 and 6.00 by the
end of 2012. This represents an appreciation of 4-5
per cent annually.
25
The yuan appreciated during 2010
20 6.50 130
6.75 125
15
7.00
120
10
7.25
115
7.50
110
7.75
105
8.00
-5
10 8.25 100
8.50 95
05 06 07 08 09 10
USD/CNY (LHS) Real exchange rate (RHS)
Source: BIS, Reuters Ecowin
Exchange controls clearly loosening
Strict currency controls are now being loosened as part
of a long-term strategy to give the yuan a larger global
role. For example, Chinese companies will be allowed
to use yuan to start operations abroad by acquiring and
merging companies. Chinese export companies will also
be allowed to keep their foreign revenue in accounts at
foreign banks. However, foreign investments in China
will remain strictly regulated, decreasing the motiva-
tion for foreign companies to hold yuan.

India: Inflation accelerating again
India’s growth remains strong, and during the third
quarter GDP rose by 8.9 per cent. Industrial production
growth is slowing, however. In November the upturn
was only 2.7 per cent year-on-year, the slowest since
May 2009. But the figures have been highly volatile in
recent months, and some observers are beginning to
question the quality of the statistics. Other indicators
are showing continued good growth. The composite
purchasing managers’ index is just above 55, indicating
continued expansion. Leading indicators have risen at a
robust rate and provide a similar picture. A favourable
trend in the agricultural sector is also contributing to
strong growth. We expect GDP growth of 8.5 per cent
in 2011 and 7.5 per cent in 2012.
India’s high inflation rate slowed in November, but
rebounded in December to 8.4 per cent. Inflation is thus
far above the central bank’s medium-term target of 3
per cent.
India: Inflation and key interest rate
Per cent
12 12
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
05 06 07 08 09 10 11
Key interest rate Inflation
Source: Ministry of Commerce and Industry, Reserve Bank of India
China’s twelfth five-year plan, 2011-2015
China has been using five-year plans since the 1950s.
These plans are now called “guidelines”, reflecting
the fact that are increasingly dominated by general
objectives instead of detailed quantitative targets for
different economic variables. A preliminary version of
the twelfth five-year plan has already been unveiled,
but the final version will not be approved until March.
The main theme of the new plan is that China is aim-
ing at a strategic change in its growth model. The
focus will be on generating higher “quality” growth
rather than merely generating rapid growth. Consump-
tion will enjoy priority by means of decreased house-
hold saving, while exports and capital spending will be
less important than before. The plan is also expected
Asia
As expected, the falling inflation rate in November
persuaded the Reserve Bank of India to hold off on any
interest rate hike in December, but late in January it
hiked its key rate by 0.25 percentage points to 6.5 per
cent. The key rate has thus been raised 1.75 percent-
age points from its low in April 2009, but in real terms
it is well into negative territory. The inflation surge in
December surprised the central bank, and several rate
hikes will probably be needed to keep inflation expecta-
tions from soaring.
Unlike other Asian countries, India is running current
account and trade deficits. The trade deficit has been
large for a long time. In December, however, it fell to
its lowest level in three years because exports in-
creased while imports were the lowest in 14 months.
Also worth noting are the liquidity problems in the
banking sector. A combination of strong growth, tighter
monetary policy, low seasonal central government
expenditures and several large companies being floated
in the stock market contributed. India’s banks have
begun competing for liquidity by raising their deposit
interest rates. For a long time, the central bank viewed
the tighter liquidity situation as a welcome strengthen-
ing of the monetary policy transmission mechanism. In
December 2010, however, the central bank made the
assessment that the liquidity situation was problematic
and took action. In addition, higher government spend-
ing is expected to contribute to better liquidity in the
next several months.
Since last autumn, the currency has stabilised against
the US dollar after a period of appreciation. We expect
that the rupee will stand at 43 per USD by the end of
2011.
to emphasise greater equality, environmental protec-
tion and investments in strategic industries. The fol-
lowing specific areas will have high priority:
ƒƒ health care
ƒƒ infrastructure
ƒƒ construction of homes for low-income households
ƒƒ environmental protection and energy efficiency
ƒƒ reduced carbon dioxide emissions
ƒƒ more equitable income distribution
Nordic Outlook – February 2011  |  25
The euro zone

Germany in the lead, amid widening gaps

ƒƒ Growth nearly 2 per cent despite contin- to high energy and food prices. Although it will probably
ued problems in southern Europe fall, inflation will remain a source of concern for the
European Central Bank (ECB) as resource utilisation in
ƒƒ HICP will fall, but inflation risks have risen
several countries moves back towards normal levels.
ƒƒ Stability Fund will narrow ECB’s role With the EFSF assuming a larger role in sustaining
growth in southern Europe, the ECB can focus more on
ƒƒ Refi rate hikes will begin in September
its inflation-related task. We believe that the ECB will
hike its refi rate to 1.25 as early as September 2011,
then raise it again in December and four times in 2012.
Euro zone GDP growth was 1.7 per cent in 2010, higher The refi rate will be 1.5 per cent in December 2011
than last autumn’s consensus. Germany, benefiting from and 2.5 per cent in December 2012.
a powerful upswing in exports and capital spending,
recorded the currency area’s highest GDP growth (3.6 Large differences in growth rates
per cent), and Greece the lowest (-4.1). Overall, the The German economy is continuing to show strength.
recovery will continue this year. As in 2010, Germany Last year’s export and capital spending upturn, which
will be the main growth engine; leading indicators such was reflected among other things in a three-year high
as the IFO index are signalling GDP growth just above for the IFO index, will continue in 2011. The “business
3 per cent this year, but continued weak performance conditions” sub-index was still around 110 in Janu-
in southern Europe will widen the gap in the euro ary and the “expectations” sub-index, which provided
zone. The Greek economy will shrink about 3 per cent upside surprises late in 2010, also remains high. Given
this year. Spain is on the brink of recession. In the euro the close co-variation between the IFO index and GDP
zone as a whole, growth will reach 1.9 per cent this growth, dynamic growth seems set to continue during
year and 1.8 per cent in 2012, somewhat higher than early 2011. Because of an improving labour market, pri-
we believed in November. vate consumption is also starting to climb. We predict
Decent growth in 2011-2012 that German growth will end up at 3.1 per cent this
Percentage change year and 2.5 per cent in 2012, above the consensus
5.0 5.0 forecast.
2.5 2.5
Widening gap in the euro zone
0.0 0.0 Composite index
112.5 112.5
-2.5 -2.5
110.0 110.0
SEB
-5.0 forecast -5.0 107.5 107.5
105.0 105.0
-7.5 -7.5 102.5 102.5
-10.0 -10.0 100.0 100.0
04 05 06 07 08 09 10 11 12 97.5 97.5
95.0 95.0
Quarter-on-quarter, annualised 92.5 92.5
Year-on-year percentage change 90.0 90.0
Growth indicator (Euroframe)
Source: Euroframe, Eurostat, SEB 87.5 87.5
85.0 85.0
Italy, Portugal and Spain carried out successful sover- 00 01 02 03 04 05 06 07 08 09 10
eign bond issues in January, slightly easing short-term Germany Southern Europe
concerns about their budget and debt problems, but Source: OECD

these problems are far from solved. The risk premium
is unsustainably high in several countries, which puts
pressure on European politicians to act. The temporary
European Financial Stability Facility (EFSF) will play a
central role in the future, partly because of an expand-
ed mandate.
Inflation as measured by the Harmonised Index of Con-
sumer Prices (HICP) rose to 2.4 per cent in January, due
Several indicators illustrate the gaps in economic
performance between different parts of the euro zone.
German order bookings are currently increasing at
about 20 per cent year-on-year and output by around
10 per cent, twice as fast as in Italy and France.
Elsewhere in southern Europe, manufacturing sector
performance is even weaker.

26   |  Nordic Outlook – February 2011

 The euro zone

It thus appears likely that the euro zone will continue consumer confidence indicate that consumption will
to show wide gaps during 2011-2012. In France, GDP increase somewhat. In Germany, a slight acceleration in
growth will reach 1.7 per cent this year and 1.5 per the rate of pay increases will contribute to this. Over-
cent in 2012. Italy will grow by 1.3 and 1.5 per cent, all, we believe that euro zone private consumption
respectively. Spain, which is teetering on the brink will increase by 0.8 per cent this year and just above
of recession, will grow by less than 0.5 per cent this 1 per cent in 2012: a cautious rebound in consumption,
year and a bit above 1 per cent in 2012, but the Greek viewed in a historical perspective.
economy will shrink again (-2.9 per cent) for the third
Consumer confidence is climbing
year in a row and move sideways in 2012. Ireland, in Index and year-on-year percentage change
turn, will grow by 0.5 and 1.1 per cent in 2011-2012. 5 4.0
0
3.0
GDP -5
2.0
Year-on-year percentage change -10
-15 1.0

2009 2010P 2011 2012 -20

0.0
-25
Germany -4.7 3.6 3.1 2.5 -1.0
-30
France -2.5 1.6 1.7 1.5
-35 -2.0
Italy -5.1 1.1 1.3 1.5 00 01 02 03 04 05 06 07 08 09 10

Spain -3.7 -0.2 0.4 1.2 Consumer confidence (LHS)

Private consumption (RHS)
Greece -2.3 -4.1 -2.9 0.0 Source: DG ECFIN, Eurostat

Portugal -2.6 1.3 -1.0 1.0

Major belt-tightening in 2011-2014
Ireland -7.6 -0.7 0.5 1.1 The euro zone’s problem countries are now carrying out
Euro zone -4.0 1.7 1.9 1.8 conspicuous cost-cutting measures to bring down their
budget deficits. Greece unveiled its austerity package
Source: Eurostat, SEB as early as last spring (including pay cuts and a higher
retirement age in the public sector). Last autumn the
Stronger domestic demand
Irish government launched a package including higher
So far, the recovery has been driven by rising exports,
value-added taxes, lower minimum wages, 25,000
while the contribution from domestic demand has been
fewer public sector jobs and a new pension system,
small. To prevent the recovery from running out of
while keeping the corporate tax at a low 12.5 per cent.
steam when the market for manufactured goods enters
The Irish budget package is expected to total about 10
a more mature phase later this year, domestic demand
per cent of GDP during the period 2011-2014. Ireland’s
will have to take over as a growth engine. This will
political crisis has deepened in recent weeks, including
also happen, though at a leisurely pace. Low interest
Prime Minister Brian Cowen’s resignation as head of the
rates and rising capacity utilisation point towards an
Fianna Fail party. A new election will be held on Febru-
acceleration in gross fixed investments this year, and
ary 25. The Green Party, Cowen’s coalition partner,
we predict an annual upturn of about 4 per cent in
terminated collaboration in January, even though the
capital spending during 2011-2012.
Greens have accepted the main features of his budget
Accelerating capital spending consolidation programme. The opposition has criticised
Year-on-year percentage change and per cent
portions of Ireland’s international loan agreement and
10 85.0
proposed improvements in borrowing conditions. We do
5 82.5 not believe the loan agreement is in danger, although
80.0 some adjustments may occur after a probable change
0
77.5 of government. Experience from other countries (such
-5 as Latvia) indicates that the entire political system
75.0
-10 normally accepts existing international agreements,
72.5
despite a domestic debate climate that can sometimes
-15 70.0 be uncompromising.
-20 67.5
00 01 02 03 04 05 06 07 08 09 10 Last autumn’s austerity budget in Portugal, including
VAT hikes and the sale of government assets, increased
Gross capital formation (LHS)
Capacity utilisation, manufacturing (RHS) that country’s total belt-tightening measures to nearly
Source: Eurostat, DG ECFIN
6 per cent of 2011-2013 GDP. Spain’s tightening meas-
Private consumption will also accelerate a bit this ures − targeting generous severance pay for dismissed
year, despite conspicuous fiscal tightening measures employees and reforming the pension system − will not
in various crisis countries. Positive signs, such as more be enough, according to the OECD, which also wants
aggressive hiring plans, falling unemployment and rising various changes in the country’s tax legislation. Spanish

Nordic Outlook – February 2011  |  27

 The euro zone
banks are sitting on dangerously large credit risks (near-
ly EUR 180 billion, according to Moody’s credit rating
agency). This has led many observers to begin speculat-
ing that Spain may also need to seek an EU bail-out.
The country’s weakest savings banks, or “cajas”, have
especially large problems and there are plans for a gov-
ernment takeover. The government has said it is willing
to resort to further belt-tightening if the budget deficit
does not improve as expected. We believe Spain will be
forced to launch further austerity packages during the
spring, increasing its total belt-tightening measures to
nearly 7 per cent of 2011-2014 GDP.
Fiscal tightening, 2010-2014
Per cent of GDP
11 11
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
Portugal Italy Spain
Ireland Greece
Source: SEB
Total belt-tightening in Greece, Ireland, Italy, Por-
tugal and Spain will end up at 4-5 per cent of GDP
during 2011-2014. Lower public sector expenditures
will account for most austerity measures: about 3 per
cent of GDP, compared to less than 1.5 per cent of
GDP in higher taxes. One reason why aggregate belt-
tightening is not higher is that Italy, the largest country
in the group, has not yet announced any major austerity
ambitions.
Public budget balance, selected countries
Per cent of GDP
2009 2010P 2011 2012
Germany -3.0 -3.6 -2.1 -1.5
France -7.5 -6.8 -5.5 -3.5
Italy -5.3 -4.4 -3.8 -3.3
Spain -11.1 -8.9 -7.0 -6.2
Greece -15.4 -9.5 -7.6 -6.1
Portugal -9.3 -7.1 -5.7 -4.7
Ireland -14.4 -32.0 -9.1 -8.0
Euro zone -6.3 -6.2 -4.5 -3.5
Source: European Commission, SEB
In Germany, the budget situation has improved. The
public deficit (according to the Maastricht definition)
reached 3.6 per cent of GDP in 2010, lower than most
observers had expected. This was mainly because the
rapid upswing in the economy led to rising company
profits and thus higher tax payments from the corporate
sector. The gradual strengthening of the labour market
28   |  Nordic Outlook – February 2011
also contributed to the budget improvement. As earlier,
we expect Germany to meet the Maastricht criterion of
a budget deficit below 3 per cent of GDP as early as this
year; the deficit will reach 2.1 per cent of GDP this year
and 1.5 per cent in 2012. In the euro zone as a whole,
the budget deficit will total 4.5 per cent of GDP this
year and 3.5 per cent in 2012.
Successful bond issues, but Spain
in risk zone
Market worries about suspended payments and about
more countries being forced to request help from the
EU and IMF refuse to go away. Long-term yield spreads
against Germany have admittedly fallen somewhat in
recent weeks, but they remain at very high levels. It
has not helped that Greece and Ireland have already
accepted loans of EUR 110 and 85 billion, respectively,
and have also unveiled tough austerity programmes.
Yields on 10-year government bonds
Spread against Germany, percentage points
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan
08 09 10 11
France Ireland Portugal
Greece Italy Spain
Source: Reuters EcoWin
In January 2011, Italy, Portugal and Spain managed to
finance their deficits in the capital markets. Generally
speaking, these countries have found it easier to obtain
financing for shorter maturities. This can be regarded
as a sign that the market is increasingly focusing on
long-term solvency problems. Although the bond issues
went smoothly and were oversubscribed, the calm in
financial markets is only temporary. We expect that as
early as this spring, Portugal will be forced to throw
in the towel and ask for emergency loans from the
EU and the IMF. It cannot be ruled out that Spain will
also need help.
We thus anticipate that additional countries will need
to take further steps to regain market confidence.
Larger countries such as Italy and France will probably
need to carry out belt-tightening programmes to avoid
the spread of mistrust.
Unemployment will fall slowly
Euro zone unemployment rose somewhat in 2010, from
9.9 per cent in January to 10.0 per cent at year-end.
This is the highest level in 12 years. Average unemploy-
ment did not climb more because the German labour
market resisted the upward trend. A combination of a
rapid upswing in the German economy and the govern-
 The euro zone

ment’s allowance system to encourage job-sharing a year. This means that it will remain as high as 18 per
helped push down unemployment from 7.3 per cent in cent in 2012.
January to 6.7 per cent at year-end (according to the
European Commission’s harmonised measure), its lowest As indicated in the chart below, the euro zone is ap-
level since 1992. proaching its long-term non-accelerating inflation rate
of unemployment (NAIRU). At the end of 2012, we
Germany's labour market has resisted the trend expect the unemployment gap (the difference between
Unemployment, per cent
actual unemployment and NAIRU) to be about 0.5
22.5 22.5
percentage point. The jobless rate will fall faster than
20.0 20.0
assumed by “Okun’s Law”, which relates unemployment
17.5 17.5 to the output gap, partly due to temporary job-sharing
15.0 15.0 allowances. But when these allowances are phased
12.5 12.5
out, there is a risk that unemployment will rebound
somewhat, thus falling more slowly than we are now
10.0 10.0
forecasting. Growth is large enough to cause unemploy-
7.5 7.5
ment to fall, according to our estimates of what GDP
5.0 5.0 growth is normally required to keep unemployment at
00 01 02 03 04 05 06 07 08 09 10 a constant level (see Nordic Outlook, August 2010).
Germany Italien These estimates indicate that the growth requirement
France Spain has fallen somewhat during the past decade in the euro
Source: Eurostat
zone as a whole, from about 2.3 per cent in 1990-2000
There are wide disparities in the euro zone, despite to about 1 per cent in 2000-2010.
similar allowance systems in other countries. In France,
Unemployment will creep downward in 2011-2012
for example, unemployment remained stable at just Per cent
below 10 per cent last year, and in Italy it rose from 8.3 11.0 11.0
per cent in January to 8.7 per cent at year-end. The
10.0 10.0
Spanish labour market is in even worse shape; early in
2007 the jobless rate was 8 per cent, in November 2010 9.0 9.0

it was a full 20.6 per cent. But last year’s strong tourist 8.0 8.0
SEB
season, with fewer dismissal notices, contributed to a forecast
7.0 7.0
degree of stabilisation during the summer and autumn.
Employment rose by 0.4 per cent between the second 6.0 6.0

and third quarter. 5.0 5.0

Employment on the way up 4.0 4.0

Year-on-year percentage change and net index 00 01 02 03 04 05 06 07 08 09 10 11 12
3.0 5
2.5 Okun's Law Unemployment NAIRU
0 Source: Eurostat, OECD, SEB
2.0
-5
1.5
1.0 -10 Continued pay squeeze in southern
0.5 -15
Europe
0.0 -20
-0.5
The upturn in unemployment over the past few years is
-25
-1.0 continuing to squeeze wages and salaries. Total hourly
-30
-1.5 wage costs in the euro zone, which rose by 3.5 per cent
-2.0 -35
as recently as 2008, ended up at a low 1.5 per cent
-2.5 -40
00 01 02 03 04 05 06 07 08 09 10
increase last year. The pressure on wages in southern
Europe will continue during the next couple of years.
Employment (LHS)
Expected employment (RHS)
The need for internal devaluation in southern Europe,
Source: Eurostat i.e. restoration of competitiveness either by lowering
Leading indicators, such as company hiring plans as relative pay or improving relative productivity levels,
measured by the European Commission, point towards is in the 20-30 per cent range. Public sector pay cuts
a continued slow improvement in the labour market. in various countries have been justified on the basis of
We believe that euro zone unemployment will fall fiscal arguments, but these measures will also lead to
to an average of 9.8 per cent this year and 9.5 per a pay squeeze in the private sector. Low pay agree-
cent in 2012. This represents a small upward adjust- ments that extend into 2012 in various other euro zone
ment compared to our November forecast. In Germany, countries also indicate that wage and salary costs will
France and Italy, we expect a downturn in the same again increase slowly this year.
range as the euro zone average, that is, around 2-3
In Germany, however, some tendencies in the opposite
tenths of a percentage point per year. Spanish unem-
direction are discernible. The stronger labour market
ployment will probably fall about one percentage point
has led to calls for higher pay, but so far no higher new

Nordic Outlook – February 2011  |  29

 The euro zone

agreements have been concluded. The collective con- HICP inflation soon below 2 per cent again
tract for Germany’s metalworkers, which provides for Year-on-year percentage change
pay hikes of 2.7 per cent year-on-year, runs until March 4.5 4.5
2012. This spring the chemical industry will negotiate 4.0 4.0
3.5 3.5
new pay agreements, and considering the recovery in
3.0 SEB 3.0
this sector it is likely that these agreements will end forecast
2.5 2.5
up somewhat higher. We expect wages and salaries to 2.0 2.0
increase by about 2.5 per cent in Germany this year and 1.5 1.5
by more than 3 per cent in 2012. In the euro zone, pay 1.0 1.0

increases will reach about 1.5 per cent this year and 0.5 0.5
0.0 0.0
about 2 per cent in 2012.
-0.5 -0.5
Low pay increases this year, higher in 2012 -1.0 -1.0
Percentage points, year-on-year percentage change 01 02 03 04 05 06 07 08 09 10 11 12
-2.0 4.5
HICP inflation Core inflation
-1.5 4.0 Source: Eurostat, SEB

-1.0 3.5
HICP inflation will now slow as the contribution from
-0.5 3.0
energy and food prices (more than 1 percentage point
0.0 2.5 in December) fades during the second quarter. In
0.5 2.0 addition, current pay agreements as well as capacity
1.0
1.5 and resource utilisation remain low in the euro zone as
1.5
1.0 a whole. Inflation expectations have admittedly risen
2.0
0.5 somewhat, but are still rather restrained (“break-even
00 01 02 03 04 05 06 07 08 09 10 11 12 inflation” is now at 1.9 per cent).
Change in unemployment, shifted 2 years forward (LHS)
Change in wage and salary cost in manufacturing (RHS) We expect HICP inflation to fall gradually to 1.5 per
Source: Eurostat, SEB
cent next December. Measured as annual averages,
HICP inflation will reach 2.0 per cent this year and
Inflation back below 2 per cent 1.4 per cent in 2012. Core inflation will be relatively
Higher energy and food prices drove up HICP inflation
stable in the 0.8-1.1 per cent range during the rest of
to 2.4 per cent in January. The inflation rate was 2.2
this year, then rise towards 1.5 per cent in late 2012.
per cent in December, and the average rate for the year
ended up at 1.6 per cent. Underlying inflation (HICP Inflation expectations just below 2 per cent
adjusted for energy and food) totalled 1.1 per cent in Net balance and per cent
35 4.5
December, making the full-year figure 1.0 per cent. 30 4.0
Higher taxes driving up inflation in southern 25 3.5
20 3.0
Europe 15 2.5
Year-on-year percentage change 10 2.0
5 5 5 1.5
0 1.0
4 4
-5 0.5
-10 0.0
3 3
-15 -0.5
2 2 -20 -1.0
02 03 04 05 06 07 08 09 10
1 1
Households' expected price trend, next 12 months (LHS)
0 0 Break-even inflation 2012 (RHS)
Source: DG ECFIN, Reuters EcoWin

-1
01 02 03 04 05 06
Southern Europe Euro zone excl. southern Europe
The upturn in energy and food prices, combined with
higher value-added taxes in several countries in south-
ern Europe, drove inflation higher than elsewhere
in the euro zone. Greece raised VAT in two stages,
from 19 to 23 per cent, Ireland from 21 to 22 per cent.
In Portugal, VAT was increased to 23 per cent (from
the previous 21). Further ahead, adjustment needs
in southern Europe will restrain wage increases and
domestic demand, contributing to a deceleration in
inflation relative to other euro zone countries in 2011
and 2012.
-1
07 08 09 10 ECB will hike repo rate in September
The euro zone’s relatively high HICP inflation at present
Source: Eurostat, SEB
exceeds the ECB’s target: inflation close to but not
above 2 per cent. This caused ECB President Jean-
Claude Trichet to express concern about continued
rising inflation after the bank’s interest rate meeting on
January 13. The ECB’s analyses now point out that only
in late 2011 will inflation again creep below 2 per cent,
but Trichet emphasised that the bank has not revised its
opinion that this trend is consistent with price stability
in a policy-relevant time horizon. He indicated, how-
ever, that medium-term risk (balanced at present) may
increase if administrative prices and taxes rise faster.

30   |  Nordic Outlook – February 2011


The ECB also shares our assessment that the
macroeconomic recovery will continue in the euro
zone as a whole. Leading indicators are climbing
higher, and decent global economic growth promises
continued export success. In addition, loose monetary
policy and a better-functioning banking and financial
sector are helping domestic demand to speed up,
which will mean more balanced growth in 2011-2012.
However, at the same time credit and money supply
growth remains historically low despite its recent
upturn, which indicates that demand is still relatively
modest.
Refi rate will be hiked in September
Per cent
5.0
4.5
SEB forecast
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
08 09 10 11 12
EONIA O/N Refi rate
Source: Reuters EcoWin, SEB
As the EU strengthens the EFSF crisis fund and expands
its mandate, the division of labour between euro zone
fiscal and monetary policy will become clearer. The
EFSF expansion will be a response to clearer demands
that countries with high budget deficits must imple-
ment forceful countermeasures in the form of budget
cutbacks and reforms.
This means that the role of the ECB in helping sustain
the economic recovery in southern Europe will diminish
and that the central bank can focus more attention on
its inflation-related tasks. In light of high spot inflation
ECB questioning core inflation as an indicator
In recent weeks, leading representatives of the Euro-
pean Central Bank have begun to question core inflation
as a reliable measure of inflation, against the backdrop
of commodity price developments and expected price
developments for imported goods from emerging econo-
mies. To date, central banks have toned down the impact
of commodity prices on monetary policy if they have
been judged as a) temporary, b) not leading to secondary
effects on other categories of goods and c) not affecting
inflation expectations.
The question that the ECB is now wondering about is
whether or not higher global/imported inflation is part
of a larger trend and should therefore play a larger
role in Western monetary policy. This new problem is
fundamentally connected to the expected large differ-
ences between the growth of developed economies and
developing economies. If global commodity and energy
The euro zone
and the ongoing economic recovery in the euro zone as
a whole, we thus expect the ECB to hike its key interest
rate to 1.25 per cent in September this year, then raise
it again in December and four times in 2012. The refi
rate will stand at 1.5 per cent in December 2011 and
at 2.5 per cent in December 2012.
The fact that Trichet is leaving his post in November
may have some significance to monetary policy next
year, although the change should not be exaggerated
since there are six people on the ECB’s Executive Board
and all 23 central bank presidents participate in the
monetary policy decisions. The main candidates for the
ECB presidency are Lorenzo Bini Smaghi, Mario Draghi
5.0 and Axel Weber. Bini Smaghi is already an Executive
4.5 Board member, while Draghi and Weber belong to the
4.0 ECB Governing Council. In a speech on January 19, Bini
3.5 Smaghi underscored the importance of well-founded
3.0 inflation expectations and toned down core inflation
2.5 and output gaps in inflation analysis. He thus seems
2.0 rather concerned about current high spot inflation
1.5 (which can of course pull up inflation expectations) and
1.0 has less faith in in the inflation-squeezing effect of low
0.5
(and difficult-to-measure) capacity and resource utilisa-
0.0
13
tion. Draghi is usually more cautious in his monetary
policy statements and often tries to avoid conflicts
with politicians. Considering the current interplay
between fiscal and monetary policy in the euro zone,
this indicates that he is somewhat more dovish than
Bini Smaghi. Weber, who heads Germany’s central bank
and can certainly be regarded as the favourite for the
ECB presidency, is viewed as one of the more hawkish
members of the ECB Governing Council. He often warns
of the risks of high spot inflation and also voted against
the ECB’s decision to buy Greek government bonds
in May last year. Thus the change of ECB president in
November this year, if anything, seems likely to mean a
somewhat more hawkish euro zone central bank.
prices rise at the pace of global economic growth −
about 4 per cent annually − the impact on the domes-
tic economy is 1.2 per cent (assuming a consumption
basket consisting of about one third imported goods).
This allows room for domestic cost pressure of around
1 per cent, if the overall inflation target has been set
at about 2 per cent. It should normally be possible to
offset higher inflation in other countries by means of
a depreciation of their currencies. At present, that
is not happening. The currencies of many emerging
economies are under appreciation pressure. Conse-
quently, domestic cost pressure should preferably rise
by less than 1 per cent. In the euro zone, both CPI
and underlying inflation are already not only above 1
percent, but above 2 per cent. This may thus be an ar-
gument for the ECB to start normalising the key rate.
Nordic Outlook – February 2011  |  31
The United Kingdom

High inflation causes policy dilemma

ƒƒ Fiscal headwinds will slow GDP growth will grow by more than 5 per cent this year and 7.5
per cent in 2012, or less than in our November fore-
ƒƒ Falling home prices, unhappy consumers cast. Austerity programmes will lead to major declines
ƒƒ No key interest rate hike until November in public sector investments. The pound is sharply
undervalued, according to our calculations. The weak
currency combined with better growth in key export
Severe December weather contributed to a dramatic markets will lift exports.
fourth quarter reversal in the British economy; GDP
fell by 0.5 per cent quarter-on-quarter. We believe this Consumers are feeling blue
Net balance, index
downturn was temporary. Loose monetary policy and 20 65
a weak pound, combined with stronger international 15
demand, will sustain decent growth despite the large 10 60
5
budget-tightening programmes now being launched. 0 55
GDP will grow by 1.5 per cent this year and 2.5 per -5
-10 50
cent in 2012. Rapid price increases − inflation will peak -15
at 4.1 per cent this summer − are creating some cred- -20 45
ibility problems for the Bank of England, but we do not -25
-30 40
believe interest rate hikes are imminent. The BoE will -35
raise its key rate in November 2011. Market pricing -40 35
92 94 96 98 00 02 04 06 08 10
indicates a hike as early as this summer.
Consumer confidence (LHS)
The fiscal austerity package will restrain growth, and PMI manufacturing (RHS)
Source: DG ECFIN, Markit, SEB
the budget deficit will shrink from nearly 10 per cent
of GDP in 2010 to 6.5 per cent in 2012. Fiscal policy Traditional measures of resource utilisation make early
will lower GDP more than 1 percentage point per year, interest rate hikes unlikely. Unemployment rose to 7.9
our calculations show. The emphasis is on lower public per cent in December and will stay above 8 per cent in
spending, but other key elements of the package are the next six months. At the end of 2012, it will stand at
higher VAT and employer fees. Budget consolidation will 7 per cent, compared to our 6 per cent estimated non-
enable the UK to keep its top credit rating even though accelerating inflation rate of unemployment (NAIRU).
gross public debt will reach 95 per cent of GDP in 2012. The industrial production index is 11 percentage points
below its 2007 peak, indicating that there are idle re-
Fast-rising prices are undermining purchasing power and sources in manufacturing as well. We estimate that the
squeezing consumption. Food prices are rising by nearly output gap in the economy is about 4 per cent.
6 per cent year-on-year and petrol prices are close to
record levels, helping explain why consumer confidence Various factors are pushing up spot inflation. Food and
has fallen sharply from last year’s peak. But no price- energy prices are each contributing 0.6 percentage
wage spiral is likely: Year-on-year pay hikes are at a points and VAT hikes 0.5. The weakening of the pound in
historically low 2.1 per cent. The freeze in public sector recent years has also helped push up inflation rates. We
pay will also contribute to low wage pressure ahead, expect inflation to fall slightly below target by the end
and consumption will be hampered by a resumption of of 2012 when these factors are neutralised. Inflation
the home price downturn. Home prices will fall 5 per expectations have not been significantly affected. It is
cent in 2011 and level off in 2012, countering the true that households have raised their expectations a
wealth effect of rising share prices; broad British indi- bit, but “break-even” inflation remains subdued.
ces gained over 10 per cent last year. Consumption will
rise 1 per cent in 2011 and 2 per cent in 2012. Despite the fact that the rate-setting committee is
split, with two votes for a hike at the January meeting,
The purchasing managers’ index in the manufactur- we predict that the BoE will hold off on rate hikes until
ing sector rose in January to its highest level since the late this year. In the course of 2012 the central bank
survey began some 20 years ago (62.0). Meanwhile will hike its key rate to 2 per cent, in relative harmony
indicators in both the service and construction sectors with the ECB. In that environment, the pound will
are weaker, and manufacturing is a mere 13 per cent recover some lost ground. The EUR/GBP exchange rate
of the economy. Overall, we believe capital spending will stand at 0.84 by the end of 2011 and 0.78 by the
end of 2012.

32   |  Nordic Outlook – February 2011


Faster pace despite currency appreciation
ƒƒ Exports continue to benefit from Germany
ƒƒ Moderate tightening will slow growth a bit
ƒƒ More interest rate hikes are on the way
The recovery in Eastern Europe continues at a healthy
pace. In 2011-2012 growth will accelerate further
in most countries but will not reach unsustainable
pre-crisis levels. We are revising our forecasts a bit
upward due to stronger international demand. Russia
and Ukraine will also benefit from higher commodity
prices.
This year exports will again strongly support growth.
The region is mainly benefiting from the positive out-
look in Germany, which buys 20-30 per cent of Polish,
Hungarian and Czech exports, for example. Eastern
European exports are in general competitive and will
not be jeopardised by the moderate currency apprecia-
tion pressure we foresee this year. Stronger curren-
cies and the need for interest rate hikes due to rising
inflation may be a dilemma for some countries, such as
the Czech Republic, but the Russian and Polish central
banks have signalled their willingness to let their cur-
rencies appreciate, within reasonable limits.
Domestic demand will gradually recover. Consump-
tion will grow, aided by rising wages and slowly falling
unemployment after last year’s turnarounds. The strict
credit environment is also starting to ease. Generally
speaking, households can tolerate the moderate fiscal
tightening that such countries as Poland, the Czech Re-
public and Ukraine have started to launch. But there is
some downside risk in consumption estimates if higher
energy and food prices erode purchasing power.
Public debt is relatively low or moderate, diminishing
the risk that financial turmoil will force further belt-
tightening such as in the PIIGS countries. Hungary may
again be under pressure, however. In December its
credit rating was lowered by Moody’s due to insufficient
action to deal with a large structural budget deficit.
Of the larger Eastern European economies, we expect
Russia to grow fastest. GDP will increase by 4.6 per
cent in 2011 and 5.0 per cent in 2012 − forecasts
that are above consensus. High prices for oil and other
commodities (more than half of exports) will result
in good export revenue and fuel continued growth in
domestic demand. In the past six months, bank lending
has also begun to recover. Due to recent commodity
Eastern Europe
price increases, the government will further postpone
the shift to tighter fiscal policy that the IMF and others
are calling for, but monetary policy will soon begin to
be tightened. The repo rate was cut from 13 per cent to
7.75 per cent during the crisis. It will now be raised to
stem inflation and money supply growth. Inflation will
reach nearly 9 per cent this year and then slow in 2012.
Russia: Exports and oil prices
Index 100 = 2000, current prices in USD
700 700
600 600
500 500
400 400
300 300
200 200
100 100
0 0
00 01 02 03 04 05 06 07 08 09 10
Exports Oil prices (Brent)
Source: Federal State Statistics Service
In Poland, growth will remain broad-based, with capital
spending as an ever-stronger factor. GDP will increase
by 4.5 per cent in 2011 and 4.8 per cent in 2012.
Another challenge will be the government’s handling of
its large budget deficit and debt. If the latter exceeds
the constitutional limit, this will trigger further fiscal
austerity measures. Meanwhile monetary policy is being
tightened. As expected, the central bank raised its key
interest rate in January, to 3.25 per cent, due to con-
cerns that energy and food price-driven inflation will
spread. We expect more rate hikes in March, May and
September, with the key rate reaching 4 per cent late
in the year. Because underlying inflation is calm, Poland
will eventually gain control of its price surges.
Since global risk appetite remains relatively good, we
foresee generally stronger currencies. The Polish zloty
will strengthen and the EUR/PLN exchange rate will
reach 3.60 at the end of 2011. The rouble rebounded
late in 2010 after earlier weakening due to renewed
and unexpected capital outflows, a process we now
believe is over. The rouble, which is as dependent on
risk appetite as some of the other Eastern European
currencies, will continue to strengthen to 33 in Decem-
ber 2011 against its USD-EUR basket because of rising
commodity prices and higher interest rates.
Nordic Outlook – February 2011  |  33
Baltics

Continued recovery at a moderate pace

ƒƒ Export boom driving growth These export surges are due to both improved
competitiveness and a favourable geographic
ƒƒ Gradual upturn in domestic demand position. In the past 2-3 years, the Baltics have
ƒƒ Major challenges in the labour market regained lost market share with the help of 10-20 per
cent pay cuts, a process that we believe is now over
ƒƒ External forces pushing up inflation
in the private sector. Also favouring Baltic exports is
the fact that the most important markets − Russia,
During the past year, the Baltic countries have begun Germany, Sweden, Finland and Poland − have shown
a gradual recovery after their depression-like down- expansive growth in the past year. Appreciating
turns in 2008-2009. Their growth continues to be competing currencies has also helped. The improvement
driven by dynamic exports. Since last autumn, domes- in competitiveness is now largely over, but the Baltics
tic demand has begun to thaw, but these upturns are continue to benefit from good economic conditions in
being hampered because households and businesses are key markets.
still feeling the after-effects of internal devaluations Exports
and tough public budget austerity. Latvia will continue Year-on-year percentage change
tightening its fiscal policy this year. 25 25
20 20
Fourth quarter figures indicate that last summer’s 15 15
export-driven economic turnaround, when all three 10 10
countries moved back into positive year-on-year 5 5
growth, is gaining a more solid foothold. The European 0 0
Commission’s forward-looking sentiment survey for the -5 -5
Baltics has climbed further, consistent with movements -10 -10

and levels in the euro zone, though Latvia has shown -15 -15
-20 -20
a somewhat weaker increase. For 2010 as a whole, we
-25 -25
predict that Estonia will show GDP growth of 2.7 per
04 05 06 07 08 09 10
cent, while we expect Latvia to report zero growth.
Lithuania has reported plus 1.3 per cent. Estonia Latvia Lithuania
Source: Local statistical offices

In 2011-2012 we expect Estonia’s GDP to increase Household consumption in the Baltics bottomed out last
by 4.5 per cent a year. Latvia’s growth will reach summer, but the recovery since then has been hesitant.
4.0 and 5.0 per cent, respectively, while Lithuanian Retail sales volume remains low.
GDP will grow by 4.0-4.5 per cent. Our forecasts, Retail sales
which remain somewhat above consensus, have been Index 100 = 2005, 3-month moving average
adjusted upward by half a percentage point yearly 180 180
for Estonia but are otherwise unchanged. With ex- 170 170
160 160
ports playing a large role in the economy, Estonia (with
150 150
exports of about 65 per cent of GDP in 2009, compared 140 140
to 55 per cent in Lithuania and 44 per cent in Latvia) 130 130
will enjoy relatively larger support from the improved 120 120
110 110
global outlook. Estonia has also been successful with 100 100
its budget consolidation, while Latvia and Lithuania 90 90
are still grappling with large deficits. This is contribut- 80 80
70 70
ing to greater uncertainty in forecasting their growth, 60 60
especially in Latvia. 04 05 06 07 08 09 10

Estonia Latvia Lithuania

Sharp upturn in exports Source: Local statistical offices
The upturn in Baltic exports is dynamic. During the
Consumption growth continues to be hampered by
third quarter of 2010, year-on-year export growth was
private debt adjustment and high, though gradually
15-25 per cent, led by Estonia. More recent statistics
declining unemployment. Meanwhile households will
using current prices also indicate continued export ac-
be helped by continued low interest rates (even after
celeration in Estonia and Lithuania late last year.

34   |  Nordic Outlook – February 2011


the ECB’s coming rate hikes, which indirectly also affect
Lithuania and Latvia). Public sector pay has been frozen
this year, but private wages and salaries are rebounding
at a moderate pace, resulting in somewhat stronger
real disposable income. Latvian households will,
however, continue to be squeezed by fiscal tightening.
Notably, Estonian households feel considerably greater
confidence in the future than Latvians and Lithuanians
do, according to the EU’s monthly sentiment surveys.
Capital spending by companies remains weak. So far
only Lithuania has shown a year-on-year increase (+15
per cent in the third quarter of 2010), though from a
very low level. Looking ahead, rising capacity utilisation
in the manufacturing sector and continued gradual re-
cuperation in housing markets point towards a gradual
increase in capital spending.
Lending to households and businesses is still declining
year-on-year, though signs of stabilisation were discern-
ible late in 2010. The demand for credit is expected to
weaken in 2011 as well.
A gradual recovery in domestic demand will lead to
higher imports. Combined with a shift in flows from
foreign-owned banks and companies, which are again
making profits, this will help turn the unusual cur-
rent account surpluses of recent years into moderate
deficits.
Major challenges in the labour market
Unemployment remains high, although it fell from
peaks of around 20 per cent in the first half of 2010
to 15-18 per cent late in 2010. During the overheated
period 2006-2008, unemployment bottomed out at 4-5
per cent after having previously been around 10 per
cent. The modest upturn in domestic demand indicates
that the labour market improvement will be slow. All
three Baltic countries show structural problems such as
a poor match between labour supply and demand, high
youth unemployment and a large-scale emigration wave
during the crisis years. Labour market issues will thus
remain pivotal challenges for policy makers.
Moderate inflation
Inflation has resumed and accelerated, but this is
largely due to the international wave of higher energy
and food prices plus administrative hikes including
value-added and excise taxes. In addition, there are
large statistical base effects in the calculations, since
2009 was dominated by deflation.
During 2010, for example, Estonia’s year-on-year
inflation rate increased from -1 per cent in January
to 5.4 per cent in December. The change in the core
inflation rate was considerably calmer, from -1.5
per cent to 1.3 per cent. There were similar trends
in Lithuania and Latvia, although year-on-year core
inflation in those countries is still below zero.
Baltics
It is difficult to foresee any broad price pressures
emerging in the short term. We expect private sector
pay to increase at a moderate pace. The three econo-
mies are also characterised by low resource utilisation,
making it difficult for companies to make price increas-
es stick. This year the inflation picture will thus
continue to be dominated by developments on the
commodity side. We are raising our inflation forecasts
and expect Estonia to show 4.0 per cent inflation in
2011 as a whole, while Lithuania’s price increases
will be limited to 3.5 per cent and Latvia’s to 2.5 per
cent. The inflation impact of Estonia’s transition to the
euro on January 1 will probably be small, but we expect
them to be somewhat higher than the 0.1-0.3 per cent
that Estonia’s Ministry of Finance foresees as a conse-
quence of companies rounding off their prices upward.
We believe that some companies will take the opportu-
nity to raise prices for other reasons.
Inflation (HICP)
Year-on-year percentage change
20.0 20.0
17.5 17.5
15.0 15.0
12.5 12.5
10.0 10.0
7.5 7.5
5.0 5.0
2.5 2.5
0.0 0.0
-2.5 -2.5
-5.0 -5.0
04 05 06 07 08 09 10
Estonia Latvia Lithuania
Source: Local statistical offices
Stabilisation in public finances
Government budgets are moving in the right direc-
tion after the tough fiscal consolidation programmes
of recent years. During the recession, Estonia managed
to maintain the stability of its public finances, includ-
ing very low debt. We expect its 2011 deficit to be 1.5
per cent of GDP. The 2011 budget includes somewhat
higher increases in expenditures than in revenue. We
expect Lithuania’s deficit to shrink from about 8 per
cent of GDP in 2010 to below 6 per cent in 2011. This
will be achieved by freezing expenditures, but without
new cutbacks. Latvia’s budget deficit will shrink from
8.5 per cent of GDP in 2010 to 5.5 per cent in 2011. To
achieve this goal, which was set in consultation with
Latvia’s international creditors, the IMF and EU, this
year the Latvian government is carrying out continued
tightening measures equivalent to 2 per cent of GDP.
Both Lithuania and Latvia are aiming at achieving
budget deficits of no more than 3 per cent of GDP in
2012 so they can qualify to join the euro zone by
2014. Our view is that these targets are within reach
in budget terms, but that the Maastricht inflation
criterion may turn out to be a threat, especially in
Lithuania.
Nordic Outlook – February 2011  |  35
Sweden

Continued strong growth

ƒƒ Exports can tolerate a stronger krona
ƒƒ Resource restrictions becoming visible
ƒƒ Inflation risks ahead
ƒƒ Riksbank rate hike at every 2011 meeting
ƒƒ Surprisingly strong public finances
The Swedish economy is continuing to grow rapidly. We
have adjusted our 2011 GDP growth forecast upward
to 4.7 per cent. This implies a slight deceleration com-
pared to the record 5.7 per cent (5.4 per cent adjusted
for the number of working days) in 2010, but growth
will still be at about the level of other peaks during
the past 20 years. Next year, growth will slow to 2.6
per cent (3.0 adjusted for working days), which is still
above the long-term trend. Looking ahead, growth will
be driven to a greater extent by domestic demand.
Capital spending will soar, while consumption will be
supported by a strong labour market and a good wealth
position. Export growth will be relatively good but will
slow down somewhat.
companied by a more broad-based upturn in inflation
towards the end of our forecast period.
Upward revisions in inflation forecasts, in a situation
where the economy is growing rapidly and the output
gap is on its way towards closing, make it likely that
the Riksbank will hike its key rate at a faster pace
than it has announced to date, in order to achieve
more normal interest levels. The European Central Bank
will already begin its rate hikes during 2011. This will
also diminish the risk of excessively large interest rate
spreads over other countries. We expect the Riksbank
to raise its repo rate at every monetary policy meet-
ing during 2011, bringing the rate to 2.75 per cent at
the end of the year. During 2012 repo rate hikes will
continue, though at a somewhat slower pace, reaching
a year-end level of 3.75 per cent.
Indicators for capacity utilisation
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5

0.0 0.0
The labour market situation improved faster than
expected late in 2010. We now believe unemployment -0.5 -0.5

will drop below seven per cent as early as this year, -1.0 -1.0
falling further to 6.4 per cent at the end of 2012. At -1.5 -1.5
that time, it will be close to its equilibrium level.
-2.0 -2.0
Continued strong GDP growth 03 04 05 06 07 08 09 10
8 8
Riksbank, RU indicator SEB's indicator
Source: Riksbank, SEB
6 6

4 4 Robust growth and rapidly rising resource utilisation

2 2 have changed the conditions for economic policy. We
0 0 thus cannot rule out the possibility that the Riksbank
must make even more radical revisions in its strategy
-2 SEB forecast -2
of raising key interest rates at a slow pace until 2013.
-4 -4
Rate hikes of 50 basis points may thus be possible in
-6 -6 mid-2011. We are not choosing to include this in our
-8 -8 main scenario, since the tightening effects of mon-
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
etary policy are reinforced by various factors. The gap
08 09 10 11 12
Quarter-on-quarter percentage change between the key rate and short-term mortgage rates
Year-on-year percentage change widened in recent months as a consequence of rule
Source: Statistics Sweden, SEB
changes and higher risk premiums. In addition, the ap-
International price upturns on food and energy have preciation of the krona has a tightening effect.
caused inflation to climb above 2 per cent. We expect
inflation to fall somewhat. Inflation excluding interest More expansive fiscal policy, on the other hand, may
rate changes (CPIF) will stay somewhat below 2 per justify additional rate hikes. We expect a continued
cent during most of 2011. Accelerating wage and salary improvement in central government finances, which
increases in 2012 will nevertheless probably be ac- will help intensify the debate on the value of further

36   |  Nordic Outlook – February 2011

 Sweden

government debt reductions. The good economic situa- to go before reaching krona exchange rates that will
tion increases the importance of reforms to improve the hamper the growth of the export industry.
supply side of the economy. The Moderate Party’s cau-
Profitability and exchange rate
tious fiscal strategy and continued emphasis on incen- 40 -15
tives to work and on further earned income deductions
30 -10
will probably be increasingly challenged by its Alliance
20 -5
coalition partners. In a situation of declining support in
public opinion surveys, these parties will intensify their 10 0

struggle to push through their own signature issues, 0 5

especially in tax policy. We thus expect to see broader -10 10
proposals in the field of taxation, as well as more pro- -20 15
posals on the public spending side.
-30 20

Manufacturers strong, despite the krona -40 25

98 99 00 01 02 03 04 05 06 07 08 09 10
Exports have now almost completely regained their
2008 and 2009 decline. Confidence indicators are also Manufacturing, profitability assessment (LHS)
TCW, % y/y, reversed scale (RHS)
pointing to continued strong growth during early 2011; Source: NIER, Reuters EcoWin

expected output and order bookings, for example, are

at their highest level of the 21st century. Combined Higher capital spending by industry
with a stronger international economic situation, this in 2011
is why we are adjusting our 2011 export growth fore- Capital spending by Swedish manufacturers was un-
cast upward. But because of continued krona apprecia- changed in 2010, despite a rapid increase in production.
tion and ever-higher capacity utilisation, export growth Low capacity utilisation at the outset limited the need
will slow from 10.5 per cent in 2010 to 9 per cent this for fixed investments to a greater degree than expect-
year and 5 per cent in 2012. ed. Late in 2010, however, capacity utilisation climbed
rapidly and is now somewhat above its historical aver-
Merchandise exports
Index 100 = 2008 age, according to the National Institute of Economic
110 110 Research’s Business Tendency Survey. The Statistics
Sweden survey in October showed that companies were
105 105
planning to increase their capital spending by 10 per
100 100 cent this year.
95 95
Gross fixed investment
90 90 Year-on-year percentage change
30 30
85 85

80 80 20 20

75 75 10 10
05 06 07 08 09 10
0 0
Sweden Germany
Source: Statistics Sweden, Deutsche Bundesbank
-10 -10
So far, however, there are few indications that the kro-
-20 -20
na exchange rate will be a major problem for Sweden’s
competitiveness, although some companies will experi- -30 -30
ence squeezed margins. Our calculations also show that 00 01 02 03 04 05 06 07 08 09 10

the krona remains undervalued (see the Theme article). Total Manufacturing Housing
Historically, demand has been significantly more impor- Source: Statistics Sweden

tant to manufacturers’ profitability than the exchange
rate, as the chart below indicates. During the past year,
profitability has improved, even though the krona has
appreciated substantially from its earlier weak levels.
A strong recovery in manufacturing productivity is
among the factors that have blunted the cost impact
of the stronger krona. Companies implemented tough
efficiency-raising measures during the economic crisis,
and employment in the manufacturing sector shrank by
nearly 15 per cent (100,000 people). The subsequent
recovery has occurred with a very limited increase in
employment. This is one reason why we still have a way
Normally, companies have a tendency to overestimate
their capital spending needs in early surveys, but this
time around the rapid upturn in capacity utilisation,
combined with a historically low capital spending level,
indicates that the increase will instead exceed corpo-
rate plans. We are thus expecting capital spending by
manufacturers to grow by 13 per cent this year and
then continue upward at a rapid pace in 2012 as well.
Residential investments have gained back their down-
turn during the crisis. Rising home prices and a low
level of residential investments compared to other
countries make a continued upturn likely. Record-

Nordic Outlook – February 2011  |  37

 Sweden
high increases in the number of housing starts in 2010
indicate that new construction will accelerate further
in 2011. But total residential investments will be held
down by a levelling-off of renovation, following a dou-
bling in 2010 after the government introduced a tem-
porary tax deduction for home renovations and repairs.
Altogether, capital spending will increase by nearly 10
per cent this year and by 4 per cent in 2012.
Gross fixed investment
Percentage change, 2009 level in current prices
(SEK bn)
2009 2009 2010 2011 2012
Government sector 101 4.2 2.5 0.0 -0.5
Housing 87 -23.3 21.0 19.0 7.0
Business sector 362 -18.7 2.6 11.5 4.5
Total 550 -16.3 5.5 10.5 4.0
Source: Statistics Sweden, SEB
Continued consumption boom
Private consumption rose by 3.5 per cent during 2010.
Partly due to a rapid recovery in auto purchases, the
upturn was on a par with the highest levels of the past
20 years. With such a strong upturn in consumption,
Sweden is diverging sharply from other industrialised
countries. The large impact of earlier interest rate
cuts, an expansionary fiscal policy, the labour market
recovery and strong increases in household wealth are
the most important factors behind this. Yet 2010 was
an off-year in terms of income growth: the contribu-
tion from tax cuts was relatively small, while wage
and salary amounts rose moderately. Because of higher
employment and continued tax cuts, the deceleration
will be temporary. Our forecast for 2012 is based on the
assumption that Parliament approves a further stage in
the earned income deduction reform equivalent to SEK
12 billion and taking effect in January 2012.
Households savings ratio
Per cent of disposable income
15.0
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
-7.5
94 96 98 00 02 04 06 08
Total
Excl collective retirement saving
Financial savings, excl collective retierment saving
Source: Statistics Sweden, SEB
Household savings rose steeply during the crisis but
fell in 2010. Our forecast implies that the savings ratio
will level off during 2011 and 2012 and that saving will
remain high in a historical perspective.
38   |  Nordic Outlook – February 2011
Household income and consumption
Year-on-year percentage change
2009 2010 2011 2012
Consumption -0.8 3.5 3.3 2.5
Income 1.6 0.9 2.7 2.8
Savings ratio 12.9 10.6 10.1 10.4
Source: Statistics Sweden, SEB
Lending to households will slow
Looking a bit ahead, the rapid upturn in home prices
and household debt in recent years constitutes the
biggest risk in the Swedish economy. After a brief
slowdown in 2008, household borrowing has accelerated
and debt is now close to 180 per cent of disposable
income, a high level in an international comparison.
Meanwhile home prices have continued climbing in a
way that diverges sharply from trends in other coun-
tries.
In the latest issues of Nordic Outlook, we have dis-
cussed these risks in detail. There are several factors
underlying current developments, for example structur-
ally low home construction, exceptionally low mortgage
interest rates and strong growth in employment and
income. Meanwhile, international experience indicates
that as a rule, a debt expansion as rapid as that occur-
ring in Sweden is followed by a significant correction.
Households continuing to increase their debts
Per cent of disposable income
11 190
180
10
170
9 160
8 150
7
140
130
6 120
5 110
100
4
90
15.0 3 80
SEB
forecast 12.5 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
10.0 Interest burden after taxes (LHS) Debts (RHS)
7.5 Source: Riksbank, SEB
5.0
2.5
Short-term signals from the housing market are mixed.
0.0
During the latter part of 2010, there was a slight decel-
-2.5
-5.0
eration in both home prices and lending to households,
-7.5 but SEB’s home price indicator remains at high levels.
10 12 A strong labour market and rising incomes are continu-
ing to drive the upturn. The most likely scenario is that
loan volume and home prices will continue to increase
this year, but that the pace will slow markedly when
rising mortgage rates and the recently enacted ceiling
on loan-to-value ratios begin to have a clearer impact.
Historically, accelerations and slowdowns in household
loans have normally coincided with shifts in monetary
policy. This has occurred even in situations where
the economic cycle and the labour market have been
 Sweden

moving in opposite directions. But thus pattern is not Productivity is continuing to recover strongly, which is
equally clear for home prices. normal in this cyclical phase, yet the 2012 level will
still be about 2 per cent below the long-term trend. In
Lending to households
16 5.0
this respect, current developments differ from the
15 4.5 1990s economic crisis. At that time, long-term
14 4.0 productivity capacity was hurt by a sharp upturn in
13 3.5 equilibrium unemployment, while productivity quickly
12 3.0 exceeded its previous trend level. This time around, it
11 2.5 looks as if there is a risk of long-term damage occurring
10 2.0 mainly on the productivity side.
9 1.5
8 1.0 Indicators of resource utilisation
7 0.5 45 90.0
6 0.0 40 87.5
99 00 01 02 03 04 05 06 07 08 09 10
35 85.0
Year-on-year percentage change (LHS)
Repo rate, per cent (RHS) 30 82.5
Source: Statistics Sweden, The Riksbank
25 80.0

Labour market stronger than expected 20 77.5

Employment rebounded as early as the end of 2009, and 15 75.0

the downturn in jobs during the crisis has now largely 10 72.5
been regained. Over the past six months, unemploy- 5 70.0
ment has fallen about one percentage point. Short-term 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
indicators such as hiring plans in the Economic Tendency
Labour shortages, business sector (LHS)
Survey and the number of newly listed job openings at Capacity utilisation, per cent (RHS)
the government employment service have also continue Source: NIER

to strengthen. For example, hiring plans are now higher

Supply restrictions approaching
than they were in 2007, when employment rose at
Because of the rapid recovery, assessments of resource
record speed. We expect unemployment to continue
restrictions will become crucial earlier than expected,
downward and to drop below 7 per cent as early as
both in forecasting and in shaping economic policy. Such
the end of 2011.
indicators as labour shortages and capacity utilisation
have climbed rapidly and in many cases are now above
Labour market historical averages. Many factors indicate that equilib-
Percentage change rium unemployment may have shifted upward from
2009 2010 2011 2012 the approximately 6-6.5 per cent that prevailed before
Employment -2.1 1.0 2.1 1.1 the crisis. For example, manufacturing employment fell
very sharply during 2008 and will probably bounce back
Labour supply 0.2 1.1 0.6 0.4
only to a limited extent. Instead, expansion is occurring
Unemployment, % 8.3 8.4 7.3 6.6 in the construction sector and in the private service
Average hours sector. This may create adjustment problems for those
worked -0.6 0.9 -0.2 -0.3 who lost their jobs in industry and must look for new
Productivity (GDP) -2.7 3.3 2.7 2.1 jobs.

Source: Statistics Sweden, SEB Hourly wages

Year-on-year percentage change
5.0 5.0
Unemployment is falling
4.5 4.5
9.0 4750
4700 4.0 4.0
8.5
4650 3.5 3.5
SEB
8.0
forecast 4600
3.0 3.0
7.5 4550
2.5 2.5
7.0 4500
4450 2.0 2.0
6.5
4400 1.5 1.5
6.0 01 02 03 04 05 06 07 08 09 10
4350
5.5 4300 Total Business sector
02 03 04 05 06 07 08 09 10 11 12 Source: Statistics Sweden

Unemployment, per cent (LHS)

Employment, thousands (RHS) If we assume that equilibrium unemployment is now
Source: Statistics Sweden, SEB 6.5-7 per cent, resource utilisation should be in balance

Nordic Outlook – February 2011  |  39

 Sweden
as early as the end of 2011. This is not necessarily a
binding restriction on long-term growth. Over time,
equilibrium unemployment may be pushed down. This
may occur as a consequence of lasting high demand
for labour or as a consequence of structural reforms
enacted by economic policy maker. Nevertheless, the
previous picture of major resource gaps in the Swedish
economy has radically changed in a short period.
Higher pay increases in 2012
The 2010 wage round took place at a time when the
labour market outlook appeared grim. This was one
reason why collective agreements were reached at his-
torically low levels, which are now reflected in the in-
coming wage and salary statistics. The rate of increases
is record-low, even taking into account that as a rule,
preliminary monthly figures are later adjusted upward.
We expect total wage and salary increases in 2011 to
be only 2.5 per cent, despite the improvement in the
labour market.
Wage expectations
Year-on-year percentage change
4.00
3.75
3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
97 98 99 00 01 02 03 04 05 06 07
Employees' organisations, 2y
Employers' organisations, 2y
Employees' organisations, 5y
Employers' organisations, 5y
The collective agreements for white-collar employees
in industry expire in September, but there are signals
indicating that they will be extended to get back into
phase with blue-collar agreements. This implies that
coordinated wage and salary negotiations for industrial
employees will be carried out in early 2012. The wage
round will occur amid a relatively strong labour market
and a favourable profit situation: Another part of the
picture is that an accelerated rate of pay increases
in Germany might also affect Sweden. We have thus
adjusted our forecast for average pay increases in
2012 upward to nearly 4 per cent. The yearly average
will also be pushed up by the fact that the revision date
in the existing agreements is at the end of 2011. It is
notable, however, that pay expectations among labour
market parties are relatively low in a longer perspec-
tive, according to a recent Prospera survey.
Higher inflation, both short-
and long-term
Inflation unexpectedly rose to 2.3 per cent late in 2010
due to higher energy and food prices. Rising electric-
ity prices because of cold winter weather in December
were one important factor, but electricity prices have
40   |  Nordic Outlook – February 2011
fallen again. We thus expect CPIF (CPI without inter-
est rate changes) to drop below 2 per cent early in
2011. The upturns in petrol and food prices will not be
reversed in the same way, however. Instead we expect
food prices to continue climbing. CPIF inflation will end
up close to the Riksbank target in 2011 as a whole, sig-
nificantly higher than forecasts showed only one quarter
ago.
Core inflation (CPIF excluding food and energy) fell to
1.2 per cent in December. A combination of continued
low pay increases and a stronger krona indicates make
it likely that core inflation will remain low during 2011,
but a broader upturn in inflation driven by rising re-
source utilisation and higher pay is not so far away. We
expect a gradual rise in core inflation during 2012,
eventually threatening to climb above the Riksbank’s
target beyond our forecast horizon.
Low inflation
Year-on-year percentage change
5 5
4 SEB forecast 4
4.00
3 3
3.75
3.50 2 2
3.25
3.00 1 1
2.75
0 0
2.50
2.25 -1 -1
2.00
1.75 -2 -2
08 09 10 08 09 10 11 12
CPIF CPIF excl energy and food CPI
Source: Statistics Sweden, SEB
Source: Statistics Sweden Headline CPI inflation will be significantly higher than
CPIF inflation, due to rapidly rising household mortgage
interest expenses. The weight of mortgage interest with
short refixing periods will probably be adjusted upward
in Statistics Sweden’s calculation model, and that will
make the impact of interest rate hikes even larger than
we had previously anticipated.
Riksbank in a hurry
Growth, labour market and inflation trends will prob-
ably lead to interest rate hikes being implemented at a
faster pace than the Riksbank has announced to date.
During 2011, we now expect inflation to be quite close
to the Riksbank’s target, which in the short term will
make rate hikes seem less uncomfortable; forecasts had
previously indicated inflation well below target. Com-
modity price increases will admittedly result in transito-
ry inflation surges, but will still probably cause greater
worries about secondary effects. Experience from both
the earliest years of the 21st century and from 2007-08
indicates that central banks in Europe, and not least
the Riksbank, have reacted in such a way. Meanwhile
falling unemployment and rising capacity utilisation will
lead to a shift in the Riksbank’s analysis of underlying
inflation pressure.

Mortgage rates up more than repo rate
Changes since Jan 1, 2010
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
10 11
Repo rate Mortgage rate, 3-month refixing
The risks of excessively large divergences from the key
interest rates of other countries have also diminished. A
recent upturn in market interest rates reflects, among
other things, expectations of earlier rate hikes by the
ECB and the US Federal Reserve. This weakens one
important justification for the Riksbank’s lowering of its
repo rate path last October.
We expect that in the February issue of its Monetary
Policy Report, the Riksbank will raise the repo rate
path in such a way that the repo rate at the end of
our forecast period will again end up at 3.8 per cent
(compared to 3.45 per cent in the latest forecast). It is
also likely that stronger global economic conditions and
higher international interest rates will help reduce the
disagreements within the Riksbank’s Executive Board.
The Riksbank and macro supervisory rules
As early as the autumn of 2009, the Riksbank began to
“shout for help” from the government, the Financial
Supervisory Authority and others on the question of
alternatives to interest rate hikes in order to prevent
the emergence of mortgage loan and home price bub-
bles. The interest rate weapon is, after all, a blunt
instrument. There is a risk that interest rate hikes
aimed at influencing household debt will having unde-
sired side-effects, for example on corporate financing
costs, and end up in conflict with the bank’s main task
of achieving its inflation target.
This Swedish debate, which has intensified in the past
six months, is taking place concurrently with discus-
sions in the Group of Twenty (G20) and other interna-
tional forums regarding macroeconomic supervisory
rules. Sweden has now enacted a ceiling on the loan-
to-value ratio for home loans (October 1). But there
are more potential tools in the policy makers’ kit:
mandatory mortgage principal payments, cash reserve
requirements and/or countercyclical capital require-
ments (Basel III) for banks, limits on bank lending, less
generous interest deductions, changes in capital gains
tax deferment and stamp duty and payment protec-
tion requirements in case of unemployment, illness
and the like.
Sweden
This might in turn raise the rate path which to some
extent mirrors the Board’s average view.
4.5
We also believe that the need for interest rate hikes
4.0
will become even clearer in the course of 2011. Our
3.5
forecast is thus that the Riksbank will raise its repo
3.0
rate at every monetary policy meeting this year, and
2.5
we foresee a repo rate of 2.75 per cent at the end of
2.0
2011. After that, we believe that rate hikes will con-
1.5
tinue to 3.75 per cent at the end of 2012.The Riksbank
1.0
will thus reach a level that we believe corresponds to a
0.5
neutral interest rate after the changes that occurred in
0.0
the wake of the financial crisis.
Jul Oct
12
During the coming year, the risks in this forecast are
Source: SEB
mainly on the upside. Given strong economic growth,
an output gap that is on its way towards closing, and
increases in household debt, it is possible that the
Riksbank will be forced to more fundamentally re-assess
its strategy of gradual normalisation of the repo rate
during a three-year period. Hikes of 50 basis points
may thus be considered on some occasions later in
2011, in order to achieve a neutral interest rate within
a reasonable period.
At present we are not choosing an aggressive repo rate
path as our main scenario, due to various factors that
help intensify the impact of key rate hikes in Sweden.
Higher risk premiums for mortgage bonds, combined
with the Swedish Financial Supervisory Authority’s new
rules for bank funding of mortgage loans have already
led to an increase in mortgage loan rates of about 50-75
Preliminary statistics indicate that the debate in itself
and the measures implemented so far may have had
a certain cooling-off effect on the credit market, but
the question is how lasting this will be in an other-
wise favourable macro environment. The Riksbank’s
dilemma − how to ensure price stability and financial
stability with only a single policy tool − has diminished
to some extent as inflation risks have increased, due
to stronger economic growth.
The need for Swedish macro supervisory rules remains,
and international proposals for tools will be present-
ed, probably late in 2011. Our assessment is that the
Financial Supervisory Authority will choose to move
forward slowly with new measures. Time is needed to
study various proposals. Changes in the tax system,
for example, should not be short-term. Instead they
should preferably be made while taking a long-term
perspective. There is, furthermore, uncertainty about
the effectiveness and the side-effects of various
measures. Introducing new rules on a broad front
while interest rates are rising may create too strong
a cooling-off effect and lead to an undesired credit
contraction and falling home prices.
Nordic Outlook – February 2011  |  41
 Sweden

points more than the repo rate hikes. In addition, tight- Exchange rates
ening effects via the currency are larger than normal 12 160
when many other central banks are leaving low key 155
11
interest rates unchanged. 150
10 145
Yield spread to Germany will slowly 9 140

widen 135
8 130
The yield differential against Germany on 10-year
125
government bonds has been relatively stable in recent 7
120
months, despite the Riksbank’s key rate hikes. The 6
115
spread has been in the 15-35 basis point interval, or
5 110
somewhat below our earlier forecast. This is partly be- 96 98 00 02 04 06 08 10
cause expectations of ECB rate hikes have risen almost
TCW Index, 1992NOV18=100 (RHS) USD/SEK (LHS)
as much as in the case of the Riksbank. In addition, the EUR/SEK (LHS)
very limited supply of Swedish government bonds has Source: Reuters EcoWin

presumably limited upward pressure on yields. Looking

ahead, we believe that a widening gap in key interest
rates will be more important than the difference in the
volume of government securities available. The spread
will thus continue to widen slowly over the next couple
of years. We expect a spread of 40 basis points at the
end of 2011 and 50 points at the end of 2012. This
means that the yield on a 10-year government bond
will climb to 4.0 per cent in December 2011 and 4.5 per
cent at the end of 2012.
Spread vs Germany
Basis points
1.5
1.0
0.5 SEB
forecast
0.0
-0.5
-1.0
05 06 07 08 09 10 11 12
Repo rate spread (LHS)
10-year government yield (RHS)
Source: Reuters EcoWin
Krona heading towards new heights
The krona continued to strengthen early in 2011. Its
levels against the euro and in trade-weighted TCW
terms are the strongest since 2000. In spite of this,
we believe that the krona will continue to appreciate.
Economic growth will remain higher in Sweden than in
both Europe and the US during 2011. Meanwhile the
Riksbank will hike its key interest rate, while the first
ECB rate hike will not occur until late this year. The key
interest rate spread is a very important explanation for
short-term exchange rate movements, according to our
models. We also expect the flow situation to benefit
Sweden. Strong government finances attract investors,
including other central banks. Switzerland, for exam-
ple, recently decided to add the krona to its foreign
exchange reserve.
Another argument for continued appreciation is that in
a long-term perspective, the krona still seems under-
valued. Our estimate of equilibrium levels (see the
Theme article), for example, indicates that the fair
value against the euro is SEK 8.30. Sweden continues to
report large current account surpluses and has begun to
build up a positive net external balance, which supports
the picture of an undervalued currency. We believe
that at the end of 2011, the EUR/SEK exchange rate
will stand at 8.50 and the USD/SEK rate will be 6.07.
In TCW terms, the krona will reach 114.4, its strongest
level since 1996.
0.5
0.4
0.3
Public finances will surprise
0.2 Net lending by the Swedish public sector fell by a total
0.1 of 4.5 percentage points of GDP between 2007 and
0.0 2009. Last year there was some improvement, and as
-0.1
early as this year we expect stronger economic condi-
-0.2
tions to lead to a slight surplus. Relatively moderate
-0.3
-0.4
pay increases will hold down income growth to some
-0.5 extent this year, which will be the most noticeable in
the local and regional government sector.
Public finances
Per cent of GDP
2009 2010 2011 2012
Revenue 52.2 51.2 49.7 49.4
Expenditures 53.2 51.0 49.0 48.4
Net lending -1.0 0.2 0.7 1.0
Gen. gov’t gross
debt 41.9 37.6 33.5 30.8
Central gov’t debt 37.2 33.7 30.2 27.5
Borrowing req.,
SEK bn 176 1 -39 -48
Source: Statistics Sweden, SEB
The central government borrowing requirement im-
proved sharply between 2009 and 2010, but more than
half of this SEK 175 billion improvement is explained
by onward lending to the Riskbank in 2009 aimed at
strengthening its foreign exchange reserve. The change

42   |  Nordic Outlook – February 2011


late last year was somewhat stronger than expected,
and according to preliminary figures from the National
Debt Office the central government borrowing require-
ment in 2010 was only SEK 1 billion.
In addition to the sale of shares in Nordea of just below
SEK 20 billions we believe that decisions Parliament has
already made will be sufficient to enable the govern-
ment to divest an additional SEK 20 billion worth of
state-owned companies this year and SEK 25 billion in
2012. Due to parliamentary resistance, however, the
government’s privatisation plans may need to be adjust-
ed in some respects. The marginal borrowing require-
ment in 2010 will be replaced by surpluses of SEK
39 billion in 2011 and SEK 48 billion in 2012. Central
government debt fell as a percentage of GDP during
2010, and we expect this figure to continue downward
to 30 per cent of GDP in 2012.
Last autumn the government’s budget bill proposed SEK
13 billion worth of reforms in 2011. Reforms approved
previously plus our assumptions about further fiscal
stimulus in 2011 will mean that total programmes in
2011 will amount to some SEK 20-25 billion (equivalent
to about 0.7 per cent of GDP). In spite of this, fiscal
stimulus will be neutral this year, since temporary cri-
sis-related government grants to local governments will
meanwhile disappear. In 2012 we expect fiscal policy to
be weakly expansionary, with reforms equivalent to SEK
20 billion or 0.7 per cent of GDP.
Approaching a political crossroads
The government’s reform programme for its 2010-2014
term of office is less extensive and more back-loaded
than its 2006-2010 programme. After the 2006 election,
the new Alliance government quickly started pushing
through reforms; today we are seeing a more caretaker-
like government. However, the strong economy will
allow the government room to spend more aggressively
on reforms than the SEK 40 billion, or a bit above 1 per
cent of GDP, it has signalled for its four-year term. A
strategy of moving cautiously at the beginning of this
term, so that it can spend more aggressively as the
2014 election approaches, may also encounter prob-
lems. For reasons of stabilisation policy, the govern-
ment’s fiscal offensive should be launched at a rela-
tively early stage.
Sweden
The government is fast approaching a fiscal cross-
roads between a tight budget and further reduction of
central government debt, or a commitment to tax cuts
or higher health and welfare spending. Regardless of
what the government does, it will attract criticism from
either the business community or the opposition. The
electoral success of the dominant Moderate Party has
also led to tensions within the Alliance coalition. In the
future, the much smaller Liberal Party, Christian Demo-
crats and Center Party will demand more follow-through
on their own proposals, to avoid being marginalised;
their demands will increase the worse these parties do
in opinion polls. The focus on budget discipline during
the crisis that characterised the election campaign has
faded, and Sweden is in a better fiscal situation. This
may help give the smaller Alliance coalition parties a
chance to push through some of their signature issues.
We can thus expect tougher battles ahead within
the government when it comes to crafting economic
policy. The policy positions of the coalition parties,
especially regarding taxes, have become clearer in
recent months. The Moderates are continuing to pursue
a policy of strengthening incentives for people to work
and they want to enact further earned income deduc-
tions, which the other three parties seem relatively
indifferent to. The Liberal Party has underscored the
importance of abolishing the extra 5 per cent income
tax on the affluent imposed as an austerity measure in
the 1990s, while the Center prioritises improvements
in the situation of businesses, for example by lowering
employer payroll fees. The Christian Democrats seem to
be moving towards more vigorously pursuing their sig-
nature issues in family and elder care policy. We expect
reforms in the tax area to be broader with less focus on
earned income tax credits compared to the past.
Nordic Outlook – February 2011  |  43
 Sweden
Is there an optimal government debt level?
During the crisis years 2008-2009, Sweden’s central
government debt was largely unchanged as a percent-
age of GDP. A margin upturn of 3 per cent of GDP can
be compared to the 35 per cent increase in the 1990s.
Because of improved economic conditions, central
government debt is expected to fall to 30 per cent
of GDP in 2012. Given the government’s assumptions
of strong growth and budget surpluses in 2013 and
2014, this debt will fall even further and in 2014 it
will reach its lowest level in 40 years: 21 per cent of
GDP. Such a trend will probably trigger an increasingly
heated debate on government debt. Is it reasonable
to prioritise further debt reductions at the expense of
urgent tax cuts or expenditure reforms?
Falling debt
Per cent of GDP
80
75
70
65
60
55
50
45
40
35
30
25
94 96 98 00 02 04 06 08
Maastricht debt Debt
Source: Eurostat, Swedish National Debt Office, SEB
It is difficult to find any clear criterion for what is an
optimal level of public debt. One general principle,
however, may be that debt should be at a level that
ensures the long-term sustainability of fiscal policy
and enough fiscal manoeuvring room to soften the
impact of economic fluctuations. Otherwise there are
reasons both for and against public debt. Low debt
means lower interest payments, which implies that a
larger percentage of tax revenue can be used for gov-
ernment operations or tax cuts. Meanwhile it should
be possible for macroeconomically profitable invest-
ments to be financed by borrowing. In addition, net
public debt should be taken into account by including
assets. A number of different criteria for the level of
public debt may be discussed:
High debt may slow growth: IMF studies show that
growth begins to be adversely affected when debt
exceeds 90 per cent of GDP. The explanation for this
is that the interest burden of such high debt levels
forces the enactment of taxes that lead to efficiency
losses. Households and businesses may also tend to
increase their saving for reasons of caution in case of
such high public debt, since there is growing uncer-
tainty about the future economic policy rules of the
game.
Risk of a snowball effect: One criterion is that a debt
increase during a recession will not lead to a situation
where fiscal credibility problems become acute. Ex-
44   |  Nordic Outlook – February 2011
perience shows that a severe crisis can lead to a rapid
debt increase, totalling 30-40 per cent of GDP. Once
central government debt moves a bit above 100 per
cent of GDP, interest payments may become so large
that a primary balance (balance minus the interest
item) is not sufficient to stabilise the debt ratio. To
avoid this, the debt level should not exceed 70-75 per
cent of GDP in a normal economic situation.
The Maastricht criterion: A public debt of 60 per cent
of GDP (or falling debt) is one of several targets for
the euro zone countries. This debt corresponded to
the average level in the countries affected during the
preparations for the the euro in the early 1990s. A 60
per cent level can also be derived with the help of the
deficit criterion and an assumption of a 5 per cent an-
nual trend level of nominal GDP growth. Given a defi-
cit of 3 per cent of GDP, the debt ratio will converge
80
75
at 60 per cent of GDP in the long term.
SEB
forecast 70
65
The need for benchmark interest rates in financial
60 markets: Sovereign borrowing fulfils purposes that are
55 not directly connected to financing. The interest rate
50
on government borrowing is used as a benchmark rate
45
40
for pricing other financial instruments. There is also a
35 demand for safe investments in the national currency;
30 Basel III rules may boost this demand. In addition,
25 there are reasons to maintain a government borrowing
10 12
function and a liquid market for government securi-
ties. This requires an outstanding debt portfolio of a
certain size. The downside pain threshold is difficult
to estimate but can be assumed to be between 20 and
30 per cent of GDP.
Should the government build up assets? In 2009 the
Swedish central government’s net financial debt was
13 per cent of GDP and it is expected to decrease in
the future. A build-up of public wealth has no intrin-
sic value. Excessively high government saving may
lead to squeezing out effects. Private sector saving
and wealth accumulation can instead benefit from a
certain level of government debt.
Conclusion
The international crisis shows the value of good public
finances and low government debt. Sweden’s central
government debt is low in a historical and internation-
al perspective. It is well below the levels where there
is obvious direct damage and risk to the economy.
Taking into account the strong net financial position
of the Swedish government and the functioning of the
money market, there are hardly any reasons to push
down the central government debt from a level of
30-35 per cent of GDP. Since Sweden has a high tax
burden, internationally speaking, where certain taxes
may be strategic for competitiveness, and since infra-
structure investments have been neglected for a long
time, there are strong arguments for not prioritising
further decreases in central government debt.
 Denmark

Good 2011 growth due to exports, weak krone

ƒƒ Continued strong exports and Norway especially. The sector is also benefiting
from favourable currency rate trends, with the Swed-
ƒƒ Domestic demand still a vital force driving ish krona and Norwegian krone continuing to appreciate
GDP growth
and the euro likely to weaken again in the future. For
ƒƒ No increase in key rate spread until 2012 some years, wages and salaries have grown more in line
with those of European competitor countries instead of
faster, as previously. As a result, Denmark can now take
Denmark’s economic recovery is continuing, and growth advantage of currency depreciation in a clearer way.
is accelerating despite the three-year public budget The Danish krone is weakening
consolidation that has now begun. Stronger interna- Effective exchange rate, index 100=2005
tional growth will continue to stimulate exports. We 107.5 107.5
are adjusting our GDP growth forecast upward from 105.0 105.0
2.2 to 2.6 per cent in 2011 and are also making a
102.5 102.5
slight upward revision to 2.3 per cent in 2012.
100.0 100.0
GDP growth in 2010 was 2.3 per cent, according to pre- 97.5 97.5
liminary estimates. The upturn was driven by a decent
95.0 95.0
improvement in private consumption and by a sizeable
inventory contribution. This year we expect capital 92.5 92.5

spending to provide additional support. Exports will 90.0 90.0

continue to increase at a good pace, and combined with 87.5 87.5
stronger domestic demand this will also push important 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
growth higher. This means that net exports will con- Källa: Reuters EcoWin

tinue to provide small growth contributions.

Private consumption grew by an estimated 2 per cent
Forward-looking indicators strengthened late in 2010. last year. A continued moderate upturn is expected. In
Changes in consumer confidence, which is somewhat 2010, tax cuts helped bolster household income, but in
above its historical average, have been moderate for 2011-2013 income will instead be undermined by fiscal
some time, but the purchasing managers’ index in austerity. Growing employment and a continued gradual
manufacturing advanced sharply above the 60 level to housing market improvement will provide support,
62.8. This puts the index close to its historical highs of however.
65-70. The main reason is strong order bookings.
The inflation rate climbed from 0.5-1.0 per cent in late
New orders push manaufacturing PMI upward 2009 to 2.8 per cent in December 2010, but this was
Net balance, above 50 positive largely due to rising energy and food prices as well as
80 80
base effects. Core inflation trended in the opposite
70 70 direction during the same period, moving from above
1.5 per cent to just over 1 per cent, though with a weak
60 60
upward trend more recently. We predict a continued
50 50 slow upturn in underlying inflation, but HICP inflation
will end up at a relatively high 2.4 per cent average for
40 40
2011 and then fall towards 2 per cent.
30 30
Due to fiscal austerity and higher growth, the budget
20 20 deficit will shrink from about 5 per cent of GDP in 2010
00 01 02 03 04 05 06 07 08 09 10 to 2.5 per cent in 2012, faster than the government’s
Total PMI New orders planned 3.5 per cent. Meanwhile the central bank will
Source: DILF
raise its key interest rate from an extremely low level,
High order inflow to companies indicates that exports in shadowing the ECB completely this year but hiking the
particular will pick up renewed speed. Other indicators key rate somewhat faster in 2012. This means that the
signal that domestic demand is recovering at a leisurely unusually low 5 basis point spread will be normalised
pace. The export sector will gain extra momentum due over time towards 20 points.
to the improved growth outlook in Germany, Sweden

Nordic Outlook – February 2011  |  45

Norway
Ongoing expansion
ƒƒ Growth in mainland GDP above trend
ƒƒ Uncomfortably high household debt
ƒƒ Norges Bank hiking slightly faster
The recovery in the Norwegian economy has gathered
pace. Nonetheless, overall GDP performed a lot worse
than expected; production in the oil sector plunged in
the third quarter due to maintenance at a number of
fields. Production has snapped back, but overall GDP
was broadly unchanged last year. However, excluding
oil, gas and shipping, growth in mainland GDP acceler-
ated to 2.5 per cent year-on-year by the third quar-
ter of 2010, and anecdotal evidence suggests continued
above-trend broad-based growth.
First, consumer confidence and manufacturing senti-
ment are the highest since 2007 when growth was surg-
ing. Second, contacts in Norges Bank’s regional network
saw output in late 2010 expanding at the fastest clip in
two years and expectations were lifted in the Janu-
ary update on improved prospects for construction and
the service industry. Finally, the economic policy mix
is favourable: fiscal policy will be broadly neutral for
growth in 2011 and key interest rates remain well below
“normal” levels.
Mainland GDP and Norges Bank's network
7 3.0
6 2.5
5 2.0
4
3
2 year increase in credit to households accelerated only
1
0
-1
-2
-3
03 04 05 06 07 08 09
Mainland GDP, year-on-year percentage change (LHS)
Norges Bank regional network output indicator, index (RHS)
Source: Statistics Norway, Norges Bank
Growth in mainland GDP will pick up from 1.9 per
cent in 2010 to 3.1 per cent in 2011 and 3.2 per cent
in 2012. In addition, overall GDP will be lifted by mark-
edly higher oil sector investment in 2011 and should
expand 2.7 per cent but decelerate slightly in 2012.
Private consumption strong but choppy
Stronger private consumption has so far been the
main engine of the recovery, rising 3.5 per cent
46   |  Nordic Outlook – February 2011
in 2010, and should accelerate slightly in 2011. The
quarterly growth rate in consumption of goods (half the
total) gathered steam in the fourth quarter, building
on the marked acceleration of the previous quarter.
However, retail sales showed a noticeable pullback in
December but the drop should prove temporary. Part of
the pullback was due to a weather-related 20 per cent
surge in electricity prices from November to December
(up 38.3 per cent year-on-year) as measured in the
consumer price index. The negative effect on household
spending in general should carry over into early 2011 as
the heating bill that households received in January was
much, much higher.
It looks as if consumption will repeat the soft patch
of early 2010. At that time, an even sharper spike in
electricity prices was instrumental for declining private
consumption of goods over the first four months of the
year, while the subsequent sharp drop in such prices
helped revive consumption. The same is likely to hap-
pen this time around as rather strong fundamentals
eventually reassert themselves.
Our forecast of 3.7 per cent consumption growth in
2011 is above that for real disposable income, implying
a lower saving ratio. However, there is a risk that the
ratio might decline further, since its 7.5 per cent level
in the third quarter of 2010 was well above the 5 per
cent long-term average.
Household debt at elevated levels
The high level of household debt is a potential risk
1.5 in the medium to long term. Very low interest rates
1.0 have so far not fuelled a credit boom: the year-on-
0.5
0.0
modestly in 2010 from 6.1 per cent in June to 6.5 per
cent at year-end. Nonetheless, credit growth is running
-0.5
ahead of disposable income, which increased 5.6 per
-1.0
cent year-on-year on average for the first three quar-
-1.5
10 ters of 2010, implying a further rise in the household
debt ratio.
The gross debt-to-income ratio steadied at 193 per
cent in 2009 after having risen sharply over the previ-
ous ten years, and looks set to surpass 200 per cent dur-
ing the current year. While structural differences and
very high public sector savings in the Government Pen-
sion Fund Global help explain a higher debt-to-income
ratio than among peers, the level looks unsustainably
high. Moreover, borrowing by households might show a
more marked acceleration, to the extent home prices
continue rising.
 Norway

Households' gross debt The strong price surge since mid-2010 is not surprising,
Per cent of disposable income since demand is running well ahead of supply. Housing
210 210 starts bottomed out in mid-2009, but new construction
200 200 has picked up only modestly and is still running well
190 Norges 190 below the ten-year average and what demographics
180 Bank's 180 suggest. At the same time, the supply of existing homes
forecast
170 170 for sale has trended markedly lower and is only slightly
160 160 higher than in 2006, when the housing market was red-
150 150 hot. Meanwhile, homebuilders reported a sharp jump in
140 140 sales of new homes in the final quarter of 2010.
130 130
Existing home prices and housing starts
120 120
30 40.0
110 110
25
90 92 94 96 98 00 02 04 06 08 10 12
20 35.0
Source: Norges Bank
15
30.0
Home prices are rising sharply 10

The trend of home prices has changed noticeably. Since 5

25.0
their low in late 2008, seasonally adjusted existing 0
home prices have risen every month but two and were -5 20.0
up 7.6 per cent in January compared to one year ear- -10
lier. While the increase was not as rapid as in late 2009, -15 15.0
prices were up almost 14 per cent at an annual rate 98 99 00 01 02 03 04 05 06 07 08 09 10

over the six months to January. This level is record- Existing home prices, year-on-year % change (LHS)
high in nominal terms. Moreover, prices are up mark- Housing starts, 12 month aggregate (RHS)
Source: Statistics Norway, Norwegian Association of Real Estate Agents
edly relative to household disposable income: some 20
per cent above the long-term average.

Fiscal policy has an expansionary bias

Non-oil budget deficit and GPFG
Norway’s fiscal policy is guided by the “fiscal policy
7000 250
rule”, stating that the structural − or cyclical-adjusted 225
6000
− non-oil budget deficit over time shall correspond 200
NOK bn (start of year)

to the expected 4 per cent real return on the Gov- 5000

175
ernment Pension Fund Global (GFPG, the sovereign

NOK bn
4000 150
wealth fund). 3000 125
100
The oil-adjusted deficit surpassed the limit in 2009 2000
75
and 2010 as the government met the cyclical down- 1000 50
turn with a more expansionary fiscal policy, letting 0 25
automatic stabilisers work as the rule implies. How- 02 04 06 08 10 12 14 16 18 20

ever, “over-spending” was less than assumed in the Government Pension Fund (LHS)
original budget proposals, due to higher revenue and Structural non-oil budget deficit, current prices (RHS)
Structural non-oil budget deficit, 2001 prices (RHS)
slower spending growth, which was not caused by ac- Source: Ministry of Finance

tive budget measures. In 2011, the structural non-oil

budget deficit should be in line with the rule, if not policy rule will work in an expansionary direction if
slightly lower. the cyclically adjusted non-oil deficit is kept at − or
not too far below – 4 per cent of the Fund. Assuming a
Politicians like to term any reduction relative to the 4
5.5 per cent average annual growth rate in mainland
per cent limit as a “sounder” or tighter fiscal policy,
GDP (marginally less than the 2000-09 average) and
but the reality may differ. Hence, while the adjusted
that the GPFG grows as projected by the Ministry of
non-oil budget deficit was unchanged as a share of the
Finance, the fund will increase from almost 150 per
GPFG from 2009 to 2010, fiscal policy actually added
cent of mainland GDP in the third quarter of 2010 to
to domestic demand. Likewise, the budget proposal
about 185 per cent in 2015. In other words, the
for 2011 saw the adjusted deficit declining from 4.7
non-oil budget deficit might increase in both nominal
per cent to 4.2 per cent of the GPFG, but the fiscal
and real terms.
policy effect was estimated to be only marginally
negative. This “inhibited” expansionary effect, although not
necessarily very strong, puts Norway in quite a differ-
The GPFG is expected to grow faster than nominal
ent position from the multi-year tightening of fiscal
GDP in the next few years, implying that the fiscal
policy going on in much of Europe.

Nordic Outlook – February 2011  |  47

 Norway

With growing imbalances between supply and demand,
and still-low interest rates adding to the upward pres-
sure, the strong rise in existing home prices will eventu-
ally fuel an accelerating trend in housing starts. Resi-
dential investment started to grow again in early 2010
and should rise 9-10 per cent in both 2011 and 2012.
Business investment about to rebound
Norwegian manufacturing output has trended up since
mid-2009, and manufacturing confidence in the final
quarter of 2010 was at the highest level since early
2007. The indicator is well above its long-term average,
suggesting above-trend growth in production as well.
the year to the fourth quarter of 2010 was surprisingly
weak and included declining exports of machinery and
transportation equipment in addition to food, while
exports of chemical products rose sharply.
Real exports of traditional goods should nonetheless
have recorded a rather solid 5 per cent growth rate for
all of 2010. However, the trajectory is weaker going
into 2011, and while momentum should pick up, full-
year growth will likely moderate to 3.5 per cent.
Exports of traditional goods
Year-on-year percentage change
20 20

15 15
Manufacturing production and sentiment
10.0 30 10 10

7.5 24 5 5
18 0 0
5.0
12
2.5 -5 -5
6
0.0 -10 -10
0
-2.5 -15 -15
-6
97 98 99 00 01 02 03 04 05 06 07 08 09 10
-5.0 -12
-7.5 -18
Exports traditional goods, volume
Export prices traditional goods
-10.0 -24 Source: Statistics Norway

98 99 00 01 02 03 04 05 06 07 08 09 10 11
While exports have disappointed in volume terms, ex-
Manufacturing prod, y/y % change, 3 m average (LHS)
Manufacturing sentiment, % of labour force, 2Q earlier (RHS)
port prices were up strongly in 2010 as well, rising 8 per
Source: Statistics Norway cent overall and by more than 6 per cent for traditional
The advance was fuelled by rising order backlog and goods. With import prices declining slightly, Norway
stronger production expectations (at a four-year high), enjoyed improving terms-of-trade, as was the case in
but was uneven among sectors. Producers of intermedi- five of the previous eight years.
ate and consumer goods reported a further accelera-
tion in production and order flow and were the most Core inflation to trend moderately
optimistic about the outlook. Producers of capital goods higher
continued to languish but reported improving domes- The jump in CPI inflation to an eight-month high of 2.8
tic orders, a development that should gather steam per cent in December should prove temporary, since it
because oil companies plans a very marked increase in was fuelled by surging electricity prices. For all of 2010,
capital spending this year. overall inflation accelerated a bit to 2.5 per cent. How-
ever, core inflation on the CPI-ATE measure − excluding
Capacity utilisation in manufacturing is still below the taxes and energy − slowed from 2.6 per cent in 2009 to
long-term average. Nonetheless, manufacturers have 1.4 per cent, almost evenly split between lower domes-
steadily upped their capital spending expectations, tic inflation and imported inflation turning to disinfla-
signalling at least stabilisation if not modest growth fol- tion, reflecting the previous appreciation of the NOK.
lowing a very deep slump. Moreover, investment inten-
tions among Norges Bank’s regional network continued Core inflation remains at low levels
to recover in late 2010. Of particular importance were Year-on-year percentage change
5 5
the almost six-year high capital spending expectations
4 4
in the private service sector. In all, non-oil business 3 3
investment should be up 5.5 per cent in 2011 and 2 2
almost as much in 2012. 1 1
0 0
-1 -1
Exports languish while prices rise fast -2 -2
Merchandise exports excluding oil/gas and ships etc. -3 -3
turned around strongly in mid-2009, but have since -4 -4
-5 -5
disappointed. They declined a bit more than 2 per cent 99 00 01 02 03 04 05 06 07 08 09 10
in volume terms from the third to the fourth quarter of
CPI-ATE
2010, according to foreign trade statistics. The decline CPI-ATE domestic goods and services
was exaggerated by a very sharp drop in exports of food CPI-ATE import consumer goods
Source: Statistics Norway, SEB
(reflecting problems in fish farming). However, the 2.8
per cent decline in real exports of traditional goods in

48   |  Nordic Outlook – February 2011


Inflation often lags the economic cycle, but the 1.0 per
cent year-on-year rate on the CPI-ATE in the final three
months of 2010 should mark the trough. In the near
term, core inflation should creep modestly higher,
mainly driven by higher food prices. In a slightly longer
term, the effect on import prices from previous NOK
strength should wane: according to foreign trade sta-
tistics, the year-on-year change in prices for imported
goods has already turned from sharply negative for
most of 2010 to unchanged in the fourth quarter. Rising
wages should start adding to inflation in 2012, and by
the end of the year, inflation should be broadly in line
with Norges Bank’s 2.5 per cent medium-term target.
Norges Bank to hike slightly faster
At its January monetary policy meeting, Norges Bank
left the deposit rate unchanged at 2.00 per cent, where
it has been since the hike last May. Bringing inflation up
to target and stabilising output and employment “imply
a low key policy rate”, while a strong krone might dent
inflation too much. However, “guarding against the risk
of future financial imbalances … suggests that the key
policy rate should not be kept low for too long.” The
bank did not send any signals that it is considering a de-
parture from the optimal rate path stated in its October
Monetary Policy Report, which sees a hike in June or
August and another in the autumn, lifting the deposit
rate to 2.50 cent by the end of the year. In 2012, the
rate path indicates a year-end level of 3.50 per cent.
These key interest rates are lower than domestic
fundamentals suggest: According to the October MPR,
simple policy rules based on actual GDP growth and
inflation or the output gap, inflation and the level of
interest rates implied that the deposit rate should be ½
percentage point higher in late 2010. However, factor-
ing global interest rates into the equation suggested a
deposit rate below the actual level.
Norges Bank's deposit rate
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
00 01 02 03 04 05 06 07 08 09 10 11 12
Norges Bank's deposit rate Forecast SEB
Optimal rate path, MPR 3/10
Source: Norges Bank, SEB
Since then, global and Norwegian interest rate expecta-
tions have increased markedly. Moreover, domestic fac-
tors have moved to the upside. Firstly, growth in main-
land GDP in the year to the third quarter of 2010 was ½
percentage point stronger than Norges Bank assumed,
implying an even smaller negative output gap (if any),
and reports from the bank’s network suggest continued
Norway
above-trend growth. Meanwhile, global growth and the
outlook are stronger than the bank had assumed.
Secondly, core inflation has stopped surprising on the
downside relative to Norges Bank’s trajectory: on the
bank’s CPIXE measure, which excluded taxes but in-
cludes an estimated trend in energy prices, the 1.5 per
cent year-on-year rate in December was 0.2 percent-
age point higher than expected. In addition, home
prices are rising faster than Norges Bank had assumed,
suggesting a subsequent increase in household debt ac-
cumulation.
On the downside, the trade-weighted NOK is somewhat
stronger than assumed by Norges Bank. To date, the
deviation is probably not sufficient to greatly alter its
inflation forecast, but any further appreciation will
be a concern. However, the price index for imported
consumer goods in the foreign trade statistics suggests
that the downward trend in imported inflation might be
coming to an end.
Absent any major changes in the short term, there is a
better-than-even chance that Norges Bank will revise
its optimal rate path slightly higher in the Monetary
Policy Report due March 16. Such a revision probably
hinges on inflation numbers. In the medium term, SEB
has brought forward the timing of a first hike from ECB
while the Swedish Riksbank is expected to hike rates
somewhat faster, which should allow Norges Bank to
slightly accelerate the normalisation process: hence,
we now expect it to hike the deposit rate three times
to 2.75 per cent by end-2011 (up from 2.50 per cent
previously), and we are sticking to our forecast of five
hikes during 2012 to 4.00 per cent.
Stronger NOK and higher rates
A wider short rate spread vs the ECB over the forecast
period will support the NOK and put upside pressure on
Norway’s 10-year bond spread vs Germany. Since the
recovery started, EUR/NOK has remained above the
7.70 level as Norges Bank has been guarding against a
too strong NOK. With imported inflation expected to
turn soon the bank could adopt a more relaxed attitude
to the krone, which in combination with Norges Bank
resuming the rate hike cycle this summer opens up for
EUR/NOK breaking below 7.70. In addition, Norway’s
outstanding fiscal position will support the already posi-
tive flow outlook as we expect continued diversification
flows to alternative safe havens. Our fair value model
points to 7.40 for EUR/NOK. We target EUR/NOK at 7.60
by the end of 2011 and 7.50 by the end of 2012.
Since the previous Nordic Outlook, the 10-year spread
vs. Germany has traded within a 55-85 basis-point
range. With Norges Bank delivering three hikes this year
and the key interest rate spread widening, the spread
will move towards the higher end of that range. With
the German bond yield expected to continue to rise, we
forecast a 10-year yield at 4.30 by the end of 2011 and
4.75 per cent by the end of 2012.
Nordic Outlook – February 2011  |  49
Finland
Recovery will continue
ƒƒ Exports and domestic demand will gain
momentum in 2011
ƒƒ Moderate downturn in unemployment
ƒƒ Budget deficits below euro zone ceiling
Because of strong fundamentals, the Finnish economy
has good potential for a strong recovery after its sharp
GDP decline during the economic crisis. The labour mar-
ket has proved resilient, the banking sector emerged
relatively unscathed and public sector finances are solid
enough to stimulate the economy. However, so far the
recovery has not been as strong as might have been ex-
pected, given the steep slide in 2009. GDP rose by 3.0
per cent in 2010, but we expect an acceleration to 3.5
per cent this year. In 2012, GDP will again grow by 3.0
per cent. Our forecast is above the consensus.
A robust recovery in key Nordic export markets and in
Russia, plus a favourable industrial mix, will continue to
stimulate exports. The expansive Asian market will also
gain in importance. In the third quarter of 2010, ex-
ports grew by 10 per cent year-on-year, but they remain
well below pre-crisis levels. The strong euro and moder-
ate expansion in production and exports of information
and communications technology are two explanations
for this, but during the next couple of years Finnish
exporters will benefit from the weakening of the euro
against the Swedish and Norwegian currencies.
Leading indicators improving
Index
60
40
20
0 0
-20
-40
-60
-80
04 05 06 07 08 09
Manufacturing sector Construction sector
Service sector
Source: DG ECFIN
Leading indicators are showing a domestic recovery
driven by the service sector. Meanwhile construction
sector activity remains relatively weak. Consumer
confidence bottomed out in early 2009, and private
consumption bounced back relatively early. Although
50   |  Nordic Outlook – February 2011
indicators fell somewhat in late 2010, we believe that
consumption will remain comparatively good, with
growth of about 2.5 per cent a year in 2011 and 2012.
To date, the capital spending upturn has been driven
by rising residential investments. Capacity utilisation in
manufacturing has also climbed, but it remains below
80 per cent. Production bottlenecks are thus rare, and
this will limit capital spending by the manufacturing
sector in the near future.
Unemployment peaked at around 9 per cent early in
2010. The upturn was milder than might be expected,
given the large GDP downturn. This was partly due to
temporary measures such as short-term lay-offs, which
affected 2 per cent of the labour force at their height.
Although the lay-offs were reversed, unemployment fell
relatively fast and now stands at around 7.7 per cent.
Nearly half the upturn has thus been reversed. Job
vacancies are close to pre-crisis levels, indicating a con-
tinued decline in unemployment. Measured as yearly
averages, unemployment will be 7.3 per cent in 2011
and 6.9 per cent in 2012.
The 2008-2009 upturn in unemployment pushed down
the rate of pay increases. They fell from an annual
average of 4 per cent in 2009 to 2.7 per cent in the first
three quarters of 2010. Pay rises will accelerate again
in mid-2011 but remain around 3 per cent during our
forecast period. During much of 2010, HICP inflation
was around 1½ per cent, but by year-end it had risen
to 2.8 per cent, among other things driven by food and
energy prices. As an annual average, inflation was 1.7
60
per cent in 2010. We expect it to remain close to 3
40
per cent for another few months and then fall; annual
20 average inflation will be 2.3 per cent in 2011 and 2.0
per cent in 2012.
-20
The budget consolidation of the 1990s led to a decade
-40 of public surpluses. This created a favourable situation
-60 of relatively low public debt when the crisis broke out.
-80 Our assessment is that 2010 will be the worst year, with
10 a budget deficit of 3.2 per cent of GDP. The deficit will
then shrink to 2.5 per cent in 2011 and 2.2 per cent in
2012. Public debt as measured by the Maastricht crite-
rion will climb from 34 per cent of GDP in 2008 to more
than 50 per cent in 2012, partly as an effect of weak
GDP growth during the period as a whole.
 Economic data

DENMARK
Yearly change in per cent
2009 level,
DKK bn 2009 2010 2011 2012
Gross domestic product 1,660 -5.3 2.3 2.6 2.3
Private consumption 817 -4.3 1.9 2.3 2.5
Public consumption 492 3.1 1.2 0.0 0.5
Gross fixed investment 312 -15.4 -3.0 4.0 5.5
Stockbuilding (change as % of GDP) -2.4 1.0 0.0 0.0
Exports 784 -9.7 7.0 6.6 5.5
Imports 727 -12.1 5.5 5.7 6.2

Unemployment (%) 3.6 4.2 3.7 3.5

Consumer prices, harmonised 1.1 2.2 2.4 2.1
Wage cost 3.1 2.3 2.1 3.0
Current account, % of GDP 4.2 4.5 4.3 4.0
Public sector financial balance, % of GDP 3.6 -5.1 -3.5 -2.5
Public sector debt, % of GDP 41.4 44.0 46.0 46.0

FINANCIAL FORECASTS Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Deposit rate 1.05 1.05 1.30 1.55 2.10 2.65
10-year bond yield 3.25 3.55 3.65 3.75 3.95 4.20
10-year spread to Germany, bp 3 15 15 15 15 20
USD/DKK 5.47 5.32 5.14 5.32 5.44 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 0.1 2.7 2.5
Gross domestic product (Mainland Norway) 1,732 -1.3 1.9 3.1 3.2
Private consumption 956 0.2 3.5 3.7 3.5
Public consumption 487 4.7 3.0 2.2 2.0
Gross fixed investment 476 -7.4 -9.2 5.9 5.3
Stockbuilding (change as % of GDP) -2.6 2.9 0.0 0.0
Exports 1,008 -4.0 -1.7 1.4 2.0
Imports 638 -11.4 8.1 3.6 4.5

Unemployment (%) 3.2 3.6 3.5 3.4

Consumer prices 2.1 2.5 1.6 2.2
CPI-ATE 2.6 1.4 1.6 2.1
Wage cost 4.5 3.6 3.8 4.1

FINANCIAL FORECASTS Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Deposit rate 2.00 2.25 2.50 2.75 3.25 4.00
10-year bond yield 3.81 4.05 4.20 4.30 4.55 4.75
10-year spread to Germany, bp 60 65 70 70 75 75
USD/NOK 5.73 5.50 5.31 5.43 5.47 5.77
EUR/NOK 7.82 7.70 7.70 7.60 7.50 7.50

Nordic Outlook – February 2011  |  51

 Nordic key economic data

SWEDEN
Yearly change in per cent
2009 level,
SEK bn 2009 2010 2011 2012
Gross domestic product 3,089 -5.3 5.7 4.7 2.6
Gross domestic product, working day adjusted -5.2 5.4 4.7 3.0
Private consumption 1,527 -0.4 3.5 3.3 2.5
Public consumption 858 1.7 1.7 0.9 0.9
Gross fixed investment 550 -16.3 5.5 10.5 4.0
Stockbuilding (change as % of GDP) -1.4 0.7 0.2 0.2
Exports 1,495 -13.4 11.4 8.9 5.4
Imports 1,294 -13.7 12.7 8.5 5.3

Unemployment, (%) 8.3 8.4 7.3 6.6

Employment -2.1 1.0 2.1 1.1
Industrial production -19.4 10.2 9.0 4.0
Consumer prices -0.3 1.3 2.7 2.4
CPIX 1.9 2.1 1.7 1.5
Wage cost 3.4 2.0 2.3 3.9
Household savings ratio (%) 12.9 10.6 10.1 10.3
Real disposable income 1.5 0.9 2.7 2.8
Trade balance, % of GDP 3.2 2.5 2.8 2.9
Current account, % of GDP 7.2 6.5 6.0 6.0
Central government borrowing, SEK bn 176 1 -39 -48
Public sector financial balance, % of GDP -1.0 0.2 0.7 1.0
Public sector debt, % of GDP 41.9 37.6 33.5 30.8

FINANCIAL FORECASTS Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12

Repo rate 1.25 1.75 2.25 2.75 3.25 3.75
3-month interest rate, STIBOR 2.10 2.15 2.65 3.15 3.65 4.15
10-year bond yield 3.44 3.70 3.85 4.00 4.25 4.50
10-year spread to Germany, bp 22 30 35 40 45 50
USD/SEK 6.47 6.21 5.93 6.07 6.13 6.46
EUR/SEK 8.82 8.70 8.60 8.50 8.40 8.40
TCW 120.3 117.4 115.4 115.0 114.4 115.8

FINLAND
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 171 -8.1 3.0 3.5 3.0
Private consumption 94 -1.9 2.1 2.4 2.4
Public consumption 43 1.2 0.2 0.2 0.3
Gross fixed investment 33 -14.5 1.5 5.1 5.9
Stockbuilding (change as % of GDP) 0.9 0.2 0.1 0.0
Exports 64 -20.5 6.5 7.4 6.4
Imports 60 -18.1 4.3 6.0 6.2

Unemployment (%) 8.2 8.3 7.3 6.9

Consumer prices, harmonised 1.6 1.7 2.3 2.0
Wage cost 4.0 2.8 2.4 2.9
Current account, % of GDP 2.7 2.5 2.6 2.5
Public sector financial balance, % of GDP -2.5 -3.2 -2.5 -2.2
Public sector debt, % of GDP 43.8 47.1 49.7 51.9

52   |  Nordic Outlook – February 2011

 International key economic data

EURO ZONE
Yearly change in per cent
2009 level,
EUR bn 2009 2010 2011 2012
Gross domestic product 8,979 -4.0 1.7 1.9 1.8
Private consumption 5,170 -1.0 0.7 0.8 1.1
Public consumption 1,975 2.4 0.8 0.8 1.1
Gross fixed investment 1,773 -11.3 -0.6 4.2 4.1
Stockbuilding (change as % of GDP) -0.7 1.3 0.2 0.0
Exports 3,259 -13.1 9.8 6.1 5.3
Imports 3,140 -11.8 10.1 5.6 5.0

Unemployment (%) 9.5 10.0 9.8 9.5

Consumer prices, harmonised 0.3 1.6 2.0 1.4
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 14,277 -2.6 2.9 3.6 4.0
Private consumption 10,132 -1.2 1.8 3.2 3.0
Public consumption 2,934 1.6 1.1 0.4 0.0
Gross fixed investment 1,638 -18.4 3.8 10.3 14.5
Stockbuilding (change as % of GDP) -0.6 1.3 -0.4 0.0
Exports 1,690 -9.5 11.7 10.1 11.3
Imports 2,116 -13.8 12.6 5.3 10.1

Unemployment (%) 9.3 9.6 8.8 8.0

Consumer prices -0.3 1.7 1.5 1.6
Household savings ratio (%) 5.9 5.8 5.6 5.8

LARGE INDUSTRIAL COUNTRIES

Yearly change in percent
2009 2010 2011 2012
GDP
United Kingdom -4.9 1.4 1.5 2.5
Japan -6.3 4.0 1.6 1.6
Germany -4.7 3.6 3.1 2.5
France -2.5 1.6 1.7 1.5
Italy -5.1 1.1 1.3 1.5

Inflation
United Kingdom 2.2 3.3 3.7 2.4
Japan -1.3 -0.7 0.2 0.4
Germany 0.2 1.2 1.8 1.4
France 0.1 1.7 1.8 1.5
Italy 0.8 1.6 1.7 1.4

Unemployment (%)
United Kingdom 7.7 8.0 7.8 7.4
Japan 5.1 5.1 5.1 4.9
Germany 7.5 6.9 6.4 6.1
France 9.5 9.7 9.6 9.4
Italy 7.8 8.5 8.3 8.2

Nordic Outlook – February 2011  |  53

 International key economic data

EASTERN EUROPE

2009 2010 2011 2012

GDP, yearly change in per cent
Estonia -13.9 2.7 4.5 4.5
Latvia -18.0 0.0 4.0 5.0
Lithuania -14.7 1.3 4.0 4.5
Poland 1.7 3.8 4.5 4.8
Russia -7.9 4.0 4.6 5.0
Ukraine -15.1 4.5 4.6 4.4

Inflation, yearly change in per cent

Estonia 0.2 2.8 4.0 5.0
Latvia 3.3 -1.2 2.5 2.4
Lithuania 4.2 1.2 3.5 4.0
Poland 3.5 2.7 3.3 3.0
Russia 11.7 6.9 8.9 7.6
Ukraine 15.9 9.4 10.3 9.6

FINANCIAL FORECASTS

Feb 3 Jun 11 Sep 11 Dec 11 Jun 12 Dec 12
Official interest rates
US Fed funds 0.25 0.25 0.25 0.25 0.75 1.75
Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50
Euro zone Refi rate 1.00 1.00 1.25 1.50 2.00 2.50
United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.25 2.00

Bond yields
US 10 years 3.55 3.70 3.85 4.00 4.10 4.30
Japan 10 years 1.24 1.30 1.40 1.50 1.70 2.00
Germany 10 years 3.21 3.40 3.50 3.60 3.80 4.00
United Kingdom 10 years 3.78 4.00 4.15 4.30 4.40 4.60

Exchange rates
USD/JPY 82 86 87 90 94 98
EUR/USD 1.36 1.40 1.45 1.40 1.37 1.30
EUR/JPY 111 120 126 126 129 127
GBP/USD 1.61 1.61 1.69 1.67 1.69 1.67
EUR/GBP 0.84 0.87 0.86 0.84 0.81 0.78

GLOBAL KEY INDICATORS

Yearly percentage change
2009 2010 2011 2012
GDP OECD -3.5 2.7 2.8 2.8
GDP world -0,6 5.0 4.5 4.6
CPI OECD 0,1 1.5 1.5 1.4
Export market OECD -11.4 11.1 9.9 7.7
Oil price, Brent (USD/barrel) 61.9 79.8 90.0 90.0

54   |  Nordic Outlook – February 2011

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