Nordic Outlook 1002: Recovery with storm clouds

8/14/2019 Nordic Outlook 1002: Recovery with storm clouds

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FEBRUARY 2010

Recovery with storm cloudsAsia and the Nordics well positioned


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Nordic Outlook - February 2010

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SEB Economic Research

Robert Bergqvist, Chief Economist +46 8 506 [email protected]

Hkan Frisn, Head of Economic Research 763 [email protected]

Daniel Bergvall, Economist [email protected]

Mattias Brur, Economist [email protected]

Susanne Eliasson, Personal Finance Analyst [email protected]

Ann Enshagen Lavebrink, Research Assistant [email protected]

Ingela Hemming, Global Head of Small Business Research [email protected]

Mikael Johansson, Economist [email protected]

Tomas Lindstrm, Economist [email protected]

Gunilla Nystrm, Global Head of Personal Finance Research [email protected]

Johanna Wahlsten, Small Business Analyst 8072 [email protected]

Fax no. +46 8 763 9300SEB, Economic Research, K A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Kbel, Klaus Schrfer, SEB Frankfurt/M and Olle Holmgren,Trading Strategy. Stein Bruun, SEB Oslo is responsible for the Norwegian analysis.

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This report was published on February 16, 2009.Cut-off date for calculations and forecasts was February 12, 2009.


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Contents

International overview 4

The United States 12Japan 17

Asia 18

The euro zone 19

The United Kingdom 24

Eastern Europe 25

The Baltics 26

Sweden 28

Denmark 37

Norway 38

Finland 42

Nordic key economic data 43

International key economic data 45

Boxes

Reshaping the credit market 5

Will G20 coordination yield results? 9

The labour market in a longer perspective 14

Many jobs saved in Germany 20

Crucial situation for PIIGS countries 23

The fiscal policy framework incorporating establishedpractices into the Budget Act 36


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International overview

Recovery with storm cloudsAbove-trend global growth in 2010

Persistently low inflationLess and less room for crafting exit strategies

Credit market changes will bring tightening

Fed and ECB will hike rates around year-end

Euro will continue to weaken

In many respects, the global recovery has gainedstrength in recent months . Emerging Asian econo-mies are expanding rapidly, driven by domesticdemand and an export upswing. American growthwas unexpectedly robust in the fourth quarter and

signs of a labour market turnaround have becomeclearer. In Europe, too, the weakening of the labourmarket has been milder than expected, strengtheningthe potential for a recovery.

Meanwhile the road to balance is lined with challengesand risks. China must cool off its economy, butworries about the consequences of this haveillustrated that the world economy remains fragile anddependent on the Chinese growth engine. Develop-ments in southern Europe show how burgeoninggovernment debts and large refinancing needscan lead to full-blown crises of confidence . Ulti-

mately, this may lead to secondary effects that affectthe stability of the entire euro zone. Large countrieslike Japan, the United States and the United Kingdomare grappling with deep deficit problems, and this alsocontributes to heightened financial risks.

The period when all means were permitted in counter-acting depression and deflation risks of the crisis isnow over. The normalisation of economic policies isfast approaching. Recent flare-ups in trouble spots

indicate that the room for crafting exit strategieshas narrowed . The task of ensuring recovery whilepreventing new imbalances and bubbles from forminghas thus become increasingly difficult.

Our overall conclusion is that GDP growth in the 30member countries of the Organisation for EconomicCooperation and Development (OECD), measured asannual averages, will be around 2-2 per centduring the next couple of years . Due in part to aclear upward revision of the GDP outlook in Asianeconomies in purchasing power-adjusted terms, globalgrowth will exceed 4 per cent both this year and next.

Because of moderate GDP growth in the OECDcountries, resource utilisation will remain low. Unem-ployment will thus be stuck at high levels over thenext couple of years. This will dominate the inflationdynamic, leading to continued low inflation . There islittle risk that monetary stimulation will eventuallytrigger inflation.

GDP growthYear-on-year percentage change

2008 2009 2010 2011United States 0.4 -2.4 3.4 2.2Japan -1.2 -5.0 1.5 1.8China 9.6 8.7 10.5 9.0Euro zone 0.5 -3.9 1.7 2.0United Kingdom 0.6 -4.6 1.8 2.6Sweden -0.2 -4.5 3.1 2.7Norway 1.8 -1.0 2.3 2.4Denmark -0.7 -4.8 1.4 1.8Finland 1.1 -7.4 2.5 2.7Nordic countries 0.5 -4.1 2.4 2.4

Baltic countries -1.0 -15.9 -0.1 4.2Emerging markets 6.1 2.1 6.3 6.0OECD 0.6 -3.5 2.4 2.3World, PPP* 3.0 -0.7 4.5 4.3World, nominal. 2.0 -1.4 3.7 3.6* Purchasing power parities

Source: OECD, SEB

Our main scenario with moderate growth, lowinflation and cautious interest rate hikes implies arather favourable environment for asset prices in boththe stock and bond markets. In addition, we expectglobal economic policy collaboration, primarily amongthe G20 countries, to help strengthen macroeconomicstability and enable the world to avoid conflicts in thetrade and currency policy fields.

The main downside risks in this scenario are that largerefinancing needs by both governments and financialinstitutions may create a wave of financial marketinstability. This could interrupt the positive spiral of recovery in asset prices and greater optimism amonghouseholds and businesses that we have seen over thepast six months or so.

On the other hand, there is clear potential for strongergrowth if the pieces of the puzzle fall into place withregard to the financial situation. Extremely lowresource utilisation combined with continued strong

Year-on-year percentage changeGDP growth

Emerging markets OECDSource: OECD, SEB

00 01 02 03 04 05 06 07 08 09 10 11

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

forecastSEB


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Reshaping the credit marketFinancial conditions have improved significantly inthe past year. Government interventions, moretransparency and greater optimism have led to apositive spiral. Further credit losses are expected, buton a more controlled scale. Improved risk appetitehas pushed down yield spreads in the corporatebond market to levels not far from those prevailingbefore the crisis, while the volume of bond issueshas been very large. Systemic risk is limited; the toolsare available to handle problem institutions.

Concurrent with the awakening of the venture capitalmarket, the global banking system is facing contin-ued pressure for structural change . Creating abanking system that is smaller in volume but morestable and resilient is becoming an ever-clearerpolitical goal. In most cases such proposals are stillon the drawing board, but they will be synchronisedunder the aegis of the G20 and the Financial StabilityBoard.

In principle, the aim of these proposals put simply is to influence the balance sheets of systemically

sensitive institutions both in terms of size andcomposition (various assets in relation to variousliabilities). A global financial sector tax is now beingstudied by the International Monetary Fund (IMF) andothers. Its purpose would be to finance crisis meas-ures that have already been implemented, but itwould also aim at building up government buffersagainst future crises. By introducing a leverage ratiothat would limit the balance sheet size to a certainlevel in relation to equity capital, it would increasepressure to strengthen the capital base. This basewould meanwhile include new and better capital,compared to the present system.

These measures imply some re-regulation of thecredit market and would influence both credit supplyand cost of capital. In a longer perspective, a smallercredit market does not necessarily have to harmeconomic growth. Preliminary studies from the IMFand elsewhere show that weaker dynamism andflexibility may be offset by greater macroeconomicstability. Over the next couple of years, however, theprocess of adjusting to a new financial framework islikely to hamper growth:

Because of uncertainty about future financialsector regulations, investments and crucialstrategic decisions about financial sectorbusiness plans will be postponed . Lingeringrisks in the real economic/sectoral environmentwill create unclear credit status among individualmarket players, which will also hamper lending.

Small and medium-sized businesses mayexperience a credit squeeze in the next coupleof years as the lending volume of the bankingsector shrinks. The potential for funding bymeans of direct issues in the global securitiesmarket is open primarily to large, establishedcompanies.

Requiring banking systems to maintain moreand better capital, combined with a squeeze onprofitability, is very likely to result in higher capitalcosts and lower lending volume. This willinfluence the impact of monetary policy on theeconomic (through the interest rate and creditchannel). One conclusion is that a neutral keyinterest rate will be lower during the transforma-tion of banking systems to a new equilibriumsituation.

Year-on-year percentage changeSharp slowdown in bank lending

US Euro zoneSource: Federal Reserve, European Central Bank

99 00 01 02 03 04 05 06 07 08 09-7.5

-5.0

-2.5

0.0

2.5

5.07.5

10.0

12.5

15.0

-7.5

-5.0

-2.5

0.0

2.5

5.07.5

10.0

12.5

15.0

US yield spread against government securities, per centCredit market moves towards normalisation

Corporate bonds, Baa ratedInterbank rate (TED)

Source: Reuters EcoWin

Jan07

May Sep Jan08

May Sep Jan09

May Sep Jan10

0

1

2

3

4

5

6

0

1

2

3

4

5

6


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monetary policy stimulus might lay the groundwork for a powerful rebound. Very strong balance sheetsamong industrial companies, combined with a deeplydepressed level of capital spending, are also argu-ments for a strong recovery than in our forecast for2010.

Asia continues to drive world economyStrong external balances and relatively little exposureto global financial problems helped Asian emergingeconomies maintain good momentum during 2009.Most of these countries were also able to take advan-tage of dynamic regional trade, sustained by Chinesestimulus policies. Asia thus played an important role instabilising the world economy during the most acutephase of the crisis.

Contributions to global GDPgrowth in 2010Percentage point

PPP NominalUnited States 0.59 0.67Japan 0.08 0.10Euro zone 0.21 0.30United Kingdom 0.04 0.06OECD 1.24 1.51China 1.34 0.82Emerging economies 3.22 2.23World 4.50 3.70Source: OECD, SEB

Looking ahead, Asia will also continue to serve asan engine of the world economy . The influx of capital to Asia will continue, and growth forces willbroaden. Due to significantly lower government debtthan in the OECD countries, the need for fiscalconsolidation will be far smaller. Emerging economies,especially in Asia, will account for the lions share of global expansion in 2010. This is especially true if wemeasure in terms of purchasing power parities (PPP).

A number of Asian countries have now initiatedmonetary tightening measures, mainly for the purposeof slowing excessively rapid credit growth that maylead to bubble tendencies in asset prices. In ourassessment, risks of a broad-based upturn in inflationare still rather small. Resource utilisation is notalarmingly high, and these countries have becomemore adept at neutralising the effects of internationalcommodity price increases. Rather mild tightening isthus probably sufficient, which means good prospectsof continued growth at a rather high level .

Strong Nordic fundamentals pay offDuring 2009, Norway put up a decent resistance tothe international downturn, while the other Nordiccountries were relatively hard hit. Because the Finn-

ish and Swedish economies are dependent on theglobal manufacturing cycle, their GDP declines werelarger than the OECD average. In Denmark, seriousimbalances in the housing market contributed to asharp economic slide.

The Nordic countries remain highly dependent on theinternational economy, but future global economicgrowth will be hampered mainly by public sectorconsolidation programmes that will curb domesticdemand. In such a situation, the secondary effectson the Nordic countries will be significantlymilder than during the acute credit crisis, when

global trade came to a sudden halt. Looking ahead, wethus believe that the Nordic countries may benefit to agreater extent from their good fundamentals in theform of large current account surpluses and stronggovernment finances, viewed in an internationalperspective.

Norway will benefit from high oil prices and extreme-ly strong public finances. Very low mortgage interestrates in Norway and Sweden have kept home pricesup, helping sustain consumption. Meanwhile Swedenand Finland will benefit from the upswing in globaldemand for industrial products; their export structure

will be an advantage in the recovery phase. In Den-mark, the recovery will be more listless, due toprotracted adjustment problems in the constructionand housing sector.

Baltics: Light at end of long tunnelThe most acute crisis period in the three Balticcountries appears to be over. The Baltics have takenadvantage of the incipient recovery in global demand.We have thus revised our GDP forecasts for Estoniaand Lithuania upward. We expect these economies tobegin growing again during 2010. Their governmentsausterity policies have remained in place, bolsteringconfidence in the Baltic strategy of maintainingcurrency pegs to the euro with the aid of internaldevaluation. As a result, local interest rates have beenpushed down sharply.

Per cent of GDPDivergent government debt burdens

Developed economiesEmerging markets

Nordic countries

Source: OECD, SEB

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

30

40

50

60

70

80

90

100

110

30

40

50

60

70

80

90

100

110

SEB forecast


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Estonia probably meets all the criteria for euro zonemembership. We thus assume it is overwhelminglylikely that Estonia will be accepted as a memberfollowing the evaluation that will occur this spring andthat it will adopt the euro on January 1, 2011.

Difficult challenges and political tensions remainbefore the economic crisis is over. This is especiallytrue of Latvia, whose ability to live up to the require-ments established by the IMF and EU for the comple-tion of their bail-out loan programme remains uncer-tain.

Persistent low inflationDuring May-September 2009, Consumer Price Index(CPI) inflation in the OECD countries as a whole wasbelow zero for the first time in many decades. It thenrebounded, entirely as forecasted, to almost 2 per centas the effects of earlier energy price declines eased.Core inflation has continued to move downward andis now around 1.5 percent. The continued decline incore inflation supports our fundamental view that lowresource utilisation is the dominant force in theinflation process .

According to most indicators, core inflation will keepmoving lower. Producer prices will be more subdued,and the rate of wage and salary increases is moving

towards its lowest level in the post-war period. Asproductivity recovers in Western Europe, companiescosts will also ease. We thus expect core inflation tocontinue downward, bottoming out at around percent both in the US and the euro zone by year-end.The energy-driven rebound in the CPI will continueover the next few months, but CPI inflation will laterdecline, too. Overall, this implies that inflation willremain below central bank targets or comfortzones for price stability.

Inflation risks exaggeratedDespite favourable inflation trends to date, there isuncertainty about inflation in a longer perspective.Several risk aspects are being discussed:

The sharp increase in the monetary base maylead to inflation . This may be connected to thefact that some countries will be tempted to solvetheir imbalance problems by inflating away theburden of government debt in real terms.

Output gap measurements may prove toounstable. This may, for example, be due to difficul-ties in assessing how much production capacityand labour are permanently sidelined during thecrisis.

Strong growth in Asia may lead to intensifiedcompetition for finite natural resources and maythus lead to a sharp price upturn for commodi-ties .

Economic policy will include sizeable elements of tax hikes that drive up inflation . This may applyto value-added tax hikes that are part of budgetconsolidation programmes, as well as higherenvironmental taxes.

We regard these risks as exaggerated, however.Monetary expansion has been a necessary element of the stabilisation of the banking sector. Broad measuresof money supply growth are continuing to slow,

which demonstrates that monetary expansion is notleaking into the real economy . Not until the appetitefor capital spending and consumption have returned insuch a lasting way that resource gaps in the economyare nearly closed will we face a genuine inflationthreat. Our conclusion is that the central banks haveboth the time and the instruments to withdrawexcess liquidity from the banking system .

Nor do we believe that commodity prices will pose amajor inflation threat over the next couple of years. Inthe short term, we anticipate a minor downturn inprices. In a somewhat longer perspective, too, the

moderate increase in global demand from deeplydepressed levels implies that imbalances of the kindthat prevailed during 2004-2007 remain relativelyremote. In this environment, the Organisation of

Year-on-year percentage changeCore inflation approaching zero

Euro zone USSource: Eurostat, BLS, SEB

98 99 00 01 02 03 04 05 06 07 08 09 10 110.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

forecastSEB

Year-on-year percentage changeInflation in the OECD countries

Core inflation CPISource: OECD

00 01 02 03 04 05 06 07 08 09-1

0

1

2

3

4

5

-1

0

1

2

3

4

5


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International overview .

Petroleum Exporting Countries (OPEC) is also highlycapable of keeping oil prices at around the USD70-90/barrel level .

Inflation expectations measured on the basis of pricing in the inflation-linked bond market haveadmittedly risen somewhat, but we regard this mainlyas a normalisation after the deflation worries thatprevailed during the most acute phase of the crisis.Expectations in a five-year perspective are nowaround 1 per cent in the euro zone and around 2 percent in the US. In light of the risk scenarios for theworld economy that have been discussed in recentyears, our main conclusion is that confidence in theability of the central banks to keep inflation stable hasbeen remarkably strong.

Fiscal stimulus now exhaustedThe recent flare-ups of market crises and instabilitydemonstrate a great need for economic policy exitstrategies . Overheating risks in Asia, collapses of confidence in southern European fiscal policies andlong-term question marks about strategy choices inthe US economy are all evidence that the period whenall means were permitted in counteracting depressionand deflation risks of the crisis is now over. But thetask of safeguarding the path to recovery without

building up new imbalances is not easy. It is neces-sary to find a suitable mix between fiscal and mone-tary policy that also takes into account the restructur-ing of the financial system.

Rising government debts represent an increasing-ly acute problem for fiscal policy . When the credi-bility of efforts to create sustainable public financescomes into question, businesses and households mayalso become more cautious in the short term. In atheme article in the November issue of Nordic Out-look , we presented a table on the thrust of fiscalstimulus policies. Our conclusion was that fiscal

policy measures provided a positive growth impulseequivalent to 2 per cent of GDP in the G20 countries.Most stimulus measures will remain in place during2010, but since their effect on growth is determined

by fiscal policy changes, the growth impulse in 2010will be neutral or slightly negative.

We expect the fiscal policy picture in 2011 to become

clearer when the G20 countries present their medium-term consolidation programmes in preparation forsynthesis and evaluation by the IMF (see box). Activecost savings measures will probably begin in variouscountries during 2011, but most implementation lies afew years ahead in time. At present, we estimatethe tightening effect in 2011 at 1 per cent of GDP .Our conclusion is that even if deficits persist andgovernment debts continue to grow, fiscal measuresto prop up the economy are unavoidably disappearing.

Fed and ECB hikes by around year-end

Aside from fiscal policy, changes in financial sectorinfrastructure and rule systems will determine theshape of future interest rate policies. Our conclusion(see the box on Reshaping the credit market) is thatan adjustment of bank balance sheets implies mone-tary policy tightening via the volume side andhigher capital costs . This will hamper economicactivity and all else being equal reduce the needfor interest rate hikes.

Most leading Western central banks have also contin-ued to emphasise the seriousness of the crisis and thefragility of the recovery. Their top priority has been topersuade markets that the zero interest rate policy willnot change in the near future, even in a situation of stabilising economic conditions and labour markets.One reason for this is that fiscal policy and thefinancial system generally can only change in onedirection, and this will have a tightening effect onthe economy. In such a situation, the central banksview the risks that low interest rates will give rise tobubble-like price increases in asset markets as beinglimited.

We thus anticipate that it will take as much as oneyear before central banks in the largest industrialisedcountries begin their interest rate hikes. The FederalReserve, the European Central Bank and the

5 years, per centBreak-even inflation

Euro zone US SwedenSource: Reuters EcoWin

06 07 08 09 10-3

-2

-1

0

1

2

3

-3

-2

-1

0

1

2

3

Per centKey interest rates

Euro zone US Bank of EnglandSource: ECB, Fed, BoE, SEB

00 02 04 06 08 100

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

forecastSEB


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Bank of England will all begin a cautious processof normalisation around year-end 2010 . Late in2011, we expect key interest rates to stand at 2.0 percent in the US and the UK, while the ECB rate which is starting from a higher level will reach 2.5per cent.

The situation varies greatly, however, both withregard to the strength and sustainability of the recov-ery and the need for fiscal consolidation. A number of central banks in emerging economies will carry outinterest rate hikes during 2010. Norges Bank hasalready raised Norways key rate twice, and the ratewill continue upward to 4.25 per cent by late 2011.We also expect Swedens Riksbank to hike its keyinterest rate in July, and we foresee a repo rate of 3.0per cent by late 2011.

Weak upturn in bond yieldsLong-term bond yields in Germany and the US havemainly moved sideways since mid-2009. Over thepast 2-3 months, however, American yields havetended to rise while German ones have instead showna downward trend. This has opened the way for ayield spread of around 60 basis points. German 10-year yields are now around 3.20 per cent: only about30 basis points above their lows early in 2009.

Because of deeply depressed short-term interest rates,we now have a historically steep yield curve; in theUS it is steeper than at any time in the past twodecades. Such a yield curve slope is normally anindicator of an improved business cycle by reflect-ing a situation where a prolonged expansionarymonetary policy is combined with rising optimism andrisk appetite. However, long-term yield levels are atpresent to a unusually high degree influenced by large

deficits, and in the American case, increased uncer-tainty about the long-term inflation outlook. Theinterpretation of the yield-curve slope thus becomesmore double-edged.

Viewed from the standpoint of financial stability, asteep yield curve on securities contributes to greaterearning capacity by making it possible to borrowshort-term and invest long-term. On the other hand,rising long-term yields also risk creating unrealisedlosses in government bond holdings, which wouldweaken the financial system.

Looking ahead, we foresee driving forces for long-

term yields pushing in different directions. Theeconomic situation is continuing its gradual improve-ment, and central bank rate hikes are moving evercloser. Meanwhile budget deficits will remain high,which implies a persistent large supply of governmentsecurities. This will push up yields, especially forsmall countries with fiscal imbalances.

Will G20 coordination yield results?The meetings of the G20 countries during 2009helped to calm financial markets and bolster opti-mism, since the leaders of major economies wereable to show a high degree of common understand-ing of the problems. This year, the ambition is tomake this cooperation more concrete and formal.Early in 2010, the G20 countries are expected topresent medium-term economic forecasts along withplans for how they intend to restore order to theirpublic finances as well as strengthen the prospectsof long-term stable growth.

The IMF has been entrusted with compiling theseplans and forecasts as well as analysing theirconsequences at the global level. The point ofdeparture of this process is that no countrys planmay adversely impact growth in another country. At theG20 meeting next June in Canada, G20 heads ofstate and government will decide among variouspolicy options for strengthening the potential forstable, sustainable global growth. This agendaseems hectic, and it is likely that more concrete

decisions will be postponed until the summitmeeting in South Korea next November.

The G20 countries will also discuss tax policy trade-offs between rapid improvement in the budgetsituation and any adverse effects on capital spendingand consumption. The G20 and the IMF will also beinvolved in the issue of changing the framework ofmonetary policy . The G20 will also discuss the issueof how the international monetary system can bedesigned in a way that will be less dependent on onecurrency (USD).

Ambitions are thus high and the agenda is far-reaching. It remains to be seen to what extent theG20 countries are capable of easing tensionssurrounding trade policy, currency rate issues andfinancial system issues that lie below the surface.The G20 countries have made agreements onworking principles, but their actual degree of enthusi-asm about reaching decisions may, of course,diminish in case of a clear economic recovery.

Government bonds, 10 year minus 2 yearSteep yield curve

US GermanySource: Reuters EcoWin

90 92 94 96 98 00 02 04 06 08 10

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0


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On the other hand, we expect inflation pressure tocontinue downward and confidence in low inflationpolicies to last. Together with changes in financialinfrastructure, this will probably cause estimates of neutral key interest rate levels to be adjusted down-ward. In addition, credible budget consolidationprogrammes may also help curb the upturn in long-term yields.

Overall, we expect a moderate upturn in long-termyields over the next couple of years. US 10-yearyields will stand at 3.95 per cent at the end of 2010,and German ones at 3.40. Looking ahead one year, weexpect Swedish 10-year yields to be about 20 basis

points higher than German ones, primarily due toSwedens earlier key interest rate hikes. Norges Bank is far ahead of the ECB in the rate hiking cycle, whichwill contribute to a yield spread between Norway andGermany of about 70 points at the end of 2010.

Stock markets at a new crossroadsThe powerful recovery that has dominated stock markets since the spring of 2009 has reflected agradually diminishing likelihood of a world economiccollapse. This, in turn, has depended upon risingconfidence in the ability of economic stimulus meas-

ures, combined with guarantees for the financialsystem, to turn around the economic cycle. In such asituation, the flow of weak actual macroeconomicfigures has been interpreted as less important to thefuture trend of profits, especially as forward-lookingindicators began to rebound. In the past month, wehave seen a correction in the worlds leading stock markets that has been especially clear in the emergingmarkets field. The positive force has weakened, partlydue to a natural process after a strong developmentlast year, and partly due to new economic and politicaluncertainties that has made the outlook more uncer-tain.

Our macroeconomic scenario moderate growth,low inflation and low interest rates implies funda-mentally favourable conditions for asset prices,

especially equities. If this scenario materialises, thereis clear potential for a further stock market upturn inthe coming year. Despite rising risk appetite and arenewed search for yield, valuations in most stock markets are still moderate.

Meanwhile, however, there are various macro-relatedrisks. In many branches of industry, there are stillquestions about the demand side. Profits have beenmaintained at tolerable levels with the help of sharpcost-cutting, but hopes of imminent improvement inthe order situation have so far been dashed. As aresult, industrial firms have remained dependent onChinas role as an economic engine. This is helping to

fuel concerns that a sharp tightening of Chineseeconomic policy might halt the upturn in the worldeconomy. Another factor influencing industrial com-panies is that fiscal imbalances might lead to interestrate instability that would halt the recovery. Ourconclusion is that a number of questions need to beaddressed before the potential for continued stock market recovery can be realised.

Worries, imbalances driving currenciesIn recent years, the forces driving currency ratemovements have changed as the economic crisis has

assumed different shapes. Last autumn, currenciesthat benefit from rising risk appetite generally gainedstrength. The currencies of fast-growing Asiancountries benefited from capital flows stimulated bythe regions dynamism. In the future, issues related tolong-term rebalancing of global demand and the abilityof the euro zone to deal with internal problems willplay a central role in currency rate movements.

Chinas currency rate policy will be increasinglycrucial to any chances of reducing global imbalancesby encouraging greater domestic demand in Asia and amore export-oriented American economy. In Novem-

bers Nordic Outlook

, we examined arguments for animminent resumption of yuan appreciation against theUS dollar. The Chinese currency has been underval-ued for a long time. Now that Chinas economic

Per cent10-year government bond yields

US GermanySource: Reuters EcoWin, SEB

99 00 01 02 03 04 05 06 07 08 09 10 112.0

2.5

3.0

3.5

4.0

4.5

5.0

5.56.0

6.5

7.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.56.0

6.5

7.0

SEBforecast

Index 100 = January 2007Stock market performance

Sweden OMXSUS S&P 500

Emerging markets FTSE USD


Jan07

May Sep Jan08

May Sep Jan09

May Sep Jan10

405060708090

100110120130140150

405060708090

100110120130140150


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recovery is on firmer ground, the time seems ripe forthe country to relinquish its CNY/USD peg. Weinterpret the Chinese central banks new policystatement that the value of the yuan will reflectchanges in international capital flows and the trendsof major currencies as a signal to this effect.

We predict that the appreciation of the yuan againstthe dollar will total 7 per cent during 2010, beginningthis spring. After that, additional appreciation of thesame magnitude will occur in 2011. Chinese currencyappreciation would also help strengthen otherAsian currencies . In addition, interest rate differen-tials against the West in the wake of strong growth in

many countries will drive currency rate movementsfurther.

The fiscal crisis in the PIIGS countries (Portugal,Italy, Ireland, Greece and Spain) has contributed to aclear weakening of the euro in recent months. Thereason why this crisis has had such a large impact onfinancial markets is probably that it exposes funda-mental problems in the euro system . The principleunderlying euro zone regulations regarding govern-

ment budget deficits, debts and so on is that nocountry should pursue an irresponsible fiscal policy atthe expense of the other member countries. The crisishas revealed that many countries have failed to take

advantage of the lengthy economic expansion in orderto save and improve their structural position.

The problems in the euro system have pushed down

the euro from the strong position it enjoyed lastautumn. We believe this will have long-lasting conse-quences and that the pain threshold for how muchthe euro zone economies can tolerate has been low-ered. We thus expect a gradual adjustment of theEUR/USD exchange rate towards levels closer to itslong-term equilibrium. We predict that the euro willreach USD 1.30 by the end of 2010 and 1.25 by theend of 2011. The British pound will also regain groundagainst the euro. By the end of 2011, the EUR/GBPexchange rate will be at 0.80. The reason why theeuro will not weaken further is that the deficit prob-lems in the US and UK are more severe than in the

core euro zone countries.The Nordic currencies will appreciate further againstthe euro in the coming year. Swedens strong currentaccount balance, an improved export outlook andrelatively early interest rate hikes by the Riksbank point towards SEK appreciation. We expect the EUR/ SEK exchange rate to stand at 9.50 a year from now.But the SEK is still undervalued from the standpoint of fundamentals. Combined with continuing weakness insome euro zone countries, this might allow furtherappreciation to 9.20 by late 2011.

The Norwegian krone will also strenghten in thecoming year. Norways central bank has alreadystarted interest rate hikes, fiscal policy is expansionaryand oil prices are relatively high. Looking ahead oneyear, the EUR /NOK exchange rate will stand at 7.80.During 2011, however, we expect the NOK to weak-en. When other central banks begin to carry out theirrate hikes, we believe that the EUR/NOK exchangerate will move back towards levels more in line withfundamental valuations and historical averages. At the

end of 2011, the EUR/NOK rate will be 8.00.

USD/CNY and indexChina: Exchange rates

Nominal effective exchange rate (RHS)USD/CNY (LHS)


05 06 07 08 09 1095

100

105

110

115

120

125

1306.75

7.00

7.25

7.50

7.75

8.00

8.25

8.50

Worries about Greece weakening the euro

EUR/USD (LHS)10-year yield spread, Greece-Germany (RHS)


Jun07

Sep Dec08

Mar Jun Sep Dec09

Mar Jun Sep Dec10

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.01.20

1.25

1.30

1.35

1.40

1.45

1.50

1.55

1.60

Krona tracks business optimism

EUR/SEK (LHS)Business confidence, net balance (RHS)

Source: NIER, SEB

98 99 00 01 02 03 04 05 06 07 08 09

-60

-50

-40

-30

-20

-10

0

10

20

308.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0


12/4812


The United States

Strong growth this year,weaker in 2011

Inventory-driven recoveryListless labour market recovery

Fed will hike key rate in December

The American recovery has shifted into higher gear.According to preliminary figures, GDP grew at anannualised 5.7 per cent rate in the fourth quarter of 2009, the strongest performance since 2003. A sharpswing in the inventory cycle explains more than half this upturn. The inventory cycle, along with expansiveeconomic policies, will also contribute greatly to

decent growth figures during the first half of 2010.

But it is still too early to breathe a sigh of relief. Thefirst challenge will appear later this year, when theimpact of the inventory build-up fades historicalexperience shows that an inventory surge usuallysubsides after about three quarters and US fiscalpolicy assumes a mildly tightening direction. By mid-year, other growth forces must kick in. Householdsnormally take over the lead, but due to rather listlesslabour market recovery and continued debt reduction,consumption will not gain much momentum. We thusexpect economic growth to slow significantly duringthe second half. Overall, this means that GDP growthmeasured as an annual average will end up at 3.4 percent in 2010 and 2.2 per cent in 2011 .

With unemployment stuck at high levels, low inflationpressure and low manufacturing capacity utilisationare likely. The Federal Reserve is thus not in a hurryto raise its key interest rate, despite certain signs of rising inflation expectations. The first rate hike willcome in December 2010 . One year later, the federalfunds rate will stand at 2.00 per cent.

Indicators point in different directionsLeading industrial indicators paint a bright economic

picture. The ISM purchasing managers index for themanufacturing sector is at a level that according tofamiliar rules of thumb is compatible with GDPgrowth of around 5.5 per cent. Our forecast impliesthat industrial production, among other things helpedby the upturn in the automotive industry, is chuggingalong at a decent pace. Besides, capital spending levelsare depressed, which means there is great potentialfor a rebound when capacity utilisation recovers.Capacity utilisation has climbed more than 3 percent-age points since it bottomed out but is still 12 percent-age points below its long-term average. This will holdback capital spending this year. Our forecast is thatcorporate capital spending will level off in 2010and grow by 8 per cent in 2011 .

The strength of the manufacturing sector stands insharp contrast to the weakness of other sectors. Thenon-manufacturing ISM index is stuck at around 50,and our composite ISM index weighted to reflectthe size of each sector in the economy is compatiblewith GDP growth of a modest 2 per cent. Thisindicator has slightly higher correlation with GDP thanISM manufacturing.

The situation is toughest for small businesses. Thedifference between the National Federal of Independ-ent Business (NFIB) small business index and the ISM

IndexISM is high while NFIB stuck in the cellar

ISM Manufacturing (LHS) NFIB (RHS)Source: ISM, NFIB

86 88 90 92 94 96 98 00 02 04 06 08 100

5

10

15

20

25

30

30

35

40

45

50

55

60

65

Index, year-on-year percentage change

ISM does not indicate very strong growth

ISM Composite index (LHS) Real GDP (RHS)Source: ISM, Department of Commerce

98 99 00 01 02 03 04 05 06 07 08 09-4

-3

-2

-1

0

1

2

3

4

5

6

35.037.540.042.545.047.550.052.555.057.560.062.5

Annualised

Fiscal stimulus and inventories areboosting GDP

Inventory contributionNet effect of stimulus

GDP growth

Source: CBO, Recovery.gov, SEB

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q409 10 11

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6


13/4813


The United States

has never been larger since small business surveysbegan in the mid-1980s. Exposure to a weak domesticmarket and difficulties in obtaining loans may explainthe problems of small businesses. The large corpora-tions in the ISM index, however, are benefiting fromgood momentum in the export sector, while enjoyingstrong balance sheets and essentially unlimited accessto cheap loans.

Rising household incomePowerful fiscal stimulus measures have succeeded instopping the decline in consumption. Cash forclunkers auto rebates, tax cuts and higher transferpayments their share of income is at a record level have contributed to rising consumption during theautumn and winter. According to the Conference

Board index, consumer confidence stood at 55.9 inJanuary, a clear improvement compared to its darkestmonth (25.3 in February 2009). But viewed in ahistorical perspective, these levels are low. Consumerconfidence is usually well above 100 during cyclicalupturns. During recessions, it averages 72.

In recent years, US household saving has undergone asignificant adjustment. Saving as a percentage of disposable income rose from 1.7 in 2007 to 4.6 percent in 2009, measured as an annual average, but oursavings model indicates a continued need for adjust-ment. In our assessment, saving will gradually rise in

the next couple of years. This is supported by arecord-low appetite for credits; lending has fallen in14 of the past 15 months. Unlike the situation duringthe last recession, weak income growth is thus notbeing offset by credit expansion.

Luckily a labour market turnaround is imminent. Alarger number of hours worked will mean that incomewill stop falling and turn upward. After a weak 2009,our forecast is that disposable income will grow by

about 3 per cent both this year and in 2011 .Income will grow more strongly than for many years during the 2001-2007 economic expansion, annualincome increased by an average of 2.7 per cent and

might justify more vigorous growth in householdconsumption than we foresee. But since householdsare continue to pay down their debts their debt-to-income ratio remains at historically high levels consumption will be restrained. Our forecast is thathousehold consumption will increase about 1.5 percent annually this year and next .

Shaky housing marketThe housing market is the sector that has benefitedthe most from government stimulus packages, whichis mainly reflected in falling home mortgage interestrates and a powerful upswing in existing home sales.Home prices have risen for 6 months in a row,

according to the S&P/Case-Shiller index. Tax creditsto first-time buyers, which have been both extendedand expanded, seem to have placed a floor underhome prices and attracted buyers into the market.

On the other hand, the supply situation looks alarm-ing, even though the upturn in housing starts hasceased. There are more than 9 million empty single-family homes and condominiums in the US. With arecord 11 per cent vacancy rate for rental units, there

is a risk-free alternative to home buying. The demo-graphic demand to absorb this home supply mighthave looked better. Employment in the key 25-44 yearold age category has fallen 8 per cent in the past two

MillionsExisting home sales way off the lows

Source: Department of Commerce, National Association of Realtors

99 00 01 02 03 04 05 06 07 08 093.50

4.00

4.50

5.00

5.50

6.00

6.50

7.00

7.50

0.30.40.50.60.70.8

0.91.01.11.21.31.41.5

New (LHS)Existing (RHS)

Home sales:

3-month annualised, year-on-year % changeWorking hours are expanding

3-month annualisedYear-on-year percentage change

Source: BLS

86 88 90 92 94 96 98 00 02 04 06 08 10-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

Year-on-year percentage changeNot a good combo for consumer spending

Consumer credit Wage and salar iesSource: Federal Reserve

60 65 70 75 80 85 90 95 00 05 10-5.0

-2.5

0.0

2.55.0

7.5

10.0

12.5

15.0

17.5

20.0

-5.0

-2.5

0.0

2.55.0

7.5

10.0

12.5

15.0

17.5

20.0


14/4814


The United States

years. With alternative home price indices such asLoanPerformance and Radar Logic having fallen onceagain, there is a clear risk that the dominant Case-Shiller index may also be affected by near-termdisappointments.

Construction industry confidence indicators are hardlypointing towards an imminent upturn. The NationalAssociation of Home Builders (NAHB) index has fallenduring the autumn and winter. Worries about thecontinuing weakness of the labour market may be oneexplanation. In addition, there is a large volume of foreclosure sales in the pipeline. According toMoodys, another 2.4 million single-family homes will

be auctioned off this year. The tough conditions thatstill typify bank lending are another factor. Applica-tions for new mortgage loans remain at low levels.Our overall assessment is that the housing marketsituation looks more worrisome today than a fewmonths ago.

Listless labour market recoveryIn recent months, US labour market statistics havebeen somewhat stronger than we foresaw in theNovember issue of Nordic Outlook . A labour marketturnaround appears relatively imminent. Given ourforecast of above-trend growth this year, we expectemployment to increase by a monthly average of morethan 150,000 during 2010. In addition, nearly a millionpeople will gain temporary jobs this spring when theUS Census Bureau counts the population.

One key question is whether unemployment will fallquickly or remain stuck at current levels, as it didduring the two previous cyclical upswings. We seeseveral important reasons why the employment upturnand the downturn in joblessness will be sluggish.

New unemployment benefit claims admittedlyshow a clear decline in lay-offs, but new hiring isconspicuously missing. Especially in small busi-nesses, which historically account for 50-60 per

The labour market in a longerperspectiveFrom a labour market standpoint, the 2000s were alost decade. In 2000, US employment stood at 131million. Ten years later, the number of people with

jobs remained the same. Meanwhile the labourforce had increased from 146 to 159 million and thepopulation by 30 million. Employment as a percent-age of population (the employment rate) has fallenby more than 5 percentage points from its peak in2007. The Fed has singled this out as an alternativemeasure of resource utilisation. Taking into accountthat the labour supply grows over time, a return to fullemployment in five years is equivalent to around 20million new jobs, according to this measure. Thegap illustrates the social tensions generated when

fewer and fewer people can support themselves byworking. On the other hand, it also illustrates thelong-term growth potential that exists if the American

economy can renew itself and once again achieve fullresource utilisation.

Employment/population ratio, per centThe employment rate down like a rock

Source: BLS

50 55 60 65 70 75 80 85 90 95 00 05 105455

56

57

58

59

60

61

62

63

64

65

5455

56

57

58

59

60

61

62

63

64

65

Month-on-month percentage changeUS home prices going where?

Loan performance indexS&P Case-Shiller 10

Source: First American Corelogic, Standard & Poor's

00 01 02 03 04 05 06 07 08 09-2.5-2.0-1.5-1.0-0.50.00.51.01.52.02.5

-2.5-2.0-1.5-1.0-0.50.00.51.01.52.02.5

Non-farm payrolls, recession trough = 100A jobless recovery so far

1954-1982 average1991

2001Most recent

Source: BLS, NBER

-3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 1499

100

101

102

103

104

105

106

107

99

100

101

102

103

104

105

106

107

Note: Assuming the recession ended in June 2009.


15/4815


The United States

cent of the job creation, hiring plans plans remainat very low levels.

Many companies have laid off employees tempo-

rarily and introduced shorter work weeks. Averageworking hours are still at levels that are equivalentto the loss of another two million full-time jobs, inaddition to the actual employment downturn of 8.4million. Those who already have jobs will first haveto increase their hours, since this is both easiestand cheapest for employers.

The manufacturing, construction and the financialsector downturn is equivalent to about half the totalloss of employment. Many of these jobs may belost for good.

Long-term unemployment (out of work for 27weeks or longer) is at a record level: 6.3 million or43 per cent of all jobless people fit into this catego-ry. There is a risk that the skills they need to returnto the labour market will be eroded.

Our conclusion is thus that the recovery, like the twoprevious ones, will be of a clearly jobless nature.This means that unemployment will remain at a highlevel; measured as an annual average it will be slight-ly above 9 per cent in 2011 .

Spare capacity will hold down inflationHeadline CPI inflation has climbed rapidly, from -1.9per cent last summer to 2.8 per cent today, but theupturn is due to the disappearance of negative energy-related base effects from the twelve-month statistics.These effects will now fade and inflation will fallagain. In terms of annual averages, CPI will endup at 1.6 per cent this year and 0.7 per cent in2011 .

The core inflation measure excludes such volatile

components as food and energy. One recurringpattern is that core inflation falls during the first yearof a recovery. Historically, this applies regardless of

the strength of the recovery, the trend of commodityprices and monetary policy. The spare capacity thathas been built up seems to offset price increaseselsewhere.

There is admittedly some uncertainty about the degreeto which the recession has wiped out productioncapacity and pushed up equilibrium unemployment.Yet our assessment is that because of its extremelysharp upturn, actual unemployment is far above theequilibrium level. We thus also believe that output gapand Phillips curve mechanisms will dominate priceformation over the next couple of years. For example,unemployment among highly educated people is at arecord level, which should keep down wages andsalaries in the highest income groups.

Another important reason why we foresee lowinflation is that the sluggish interest rate component inthe CPI has systematically crept downward. Rentshave fallen month-on-month for five months in a row.Rents and single-family home expenses account forabout 30 per cent of the CPI basket. Since 4.7 millionUS rental units are empty (15 per cent more than ayear ago), the downturn may be prolonged.

Productivity, which has grown by an impressive 6.7per cent on average for the past two quarters, willprobably continue climbing for a while. Productivitygrowth will end up at 3.5 per cent this year and 1 percent in 2011. Unit labour cost will fall 1 per cent thisyear and then rise by 0.5 per cent in 2011. Lookingfurther ahead, this will lay the groundwork for higheremployment and robust real wage increases. Viewedover our forecast period, however, the resourcesituation, household income expectations, the percent-age of businesses planning to raise prices and actualevents point towards a continued price and wagesqueeze. Instead, productivity will trickle down intocompany profit margins. Overall, we anticipate thatcore inflation will fall from 1.1 per cent this yearto 0.5 per cent next year .

Fading stimulus effectsAfter one year in power, President Barack Obamafaces mounting headwinds. Health care reform, whichappeared poised for approval before Christmas, raninto major obstacles. Meanwhile the Democrats havelost their supermajority in the Senate. This means, inturn, that it may be difficult for the administration toenact new stimulus measures. The 2009 stimuluspackage will nevertheless provide a big push to GDPgrowth during the first half of 2010. But withoutrenewed legislation, the situation may become criticalin 2011 when a combination of expenditure cuts andtax hikes leads to a tightening equivalent to 2.5 percent of GDP, according to Congressional BudgetOffice (CBO) estimates. Such a powerful headwindmight threaten the economic recovery.

Year-on-year percentage changeBenign inflation outlook

Core inf lation Headline inf lationSource: US Department of Commerce, SEB

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

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

forecastSEB


16/4816


The United States

We nevertheless expect further stimulus measuresequivalent to about USD 150 billion, or somewhat lessthan the USD 200 billion recently announced in thepresidents fiscal 2011 budget. Congress will probablyapprove many of the measures that the administrationis proposing, which include infrastructure spending,aid to state governments and unemployment benefits.In addition, large portions of the Bush administrationstax cuts will probably be extended. But the richesthouseholds with annual incomes of more than USD250,000 will face tax increases of 2-3.6 percentagepoints if the administrations budget is approved.

Overall, we expect fiscal policies to contribute 1percentage point to GDP growth in 2010 and -0.8 percent in 2011. We now estimate that the budget deficitwill rise to close to USD 1.6 trillion (10.8 per cent

of GDP) in fiscal year 2010, from USD 1.4 trillion infiscal year 2009.

Fed continuing to hold off on rate hikesWe are sticking to our forecast that the FederalReserve will not raise its key interest rate untilDecember 2010 . The resource situation, combinedwith fiscal policies that are moving in a tighteningdirection while the economy is still searching for firmground justifies an ultra-loose monetary policy foranother while. The Feds balance sheet has stoppedexpanding, which is already visible in slower money

supply growth. This may be regarded as a form of monetary tightening, although a formal exit fromquantitative easing is still some distance away.

Another example is the Feds purchases of mortgage-backed securities, which will probably end this spring.These purchases have helped push down mortgagerates to very low levels, even more than long-termgovernment bond yields justify. Once the Fed stopsbuying such securities, historical experience indicatesthat mortgage rates may climb by about 50 basispoints.

What could persuade the US central bank to raise itskey rate earlier than we are now expecting? A sharpupturn in inflation expectations would probably triggerearlier rate hikes, as the Fed has clearly signalled.

Break-even inflation expectations are also showingslightly larger inflation worries in the market. But weare now back at 2007 levels according to this meas-ure, which is hardly an indication of imminent runa-way inflation. Surveys and the Feds own measure-ments of inflation expectations both point towards acontinued stable trend.


17/4817


Japan

Intensified deflation worriesSlow recovery this year and in 2011

Stronger business sentiment, but weakercapital spending plans

Intense currency debate; yen weakening to 110

Japan has been hit hard by the financial and creditcrisis. GDP declined by about 5 per cent last year.Industrial production fell significantly more deeplythan in the euro zone and the US. The strong yen,which recorded a 14-year high against the dollar inNovember, helped deepen the export downturn ascapital spending plunged. Looking ahead, we believethat a weaker yen, global economic recovery and

some additional fiscal stimulus is enough to ensurethat growth will reach 1.5 per cent this year and1.8 per cent in 2011 , just above the consensus view.

The government has launched several fiscalexpansion packages to help prop up the economy .In December it unveiled the latest package, equivalentto 1.5 per cent of GDP. So far, stimulus packageshave not caused household consumption to take off,even though unemployment peaked last November

and is now shrinking. We predict a cautious upturn inconsumption of 1 per cent this year and in 2011. It isworrisome that consumer confidence has fallen afterlast years upturn. If it should continue downward,private consumption may show weaker growth.

Rising business sentiment in the Bank of JapansTankan report, especially in the manufacturing sector,indicates that a recovery in capital spending is on itsway. We thus believe that capital spending will in-crease by 3 per cent this year and more than 4 percent in 2011, although actual investment plans are stillvery tentative.

Inflation pressure is very low. Both CPI and coreinflation are now well below zero. There are manyindications of continued deflation pressure . CPI

inflation (-1.7 per cent in December) will stay be-tween -1.5 and -2 per cent for another few months,then rise as domestic and global growth accelerate. Itwill average -1.2 per cent this year and 0.0 per cent in2011. Core inflation, too, will remain below zero forquite some time, averaging -1.0 per cent this year and-0.5 per cent in 2011.

The new finance minister, Naoto Kan, has stressedthe importance of a weaker yen and indicated that aUSD/JPY exchange rate of 95 is suitable for Japaneseexporters. The Finance Ministry has thus changed itscommunication strategy regarding the currency. Thismay be interpreted as a sign that Japan is ready to

intervene in the foreign exchange market. In that case,it would be for the first time since 2004.

The Japanese economy would undoubtedly benefitfrom a weaker currency, especially considering thesharp nominal appreciation of the yen in recent years.A weak currency would be a way of both endingdeflation and stimulating growth. In light of this, webelieve that the Bank of Japan will keep its keyinterest rate at the current 0.1 per cent until thefirst quarter of next year , when a cautious ratehiking cycle will begin. We expect the yen to weakengradually in this environment. In June the USD/JPY

rate will stand at 95. It will reach 110 by the end of 2011. This trend is compatible with export growth of 4 per cent annually in 2010-2011.

Weak growth combined with large fiscal stimuluspackages will erode the central government budget.Last years budget deficit of nearly 8 per cent of GDPwill increase to 9 per cent this year. This implies thatcentral government debt will reach levels of wellabove 200 per cent of GDP next year. Due to thesevere budget situation, Standard & Poors hasrevised its government bond rating to negative and adowngrade from todays AA credit rating is creeping

closer. At the same time, the public sector has largeassets, which means that the net debt is not muchhigher than in the United Kingdom or the UnitedStates. Also, the long period of large current accountsurpluses has resulted in an exceptionally strongwealth position compared to the rest of the world.

Year-on-year percentage changeCollapse in production

Euro zone Japan USSource: Eurostat, Federal Reserve, METI

00 01 02 03 04 05 06 07 08 09-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

Index 100 = July 2007Exchange rates

EUR USD JPY GBPSource: Reuters EcoWin

Jul07

Oct Jan08

Apr Jul Oct Jan09

Apr Jul Oct Jan10

70

8090

100

110

120

130

140

150

70

8090

100

110

120

130

140

150


18/4818


Asia

Continued strengthMonetary tightening

Risks of asset price bubblesLimited inflation pressure

The cyclical downturn in emerging Asia was mild .Unlike the trend elsewhere in the world, including theemerging economies of Eastern Europe, GDP rose inmost Asian countries in 2009. In the second quarter, arecovery occurred supported by improved exports,returning capital flows and fiscal stimulus measures.Rising confidence indicators point towards a strongerupturn this year and a broader range of economicengines. Asia, excluding Japan, can thus preserve

strong growth despite moderate demand in the West.Due to this growth dynamic, by late 2009 many Asiancentral banks began monetary tightening, mainly toprevent tendencies towards asset price bubbles. Sofar this has consisted of various lending regulationsand stricter reserve requirements for banks, and inChina also upward adjustments in market interestrates. This spring we also expect the first key interestrate hikes in China and India. Combined with fadingfiscal stimulus effects, monetary tightening will causeGDP growth rates to level off or slow somewhat in2011.

As earlier, our assessment is that a serious consumerprice upturn is less risky than bubble tendencies inthe stock and property markets. Today the Asianeconomies are more capable of neutralising commodi-ty price impulses. Resource utilisation is not over-stretched, and so far the cyclical upturn has largelybeen investment-led. Nor will these economies reachthe same rapid growth rates as in the 1990s and2000s. A few countries, including India and Vietnam,are grappling with difficult inflation problems, withprice increases approaching double digits this year.

Robust Chinese growth, no overheatingGDP growth in China accelerated, in line with ourforecast, to 10.7 per cent in the fourth quarter. Thefull-year 2009 figure was 8.9 per cent, a bit above theofficial long-term target of 8 per cent. Various signs,mainly an export recovery, indicate that the economywill now speed up. We predict that growth will climbto a 12 per cent rate in the first half . According toa compilation of leading indicators, growth may climbeven higher. But this growth signal is probably some-what exaggerated by last years sharp stock marketsurge, since share prices are one sub-indicator.

To date, growth has been largely stimulated bygovernment investment projects and rapid creditexpansion. New bank lending more than doubled in

2009, as reflected by a sharp increase in broad moneysupply measures. Due to the risk of overheating, theauthorities have begun hitting the brakes by takingvarious steps that are mainly targeted to thebanking system . During the second quarter of 2010,they will begin hiking key interest rates and allowingcurrency appreciation (see also International over-view). Monetary tightening combined with diminish-ing investment stimulus will help to moderate thegrowth rate in the second half. We expect ChinasGDP growth to average 10.5 per cent this year and9.0 per cent in 2011 , with upside risks in 2010.

The annual rate of CPI inflation rose from -1.5 per

cent six months ago to +1.5 per cent in December.Core inflation rose more moderately, from -1.5 to zeroper cent in December. There is relatively little risk thatinflation will continue upward uncontrollably. Thereare several restraining price factors: Manufacturingcapacity utilisation is still a bit below the trend of thepast five years. Pay hikes have slowed greatly in thepast year. The coming yuan appreciation will lowerimport prices. We thus we expect moderate economicpolicy tightening to suffice to keep average inflationat 4 per cent in 2010 and 5 per cent in 2011.

Rapid turnaround in IndiaIndia has bounced back unexpectedly fast , withfiscal expansion as a driving force. Since last August,industrial production has risen more than 10 per centyear-on-year, credit growth has recovered somewhat,and rather strong domestic demand is already evidentin the cities. Meanwhile inflation and inflation expecta-tions have climbed rapidly. This winter, the govern-ment introduced certain food price regulations. Bank reserve requirements were tightened. As interest ratesare raised later this year, price acceleration will end.Next year the government will also tighten fiscalpolicy in order to rein in its budget imbalances. We are

raising our GDP forecast somewhat, to 8.5 per centin 2010 and 7.5 per cent in 2011 .

Year-on-year percentage change and index 100=1996China's growth surge not quite over yet

GDP (LHS) Leading indicators (RHS)Source: Reuters EcoWin

00 01 02 03 04 05 06 07 08 0997

98

99

100

101

102

103

104

105

106

6

7

8

9

10

11

12

13

14

15


19/4819


The euro zone

Shaky road aheadThe recovery will continue

Persistently large budget deficitsGreek crisis weighing down euro

ECB will begin hiking its key rate in December

Euro zone GDP fell by 3.9 per cent in 2009. The slidein the global market for industrial goods following thefinancial crisis hit Germany especially hard, contribut-ing to a deeper GDP decline in the euro zone than inthe United States. But industrial production bouncedback in the fourth quarter and will accelerate furtherthis year as the global economy improves. We foresee

a production upturn of about 5 per cent both this yearand next in the euro zone as a whole, and that GDPgrowth will end up at 1.7 per cent this year and2.0 per cent in 2011 , which is above the consensusview. Unemployment will level off at around 10.5 percent this summer, and government budget deficitswill grow on a broad front . The budgetary and fiscalchaos is pushing down the euro and raising a numberof difficult questions about principles and regulationsin the euro system.

Our relatively optimistic growth forecast is based,among other things, on various leading indicators,including the Euroframe indicator, Germanys IFOindex and the European Commissions sentimentindicator . The IFO index rose more than expected inJanuary and now stands at an 18-month high. Thehistorical association between the ISM purchasingmanagers index in the US and the IFO index inGermany signals a continued improvement in thecoming months, which would help export-dependentGerman industrial companies. A recovering ordersituation in the manufacturing sector and weaker euro

are pointing in the same direction.The indicators are not clear-cut, however, and itcannot be ruled out that the recovery will be more

tortuous and drawn-out than our forecast . Forexample, the German economy lost a bit of its mo-mentum late in 2009, and financial market playershave also begun to doubt the strength of therecovery , according to the ZEW index. In January,the composite purchasing managers index for theentire euro zone also fell for the first time in a year.

Weak retail sales are another downside risk for ourGDP forecast, and the prevailing uncertainty isreflected in the wide disparity between forecasterswhen it comes to household consumption. Both theEuropean Commissions consumer indicator and ourown indicator (based among other things on disposa-

ble income, various interest rates and sentimentindicators) nevertheless signal a clear recovery thisyear.

Altogether, we expect quarter-on-quarter GDP growthto end up at 0.3 per cent in the first quarter of 2010,then gradually rise to 0.6 per cent in the fourthquarter. The full-year figure will be 1.7 per cent forthe whole euro zone. Germany will lead the recoverywith a GDP growth of 2.1 per cent. Next year GDP

will increase by 2.0 per cent in the euro zone, whichis above both the consensus view and trend growth.

Percentage changeGDP on the way up

Quarter-on-quarter, annualisedYear-on-yearGrowth indicator (Euroframe)

Source: Euroframe, Eurostat, SEB

04 05 06 07 08 09 10 11-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0forecastSEB

Index (IFO: 2000=100) and net balance (ISM)Synchronised recovery

Germany (IFO, LHS) US (ISM, RHS)Source: IFO, ISM

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 0930

35

40

45

50

55

60

65

80

85

90

95

100

105

110

Year-on-year percentage change and net balancePositive signals in manufacturing

Industrial production (LHS)Order bookings (RHS)

Source: Eurostat, DG ECFIN

00 01 02 03 04 05 06 07 08 09-70

-60

-50

-40

-30

-20

-10

0

10

-20

-15

-10

-5

0

5

10


20/4820


The euro zone

Private consumption in the euro zone as a whole willrecover, even though Germany is phasing out itsbonus for scrapping old cars. We expect a 0.4 percent increase this year, and 0.9 per cent in 2011.Exports will gradually rise during our forecast period:by about 4 per cent in 2010 and somewhat morestrongly in 2011. This means that the contribution togrowth from net foreign trade will shift from -1.2 percent of GDP to about 0.5 per cent in 2011. Capitalspending will also recuperate after a full 10 per centdownturn in 2009. The rate of increase will be 3 percent in 2010 and 4.2 per cent in 2011.

Many jobs saved in GermanySo far, unemployment has risen less than might havebeen feared in light of the downturn in output especially in Germany, where the jobless rate evenfell slightly during the autumn. This was largelybecause the governments of many EU countries payallowances for employees who temporarily workshorter hours (Kurzarbeit in Germany). Theseemployees work about two thirds of normal hours butretain a larger proportion of their regular pay. Thistype of government-subsidised job sharing is intend-ed to serve as a bridge over the economic crisis,enabling businesses to retain their workforce andthus quickly ramp up production when the economic

turnaround arrives. The allowances, which have beenextended several times during the crisis, haveprobably saved more than 500,000 German jobs .The cost to the government is estimated at aboutEUR 590 per month for an employee working shorterhours, or less than the EUR 1,500/month a joblessperson costs the government in unemployment andother benefits.

In the prevailing exceptional situation, the OECD haspraised this type of subsidy, while warning thatadverse effects may arise if the subsidy artificiallyprolongs the life of fundamentally unprofitablebusinesses, thereby making it harder for productive

businesses and sectors to recruit employees. It isthus very important to the recovery dynamic to phaseout these allowances at the appropriate time.

Unemployment close to peakingWe believe that euro zone unemployment is now closeto a turning point. It will continue to rise for anotherseveral months, peak at 10.4 per cent this summer,then fall very slowly. The full-year figure will end upat 10.2 per cent both this year and next. Our unem-ployment forecast for Germany is 8.4 per cent boththis year and next (using the EU-harmonised meas-ure). French unemployment will be higher, averaging10.3 per cent in 2010. In Spain, the jobless rate willreach a record-high 20 per cent this year.

German labour market figures in January wereunexpectedly weak (6,000 more unemployed) despitean improvement in business hiring plans. This illus-trates the risks of disappointments as government jobprogrammes are phased out. The sharp decline inproductivity during the past year can also be interpret-ed as signalling a future need for many businesses tocut back their labour force.

Last years rapid upturn in unemployment is clearlyimpacting wage formation. So far, the annual rate of increase in industrial wages and salaries has decelerat-ed from more than 4 per cent in mid-2009 to just over3 per cent today. We predict a further deceleration to1.5 per cent by the end of 2010.

Year-on-year percentage changeConsumption will recover this year

Consumer confidence (LHS)SEB consumption indicator (RHS)Private consumption (RHS)

Source: DG Ecfin, Eurostat, SEB

00 01 02 03 04 05 06 07 08 09-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

-35

-30

-25

-20

-15

-10

-5

0

5

Percentage points and per centLower wage inflation this year

Change in unemployment, shifted two years forward (LHS)Change in total wage and salary cost in industry (RHS)

Source: Eurostat, SEB

00 01 02 03 04 05 06 07 08 09 10 111.0

1.5

2.0

2.53.0

3.5

4.0

4.5-2.0

-1.5

-1.0

-0.5

0.00.5

1.0

1.5

2.0

2.5

Per centUnemployment will peak this summer

NAIRU according to OECDUnemployment, SEB forecast

Okun's Law

Source: OECD, SEB

99 00 01 02 03 04 05 06 07 08 09 10 116.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5


21/4821


Continued low inflationThe large quantity of idle resources has continued tosqueeze underlying inflation, in keeping with ouroverall analysis of the inflation dynamic. Core infla-tion is currently at 1.1 per cent and will fall further inthe coming months. In June it will stand at 0.8 percent, and it will bottom out at zero in December. Thefull-year figure will end up at 0.7 per cent this yearand 0.5 per cent in 2011, the lowest ever recorded.

Budget balance, current account, centralgovernment debt and inflation, 2009

Budget balance, current account (CA) and debt aremeasured as a percentage of GDP, HICP inflation asyear-on-year percentage change.

Budget CA Debt HICPGreece -13.1 -8.6 112.6 1.3Ireland -12.5 -3.1 65.8 -1.7Spain -11.5 -5.4 54.3 -0.3France -8.5 -2.3 76.1 0.1Portugal -8.2 -10.4 77.4 -0.9Slovakia -6.4 -6.1 34.6 0.9Slovenia -6.3 -0.8 35.1 0.9Belgium -5.9 0.6 97.2 0.0Italy -5.4 -2.4 114.6 0.8Netherlands -4.8 3.1 59.8 1.0Malta -4.5 -3.6 68.5 1.9

Austria -4.3 1.5 69.1 0.4Cyprus -3.5 -11.8 53.2 0.2Germany -3.2 4.0 73.1 0.2Finland -2.5 1.1 41.0 1.6Luxembourg -2.2 9.9 15.0 0.0Euro zone -6.5 -0.7 78.8 0.3Source: European Commission, Eurostat, SEB

However, weak productivity growth last year (-2 percent) will drive inflation by means of higher unitlabour costs ; these costs rose by about 3.5 per centin the euro zone last year (4.5 per cent in Germany),

but will fall by 0.5 per cent this year.

The euro zone

As usual, inflation measured by the Harmonised Indexof Consumer Prices (HICP) fluctuates more than coreinflation. Rising energy prices and, to some extent,higher food prices contributed to a swing from -0.5per cent HICP inflation in September to 0.9 per cent inDecember. A decline in the producer price index(PPI) in manufacturing, combined with lower energyprices, indicates that HICP inflation will soon decline.It will bottom out at 0.3 per cent in January next yearand then climb to 1.1 per cent by the end of 2011.Measured as an annual average, HICP inflationwill end up at 0.8 per cent both this year and next.

The inflation rate varies greatly in the euro zone.Problem countries with big budget and current ac-count deficits (twin deficits) tend to have lowerthan average inflation. One interpretation is that these

countries now face a great need for real-termcurrency depreciation in order to become morecompetitive and shrink their current account deficits.This means that the rate of inflation must deceleratecompared to other regions. Such a process seems tohave begun in such countries as Ireland, Portugal andSpain, but experience indicates that such internaldevaluation is often both protracted and painful. Nor isthere a clear pattern in the euro zone, as the relativelyhigh inflation rate in Greece indicates. The situation inGermany, with low inflation and high householdsaving sustaining a current account surplus, is also animportant exception.

ECB will hike key rate in DecemberLow resource utilisation, low inflation, weak creditand money supply growth as well as weak inflationexpectations are indications that the euro zones keyinterest rate will remain low for an extended period.So do monetary policy rules of thumb Taylor rules based on resource utilisation and the inflation trend.Nor does the European Central Banks own rhetoricsignal that it is in any rush to raise its refi rate. Thebank is sticking to a very modest GDP forecast (0.8per cent growth in 2010 and 1.2 per cent in 2011) andan HICP inflation rate clearly below its target .

Per centFalling core inflation

Core inflation HICP inflationSource: Eurostat, SEB

01 02 03 04 05 06 07 08 09 10 11-1.0

-0.50.00.51.01.52.02.53.03.54.0

4.5

-1.0

-0.50.00.51.01.52.02.53.03.54.0

4.5

PrognosSEB

Per cent of GDPBurgeoning budget deficits

Euro zoneGermanyFrance

ItalySpainIreland

Greece

Source: Eurostat, SEB

01 02 03 04 05 06 07 08 09 10 11

-17.5

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-17.5

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0SEB forecast


22/4822


The euro zone

Concerns about the health of the euro zonesbanking system are another reason for the ECB tobide its time. According to the IMF, larger write-downs remain in the euro zone than in the US, wherebanks have already carried out most of these. Heavydemand from the banking sector for long-term credits(main refinancing operations ) also signal that it willtake a fair amount of time before the banking sectorreverts to its normal situation.

Credit conditions in the euro zone also remain relative-ly tight although they have recently eased, accordingto the ECBs own Bank Lending Survey. Large sumsare being parked in accounts at the ECB, indicating

that the banks liquidity injections are not yielding thedesired stimulus effect on the economy. This is afurther argument for a low key interest rate.

Year-on-year percentage changeWeak credit growth

Credits M3 money supplySource: ECB

99 00 01 02 03 04 05 06 07 08 09-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Net balanceCredit conditions have eased

Source: ECB

03 04 05 06 07 08 09-40

-30

-20

-10

0

10

20

30

4050

60

70

-40

-30

-20

-10

0

10

20

30

4050

60

70

We now anticipate that the ECB will begin a cau-tious rate hiking cycle in December 2010, which isthree months later than we thought in the Novemberissue of Nordic Outlook . The ECB will then raise itsrefi rate by 25 basis points to 1.25 per cent. Beforethis, however, the bank raises the Euro OvernightIndex Average of interbank interest rates, the EONIArate, which is now about 70 basis points below therefi rate. The bank will later follow this up with fiveadditional 25 basis point refi hikes in the course of 2011. The refi rate will stand at 2.50 per cent bythe end of 2011 .


23/4823


The euro zone

Crucial situation for PIIGS countriesThe lack of national monetary policies in the eurozone makes heavy demands on fiscal policy. This is

the main reason for the Stability and Growth Pactsfocus on restricting public sector debt levels anddeficits. A number of countries, especially the PIIGScountries (Portugal, Ireland, Italy, Greece and Spain),must now pay the price for a long period of weakfiscal policy in the form of higher interest rates.

The situation is definitely the most acute in Greece .The country has the largest overall problems, amongthem rising public expenditures, exploding budgetdeficits and a high level of central government debt. Inaddition, an unfavourable cost trend and low nationalsavings will lead to an extra large need for interna-tional financing. Greeces credibility has also been

damaged by repeated instances of manipulation ofofficial budget figures.

In our assessment, after Greece the situation is themost serious in Portugal and Spain . Portugalsproblems are largely of the same kind as those ofGreece, though not as severe. In Spain, the housingmarket crash has led to extremely high unemploy-ment levels, contributing to rapidly rising deficits. Thishas revealed underlying problems with competitive-ness and demographic cost pressures.

The situation looks somewhat less bad for Irelandand Italy . Irelands financial system was hard hitduring the culmination of the credit crisis, and thegovernment budget deficit has climbed rapidly, butthe country entered the crisis with a much lower debtlevel and has also introduced sizeable cost savingspackages. Italy has had a high level of public sectordebt for a long time, but its budget deficit is not aslarge as that of other Mediterranean countries.

There are various conceivable short-term scenariosfor how the crisis will evolve: 1) These countries willtackle the problem themselves and implement

major fiscal reform programmes. 2) Internationalbail-out packages will be crafted, with major eurozone countries as lenders, while fiscal reform

programmes are implemented. 3) The countries willdefault on their loans and withdraw/be ejected fromthe euro system.

A default by a euro zone country or its withdrawal fromthe currency union would probably be perceived as ahuge reversal for the whole euro project. There isalso a very large risk of secondary effects, includingfinancial instability. If Greece should default, themarkets expectations regarding possible defaults inother PIIGS countries would escalate drastically.Meanwhile it is increasingly doubtful at presentwhether Greece, in particular, has the politicalstrength to restore order to its economy by itself. Themeasures it has unveiled to date are far from suffi-cient. More far-reaching action is required, but aboveall, quick reforms that are actually approved andimplemented, in order to calm the markets.

At present, we thus view alternative 2 as the mostlikely scenario for Greece. An international rescuepa

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