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

In its February 2020 Nordic Outlook, SEB says that the world economy seems to have emerged from last year’s manufacturing slump. Growth is accelerating cautiously, but lingering political uncertainty and supply-side constraints are diminishing the power of the upturn. Central bank signals of low key interest rates for a lengthy period will provide support, but they also raise questions about long-term risks of debt build-up and spiralling asset prices. Fiscal policymakers can play an increased role, but because of rigid fiscal frameworks and weak government finances, the dose of stimulus will still be cautious.

In Sweden, sentiment indicators point to weak or even falling GDP in late 2019 and early 2020, but a recovery in household consumption and a turnaround in residential construction suggest that the economy will keep expanding in 2020. Growth will speed up in 2021 as Sweden joins in the international upswing. Continued strong population growth is one reason why unemployment will keep rising during the coming year. The Riksbank will keep the Swedish key interest rate unchanged, even though inflation will fall further below the central bank’s 2% target.

Global growth is accelerating cautiously, after bottoming out in 2019

The US Federal Reserve’s key interest rate cuts and decreased trade risks due to progress in US-Chinese negotiations have led to a resurgence of optimism in financial markets. Manufacturing activity is showing signs of having bottomed out, with small hints of recovery in sentiment indicators. Domestic demand has remained resilient in most countries, sustained by strong labour markets. This has laid a more stable foundation for future growth. SEB economists predict that global GDP growth will increase from 3.0% in 2019 to 3.1% this year and 3.3% in 2021 - marginally better than SEB’s forecast in November’s Nordic Outlook. A recovery in emerging market (EM) economies is the main reason for the acceleration, as large countries like India, Russia, Brazil and Turkey gain momentum while China’s economy continues to decelerate. Improved world trade will also help to sustain exports in Europe and elsewhere during 2021, but for various reasons global growth looks set to be lower than the average during recent decades.

Many EM economies have reached a degree of maturity that makes it difficult for them to maintain their earlier rapid trend growth. In advanced economies, the lowest unemployment levels in 40-50 years are shifting the focus of attention to supply-side constraints, as downside risks to demand fade. Yet the potential for a further upturn in US labour force participation and a lower equilibrium unemployment rate in the euro area – including reforms in France, Spain and elsewhere – will make it possible to prolong the economic expansion further. Political uncertainty factors also remain, with question marks about US-Chinese trade after their success in reaching a Phase 1 agreement, as well as about trade between the European Union and both the United States and the United Kingdom. Another source of uncertainty is increased tensions between the US and Iran. In all these cases, however, the parties involved have powerful reasons to avoid an escalation. 

Extended period of low interest rates and yields raises new questions

Central banks will continue to support their economies in the prevailing low-inflation environment, but there is not much room for new initiatives. An increased awareness of the drawbacks of negative rates and yields has raised the bar for further stimulus measures in the euro area, for example. Signals from leading central banks that they will accept a degree of inflation overshooting − after a long period of below-target inflation rates − meanwhile imply that the threshold to rate hikes will be high.

In this environment, fiscal policymakers are expected to play an increased role, for example through public sector investments in infrastructure, climate-related projects and education. Yet in practice, the dose of fiscal stimulus is expected to be limited, given already high US federal budget deficits and rigid fiscal frameworks in Europe. An extended period of low interest rates and bond yields meanwhile raises questions about the long-term risks of debt build-up and spiralling asset prices starting on the day that there may be changes in underlying conditions affecting inflation, interest rates, bond yields and other variables.

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

Bond yields have stabilised a bit above their previous lows. In the prevailing low-inflation environment, central banks have an asymmetric reaction function: key interest rate cuts are closer at hand than rate hikes. This pushes down short-term yields and leads to a steepening of yield curves. SEB’s forecast of one more Federal Reserve rate cut this coming autumn will nevertheless contribute to a temporary downturn in long-term Treasury yields.

By the end of 2021, 10-year US Treasury securities will yield just over 2.00%, while long-term German government bond yields will be slightly above zero. An improved risk climate, including positive economic growth signals and successful trade negotiations, will cause USD-positive drivers to fade. Because the US dollar is overvalued in the long term, it will gradually depreciate, with the EUR/USD exchange rate climbing to 1.20 by the end of 2021. Slightly better growth and ultra-low bond yields will help to sustain high share price valuations. Our main scenario is slightly positive stock market returns and good performance for both cyclical industrials and structurally favoured growth companies in digitisation and sustainability.     

Decelerating Nordic growth, delayed Baltic impact of global slowdown

The Norwegian economy appears to have peaked in autumn 2019. The mainland economy (excluding oil, gas and shipping) will slow towards its trend growth rate as oil investments fall and demand from this sector shrinks. Mainland GDP growth will decelerate from 2.5% last year to 2.0% in 2020 and 1.8% in 2021. The weak krone will push inflation above target this year, but because of increased international risks, slower domestic economic growth and less risk to financial stability, Norges Bank will leave its key interest rate unchanged at 1.50%.

Denmark will show faster economic expansion than the euro area, sustained by strong job growth and decent private consumption, yet it will decelerate gradually from more than 2% last year to 1.5% in 2021. Improved consumption and service exports sustained Finnish economic growth last year; it will level off at around 1.5%, supported by somewhat better global economic conditions.      

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

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

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


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