Growth accelerating, but difficult

Nordic Outlook post-crisis choices ahead

New focus on government debt
Economic Research – May 2010 and financial regulations
 Contents

International overview 5

Theme: Reforming the financial infrastructure 14

The United States 16

Japan 21

Asia 22

The euro zone 23

The United Kingdom 28

Eastern Europe 29

The Baltics 30

Sweden 32

Denmark 41

Norway 42

Finland 45

Nordic key economic data 46

Boxes

Next phase in the Greek crisis 6

Rapid recovery or new crisis wave? 7
The economic policies of the future 12
Can the US double its exports in 5 years? 17
Health care reform approved 20
Great need for internal devaluations 25
Public finances and long-term yields 27
How much divergence from euro zone? 33
Large gap between GDP and labour market 35
Home price correction on the way 37

Nordic Outlook – May 2010  |  3

 Economic Research

This report was published on May 4, 2010.

Cut-off date for calculations and forecasts was April 29, 2010.

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4   |  Nordic Outlook – May 2010


Recovery despite imbalances and crises
 Deficits creating dual-track world
 Inflation continuing downward
 Central banks will hold off another while
 Euro will continue to weaken
 Economic policy framework being
reassessed
The economy is now entering a new phase, where differ-
ences in underlying conditions are becoming ever clearer.
The recovery is gaining strength in many places. Mean-
while the crisis in Greece and the other “PIIGS” countries
(Portugal, Ireland, Italy, Greece, Spain) is highlighting
the major adjustments that are still needed.
In many respects, extremely low interest rates have post-
poned the adjustment burdens. But rapidly escalating
government debts and a banking system that remains
squeezed will lead to major economic policy challenges
during the next couple of years. The task will be to re-
form the economic policy framework in order to reduce
the risks that new financial crises will arise. Meanwhile
governments must present and implement credible aus-
terity programmes.
GDP growth
Year-on-year percentage change
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
00 01 02 03 04 05 06 07 08 09
Emerging economies OECD
Our main scenario is that the recovery will continue
in spite of imbalances and crises. The Asian emerging
economies will remain an important engine of global
growth. The American upturn is now beginning to gain
support from rising employment, while the competitive-
ness of German exporters is benefiting from a weaker
euro. Overall, we expect global growth of 4.7 per cent,
both this year and next. In the 30 member countries of
International overview
the Organisation for Economic Cooperation and Devel-
opment (OECD), growth will be 2.5 per cent in 2010, or
somewhat above trend.
Inflation will remain low in the next couple of years.
Core inflation has continued downward. Low resource
utilisation and high unemployment will continue to de-
press wages and prices. Due to low inflation pressure,
combined with worries about the resilience of the finan-
cial system, the leading OECD central banks will proceed
cautiously with their interest rate hikes. By late 2011,
the US Federal Reserve (Fed) and European Central Bank
(ECB) key rates will stand at 2 and 2.25 per cent, respec-
tively.
Continued expansionary monetary policies will help sus-
tain growth in 2011 as well. This will create the prospect
of a further stock market upturn, which in turn will help
ease the impact of earlier wealth losses on the economy.
Yield curves will remain steep. Despite low inflation,
long-term sovereign bond yields will be pushed a bit
further upward due to large borrowing requirements and
rising short-term interest rates.
Fourth crisis phase: wheat from chaff
The economic and financial crisis of the past few years
can be schematically divided into four phases. The first
phase occurred from the collapse of confidence in the US
mortgage loan market in July 2007 to the Lehman Broth-
10.0
SEB ers crash in September 2008. During that period, the
forecast
7.5 impact was largely limited to affected sectors in certain
countries, plus general mistrust in the banking system.
5.0
The second phase from September 2008 to March 2009
2.5 was characterised by a breakdown in the interbank mar-
0.0
ket, causing paralysis in international trade. The third
phase is characterised by economic policy measures that
-2.5 are gradually beginning to restore confidence in financial
-5.0 markets. The Group of 20 meeting in London in April 2009
10 11 kicked off a process that restored risk appetite, leading
to a stock market turnaround and rapidly falling credit
Source: OECD, SEB spreads.
A fourth phase started early in 2010. It is characterised
by a focus on the sustainability of public sector com-
mitments. The Greek crisis is the clearest example, but
other countries are also affected. Financial markets are
also beginning to focus more broadly on the consequenc-
es of stimulus measures and what will happen when they
disappear.
Nordic Outlook – May 2010  |  5
 International overview
The next phase of the Greek crisis
Many years of weak fiscal policy, combined with stimu-
lus measures in 2008/2009 in response to the econom-
ic crisis, have pushed various countries to the edge of
fiscal exhaustion. The need for credible, sustainable
budget consolidation has become acute, especially in
Greece. Market scepticism has led to exploding bond
yield spreads against other countries. Other crisis-
plagued countries − Portugal and Ireland in particular
− have also been hit by rising interest costs. Domestic
protests against belt-tightening measures and slow,
discordant international bail-out deliberations have
further aggravated the situation.
At this writing, our main scenario for Greece is that it
will receive a bail-out loan from the IMF and its fellow
euro zone countries of EUR 110 billion. In principle,
this will cover 2-3 years of refinancing. It is reasonable
to assume that the EU-16 will also approve a broader
emergency loan programme that can be used to pre-
vent secondary effects in other euro zone countries.
The terms will be tough and unappetising enough to
discourage over-utilisation. The Greek programme
will be supervised and monitored by the IMF, the euro
group and the ECB. It will put Greece in a kind of eco-
nomic policy guardianship. Since euro zone stability is
of international interest, aid from countries like Japan
and China via the IMF may be discussed.
It now looks as if Greece will be forced to implement
an austerity programme equivalent to 10-11 per cent
Divergent government debt burdens
Per cent of GDP
110
100
90 SEB forecast
80
70
60
50
40
30
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Developed economies The Nordic countries
Emerging markets
Source: OECD, SEB
So far, the fourth phase has revealed major divergences
in both the financial and economic situation. In Asian
countries, expansion is continuing at a rapid pace. They
are benefiting both from good domestic fundamentals
and an ever-larger influx of capital. The risks of new as-
set price bubbles are thus moving closer and closer.
Those OECD countries that were primarily affected by
the crisis via the international trade collapse, but avoid-
ed severe damage to their financial sector and residential
market, are now rebounding more quickly. This applies,
for example, to Japan, Germany and the Nordic countries
(except Denmark).
6   |  Nordic Outlook – May 2010
of GDP. Value-added tax hikes, public sector pay cuts
and bonus cuts will be key elements. Other countries
will probably be forced into similar measures. There
is a great risk of increasing political instability, among
other things because crisis awareness is still low.
Relationships between countries also risk becoming
strained when domestic political interests must be
balanced with international cooperation.
Our assessment is that these measures will now lead
to a gradual improvement. Greece can avoid default
and stay in the euro zone. But the crisis will have vari-
ous long-term consequences. Bond yields will remain
high in Greece and some other countries. The need
to restore competitiveness and fiscal balance will
squeeze their economies for many years. The funda-
mental shortcomings in the euro system that the crisis
has exposed will take a long time to repair.
An alternative scenario is that Greece’s problems are
so profound that necessary adjustment in the real
economy will be too costly, both economically and po-
litically. Greece may thus need to renegotiate the size
and terms of its government debt. In such a situation,
it is reasonable for the country to leave the euro sys-
tem. But both debt haircuts and euro zone withdrawal
risk triggering instability and increasing secondary
problems in other countries and are a substantially
worse alternative than following a tough approach.
Deep-seated problems in the PIIGS countries are hamper-
ing growth in the euro zone (see box). At present, our
110 basic scenario is that the core countries of the euro zone
100 will perform decently, among other things because the
90 slide in the euro from previous high valuations will ben-
80 efit their exports.
70
60
GDP growth
Year-on-year percentage change
50
40 2008 2009 2010 2011
30 United States 0.4 -2.4 3.6 2.8
14 Japan -1.2 -5.2 2.4 2.2
China 9.6 8.7 10.5 9.0
Euro zone 0.5 -4.0 1.5 1.8
United Kingdom 0.5 -4.9 1.5 2.0
Sweden -0.2 -4.9 3.0 2.7
Norway 1.8 -1.5 2.0 2.3
Denmark -0.7 -4.8 1.5 1.8
Finland 1.2 -7.8 2.6 2.7
Nordic countries 0.5 -4.4 2.3 2.4
Baltic countries -0.7 -15.7 0.1 4.2
Emerging markets 6.1 2.4 6.8 6.4
OECD 0.6 -3.5 2.5 2.4
World, PPP* 3.0 -0.6 4.7 4.7
World, nominal 2.0 -1.3 4.0 4.0
* Purchasing power parities
Source: OECD, SEB­

Both the US and the UK face major challenges, with a
ravaged financial sector and large central government
deficits. Yet US growth appears set to be relatively
strong. So far, the inventory cycle and fiscal stimulus
measures have served as driving forces, but now that the
labour market is about to turn around and the corporate
sector is in good financial shape, there are prospects
of broader-based growth. In many respects, the UK has
suffered substantially worse damage from the financial
crisis. The weak pound will still contribute to decent
growth, despite coming fiscal austerity measures.
The Nordic countries are well positioned to take advan-
tage of the international recovery, due to strong balance
sheets and a favourable industrial structure.
Gentle debt-reduction process
Households and businesses are in the process of reducing
their debts, but effects and needs vary greatly between
regions and sectors. For example, the debt expansion of
the past decade went considerably further in the UK than
in the euro zone or the US. In particular, the US corpo-
rate sector and euro zone households stand out as having
increased their indebtedness relatively little in such a
comparison.
Rapid recovery or new crisis wave?
Favourable short-term growth conditions combined
with the need for major reforms in the financial rule
system and in economic policy make forecasting espe-
cially uncertain. Our main forecast implies a lacklus-
tre recovery in which growth is held back to some
extent by restraining forces such as less expansionary
economic policies and a slimmed-down credit market.
GDP growth of 2½ per cent in the OECD will result in a
sluggish downturn in unemployment and lead to large
structural deficits in public sector finances.
GDP OECD
Index 2000 = 100
125.0
122.5
120.0
117.5
115.0
112.5
110.0
107.5
105.0
04 05 06 07 08 09 10
New crisis wave SEB's main scenario
Rapid recovery
Source: OECD, SEB
A scenario of stronger growth during the next cou-
ple of years might be driven by a positive spiral in
which good growth will result in a faster recovery in
public finances, thereby reducing the need for auster-
ity measures. In such a scenario, rising stock market
prices and a brighter labour market will stimulate
International overview
Debt as a percentage of GDP
Households Companies Total
2000 2009 2000 2009 2000 2009
US 62 86 63 75 125 161
Euro zone 47 64 68 100 115 164
UK 63 97 72 110 135 207
Source: IMF, April 2010
The process is being driven both from the demand and
supply side of the credit market. Continued consolidation
requirements in the banking sector (see “Theme” article)
are interacting with increased precautionary saving and
the desire to adjust debts because of lower home price
levels. Meanwhile the pace of debt adjustment appears
to be decelerating, due among other things to the re-
covery in asset prices. In the US, household debts as a
percentage of income have fallen moderately. Meanwhile
the savings upturn has come to a halt, and we believe
that the household savings ratio will not exceed 3-4 per
cent over the next couple of years.
consumption and capital spending to a greater degree
than in our main scenario. Large output gaps at the
outset and a corporate sector benefiting from excep-
tionally strong balance sheets are additional factors
pointing towards a faster recovery, with annual GDP
growth around 3½ per cent in 2010 and 2011.
The risks that the world economy will be hit by a new
crisis wave in the next couple of years are not negligi-
ble. There may be several reasons for such a double-
dip scenario. The Greek crisis may escalate into a sys-
temic crisis with global consequences. The underlying
weaknesses in the financial system may prove larger
125.0 than expected and be exposed even after very moder-
122.5 ate interest rate hikes. The risks of policy mistakes in
120.0 the normalisation process or in the shaping of a new
117.5
financial rule system are also substantial. Historical
115.0
experience shows that financial crises both take a long
112.5
time to resolve and may appear in several waves with
110.0
intervening periods of easing. Such a scenario implies
107.5
105.0
a new recession in the OECD countries.
11
In our assessment, the probability of a positive spiral
is somewhat higher (25 per cent) than that of a new
period of severe weakening (15 per cent). On the
other hand, these risks are hardly symmetrical. A new
crisis period may lead to a relatively deep slump,
while upside potential is more limited.
Nordic Outlook – May 2010  |  7
 International overview

US: Modest pace of debt retirement
Per cent of disposable income
140
130
120
110
100
90
80
70
60
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Household debts (LHS)
Household savings ratio (RHS)
Source: Federal Reserve
Our conclusion is that because of extremely low inter-
est rates, debt reduction is occurring at such a modest
pace that it can be combined with a fairly good economic
recovery. To some extent, this implies postponing adjust-
ment burdens. There is a long-term risk that interest rate
hikes combined with new rule structures in the credit
market may contribute to more rapid debt adjustment.
Big differences in the labour market
The consequences of the financial crisis on the labour
market have varied greatly between countries. In Ger-
many, for example, unemployment has fallen, while it
more than doubled in the US. These divergences can be
explained partly by different legislation regarding the
hiring and firing of employees.
economic growth figures we foresee in the next couple
of years are hardly sufficient to bring about any rapid
downturn in unemployment. Preventing unemployment
11 from ending up permanently higher than pre-crisis levels
9
will thus be a major challenge for economic policy in the
next couple of years.
7
The IMF is providing various advice on achieving this. In
5
countries like the US, for example, it recommends active
3 measures such as re-training grants to ease the impact of
1 deep crises in specific economic sectors. In Germany, the
IMF emphasises the importance of removing aid meas-
ures in an orderly way so as not to hamper the upturn.
It also recommends continued macroeconomic stimulus
measures in those countries that have room for this. It is
clear that a pragmatic approach focusing on the special
situation of different countries dominates the IMF’s rec-
ommendations.
Inflation will remain low
During the past six months, Consumer Price Index (CPI)
inflation in the OECD countries has climbed as the effects
of earlier energy price declines have faded from the sta-
tistics. Instead, the recovery in energy prices has domi-
nated the 12-month figures. We now expect CPI inflation
to fall in most countries when the contribution from en-
ergy prices becomes more neutral.
Falling rate of pay increase
Year-on-year percentage change
4.5 4.5

4.0 4.0
There are also other reasons why labour market reac-
tion to a given GDP change has diverged from expecta- 3.5 3.5

tions based on historical associations (“Okun’s Law”). In 3.0 3.0

countries where the financial system has been the most 2.5 2.5
heavily damaged and where the housing market has
2.0 2.0
been hard hit, domestic demand has fallen on a broad
front. Labour-intensive portions of the economy have 1.5 1.5

thus been affected to a greater degree than in those 1.0 1.0

countries that have been affected by the crisis primarily 98 99 00 01 02 03 04 05 06 07 08 09

via the collapse in world trade. The shape of crisis meas- Euro zone US
ures has also been of great importance. Many countries Source: ECB, BLS

in Europe, most prominently Germany, have used various

types of working hour reductions, which have propped
up employment.
The labour market in the Nordic countries has gener-
ally been resilient. In Denmark and Norway, unemploy-
ment has historically shown very low cyclical sensitivity,
which has also been confirmed during the current crisis.
In Sweden, however, such sensitivity has increased sig-
nificantly in the past 20 years. This time around, though,
the government’s expansionary economic policy helped
keep the upturn in joblessness substantially lower than
the historical connection with production indicates.
In recent months, the labour market situation has been
better than expected. A turnaround is finally on the way
in the US, while positive surprises have continued in Ger-
many and the Nordic countries, among others. But the
The downward trend in core inflation has continued,
and right now the rate is just above 1 per cent. Low re-
source utilisation dominates the underlying inflation dy-
namic. The rate of pay increases has slowed appreciably.
In the US, combined with a sharp recovery in productiv-
ity, this has led to a 5 per cent decline in unit labour
costs (ULC) over the past year. In Western Europe, falling
productivity has so far helped keep ULC high to a consid-
erably greater extent, but productivity is now on the way
up during the initial phase of the recovery.
We thus expect core inflation to continue downward dur-
ing the coming year, bottoming out at close to zero both
in the US and the euro zone. Overall, this means that
inflation will be well below central bank targets or com-
fort zones for price stability. Deflation risks will thus be
a bigger headache than inflation risks in the next couple
of years.

8   |  Nordic Outlook – May 2010

 International overview

Core inflation approaching zero Budget-tightening will be postponed

Year-on-year percentage change The timing of the budget-tightening measures that must
3.0 SEB 3.0 sooner or later be implemented will be important to the
forecast
economic recovery process. Major fiscal programmes in
2.5 2.5
2009 provided an overall stimulus effect equivalent to
2.0 2.0 2 per cent of GDP in the G20 countries. Most stimulus
1.5 1.5
measures will remain in place during 2010, but the effect
on growth will be slightly negative.
1.0 1.0
In 2011 we may see different patterns. A number of small
0.5 0.5
countries with twin (budget and current account) deficits
0.0 0.0 will be forced to make sharp cutbacks in the wake of the
98 99 00 01 02 03 04 05 06 07 08 09 10 11
Greek fiscal crisis. Large countries have a greater degree
Euro zone US of freedom in choosing ways to deal with the crisis. It is
Source: Eurostat, BLS, SEB
thus likely that both the US and the UK will largely post-
pone their belt-tightening. Stronger economic conditions
Inflation threats exaggerated
will presumably also mean that they will begin revising
Despite low resource utilisation and falling core inflation,
their budget figures in the right direction, which will
there are a few factors that will generate inflationary
ease the pressure to impose austerity measures. Overall,
impulses in the next couple of years.
we expect a total tightening effect equivalent to 0.5 per
ƒƒ Strong growth in Asia has already pushed up com- cent of GDP in the OECD countries as a whole.
modity prices substantially. A broader international Yield on 10-year government bonds
upturn may lead to intensified competition for finite Spread against Germany, basis points
commodity resources. This may lead to a new surge in 9 9
commodity prices. 8 8
7 7
6 6
ƒƒ Economic policy will include a sizeable element of
5 5
tax increases that drive up inflation. This may include 4 4
value-added tax increases that are part of budget 3 3
consolidation programmes and higher environmental 2 2
1 1
taxes.
0 0
-1 -1
These factors will slow the decline in inflation during the Jul Nov Jan Mar May Jul Sep Nov Jan Mar May
next couple of years. But since they will have a tighten- 08 09 10
Greece Sweden United Kingdom
ing effect on the world economy, it is unlikely that they Portugal US
will lead to a broad inflationary spiral. Source: Reuters Ecowin

Meanwhile medium-term consolidation strategies are in

The risks that monetary expansion will lead to a broad
the process of crystallising as part of the work of the IMF
inflation upturn can be analysed in a similar way. Broad
and the G20 countries. Making the situation more dif-
measures of money supply growth are continuing to slow,
ficult is that large deficits in the aftermath of the crisis
which demonstrates that monetary stimulus is not leak-
are coinciding with ever-increasing demographic strains.
ing out into the real economy. Our conclusion is that the
The IMF has, for example, presented some fundamental
central banks have both the time and the instruments
principles on how the adjustment can be carried out in
to withdraw excessive liquidity from the banking system
ways that minimise damage to the functioning of econo-
before the increase in the monetary base becomes an
mies. Looking at the revenue side, it singles out the
inflation threat.
potential for raising real estate taxes, environmental
If inflation should take off before resource utilisation taxes and tobacco and alcoholic beverage taxes. On the
returns to more normal levels, some form of far-reaching expenditure side, the IMF proposes as a target that ex-
institutional change will be needed. Fundamentally, this penditures related to the ageing of the population should
is related in various ways to the mandate and credibil- be kept constant as a percentage of GDP, while other
ity of central banks. Changes might be associated with expenditures must be pushed down.
temptations for some countries to solve their imbal-
ance problems by inflating away the real-term burden
Cautious central banks
The world’s central banks now face a number of trade-
of government debt. A radical change in wage formation
offs. The economic cycle is on the way up, making the
or a trade policy collapse that leads different regions in
risk picture more symmetrical and paving the way for a
the world economy to choose different inflation strate-
transition from crisis policies to more ordinary recession
gies might also mark the beginning of a change. Yet at
policies. In addition, asset prices − especially share pric-
present, such risk scenarios seem remote.
es − have climbed sharply. Meanwhile inflation is continu-
ing downward and the state of the banking sector re-

Nordic Outlook – May 2010  |  9

 International overview

mains very strained. Rule changes for the financial infra-
structure will also mean new strains and risks.
Key interest rates
Per cent
7 7
6 6
5 SEB 5
forecast
4 4
3 3
2 2
1 1
0 0
00 02 04 06 08 10
Euro zone US Bank of England
Source: ECB, Fed, SEB
Differences in economic situation and in the vulnerabil-
ity of the financial sector are now leading to divergent
strategies. The Asian central banks have begun monetary
tightening aimed at preventing market bottlenecks and
asset bubbles. The leading central banks in the OECD
countries, however, continue to send out relatively gen-
Weak upturn in long-term yields
In an interesting way, developments in the long-term
government bond market reflect the various dramatic
processes that dominate the world economy. Budget defi-
cits and a brighter economic situation are helping to push
up yields, while falling inflation has the opposite effect.
Meanwhile an increasing focus on country risks has led to
sharper distinctions between different European coun-
tries. Yields have been pushed down in core countries led
by Germany, driven by both flight to quality and greater
uncertainty about the recovery. This is one of the reasons
why German and American long-term yields have recently
moved in different directions. German 10-year yields are
at almost the same low level as during the most intensive
period of the crisis, while American ones are 125 basis
points higher than at the end of 2008.
10-year government bonds
Per cent
7.0 7.0
6.5 6.5
SEB
6.0 forecast 6.0
5.5 5.5

tle signals and are focusing on being careful to prop up 5.0 5.0
4.5 4.5
the economic recovery.
4.0 4.0
3.5 3.5
We thus anticipate that it will take until December be-
3.0 3.0
fore the Fed begins hiking its federal funds rate. Before 2.5 2.5
that, it will withdraw liquidity from the market, while 2.0 2.0
it will wait until mid-2011 before slimming down its bal- 99 00 01 02 03 04 05 06 07 08 09 10 11
ance sheet by beginning to sell off assets. The ECB will US Germany
begin hiking its refi rate in March 2011. As early as this Source: Reuters EcoWin, SEB

summer, however, it will begin to withdraw liquidity from

the market, causing the effective overnight interbank
rate (EONIA) to creep upward. The Bank of England is
grappling with large fiscal imbalances, but is meanwhile
encountering stronger inflationary tendencies. We thus
expect the BoE to begin rate hikes at about the same
time as the Fed. Central banks will then proceed cau-
tiously, and their key rates will be around 2-2.25 per cent
by late 2011.
The Nordic central banks can expect a stronger economic
upturn. Growth in both Sweden and Norway is rela-
tively high, while home prices have continued upward
and household indebtedness has reached record levels.
Sweden’s Riksbank has now signalled that it will hike its
repo rate soon. We expect that due to strong economic
data and worries about rapid household credit expansion,
the first rate hike will occur in July. At the end of 2010,
the key rate will stand at 1.25 per cent and at the end
of 2011 at 2.75 per cent. Norges Bank began raising its
deposit rate as early as October 2009. Because of the risk
that too wide an interest rate spread over the ECB might
lead to excessively rapid krone appreciation, the Norwe-
gian central bank is moving ahead relatively cautiously.
We expect the key rate to continue upward to 3.75 per
cent by the end of 2011.
In the immediate future, we expect long-term yields to
move sideways. Concerns about Greece and its fellow
PIIGS countries will continue to push down yields in other
countries, while central bank key rates remain record-
low. During 2011, on the one hand, continued economic
recovery and key rate hikes will lead to a slight upturn
in long-term yields. On the other hand, there are also
strong forces that are holding back such an upturn. Re-
source utilisation and inflation pressures will remain low,
which will contribute to gentle central bank rate hikes.
Our overall conclusion is thus that government bond
yields will remain at historically low levels, despite large
funding needs in both the private and public sector. In
a world that is still in an economic slump, there is an
underlying savings surplus, which limits the potential
for rising real-term yields. We expect American 10-year
Treasuries to climb by about 50 basis points to 4.10 per
cent by the end of 2011, while corresponding German
yields will remain at 3.40 per cent.
In recent weeks, Swedish bond yields have been traded
on a par with German ones. We expect stronger eco-
nomic conditions and faster Riksbank key rate hikes in
Sweden to gradually help open up a spread of +30 basis
points by late 2011; strong Swedish public finances will

10   |  Nordic Outlook – May 2010

 International overview

pull in the other direction. The yield spread between have also been an important explanation, as shown by
Norway and Germany will remain around 70 basis points currency appreciation in commodity-producing emerging
in the next few months. After that, we expect continued economies. In addition, the recent increase in concerns
key rate hikes by Norges Bank to help widen the spread about fiscal problems has also been of great importance.
to 80 basis points towards year-end, after which it will
fall somewhat in 2011. The escalation of the crisis in Greece, along with its
secondary effects especially on Portugal and Ireland, has
Stock markets face new challenges continued to push down the euro. Powerful international
Share prices have continued upward in recent months rescue programmes are now being put in place, which
after a minor slump early in 2010. Positive macroeco- will stabilise the situation in the short term. But the
nomic signals and indications of continued, extended crisis has exposed fundamental problems in the euro
support from low interest rates have helped fuel the system, and the necessary budget tightening will hamper
upturn. In addition, company financial reports have been growth, even in a more long-term perspective. The pain
very strong. Many industrial companies have shown great threshold for how strong a currency the euro zone can
skill in transitioning to larger sales in expansive markets, tolerate has thus been lowered. We thus believe that the
primarily in Asia. High margins have also contributed to a euro will continue to weak. We predict that it will stand
clear increase in profits, despite modest volume increas- at USD 1.20 by the end of 2011. The British pound will
es (a kind of leveraging effect). also regain ground against the euro. By the end of 2011,
the EUR/GBP exchange rate will be 0.80.
Stock market performance
Index 100 = January 2007
Currency movements since the EUR/USD peak
150 150 Percentage change against USD since December 3, 2009
140 140 5,0%
130 130 3,0%
120 120 1,0%
110 110 -1,0%
100 100 -3,0%
90 90
-5,0%
80 80
-7,0%
70 70
-9,0%
60 60
50 50 -11,0%

40 40 -13,0%

Jan May Sep Jan May Sep Jan May Sep Jan May -15,0%
07 08 09 10
D

D
XN

ZD

N
R

R
K

Y
R

H
N
TR

B
JP
A

O
IN

PL
SE

EU
R

Sverige OMXS Emerging markets FTSE USD

N

C
M

G
C

N
K

USA S&P 500

Source: Reuters EcoWin
Looking ahead, there is potential for a good stock market
performance. Valuations are relatively moderate, and
continued economic recovery will strengthen the profit
outlook. The order situation cited in company financial
reports also indicates that a clearer upturn in volume is
on the way. In Sweden, for example, we anticipate a 20
per cent profit increase in 2010. Meanwhile central banks
appear likely to provide continued stimulus and have an-
nounced that their low interest rate policies will remain
in place.
The Greek crisis and its secondary effects pose a short-
term risk, but in order for stock markets to lose momen-
tum for a longer period, the crisis would need to have
global consequences and hamper the economic upturn in
the US and Asia as well. Looking further ahead, the ar-
chitecture of economic policy normalisation and the re-
structuring of the financial system will play a crucial role
in stock market performance. Both interest rate hikes
and tax hikes in the wake of budget crises will squeeze
demand and profits.
Deficits, commodities driving currencies
In recent months, the driving forces in the foreign ex-
change market have been clear. The currencies of fast-
growing economies have been stimulated by the influx
of capital and strong dynamism. Rising commodity prices
The Japanese yen has carried a heavy burden in recent
years. Partly due to large domestic capital surpluses, the
yen has not followed the usual pattern that currencies
in countries with large budget deficits have weakened.
Looking ahead, however, we expect the yen to lose value
against the US dollar. The USD/JPY exchange rate shows
a strong correlation with US interest rates. When the Fed
begins raising its key interest rate late in 2010, we be-
lieve that the USD/JPY exchange rate will move towards
110 late next year. Although the USD and GBP will regain
ground against the euro and yen, we expect the serious
deficit problems in the US and UK to result in deprecia-
tion against many other currencies.
China’s currency strategy will be crucial in determin-
ing whether the trend towards better balance in the
world economy can continue. This issue will be one of
the main points in upcoming G20 discussions. We inter-
pret recent (quiet) signals from China as meaning it is
ready to resume the appreciation of the yuan against the
USD, especially in light of domestic economic tightening
needs. We predict that this process will begin during the
next few months and that yuan appreciation will total 5
per cent this year and somewhat more next year.
The Swedish krona will continue to strengthen against
the euro. Strong government finances and an expansion-
ary fiscal policy, improved export prospects and relative-
ly early Riksbank interest rate hikes will make the krona

Nordic Outlook – May 2010  |  11

 International overview
The economic policies of the future
Concurrently with the ongoing restructuring of the
financial system, the IMF has also taken the initiative
for a fundamental discussion on the means and ends of
economic policy and what lessons can be drawn about
the origins and management of the crises of the past
few years.
The Mutual Assessment Process (MAP) recently initiated
by the G20 and produced by the IMF postulates that
international economic cooperation should be based on
the principle that the fiscal, monetary, currency and
structural policies of an individual country must not cre-
ate obstacles to the economic development of another
country. The purpose of MAP is to identify inconsisten-
cies in global economic policy and confront the largest
economies with these. At the G20 summit in Canada on
June 26-27, the IMF will present proposed policy options
aimed at achieving better global economic coordina-
tion and more efficient economic policy instruments. A
number of changes in various areas have come up for
discussion, and others will follow. The next opportunity
for the G20 to make decisions will be in South Korea on
November 11-12.
Monetary policy reforms
The crude nature of the interest rate weapon and its
limited ability to respond to excess indebtedness and
risk-taking, as well as the accompanying system-endan-
gering asset price bubbles, while achieving economic
stability is increasingly being viewed as a problem. The
question will thus be whether interest rate policy needs
to be supplemented with other instruments that can
influence credit volume (loan-to-value ratios, principal
payment requirements or new regulations). This may
also lead to calls for greater integration of macroeco-
nomic analysis and financial oversight, which implies
greater cooperation (or mergers) between central banks
and regulatory authorities.
The IMF has raised the question of boosting infla-
tion targets (normally 2 per cent) in order to create a
greater safety distance to the deflation point. This is
a way of achieving greater manoeuvring room in inter-
est rate policy, since the neutral interest rate is higher
and the distance to the zero interest rate limit are
thus greater. Higher inflation targets also increase op-
portunities to bring about relative wage changes, which
would increase economic mobility. This question is very
controversial, however, among other things because it
is linked with concerns that some countries may try to
inflate away their debts. The IMF continues to maintain
that higher inflation targets have various advantages,
but it seems unlikely that such a proposal will be pre-
sented to the G20 in Toronto or Seoul.
12   |  Nordic Outlook – May 2010
Fiscal policy reforms
The point of departure for discussing future fiscal
policy is how the international community can create
a stronger framework for fiscal discipline. The G20 will
probably issue recommendations in line with the EU
Growth and Stability Pact that is currently in effect,
for example establishing a target for bringing down
general government debt to a maximum of 60 per cent
of GDP over a certain period. Sweden’s fiscal frame-
work, with surplus targets for public sector finances
and expenditure ceilings, may be cited as an example
of how a country can create sufficient political ma-
noeuvring room in case of recession.
Such frameworks can be supplemented with exemp-
tions that allow a greater degree of freedom under
exceptional circumstances. It would be conceivable to
have rules that automatically activate economic stabi-
lisers in case of major recessions. For example, if the
decline in GDP or the unemployment rate surpasses
certain predetermined levels, tax cuts and grants to
households may be implemented immediately. Such
temporary measures must be tailored to have the
largest and fastest possible impact. The knowledge
that there is a credible stimulus system may in itself
reduce economic fluctuations.
Historical breakpoint
One basic reason why so many questions are now
being opened up for discussion is that the crisis ex-
posed a number of weaknesses in the macroeconomic
framework. The basic principles that have dominated
economic policy in the past 25 years, including infla-
tion targeting, deregulated capital markets and a pas-
sive role for fiscal policy turned out not to deliver the
stable high growth embodied in the concept of ”The
Great Moderation”. The violence of the crash instead
implies that world leaders must now assume the task
of developing new regulations and principles. In that
sense, the situation is reminiscent of the early 1970s,
when the Bretton Woods system collapsed. This was
followed by more than a decade of repeated crises
before the contours of a new system began to take
shape. That experience shows that it may take a long
time to find a way to a new, sustainable system and
that there are major risks of temporary mistakes dur-
ing the reassessment process.
 International overview

an attractive alternative in the prevailing international The Norwegian krone will benefit from rising oil prices,
climate and flight to safety. We thus expect the EUR/SEK twin surpluses in the budget and current account and
exchange rate to be 9.00 as early as the end of 2010. tighter monetary policy ahead. The strength of the krone
will help push down inflation during 2010. Looking ahead,
Krona tracks business optimism Norges Bank thus regards a somewhat weaker NOK as
11.5 -60 desirable. But in the prevailing international environ-
-50
11.0 ment, replete with fiscal worries, it is difficult to foresee
-40
10.5 anything but continued krone appreciation. We forecast a
-30
EUR/NOK rate of 7.75 in December 2010.
10.0 -20

9.5 -10
0
9.0
10
8.5 20
8.0 30
98 99 00 01 02 03 04 05 06 07 08 09 10

EUR/SEK (LHS)
Business confidence, net balance (RHS)
Source: NIER, SEB

Nordic Outlook – May 2010  |  13

Theme: Reforming the financial infrastructure
Rule changes for a squeezed credit market
 Systematic timetable for rule changes
 Big adjustments for global financial sector
 Banks squeezed from many directions
The international community is now engaged in an inten-
sive period of discussion and decision making aimed at
finding a fast, sustainable path back to global economic
and financial stability. This task is a top priority of the
G20 (19 countries plus the EU), a forum that represents
80 per cent of world trade and 70 per cent of the earth’s
population.
The work is taking place concurrently in three mutually
dependent areas:
ƒƒ Finding an optimal economic policy that can manage
the aftermath of the deep crisis and look after the
recovery
ƒƒ Evaluating and reassessing the future means and ends
of the economic policy that will be pursued
ƒƒ Reforming the financial infrastructure
The potential to achieve the aims in the third point
are discussed below.
New financial infrastructure − getting there
The purpose of introducing new requirements and regu-
lations for banks and other financial institutions is to
create a financial infrastructure with a higher degree of
resilience and stability. Fundamental questions in this
context are what functions the financial sector should
have and how big it should be. Another question that de-
cision makers are increasingly facing is whether a strat-
egy of gradual changes is the most fruitful, or whether
more far-reaching reforms are needed.
TODAY FUTURE
= Real economy = Credit/banking market
14   |  Nordic Outlook – May 2010
There is a long list of proposed rule changes and new re-
quirements. This work is being coordinated by the Bank
for International Settlements (BIS), or Basel Committee
on Banking Supervision, and the Financial Stability Board
(FSB). The pace of work is very fast. The public comment
period for these proposals expired in April, and continued
negotiations and impact assessments will now follow. The
aim is for the G20 to make a decision in late 2010 for a
launch in 2012. This timetable is probably too optimistic,
but it is nevertheless likely that the financial sector is
already beginning an adjustment. There are strong rea-
sons to quickly prepare for changes that will lead to new
conditions for selecting a business model. This is true
even if generous transition rules will apply. Among other
things, these proposals deal with the following:
ƒƒ That banks/financial institutions must have more and
better capital and that capital adequacy require-
ments must be raised
ƒƒ Introducing capital buffers with cyclical elements that
reduce the risk of “feedback loops” in the economic
and financial system
ƒƒ Limiting the build-up of excessive leverage ratios
ƒƒ Strengthening both short and long-term liquidity and
financial buffers (liquidity coverage ratio, structural
liquidity ratio)
ƒƒ Introducing a financial sector tax
The purpose of the international process is to find the
lowest common denominator. But it is always possible
for a country or region to introduce tougher require-
ments than the minimum ones that apply at the interna-
tional level.
Higher cost of capital
At present it is difficult to assess the impact of the
proposals on the credit market and the overall economy.
There is great uncertainty about which measures will
actually be enacted. The politicians have “pledged” that
these proposals will not jeopardise the healing process in
the financial sector and/or the economic recovery. This
summer, impact assessments that examine this will be
presented.
Our fundamental conclusion is, however, the same as
previously. Since the purpose of the proposals is to influ-
ence the balance sheets and income statements (struc-
ture and potential return) of financial institutions, it
is reasonable to count on a tighter credit situation than
 Theme

normal during a transitional period. In addition, the
cost of capital will establish itself at a higher level than
before the crisis. One reason for this is that the cost of
equity for banks is normally higher than the cost of de-
posits.
Credit conditions remain squeezed
The situation in the global credit market has improved
appreciably in the past year, but due to the lingering
effects of the economic and financial crises and new
rules/requirements, the situation is far from normal.
Depressed profitability and maturing loans for the bank-
ing sector totalling about USD 5 trillion during 2010-2012
will result in major strains.
The need for banks, governments and companies to re-
finance maturing loans (and finance new deficits) simul-
taneously may create upward pressure on interest rates.
many financial institutions need to extend the maturity
of their borrowing. The process is being accelerated
because central banks are reducing their quantitative
easing operations, while regulators are requiring a bet-
ter match between long-term deposits and lending in the
banking system.
Since funding with longer maturities is more expen-
sive than today’s borrowing via central banks, this will
squeeze future profitability. Also squeezing profitability is
greater competition for household and company deposits
and the fact that the yield curve will eventually become
less steep.
Low credit expansion in euro zone
Year-on-year percentage change
12.0 12.0
Credit growth
10.0 10.0

But a maturing loan also means that an investor needs to 8.0 8.0
find somewhere to put his funds. The important question 6.0 6.0
is whether, for example, the investor will demand com-
4.0 4.0
pensation for extending the maturity of a loan and for Average M3
2.0 2.0
accepting a foreign exchange or credit risk. Money supply growth (M3)
0.0 0.0
The global banking system’s credit side has not yet been
-2.0 -2.0
restored. Further write-downs can be expected. Ac- 92 94 96 98 00 02 04 06 08 10
cording to a compilation by the IMF, global write-downs
Source: ECB
realised to date total USD 1.5 trillion. Write-downs of
another USD 700 billion or so are expected in the near
The calculations that the IMF has recently published
future. The situation is the most serious in the United
about the “funding gap” (estimated credit capacity mi-
Kingdom, where write-downs are by far the largest in
nus credit demand from the non-financial sector) focus
relation to the size of the economy. The euro zone, on
primarily on the UK, where the 2010 budget deficit is
the other hand, has a larger percentage of overall write-
projected at about 10 per cent of GDP, while the cor-
downs ahead.
responding imbalance in the euro zone and the US is only
New write-downs ahead for banking sector. equivalent to 2 per cent of GDP.

To summarise, we are drawing the conclusion that be-

900
Expected writedowns, USD bn cause of rule changes, underlying economic factors and
800 180 Realised writedowns, USD bn self-imposed balance sheet adjustments, there will be
700 no room for credit expansion via the banking system
over the next couple of years. Conditions vary between
600
280 countries, regions and sectors, but on the whole, shrink-
500 ing credit volume will hold down medium-term economic
400 100 growth.
680
300

200 400
350
70
100 100
80
20
0
US UK Eurozone Other Asia
Europe

Source: IMF

Looking ahead, the debit side of banks will also be more

in the spotlight. After two years of serious liquidity crisis,

Nordic Outlook – May 2010  |  15

The United States

Inflation will continue to fall

 Increasingly broad-based but fragile recovery ISM indicates stronger growth
Index, year-on-year percentage change
 Households postpone their saving adjustment
62.5 6
 Employment increasing, but jobless rate will 60.0 5
remain high 57.5 4
55.0 3
 Fed will hike its key interest rate in December 52.5
2
50.0
1
47.5
0
45.0
42.5 -1
The American economic recovery is continuing. The up- -2
40.0
turn has gradually broadened and stands on increasingly 37.5 -3
firm ground. Yet GDP growth during the first quarter, 3.2 35.0 -4
per cent on an annualised basis, was somewhat weaker 98 99 00 01 02 03 04 05 06 07 08 09

than we anticipated in our February forecast. GDP ISM Composite index (LHS) Real GDP (RHS)
growth will end up at 3.6 per cent this year and 2.8 Source: ISM, Department of Commerce

per cent next year. The growth contribution from inven-

Because of strong company balance sheets and a low
tory build-up and fiscal stimulus is fading, which is being
initial level of fixed investments, we expect a decent
offset by stronger final domestic demand. Employment is
upturn in capital spending − especially in 2011 − despite
moving towards an upturn, but the jobless rate will de-
low capacity utilization.
cline only slowly to just below 9 per cent at the end of
2011. This, combined with a continued decline in core It is still remarkable, however, how differently large
inflation, will help persuade the Federal Reserve to hold companies and small businesses view the future. The
off on hiking its key interest rate until December this gap between the National Federation of Independent
year. By the end of 2011, the federal funds rate will be a Business (NFIB) small business index and the ISM, which is
low 2.0 per cent. dominated by large companies, is the widest since small
Fiscal stimulus and inventories are boosting GDP business surveys began in 1974. There are several reasons
Annualised for this difference. Small businesses are dependent on
6 6 bank loans for their funding, while large companies have
SEB forecast
5 5
access to the global capital market. Large companies can
4 4 also benefit from a strong upturn in exports, while the
3 3
depressed construction industry is having a considerably
2 2 larger downward effect on the NFIB index.
1 1
0 0 This gap is a warning signal, since the NFIB index actually
-1 -1 has a slightly higher correlation with GDP than the ISM
-2 -2 index, viewed over the past 30 years. Current NIFB index
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 levels are consistent with a GDP growth rate of around
09 10 11
Inventory contribution GDP growth zero.
Net effect of stimulus
Source: CBO, Recovery.gov, SEB
Small firms are lagging behind
Index
Big companies happy, small ones hesitant 65 30
All the important confidence indicators have rebounded 60 25
from their lows. The ISM purchasing managers’ index for
55
manufacturing is now approaching historical peaks, with 20
especially high levels for the “Production” and “New 50
15
orders” sub-indices. In recent months the ISM purchasing 45
managers’ index for services has also climbed sharply. 40
10

Given this broadening of optimistic expectations, our 5

35
composite ISM index indicates GDP growth of 3½-4 per
30 0
cent. The US business sector has clearly been able to
86 88 90 92 94 96 98 00 02 04 06 08 10
take advantage of a combination of credit market easing,
a relatively weak dollar and strong Asian demand. ISM Manufacturing (LHS) NFIB (RHS)
Source: ISM, NFIB

16   |  Nordic Outlook – May 2010

 The United States

Higher consumption despite weaker income Consumption will grow more strongly than disposable
Household consumption rose significantly faster than income this year, and the opposite will be true in 2011.
expected in the first quarter, even though disposable Consumption growth will end up just below 2½ per
income actually fell in real terms. The upturn reflects an cent both this year and next. Household confidence
unexpected fall in the household savings ratio. Wealth- indicators remain at historically very low levels. This sup-
based savings models indicate that the savings ratio ports a cautious consumption forecast. Consumer confi-
should climb substantially from today’s levels. But over dence is compatible with consumption growth of 1-1½
the past two decades, such models have generally over- per cent this year: well below our forecast.
estimated the savings ratio. There are many signs that
the Fed’s low interest rate policy will help this pattern to Household balance sheets on the mend
Ratio
persist during the next couple of years. Our forecast for
9.5 Long-run average 3.00
this period is thus no longer based on a sharp upturn in 9.0
2.75
savings. The savings ratio will amount to 3 per cent this 8.5
8.0 2.50
year and then rise moderately to 3.6 per cent in 2011,
7.5
measured as annual averages. 7.0 2.25
6.5 2.00
Weak income growth will nevertheless restrain private 6.0
5.5 1.75
consumption. The labour market recovery looks set to 5.0
Liquid assets = deposits, credit market instruments
and corporate equities 1.50
follow the pattern of the two most recent economic up- 4.5
4.0 1.25
turns: employment growth will be considerably slower
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
than the usual scenario during the period 1950-1983,
when fast-growing employment laid the groundwork for a Total assets to liabilities (LHS)
Liquid assets to liabilities (RHS)
sharp upturn in consumption during the first year of reco- Source: Federal Reserve
very. In addition, tax hikes are likely in 2011. Our overall
Household balance sheets will remain an obstacle to
forecast is that real disposable income will grow by a
growth in the longer term as well. Because of house-
low 1 per cent this year and 3 per cent in 2011.
hold debt retirement, combined with the stock market

Can the US double its exports in 5 years?

A few months ago, the Obama administration estab- a large decline in the US currency has not occurred,
lished a foreign trade target: a doubling of US exports however, since the Bretton Woods system was buried
in five years. The background of this National Export in 1971. The 26 per cent decline in the dollar during
Initiative is that US household consumption will prob- 1985-1990 comes the closest.
ably show weak growth for some time to come, so
foreign trade must shoulder a larger part of the bur- Doubling US exports in 5 years
5-year percentage change, index
den. The US would thereby also contribute to a better 225 60
global trade balance. Today consumption accounts 200 70
175
for near-record levels (71 per cent) of American GDP, 150
80
while exports are equivalent to less than 12 per cent: 125 90
100 100
a level that seems to ensure chronic current account 75 110
deficits. 50
120
25
0 130
Viewed in a historical perspective, this is a tough tar- -25 140
get: exports have indeed previously doubled in five 75 80 85 90 95 00 05 10 15
years, but usually high inflation has helped puff up the US exports (LHS)
figures. SEB model: US exports (LHS)
Trade weighted real exchange index (RHS)
Source: IMF, Fed, Census Bureau, SEB
According to established theory, exports are deter-
mined by relative prices and income trends in the
countries one trades with. It is thus possible to design Our conclusion is that this target is unrealistic. The ag-
an export model with real, trade-weighted exchange gressive “weak dollar” policy that would be required
rates and global GDP as explanatory variables. Assum- would be very difficult for other countries to accept,
ing that global GDP grows according to our forecasts, especially in a situation where many countries need to
our estimates indicate that a real-term weakening rely on fairly strong exports in order to emerge from the
of the dollar by nearly 30 per cent during a 5-year economic crisis.
period is required in order to double exports. Such

Nordic Outlook – May 2010  |  17

 The United States
upturn, the ratio between household (liquid) assets and
liabilities looks healthier than a year ago. But this ratio
still has a long way to go before reaching its long-run
average.
Housing market shaky once again
The housing market is normally the sector that rebounds
first when monetary policy eases. But despite record-
low interest rates, the Fed’s purchases of mortgage
bonds and government subsidies to home buyers, hous-
ing statistics have been a disappointment over the past
six months. The National Association of Home Builders
(NAHB) index of construction industry confidence rose
to 19 in April but this is the same level as in September
2009 and is far below the 50 mark that indicates growth.
Another 5 to 6 million foreclosures are in the pipeline,
which means that the “shadow supply” of homes is
considerably larger than the 8-9 months of inventory
that the official figures indicate. The supply situation is
holding down both prices and new construction. Hous-
ing starts will total 620,000 this year and 850,000 in
2011, measured as annual averages.
The S&P/Case-Shiller home price index, the main price
measure that the market focuses on, has climbed eight
out of the last nine months in seasonally adjusted terms.
Without seasonally adjustments, however, it has fallen
for five months in a row. Meanwhile, alternative meas-
ures such as the FHFA and Loan Performance home price
indices have turned downward again. By year-end, we
expect the S&P/Case-Shiller index to remain close to cur-
rent levels, but the risk is on the downside. This spring,
before bouncing back in March, home sales weakened to
new lows and this points towards continued depressed
prices.
A double-dip in home prices?
Rebase 2005:1 = 100
120
115
110
105
100
95
90
85
80
75
05 06 07 08 09
Loan Performance FHFA
S&P Case-Shiller 20
Existing-home sales, median price
Source: OFHEO, S&P, NAR
For the Fed, developments in the housing market have
undoubtedly been a disappointment. During the past
six months, the central bank has expressed hopes that a
turnaround is imminent and highlighted early indications
that the trend has been moving in the right direction.
Employment is rebounding
Employment has rebounded at a faster pace than we
had anticipated. In March, the number of jobs rose by
18   |  Nordic Outlook – May 2010
162,000. We expect business sector employment to con-
tinue rising during the rest of 2010. Cutbacks during the
economic crisis were forceful; this is reflected by far
higher sustained US productivity growth than in Western
Europe, for example. The need to rehire employees is
thus likely to become apparent relatively soon, but due
to the moderate production upturn, during the coming
year we expect private sector employment growth not
to exceed an average of 130,000 jobs per month, or less
than 1½ per cent on an annualised basis.
During the spring nearly a million people are working on
short-term contracts for the 2010 Census, which is tem-
porarily driving up public sector employment. This ef-
fect totalled 48,000 in March. Public sector employment
is nevertheless being undermined by the poor financial
health of state and local governments, indicating a con-
tinued need for employee cutbacks. State and local gov-
ernment employees total around 20 million people and
thus represent about 15 per cent of the US labour force,
compared to fewer than 3 million federal jobs.
Overall, the employment upturn will not be enough to
push down the jobless rate especially far. We expect US
unemployment to average 9.5 per cent this year and
8.9 per cent in 2011. Hours worked will increase by less
than 2 per cent in the coming year.
Continued high unemployment will contribute to a clear
wage and salary squeeze. In the past year, average hourly
wages have risen by 1.8 per cent, which is lower than
the rate of increase in the Consumer Price Index during
the same period. This pay squeeze will continue during
our forecast period. In 2010, hourly wages in the private
sector will go up by 1.6 per cent and in 2011 by 1 per
cent: the lowest rate of increase in recent decades.
Inflation will continue to fall
A recurring pattern in American economic cycles is that
120
115 inflation declines well into the economic upturn. In 87
110 per cent of cases, core inflation is lower one year into
105 the recovery, compared to when the recession ended.
100
In 75 per cent of cases, core inflation is also lower after
95
90 two years. Idle capacity seems to dominate price for-
85 mation. This occurs primarily by squeezing unit labour
80 cost (ULC). The historical association between ULC and
75
inflation is also strong; the correlation is 0.82. As a com-
10
parison, the correlation between commodity prices and
inflation is 0.33.
ULC fell by no less than 5.9 per cent on an annualised
basis in the fourth quarter of 2009. Year-on-year, the
change in ULC was a record-low -4.7 per cent.
Core inflation continued downward this past winter and is
now at the low point of the previous cycle: 1.1 per cent
in November 2003. However, conditions are different
today from six years ago. At the end of 2003, unemploy-
ment was 5.8 per cent and capacity utilisation in manu-
facturing was 75 per cent (not 70 per cent like today);
idle capacity is thus considerably larger at present.
 The United States

Unit labor cost relative to inflation growth in M2 has fallen below 1.6 per cent, compared to
Year-on-year percentage change 8 per cent a year ago.
15.0 15.0
12.5 12.5
MZM now below the zero line
82% correlation Year-on-year percentage change
10.0 10.0 40 40
7.5 7.5 35 35
5.0 5.0 30 30
2.5 2.5 25 25

0.0 0.0 20 20
15 15
-2.5 -2.5
10 10
-5.0 -5.0
5 5
50 55 60 65 70 75 80 85 90 95 00 05 10
0 0
Unit labour cost CPI inflation -5 -5
Source: BLS
80 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Our forecast is that core inflation will fall from 0.9 per MZM M2
cent this year to 0.5 per cent in 2011. Consumer Price Source: Federal Reserve

Index inflation will also fall after a temporary energy-
driven upturn. Altogether, we expect inflation to end up
at 1.5 per cent this year and 0.7 per cent next year.
Further decline in core inflation
Year-on-year percentage change
6 6
5 SEB 5
forecast
4 4
3 3
2 2
In addition, the decline in bank lending is continuing.
This decline is currently more than 8 per cent year-on-
year, which means that we are still in the midst of the
steepest downturn in at least 40 years. The Fed has un-
derscored that it is keeping an eye on the development.
In our assessment, monetary curves must begin to point
upward before interest rate hikes begin to make sense.
Bank lending keeps falling
Year-on-year percentage change
20 20

1 1
15 15
0 0

-1 -1 10 10

-2 -2
5 5
98 99 00 01 02 03 04 05 06 07 08 09 10 11
0 0
Core inflation Headline inflation
Source: US Department of Commerce, SEB
-5 -5

Fed will hike key interest rate in December -10 -10

Despite overwhelmingly positive signals regarding output
and the labour market, the Federal Reserve has commu-
nicated a continued dovish message. Market expectations
on the timing of the Fed’s first rate hike have thus gradu-
ally been pushed back.
In various contexts, members of the Federal Open Mar-
ket Committee have expressed irritation at the market’s
attempts to determine the timing implied by the policy
formulation that the Fed will maintain its key interest
rate at a low 0-0.25 per cent ”for an extended period”.
Instead the Fed has tried to describe what changes in the
economic situation might catalyse a shift in monetary
policy. These primarily include changes in resource utili-
sation, inflation trends and inflation expectations. Given
both our forecast and the Fed’s current picture of the
economic situation, no interest rate hike is imminent.
75 80 85 90 95 00 05 10
Source: Federal Reserve
In the same way as after the last recession, when the
dotcom (IT) bubble popped, persistent concerns about
deflation may cause the Fed to remain passive. Core
inflation, measured using a personal consumption expen-
ditures (PCE) deflator − the measure that the Fed focuses
on − is generally a bit lower than core inflation based on
the CPI. Core PCE inflation will thus probably fall below 1
per cent, the lower limit of the Fed’s comfort zone, this
year. Because of such low inflation figures, the Fed may
raise its key interest rate later than we have forecasted.
In addition, the central bank’s own measure of underly-
ing price pressure, where the currently most volatile
components are excluded, is at record-low levels.

One important reason for the Fed’s caution is probably
that the transmission mechanism still works poorly. The
monetary base is currently increasing at around 20 per
cent on an annualised basis. Meanwhile broad measures
of money supply are continuing to fall; for the first time
in 15 years, MZM growth is now below zero. Year-on-year
In spite of this, we are sticking to our forecast that the
Fed’s first key rate hike will occur in December 2010
and that the federal funds rate at the end of 2011 will be
2 per cent. Meanwhile preparations are under way to
pave the way for a normalisation of monetary policy. This
year it is mainly a matter of testing the tools for with-

Nordic Outlook – May 2010  |  19

 The United States

drawing liquidity. The arduous task of slimming the bal- The higher yield caused by rising government debts, large
ance sheet by selling assets will not begin until 2011 at budget deficits and acerbic announcements from rating
the earliest. agencies thus have to be weighed against the squeeze on
Sharp moderation in underlying inflation yields resulting from continued low capacity utilisation
Year-on-year percentage change and a falling trend of inflation.
5.5 5.5
5.0 5.0 Health care reform approved
4.5 4.5 Congress finally voted in favour of President Obama’s
4.0 4.0
health care plan. According to the Congressional
3.5 3.5
3.0 3.0 Budget Office (CBO), the plan will cost an estimated
2.5 2.5 USD 940 billion over a 10-year period. It will provide
2.0 2.0 coverage to 32 million Americans who lack medical
1.5 Fed central tendency: core PCE inflation in 2010 1.5
insurance today. Its costs will be funded with the help
1.0 1.0
0.5 0.5 of new taxes on high income earners, fees on health
84 86 88 90 92 94 96 98 00 02 04 06 08 10 care companies and cuts in Medicare.
FRB Cleveland, Median
FRB Cleveland, 16% trimmed-mean
The health care reform is a major success for the
Source: Cleveland Fed administration. It signifies that in the future, Barack
Obama may be counted as one of the few presidents
Fading stimulus effects
who reshaped American society. But its impact in the
Our assessment of fiscal policy has not changed signifi-
form of GDP growth and budget deficits will be very
cantly since February; stimulus measures will contribute
small during the next couple of years. Not until 2012
1 percentage point of GDP to growth this year and -0.8
will the reform help lower the federal deficit.
per cent in 2011. The federal budget deficit, which to-
talled USD 1.4 trillion in fiscal 2009 (9.9 per cent of
GDP), will reach close to USD 1.6 trillion this fiscal year
and USD 1.4 trillion next year. Federal debt, which stood
at 84 per cent of GDP in 2009, will be just below the 100
per cent mark at the end of our forecast period. The
difficulties of managing such a high debt level will mean
that the country’s sovereign credit rating may be in
danger a few years from now. The risk that the US may
lose its AAA status has increased “substantially”, accord-
ing to Moody’s ratings agency. One common rule of thumb
is that government bond yields rise by about 50 basis
points if their credit rating is downgraded by one step.

*
Debt to GDP ratios
Per cent of GDP
130 130
120 SEB 120
110 forecast 110
100 100
90 90
80 80
70 70
60 60
50 50
40 40
30 30
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

United States United Kingdom Canada

Source: IMF

20   |  Nordic Outlook – May 2010


Surprising strength
 Record-fast export recovery
 Unemployment below 5 per cent
 Bank of Japan will raise key rate in 2011
The Japanese economy is doing better than expected.
Exports of goods and services, which fell by nearly 25 per
cent last year despite a fourth-quarter lift, have contin-
ued to climb thanks to higher demand from China and
other Asian countries. Exports to China rose by a full 30
per cent in the fourth quarter and will continue upward
this year. Total exports have not increased so fast since
1980, but this is occurring from a low level, at present
about 20 per cent below that of a year ago.
Tankan Survey: Take-off in manufacturing
Net balance
40
20
0 0
-20
-40
-60
-80
Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan
06 07 08 09 10
Housing and construction Manufacturing
Retail sales
Source: Bank of Japan
The surge in exports represents a shot in the arm for
the entire economy; manufacturing is benefiting from
higher auto and electronics sales, the retail sector from
falling unemployment and rising consumer confidence.
The manufacturing rebound is more powerful than in
other countries, both because last year’s decline was
deeper and Asia is now growing faster than other parts of
the world economy. We expect industrial production to
rise by 15-20 per cent this year and nearly 10 per cent in
2011. Retail sales have also turned around quickly, rising
more than 4 per cent year-on-year in February.
The central bank’s Tankan Survey nevertheless shows
that the housing and construction industry is still grap-
pling with major problems. The reason, as earlier, is
that deflationary forces in the Japanese economy make it
advantageous to postpone investments and durable goods
purchases.
Japan
Japan
GDP growth will reach nearly 2.5 per cent this year,
half a percentage point higher than our February forecast
and above the consensus view. Exports will increase by
6-7 per cent, capital spending by more than 4 per cent
and private consumption just above 2 per cent. Next
year, growth will total more than 2 per cent, also an up-
ward adjustment from our February forecast.
The economic rebound is pulling the labour market with
it; unemployment peaked at 5.6 per cent last year and
fell unexpectedly to 4.9 per cent in January 2010. The
downturn occurred faster than anticipated and we fore-
see a continued downturn, albeit at a fairly slow pace.
The jobless rate will average just below 5 per cent this
year and about 4.5 per cent in 2011.
Deflation pressure will continue in Japan but will be
somewhat less powerful. CPI inflation bottomed out at
40 -2.5 per cent in October 2009 and is now at about -1 per
cent (negative inflation 13 months in a row). We expect
20
rather small movements ahead, and CPI inflation will
average -0.6 per cent in 2010. Next year, decent GDP
-20 growth and an improved labour market will help inflation
climb above zero again.
-40
-60 The government’s many stimulus packages since 2008
have contributed to the economic turnaround but have
-80
further exacerbated Japan’s precarious fiscal situation.
The total cost of these measures is equivalent to nearly
7 per cent of GDP, allocated over 2008-2010. The general
government budget showed a deficit of about 10 per
cent of GDP last year, and the economic turnaround is
not strong enough to generate any improvement over the
next couple of years.
The economic turnaround has persuaded the govern-
ment, following the lead of Finance Minister Naoto Kan,
to declare its support for a formal inflation target. The
Bank of Japan has expressed doubts, however, on grounds
that such a target risks shifting decision makers’ focus
from imbalances in the economy and in the financial sys-
tem. This discussion will hardly affect interest rate deci-
sions in the near future, though. We expect the BoJ to
hike its key interest rate during the second half of 2011,
but it cannot be ruled out that the bank will act earlier if
growth or inflation should prove faster.
The yen will gradually weaken during our forecast pe-
riod. In September the USD/JPY rate will be 95 and in
December 2011 it will be 110. The EUR/JPY rate will be
123 in December 2010 and 132 in December 2011.
Nordic Outlook – May 2010  |  21
Asia
Continued strong growth
 China will grow 10.5 per cent this year, India 8
per cent
 Fiscal and monetary tightening
 Inflation under control in China
The 2009 global recession pulled down growth in Asian
emerging countries to its lowest level in eight years,
but these economies have shown better resilience than
the West. China and India were among the countries
that managed to maintain a relatively good growth rate,
driven by sharply expansionary fiscal and monetary poli-
cies. Because of their strong balance sheets, many Asian
countries had room to respond to the economic crisis
with vigorous fiscal policies. The average stimulus in 15
Asian developing countries is equivalent to 7.5 per cent
of GDP over the years 2008-2010 (India about 4 per cent
and China about 14 per cent), compared to less than 3
per cent of GDP in the G7 countries.
In Asia the recovery began as early as the second half
of 2009. Signals from a number of countries now indicate
good growth. The challenge ahead will be to ensure that
the recovery in domestic demand can survive on its own
power, without support from stimulus measures.
China growing strongly
China’s GDP growth bottomed out as early as the first
quarter of 2009. Because of rapid growth after that,
strengthened by stimulus-driven domestic demand and
exports, growth reached 8.7 per cent in 2009. In the first
quarter of 2010, GDP was up by 11,9 per cent, in line
with our February forecast. Our assessment that the GDP
will rise at a 12 per cent rate in the first half thus re-
mains in place. There are many indications of continued
good growth. Leading indicators are at pre-crisis levels
and consumer confidence has strengthened. Output data
also show strong performance. Industrial production rose
by 18.1 per cent in March; retail sales and capital spend-
ing in manufacturing have recovered.
Because of the rapid increase in domestic demand, Chi-
na’s trade balance during March was negative for the first
time since 2004. The risk of overheating has persuaded
Chinese authorities to tighten economic policy since last
autumn, mainly by placing limits on lending; M2 money
supply and lending by the banks are now expanding more
slowly. So far, however, the upturn in inflation has been
moderate, despite rising economic activity. CPI inflation
is now around 2.5 per cent, while core inflation is slightly
22   |  Nordic Outlook – May 2010
above zero. Looking ahead, we expect inflation to climb
somewhat, reaching 3.0-3.5 per cent in 2010-2011.
We foresee encouraging prospects for good Chinese eco-
nomic performance ahead. Several policy tools, the same
ones employed to stimulate the economy, will need to be
used. With the aid of fiscal belt-tightening (starting next
year), a higher key interest rate and currency apprecia-
tion, growth will decelerate to a level compatible with
a controlled inflation rate. Yuan appreciation will begin
late in the second quarter and be about 5 per cent this
year and somewhat more in 2011. When this occurs, it
will be an important signal that the authorities view do-
mestic demand as more robust and not so dependent on
stimulus programmes.
Belt-tightening and base effects will slow growth, start-
ing in the second half of 2011. GDP growth will thus
not exceed 10.5 per cent in 2010 and 9.0 per cent in
2011. Reforms in education, health care and pension
systems will enable households to reduce their precau-
tionary saving. Rising private consumption could thus
decrease the Chinese economy’s dependence on exports.
Inflation in China and India
Per cent
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
Jan May Sep Jan May Sep Jan May Sep Jan
07 08 09 10
China India
Source: Reuters EcoWin
India: Good growth but high inflation
India has also weathered the crisis well, but fiscal ex-
pansiveness has swelled already large public sector
deficits to around 10 per cent of GDP this year and next.
Industrial production has been growing since the fourth
quarter of 2009 by more than 10 per cent year-on-year.
Meanwhile inflation has climbed above 10 per cent. Cer-
tain price controls have been imposed, and the central
bank has raised its reserve requirements for banks and
hiked its key interest rate. Further rate hikes plus fiscal
tightening measures are expected to slow price increases
ahead as the economy cools off. We expect GDP to grow
by 8.0 per cent in 2010 and 7.0 per cent next year.
 The
Theeuro
eurozone
zone

Imbalances hampering recovery

 Indicators continuing upward, decent growth positioned, since the weaker euro and the recovery in
Asia and the United States are now stimulating the ex-
 Inflation will keep falling
port sector.
 Major differences in cost situation
Altogether, we believe that GDP growth will reach 1.5
 ECB will not hike refi rate until March 2011 per cent this year and 1.8 per cent in 2011, a small
downward adjustment compared to our February forecast
and below trend growth this year. This is nevertheless a
Euro zone economic growth slowed more rapidly than relatively optimistic forecast, compared to the consen-
expected late in 2009. GDP levelled off completely be- sus view. GDP will rise about 0.2-0.3 per cent in the first
tween the third and fourth quarter. Nor has 2010 started quarter compared to the fourth quarter of 2009 and then
off convincingly. German industrial production in Feb- accelerate somewhat during the rest of 2010.
ruary was weak, especially with respect to consumer Decent growth in spite of everything
goods, while retail sales figures have provided downside Percentage change
surprises, but these disappointments are probably partly 5.0 5.0
a consequence of the cold winter weather, which has 2.5 2.5
hampered construction and other activities.
0.0 0.0
SEB
The government budget crisis in some of the “PIIGS” -2.5 forecast -2.5

countries (Portugal, Ireland, Italy, Greece and Spain) is -5.0 -5.0

also contributing to greater uncertainty. In particular, the -7.5 -7.5
situation in Greece reveals important shortcomings in the
-10.0 -10.0
entire euro system. Market scepticism about Greece’s 04 05 06 07 08 09 10 11
ability to deal with its situation remains very high, de-
Quarter-on-quarter, annualised
spite domestic austerity programmes and international Year-on-year percentage change
aid efforts. There is also lingering concern that other Growth indicator (Euroframe)
Source: Euroframe, Eurostat, SEB
countries will suffer similar problems and that the final
bill for the euro zone as a whole will be so high as to af-
fect the growth potential of the whole region. Germany will grow fastest in the euro zone − by 1.8
per cent this year and 2.0 per cent in 2011 − a marginal
IFO index continuing upward downward adjustment. France will end up around the
Year-on-year percentage change (GDP), index 2000=100 euro zone average both this year and in 2011, with Italy
5.0 120 growing by just below 1 per cent this year and somewhat
115
3.0 faster in 2011.
110
1.0 105
Household consumption will increase by only 0.2 per
100
-1.0 cent this year in the euro zone. This is partly because
95
-3.0 90
the German bonus for scrapping old cars has been phased
85 out, with fewer car purchases in 2010 as a consequence.
-5.0
80 Capital spending will rebound by about 1.5 per cent,
-7.0 75 following last year’s slide of about 11 per cent. Exports
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
of goods and services will recuperate faster, with an up-
GDP (LHS) Expectations (RHS) turn of more than 4 per cent this year. Since imports will
Business conditions (RHS) increase by 4 per cent, the GDP contribution from net
Source: Federal Statistics Office, IFO
foreign trade will be neutral this year (-0.8 percentage
Decent growth this year
points in 2009).
But meanwhile there are signs that the economic re-
covery will continue, though at a leisurely pace. Various
Southern Europe hampering growth
important leading indicators have continued upward. The
The crisis in southern Europe is continuing (see also “In-
ESI sentiment indicator from Eurostat (the EU’s statistical
ternational overview”). After negotiations with the EU
office) and Germany’s IFO business sentiment index, for
and IMF on the recently unveiled aid package, Greece
example, point to continued growth momentum well
has pledged to carry out austerity measures equivalent
into the autumn. The German economy is favourably

Nordic Outlook – May 2010  |  23

 The euro zone

to more than 10 per cent of GDP, with the aim of bringing unemployment of nearly 20 per cent: almost double the
down the deficit to less than 3 per cent of GDP by 2014. 2007 figure. Youth unemployment is as high as 30 per
The package is sizeable enough to give Greece a chance cent. The labour market situation has made Spanish
to implement the necessary belt-tightening, but mean- households uncertain, which is apparent from their high
while it is too early to declare an end to the emergency level of precautionary saving (the household savings ratio
before these measures are actually in place and lower is now at 18 per cent).
budget deficits begin to be reported. What has been an-
Positive signs in the labour market
nounced to date is that Greece’s budget consolidation Year-on-year percentage change and net balance
programme includes lower wage and salary payments in 2.5 5
the public sector, a hike in value-added tax and a higher 2.0 0
retirement age. This has triggered protests, and there is 1.5 -5
1.0
still a risk that the government will not have the stamina -10
0.5
-15
to implement all these measures. 0.0
-20
-0.5
After Greece, Portugal is the country that runs the great- -1.0 -25
-30
est risk of being hit by market instability. Large government -1.5
-2.0 -35
budget and current account deficits, combined with limited -2.5 -40
political experience of belt-tightening programmes, make 00 01 02 03 04 05 06 07 08 09 10
this small economy highly vulnerable. After that comes
Employment (LHS)
Spain, whose extremely high unemployment and weak Expected employment (RHS)
real estate market provide fertile ground for market scepti- Source: Eurostat, European Commission

cism to emerge. We anticipate that unemployment will peak at 10.3

Finland per cent this summer in the euro zone, then slowly fall
Greece, Portugal and Spain are in the worst shape
Budget balance on vertical axis, current account balance on horizontal axis
next autumn and winter. It will end up averaging 10.2
(% of GDP, 2009) per cent this year and 9.9 per cent in 2011.
0.0 0.0
Finland
-2.5
Luxembourg
Germany -2.5
Pay increases will decelerate
Austria
Cyprus Low capacity and resource utilisation is holding down pay
Malta
-5.0 Italy Slovenia
Netherlands
-5.0 and inflation. The OECD estimates that the output gap in
Belgium
the euro zone is as large as 4.5 per cent. The unemploy-
-7.5 Slovakia -7.5 ment gap − the difference between actual unemployment
France
and the non-accelerating inflation rate of unemployment
-10.0 Portugal -10.0 (NAIRU) − is around 2 percentage points. These meas-
ures are admittedly more uncertain than usual, after last
Spain
-12.5 Greece -12.5 year’s abrupt economic deceleration. There is a risk that
Ireland
productive resources − both labour and capital − will be
-15.0 -15.0 squeezed out when the wheels of production spin more
-12.5 -10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0
Source: Eurostat, IMF, SEB slowly (dismissals, early retirements, disposal of old capi-
tal equipment, cancelled investments etc.). This indi-
Unemployment will peak soon cates that capacity and resource utilisation may perhaps
Overall euro zone unemployment rose to 10 per cent in be somewhat higher than the official figures indicate.
January, after having stood still at 9.9 per cent for three
Pay increases decelerating further
months in a row. The upturn during 2009 was slower than
Percentage points and year-on-year percentage change
expected, which was very much related to a favourable -2.0 4.5
trend in Germany, where unemployment fell and lev- -1.5 4.0
elled off at 7.5 per cent during the autumn and winter. -1.0
3.5
A number of EU countries have systems that pay govern- -0.5
3.0
ment allowances − “Kurzarbeit” in Germany − enabling 0.0
employees who would otherwise be laid off to work 0.5 2.5

fewer hours but keep most of their regular pay. This 1.0 2.0

form of job sharing has served as a bridge over the eco- 1.5 1.5
nomic crisis. Since businesses have been able to retain 2.0
1.0
employees, they are now ready to ramp up production 00 01 02 03 04 05 06 07 08 09 10 11
quickly once the economy turns around. In Germany, Change in unemployment, shifted two years forward (LHS)
this allowance system has probably saved more than Change in total wage and salary cost in industry (RHS)
Source: Eurostat, SEB
500,000 jobs.

Yet unemployment has continued upward in other euro But regardless of this, today’s levels are extreme, which
zone countries, despite measures to stimulate jobs. It has an impact on the actions of both sides in the labour
now stands a bit above 10 per cent in France and at 8.5 market. Employers cite continued profitability problems,
per cent in Italy. In Spain, the trend is disastrous, with while employees and trade unions seem to be focusing

24   |  Nordic Outlook – May 2010


more on preserving jobs than on boosting wages and sala-
ries. Overall euro zone labour costs in the manufacturing
and service sectors, which rose by 4.5 per cent year-on-
year late in 2008, have actually slowed a bit more quick-
ly than expected. In December 2009 the rate of increase
was 2.2 per cent, and there are now many indications
that labour cost increases will decelerate further to
about 1 per cent in 2011.
Core inflation will continue downward
Inflation in the euro zone, as measured by the Harmo-
nised Index of Consumer Prices (HICP), rose unexpectedly
to 1.4 per cent in March from 0.9 per cent the month
before. One reason was a rapid increase in energy prices
due to the cold weather early in 2010, but this burst of
Great need for internal devaluations
One fundamental reason for the tensions that now
characterise the euro zone is the large differentials in
the cost increase situation, mainly between Germany
and the PIIGS countries. Since 2000, the accumulated
effects of higher pay increases and lower productiv-
ity growth on competitiveness have totalled around
50 per cent in Greece and about 35-40 per cent in the
other PIIGS countries. Taking into account that at the
turn of the millennium, Germany probably started
with a higher cost level than the PIIGS countries, the
trend is somewhat less dramatic, but a reasonable
estimate is that the need for adjustment is in the 20-
30 per cent range.
Major deterioration in competitiveness
Trend of unit labour costs, index 2000=100
160
150
140
130
120
110
100
90
00 01 02 03 04 05 06 07 08 09
Greece Portugal Spain
Ireland Italy Germany
Weak competitiveness has increasingly resulted in
macroeconomic imbalances. Big budget and current
account deficits − “twin deficits” − plague a number of
countries. A degree of adjustment in the cost situation
now appears to have begun. A number of countries
with deficits show a lower inflation rate than average,
both in terms of HICP and underlying inflation rate.
For example, Irish HICP inflation was 2.2 percentage
points below the euro zone average last year and core
inflation was a full 2.8 percentage points lower. In
Portugal the corresponding figures were 1.1 and 0.9, in
Spain 0.5 and 0.6. In Greece, the adjustment has not
The euro zone
inflation will subside in the coming months. This is why
we now predict a falling inflation path: the rate of HICP
inflation will be 1.1 per cent in October 2010, then fall
to 0.7 per cent in December and bottom out at a low
0.3 per cent in April 2011. Measured as annual averages,
HICP inflation will be 1.1 per cent this year and 0.8 per
cent next year. Underlying inflation will gradually fall
from today’s 1 per cent to zero in December this year. As
capacity and resource utilisation cautiously rise, it will
then climb slowly, ending up between 0.2 and 0.9 per
cent during 2011. In terms of annual averages, underlying
inflation will be 0.6 per cent this year and 0.5 per cent
in 2011.
yet begun; despite large budget and current account
deficits, the country had higher inflation than the euro
zone average.
Budget balance, central government debt,
current account and inflation deviation,
2009
Budget Debt CA ΔHICP ΔCore
Greece -13.6 115.1 -11.2 1.1 0.9
Ireland -14.3 64.0 -2.9 -2.2 -2.8
Spain -11.2 53.2 -5.1 -0.5 -0.6
France -7.5 77.6 -1.5 -0.2 0.0
Portugal -9.4 76.8 -10.1 -1.1 -0.9
Slovakia -6.8 35.7 -3.2 0.4 0.3
Slovenia -5.5 35.9 -0.3 0.6 0.1
160 Belgium -6.0 96.7 -0.3 -0.3 0.7
150
Italy -5.3 115.8 -3.4 0.4 0.3
140
Netherlands -5.3 60.9 5.2 0.5 0.0
130
Austria -3.4 66.5 1.4 0.1 0.3
120
Germany -3.3 73.2 4.8 -0.1 -0.1
110
Finland -2.2 44.0 1.4 1.2 0.8
100
Luxembourg -2.2 15.0 5.7 0.0 0.6
90
10 11 Budget balance, debt and current account (CA) are measured as
a percentage of GDP, inflation deviation (ΔHICP, ΔCore) as the
difference between actual inflation (HICP and core inflation) in
Source: OECD each country and the euro zone average.
Source: European Commission, IMF, SEB
Countries that previously had high inflation thus seem
to have begun a “real depreciation”. When prices
increase more slowly (or fall faster) than in other
countries, competitiveness improves. More aggressive
fiscal austerity works in the same direction, but in a
historical perspective, the task of bringing about such
large cost changes within the euro system looks like
a very tough task. Internal devaluations on this scale
are likely to entail a protracted deflationary trend,
with large political strains that many countries are not
prepared for.
Nordic Outlook – May 2010  |  25
 The euro zone

Core inflation will bottom out late in 2010 At present, however, the interest rate puzzle is not so
Per cent difficult, since other factors also justify low interest
4.5 4.5 rates: GDP growth is below trend, inflation is below tar-
4.0 4.0 get, credit and money supply growth are low, and infla-
3.5 3.5
tion expectations are low and stable. In addition, the
3.0 3.0
2.5
SEB
2.5 Euro Overnight Index Average of interbank interest
forecast
2.0 2.0 rates (EONIA) is still about 70 basis points below the
1.5 1.5 refi rate. This means that the ECB can begin tightening
1.0 1.0
0.5 0.5
interest rates without touching its key rate. We expect
0.0 0.0 EONIA to stay at its current level until mid-2010, then
-0.5 -0.5 gradually be raised toward the refi rate. The first refi
-1.0 -1.0
rate hike will come in March next year; the refi and
01 02 03 04 05 06 07 08 09 10 11
EONIA rate will then be raised to 1.25 per cent. The
Core inflation HICP inflation refi rate will be 2.25 per cent at the end of 2011.
Source: Eurostat, SEB

Low credit and money supply growth

ECB in no rush to raise key interest rate Year-on-year percentage change
The euro zone’s growing mountain of debt and the spe- 15.0 15.0
cific problems of Greece have put the European Central
12.5 12.5
bank in a delicate situation. The central bank can lend to
10.0 10.0
Greek commercial banks on favourable terms and ap-
prove the use of Greek government securities as collat- 7.5 7.5

eral, despite the country’s poor credit rating. The risk 5.0 5.0
that additional countries (for example Portugal and 2.5 2.5
Spain) will have problems cannot be ruled out either, and
0.0 0.0
this poses further demands on the ECB’s precision in tim-
ing interest rates. Raising the refi rate too early might -2.5 -2.5
99 00 01 02 03 04 05 06 07 08 09
kill economic recovery in the region.
Credits M3
Overnight interest rate still below refi rate Source: ECB

Per cent
5.0 5.0
4.5 4.5
4.0 4.0
3.5 3.5
3.0 3.0
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
08 09 10
EONIA O/N Refi rate
Source: Reuters EcoWin

26   |  Nordic Outlook – May 2010

 The euro zone

Public finances and long-term yields
The association between a country’s public sector
finances and bond yields has been in the spotlight
during recent months; the bigger a country’s budget
and central government debt problems are, the higher
its yields will be, especially for longer maturities. For
example, yields on ten-year Greek sovereign debt are
currently around 10 per cent and on German debt
around 3. Such large spreads are directly connected
to the risk of defaults. But even given more normal
central government budget and debt levels, there is
an association that has to do with the relation be-
tween savings and investments in the economy as a
whole. If savings decline compared to investments, for
example as a consequence of an expansionary fiscal
policy, yields go up. This explains why countries with
large current account surpluses (i.e. high national
savings) often have low yields. Long-term yields are
also affected by economic and inflation prospects: the
stronger economic growth and inflation are, the higher
both key interest rates and long-term yields will be.
Public finances and long-term yields in
the euro zone
10 year 5 year 2 year
Bond yields
GDP growth 12 19 15
Budget deficit 50 47 45
Central government debt - - -
To determine how yields with different maturities
are affected by budget deficit and debt levels, we
have estimated yield equations for the 16 euro zone
countries between 1980 and 2009. The table shows,
among other things, that a one percentage point in-
crease in the budget deficit (measured as a share of
GDP) increases the ten-year yield by 0.50 percentage
points (50 basis points). The corresponding effect on
five- and two-year yields is 47 and 45 points. No effect
from debt level can be found. The table also shows
that a one percentage point increase in GDP growth
raises the ten-, five- and two-year yield by 12, 19 and
15 points, respectively. This result is quite consistent
with studies from the IMF, which are related to the
United States, however.
Estimates of the slope of the yield curve are present-
ed in the lower table. A one percentage point rise in
the budget deficit boosts the 10yr-3m curve (ten-year
yield minus three-month yield) by 13 basis points, the
5yr-3m curve by 10 points and the 2yr-3m curve by 7
points. This time debt level also has an impact. A one
percentage point higher debt ratio leads to 4, 2 and 2
point steeper yield curves. These results are also con-
sistent with other studies.

10yr-3m 5yr-3m 2yr-3m

Yield curves
GDP growth 20 22 25
Budget deficit 13 10 7
Central government debt 4 2 2
The table shows by how many hundredths of a percentage
point (basis points) yields with different maturities (10, 5 and
2 years) and yield curves (10yr-3m, 5yr-3m, 2yr-3m) are
affected when GDP growth, the budget deficit and central
government debt are one percentage point higher.

Source: SEB

Nordic Outlook – May 2010  |  27

The United Kingdom
Decent growth despite major imbalances
 Weak pound buoys exports
 Further tightening after the election
 Bank of England hikes in December
The British economy is on its way up despite major
imbalances. After six quarters of falling GDP, the
economy grew by a modest 0.3 per cent in the latest
two quarters. We foresee GDP growth of 1.5 per cent
this year and 2.0 per cent in 2011, which is below
trend.
The purchasing managers’ index in manufacturing
reached a 15-year high during the spring, but other in-
dicators such as Bank of England (BoE) surveys are not
as optimistic. A 25 per cent drop in the pound since
mid-2007, combined with the surge in global demand
is, however, still helping drive exports and manufac-
turing. Industrial production will increase by 2.5
per cent this year and 4 per cent in 2011. Exports
will increase by 6 per cent in 2010 and accelerate
to 8.3 per cent growth in 2011. The current account
balance (-2.7 per cent of GDP in 2007) will keep im-
proving to 0.2 per cent of GDP in 2011.
Capital spending fell by about 20 per cent in 2009, far
more than in previous recessions. Such a large down-
turn may impede underlying economic dynamism. But
the manufacturing upturn means that fixed invest-
ment will recover and grow by 1 per cent this year
and 8 per cent in 2011. Unemployment reached a
14-year high of 8.2 per cent in January and will slowly
fall to 7.5 per cent by the end of 2011. Tighter fiscal
policy in combination with households being the most
heavily indebted in the G7 hamper consumption.
The UK parliamentary election is being held on May
6, two days after Nordic Outlook appears. It appears
likely that the result will be a minority government
(due to a “hung Parliament”) for the first time since
1974. Recent Liberal Democrats successes in public
opinion polls seem to be creating a new situation in
British politics: three almost equally large parties.
Regardless of the election outcome, the government
will face exceptional challenges. The British economy
is struggling with deeper imbalance problems than
other leading economies. According to IMF estimates,
for example, the UK has a funding gap (credit sup-
ply minus demand) of a full 10 per cent of GDP, while
both the US and the euro zone are near balance.
28   |  Nordic Outlook – May 2010
This credit gap exists largely because UK public fi-
nances are in miserable shape. The government budg-
et deficit will end up close to 12 per cent of GDP
this year and slightly below 10 per cent in 2011, the
highest in the G7 countries. Central government debt
is expected to reach 100 per cent of GDP in 2014, ac-
cording to the IMF. We expect the new government to
approve fiscal tightening measures immediately after
the election that will hold back domestic demand.
Unless the new government is able to produce a cred-
ible plan for restoring fiscal order, the UK’s sovereign
credit rating will be threatened with downgrading as
early as autumn. This is clearly indicated by market
pricing: 5-year credit default swap contracts for the
UK are trading well above AAA-rated France and Ger-
many, but below AA-rated Italy. The UK has probably
not suffered even worse market mistrust due to the
size of its economy plus past experience which indi-
cates that in the end, the country usually displays a
talent for dealing with its problems.
5-year CDS iscontracts
Unless the new government able to produce a cred-
Basis points
ible plan for restoring fiscal order, the UK’s sovereign
275
credit rating will be threatened with downgrading as250
275
250
early
225 as autumn. This is clearly indicated by market 225
200
pricing: 5-year credit default swap contracts for the200
175 175
UK
150 are trading well above AAA-rated France and Ger- 150
many,
125 but below AA-rated Italy. The UK has probably125
100
not suffered even worse market mistrust due to the 100
75 75
size
50 of its economy plus past experience which indi- 50
cates
25 that in the end, the country usually displays a 25
0 0
talent
Jan for
Apr dealing withJan
its problems.
Jul Oct Apr Jul Oct Jan Apr
08 09 10
United Kingdom Italy
Germany France
Source: Reuters
The Conservatives have proposed an 80-20 allocation
between spending cuts and tax hikes. We expect a
value-added tax hike of nearly two percentage points
in 2011, pushing up CPI, yet our inflation forecast in-
dicates mild price increases. Inflation will reach 2.8
per cent in 2010 and 1.3 per cent in 2011.
Tightening measures will lower demand, but offsetting
this is that the BoE will move slowly and cautiously with
its key interest rate hikes: the first hike will come in
December, and in December 2011 the key rate will
be a low 2.0 per cent. Partly due to low mortgage loan
rates, home prices have rebounded fast. According to
the Nationwide index they are up 9 per cent in the past
year, despite indications that residential properties are
clearly overvalued.

On track for recovery
 Export-led economic turnaround
 Reduced imbalances
 Continuing currency appreciation
Even Eastern Europe − the region that was hardest hit
by the global credit crisis and recession − has begun a
gradual economic upturn in the past six months. How-
ever, this turnaround is limited to exports and industrial
production, which in some places have increased more
strongly than in the West. The upturn is occurring from
low levels after major declines in preceding years.
Forward-looking indicators rebounded during the spring
and summer of 2009, and this process was primarily
driven by greater optimism in the manufacturing sector.
The EU’s sentiment indicator (80 per cent based on com-
pany surveys and the rest on households) continued to
strengthen this past winter and has thus not been affect-
ed by increased concerns about the euro zone recovery.
Sentiment indicators pointing upward
Index
130
120
110
100
90
80
70
60
50
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Poland Hungary
Czech Republic Slovakia
Source: European Commission
We are revising our growth outlook for Eastern Europe
a bit upward, despite downward revisions for the euro
zone, but most Eastern European economies are continu-
ing to display dual tendencies. The recovery is being
driven by competitive export sectors. Russia and Ukraine
are also benefiting from high, though stabilising com-
modity prices, but consumption and investments will be
weighed down for another while by rising unemployment,
weak wage and salary growth, fiscal tightening and low
capacity utilisation. Lending is slowly thawing; in Poland,
the first positive signs are now evident.
During 2010-2011, the Eastern Europe region will not
bounce back to the inflated growth figures that prevailed
before the crisis. Of the six countries (including the
Eastern
EastenEurope
Europe
Baltics) that we cover, only Poland will reach its trend
growth rate in 2011. In Poland − the only EU country with
positive GDP growth last year and perhaps with the best
economic fundamentals in the Eastern European region
− the economy will expand by 3.5 per cent this year and
4.5 per cent in 2011. Russia will recover from deep re-
cession and reach annual growth of 5 per cent. Ukraine’s
GDP will increase by a moderate 3.5 and 4.5 per cent,
respectively, after last year’s 15 per cent slide.
Adjustment of earlier imbalances is continuing, especial-
ly in countries that previously struggled with large cur-
rent account deficits. Inflation is decelerating, although
its downturn will be slowed somewhat in the short term
by higher oil prices. Because of lower inflation, Poland
can hold off on its first key interest rate hike until the
second half of 2010 and Russia can continue to cut inter-
est rates somewhat. Budget deficits will remain large this
year but will then decrease, due to some fiscal tightening
and higher growth. Public sector debts will continue to
climb but are moderate or low compared to the West.
In light of these developments, the market confidence
that the region has regained during the past year rests
130
on stable ground. The appreciating trend in Eastern Eu-
120
ropean currencies will continue, among other things due
110
to relatively better GDP growth than in the West. Risks of
100
declining global risk appetite as well as conflicts related
90
to austerity policies may trigger some reversals, but cen-
80
tral bank interventions to counteract excessive currency
70 appreciation, such as Poland’s unusual action during
60 April, only have a short-term market impact.
50
The recent presidential election in Ukraine and parlia-
mentary election in Hungary, as well as approaching par-
liamentary elections in Slovakia and the Czech Republic
plus an earlier-than-scheduled presidential election in
Poland, are a source of some uncertainty in making GDP
and currency forecasts. The prospects of greater politi-
cal stability in Ukraine have improved. In Hungary, a new
centre-right government is expected to shift to more
growth- and reform-oriented policies. The Hungarian
economy is now also in better shape, since the budget
deficit has been squeezed to a more sustainable level and
IMF aid is no longer needed. As for Slovakia, the Czech
Republic and Poland, we foresee no changes in political
direction.
Nordic Outlook – May 2010  |  29
The Baltics

Growth will return gradually

 Estonia on its way into the euro zone
 Latvia is lagging behind
 New hesitation about Lithuanian austerity
est rate declines in local currencies will only marginally
ease the process of debt reduction, since an absolute
majority of the loan amount is in foreign currencies, pri-
marily euros.

The retail sector remains depressed, although signs of

bottoming out are beginning to be apparent. In addition,
A gradual export-led recovery in the Baltic countries is
base effects contributed to noticeably smaller negative
now on the way, following an exceptionally deep down-
year-on-year figures during the first quarter of 2010. The
turn. In recent months, exports and industrial indicators
real estate markets are also showing clear signs that the
have continued to climb. Estonia and Lithuania noted
worst may be over. We expect domestic demand, both
positive quarterly GDP growth in the second half of 2009,
consumption and capital spending, to slowly begin re-
while the upturn will begin only in the spring of 2010
awakening towards the end of 2010.
in Latvia. Earlier upward revisions in our GDP forecasts
for Estonia and Lithuania have thus gained traction. The Shrinking imbalances
light is visible at the end of the tunnel, as also indicated The slide in imports, combined with decently resilient
by upgrades of all three countries by international credit exports, has led to sharply improved external bal-
rating agencies. ances in recent years. Earlier extreme current account
deficits − at most 22.5 per cent of GDP in Latvia in 2007
Exports rose 15-25 per cent year-on-year (fastest in
− have been replaced by surpluses. A shift in capital flows
Estonia), according to trade data for February. The re-
caused by the crisis in the foreign-dominated banking
covery has been stronger than in most Western European
system has also contributed to the turnaround. Stronger
countries, a sign that internal devaluations in the Baltics,
exports and weak imports will mean that current account
whose purpose is to regain lost competitiveness by cut-
surpluses will continue this year. Next year, however, we
ting pay, are bearing fruit. A weaker euro also boosts
expect a modest deficit in Estonia, since imports will
exports.
experience an upswing.
Exports
The recession has also helped to dampen inflation dra-
Year-on-year percentage change, current prices
50 50
matically. In two years, the Baltics have moved from
40 40 very high to non-existent inflation or to deflation, largely
30 30 due to sharp wage and salary cuts. We believe that 2010
20 20 will be the last year of the pay-cutting process, but de-
10 10 flation pressure will linger in Latvia and to some extent
0 0 also in Lithuania. In Estonia, inflation will increase to an
-10 -10 average of 2 per cent a year, from around zero last year.
-20 -20 We expect real effective exchange rates for Baltic cur-
-30 -30 rencies to continue falling due to lagging wage effects
-40 -40 on inflation, a weaker euro and currency appreciation in
06 07 08 09
nearby countries such as Poland, Russia and Sweden.
Estonia Latvia Lithuania
Source: Reuters EcoWin Easing economic imbalances have further underscored
our belief that the three countries’ currency pegs
The European Commission’s composite monthly business
against the euro will survive, meaning there will be no
and household survey rebounded in the spring of 2009.
devaluations. There are some lingering currency risks
But these improvements − which have become clear in
related to Latvia and Lithuania, where weakened gov-
Latvia and Lithuania only recently − are still very much
ernments may have difficulty pushing through necessary
driven by the manufacturing sector, while consumption
fiscal tightening measures in 2011 as well. But given our
is lagging behind. Households continue to be squeezed
view that the economic recovery is beginning to take
by pay cuts, budget austerity and high, growing unem-
hold, these risks are small.
ployment. In Estonia, joblessness seems set to culminate
soon at around 16 per cent, but in Lithuania and Latvia it
will peak only late in 2010. This past winter’s large inter-

30   |  Nordic Outlook – May 2010

 The Baltics

Questions about inflation in Estonia GDP downturn during the depression-like period 2008-
We expect Estonia’s GDP to increase by 2 per cent in 2010 will thus end up exceeding 25 per cent. Next year,
2010 and 5 per cent in 2011, after last year’s 14 per cent however, a decent recovery will occur and GDP will grow
decline. A high ratio of exports to GDP and heavy de- by 4 per cent. Fiscal austerity will then ease, while the
pendence on the expansive Nordic economies will benefit labour market will improve somewhat.
the recovery. Estonia’s expected euro zone accession in
Budget consolidation remains a top Latvian government
January 2011 also strengthens its growth prospects, via
priority. The deficit was 9 per cent of GDP last year, or
somewhat higher investments.
below the 10 per cent ceiling that international creditors
Our main scenario (which we raised to a 90 per cent had stipulated in their bail-out loan programme. We be-
probability in the March issue of Eastern European Out- lieve that Latvia will barely meet the 8.5 per cent ceil-
look) is that Estonia will meet all Maastricht criteria ing in 2010 and the 6 per cent deficit limit in 2011, but
− such as price stability, public finance and currency the political risk related to belt-tightening policies has
stability − during the evaluation that the European Com- increased since last winter after one party left the five-
mission and the ECB will perform in May and that the EU party coalition. A minority government is thus running
summit early in the summer will give Estonia the green the country as the autumn parliamentary election draws
light. Last year’s budget deficit was 1.7 per cent of GDP, closer. Since individual opposition parties have, in prac-
well below the 3 per cent Maastricht limit. This year we tice, declared their support for the austerity programme,
expect it to end up around 2.5 per cent. Estonia also however, we find it hard to foresee a post-election
has a tradition of strong budget figures, which is likely change of political course.
to influence the evaluation. The most recently reported Latvia's manufacturing sector
12-month inflation average until March 2010 was -0.7 per Production, 3-month moving average
cent. This meets the criterion that inflation may not ex- 115 20
ceed 1.5 percentage points above the three EU countries 110 15
105 10
with the lowest inflation.
100 5
95 0
There is one small catch, however. The Maastricht cri- 90 -5
teria are partly flexible. For example, a country must 85 -10
show credible, sustainable low inflation. On that point, 80 -15
75 -20
Estonia’s phase-in of low inflation is not as reassuring as, 70 -25
for example, Slovakia’s before it joined the euro zone 65 -30
in 2009 (see chart). We also predict rising inflation in 01 02 03 04 05 06 07 08 09
Estonia the rest of 2010, with an annual average of 2 per Year-on-year percentage change (RHS)
cent. Level, index 100 = 2005 (LHS)
Source: Reuters EcoWin

Inflation in Estonia and Slovakia

Year-on-year percentage change
Lithuanian growth but political worries
17.5 17.5
The Lithuanian economy will grow by 1 per cent this
15.0 15.0
year and 4 per cent in 2011, after falling by 15 per cent
12.5 12.5
in 2009. A broad-based export recovery will initially sus-
10.0 10.0 tain growth.
7.5 7.5
5.0 5.0 Public finances are strained but are improving, due to
2.5 2.5
a strong commitment by the government and the presi-
0.0 0.0
dent to fiscal austerity. In recent months, however, the
government’s position has weakened. Due to political
-2.5 -2.5
00 01 02 03 04 05 06 07 08 09 10 tensions it no longer has a parliamentary majority, but
we do not foresee an imminent government crisis. The
Estonia Slovakia
Source: Reuters EcoWin budget deficit was 8.9 per cent of GDP in 2009, or some-
what better than expected, and may shrink to 8 per cent
Although our main scenario is that Estonia will be ap- in 2010.
proved as a euro zone member, there is a risk that Greek-
related market turbulence will lead to extra caution. In
such a situation, the European Council and the Ecofin
Council may come to the conclusion that Estonia is not
yet in sufficiently balanced shape after the crisis to be
accepted as a euro zone member. The sustainability issue
as regards inflation could be utilised to say no.

Latvia has a long way to go

After last year’s 18 per cent slide, Latvia’s GDP will con-
tinue to fall by 2.8 per cent this year. The accumulated

Nordic Outlook – May 2010  |  31

Sweden

Exports will lift GDP growth

 Growth of 3 per cent in 2010 room for manoeuvre. During 2011 we expect a dose of
stimulus measures totalling SEK 20 billion, equivalent to
 More jobs but continued high 0.6 per cent of GDP.
unemployment
 Core inflation will continue to fall The outcome of the September 2010 parliamentary elec-
tion is still uncertain. Many key initiatives will come dur-
 Key rate hikes will drive EUR/SEK to below ing the election campaign, but the dividing lines between
9.00 the two main government alternatives have become
 Fiscal expansion regardless of election clearer and follow a classic left-right pattern. The red-
result green block (Social Democrats, Left Party and Greens) is
focusing to a greater extent than the most recent Social
Democratic government, which lost the 2006 election, on
A recovery in the Swedish economy is now on the way.
social welfare issues and tax hikes. Meanwhile the em-
Although the national accounts recorded a GDP decline
phasis of the incumbent centre-right Alliance (Moderates,
during the fourth quarter of 2009, we can see how the
Centre, Liberals and Christian Democrats) is on continu-
signals of a recovery are broadening. Expansionary eco-
ing current efforts to strengthen incentives to work.
nomic policies will continue. Households and businesses
are very optimistic. Export figures are about to take off, Downside risks are primarily related to the problems of
while company reports confirm rising international de- the euro zone. A deep crisis that has secondary effects on
mand. An unexpectedly rapid stabilisation in the labour the global financial system and hampers the recovery of
market is contributing to a recovery in private consump- world trade would have major consequences for Sweden.
tion. We expect a strong rebound in the first half of Historical comparisons, however, show that on many oc-
2010, leading to a GDP increase of 3.0 per cent in 2010 casions Sweden has had substantially higher growth than
and 2.7 per cent 2011 (calendar adjusted: 2.7 per cent the euro zone.
in 2010). The GDP forecast is unchanged compared to
Nordic Outlook in February.
Exports are reviving
Employment has turned around, and the jobless rate is The sharp upturn in sentiment indicators is now starting
now close to peaking. Inflation will nevertheless remain to be reflected to some extent by actual data. Industrial
low. The 2010 wage round seems likely to result in some- production is still bumping along the bottom, but both
what lower pay increases than expected, and the risk of exports and orders are on their way up. Merchandise
major disruptions in the remaining negotiations is small. exports increased by 6 per cent year-on-year in the first
Low resource utilisation will also restrain wage drift in quarter of 2010. Order bookings indicate further acceler-
the near future. Meanwhile rising productivity and krona ation ahead. According to international indicators as well
appreciation will help keep core inflation down. We thus as quarterly earnings reports, international trade is now
expect the core inflation (CPIF excluding energy and in the midst of a fairly strong recovery phase.
food) rate to bottom out below 1 per cent early in 2011.
NIER foresees continued export upturn
Strong economic signals in the coming months will help 20 50
15 40
persuade the Riksbank to hike its repo rate in July.
10 30
Partly due to a rapid increase in lending to households, 5 20
the bank’s key rate hikes will occur at a faster pace than 0 10
those of the European Central Bank (ECB), but low infla- -5 0
tion and continued relatively low resource utilisation will -10 -10
help ensure that the key rate remains low. By the end -15 -20
-20 -30
of 2010, it will stand at 1.25 per cent and by the end of
-25 -40
2011 at 2.75 per cent. -30 -50
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Public finances have continued to provide positive sur-
prises. The central government budget deficit appears Merchandise exports, year-on-year % change, 3-mo avg (LHS)
Orders, Economic Tendency Survey, net balance (RHS)
likely to be 1.0 per cent of GDP in 2010 and 0.6 per cent Source: NIER

of GDP in 2011. This has given fiscal policymakers greater

32   |  Nordic Outlook – May 2010


Our forecast is that exports will grow by 7 per cent both
this year and next, or roughly in line with long-term
trend growth. The risks in this forecast are on the upside.
Swedish economic recoveries are normally characterised
by faster growth, and the earlier deep downturn also
means that there is extra large potential for a rebound.
Production and order levels according to the National
Institute of Economic Research’s Economic Tendency Sur-
vey and the purchasing managers’ index are also consist-
ent with stronger exports than our forecast. On the other
hand, there is greater uncertainty about the recovery in
the euro zone.
Early upturn in capital spending
According to Statistics Sweden’s latest fixed investment
survey, manufacturers are planning to increase their
investments as early as this year, despite low capacity
utilisation. We have thus made an upward adjustment in
our forecast of capital spending in manufacturing. Busi-
nesses admittedly tend to exaggerate their investment
needs early in the year, but on the other hand histori-
cal experience indicates that they underestimate these
needs at the beginning of a recession.
In addition, housing investments look set to regain a
large proportion of last year’s downturn. For example,
the National Board of Housing, Building and Planning
expects a 50 per cent increase in housing starts during
2010 and 2011. Public sector investments will continue to
How much divergence from euro zone?
The profound economic problems of the euro zone
raise a question: To what extent will economic growth
in Sweden be adversely affected? Swedish GDP growth
shows strong co-variation with other countries. Its cor-
relation with the euro zone is somewhat higher than
with the US (0.91 compared to 0.82). The difference
is smaller than the export structure indicates. Only 6
per cent of Swedish merchandise exports go to the US,
while the euro zone buys 40 per cent. Sweden’s direct
exposure to the crisis-plagued PIIGS countries is small,
however; only 7 per cent of its merchandise exports
go to these countries.
High correlation for growth
GDP, year-on-year percentage change
7.5
Sweden
US
5.0
2.5
Euro zone
0.0
-2.5
-5.0
-7.5
96 97 98 99 00 01 02 03 04 05
Sweden
increase this year, mainly due to infrastructure projects.
Our overall forecast is that after last year’s sharp de-
cline, fixed investments will climb by 3 per cent in 2010
and by 5 per cent in 2011.
Gross fixed investments
Percentage change, 2009 level in current prices (SEK bn)
2009 2009 2010 2011
Government sector 102 7 2 0
Housing 78 -21 8 12
Business sector 351 -19 3 6
Total 531 -15 3 5
Source: Statistics Sweden, SEB
A sharp inventory draw-down helped lower Sweden’s GDP
growth rate by nearly 3 percentage points at most in
mid-2009. During the fourth quarter, however, invento-
ries shifted to a positive growth contribution. Most indi-
cations are that this trend is continuing. We expect in-
ventories to level off in 2010. This will result in a positive
gross GDP contribution of one percentage point, but due
to large import content, the net effect on production will
be substantially smaller. Changed inventory behaviour in
other countries will nevertheless also stimulate growth
via rising Swedish exports.
Over the past 15 years, the difference in Swedish and
euro zone growth has varied between -1 and +2 per-
centage points. During the period 2002-2006, Swedish
GDP growth was about 1.5 percentage points higher
than euro zone growth. In light of this, the forecasted
growth differential of just over 1 percentage point per
year in 2010 and 2011 does not appear especially re-
markable.
Growth differential, Sweden and euro zone
Year-on-year percentage change, 4-quarter moving average
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
7.5 0.0 0.0
-0.5 -0.5
5.0
-1.0 -1.0
2.5 -1.5 -1.5
0.0 -2.0 -2.0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
-2.5
Source: Statistics Sweden, Eurostat
-5.0
Our conclusion is that a weak economic trend in the
-7.5 euro zone is not incompatible with fairly strong
06 07 08 09 growth in Sweden. Only if the fiscal crisis in southern
Source: Reuters Ecowin
Europe leads to severe disruptions in the global finan-
cial system that block a recovery in global trade will
Sweden’s economic upturn be seriously jeopardised.
Nordic Outlook – May 2010  |  33
 Sweden

Ash clouds will mean lower GDP growth Strong increase in new car registrations
120
Air traffic in large parts of Europe more or less stood 30
115
still for a week in April due to clouds of ash from the
28 110
Icelandic volcano Eyjafjallajökull. We estimate that
105
this will lower GDP in Sweden and the euro zone by 26
100
0.2-0.3 per cent in the second quarter of 2010. Assum- 24 95
ing no recurrence of the ash problem, the downturn
22 90
will be temporary and its full-year effect will be very
85
small. The aviation industry accounts for about one 20
80
per cent of GDP, which means that the direct effect 18 75
on output due to grounded aircraft is still less than a 00 01 02 03 04 05 06 07 08 09 10
tenth of a percentage point. In addition, an estimated
Thousands of new car registrations (LHS)
1-2 per cent of the labour force was prevented from Retail sales, index (RHS)
travelling to their workplaces during portions of this Source: Statistics Sweden

period. Transport problems also led to certain produc-

tion disruptions in other sectors, for example by caus- Household income and consumption
ing a shortage of input goods. Percentage change

If new ash clouds should drift in over Europe and cause
more long-lasting disruptions in aviation, the effect
on growth could be considerably larger. However, his-
torical experience shows that production disruptions
caused by natural disasters, strikes or the like almost
never have any decisive impact on economic trends.
2008 2009 2010 2011
Consumption -0.2 -0.8 2.9 2.6
Income 2.7 2.1 0.7 2.3
Savings ratio,
% of income 11.6 13.9 12.1 11.8
Source: Statistics Sweden, SEB

Large swing in inventory contribution Employment has turned around

21 2.5 In recent months, employment has turned around surpris-
20 2.0 ingly. Such indicators as the number of lay-off notices,
1.5 new openings posted with the Public Employment Service
19
1.0
18 and NIER Economic Tendency Surveys have also been
0.5
17 0.0 very strong. This shows that the employment upturn is
16 -0.5 not a temporary statistical anomaly. We thus expect the
15 -1.0 improvement to consolidate. The number of jobs will
-1.5
14 increase by an average of 0.3 per cent this year and 0.6
-2.0
13 -2.5 per cent in 2011. Moderate GDP growth is a downside risk
12 -3.0 for our forecast, but the indicators are compatible with
98 99 00 01 02 03 04 05 06 07 08 09 10 11 an even stronger upturn in the coming months.
Inventories relative to GDP, index (LHS)
Contribution to year-on-year GDP, % points (RHS) Employment has turned around
Source: Statistics Sweden, SEB

4650 Number of jobs, thousands (LHS) 9.0

Auto purchases lifting consumption Unemployment, per cent (RHS)
Strong household optimism has begun to be reflected in 4600 8.5
rising consumption. Retail sales were admittedly been a
bit weaker than expected during the latest quarter, yet 4550 8.0
new car registrations have climbed sharply since mid- 4500 7.5
2009. We expect auto purchases to increase more than
30 per cent this year, which will boost total consumption 4450 SEB 7.0
forecast
by more than one percentage point.
4400 6.5
Households are showing underlying financial strength, so
4350 6.0
we are sticking to our forecast that consumption will rise
nearly 3 per cent this year, despite a downward adjust- 4300 5.5
05 06 07 08 09 10 11
ment in income growth. The combination of rising asset Source: Statistics Sweden, SEB
prices, a stronger labour market and a high initial house-
hold savings ratio is more important than short-term Due to a rising influx into the labour market, unemploy-
income fluctuations. ment has continued to climb despite the upturn in the
number of people with jobs. However, we expect un-
employment to peak during the next quarter and then

34   |  Nordic Outlook – May 2010

 Sweden

slowly decline again. By late 2011 the jobless rate will
still be 2.5 percentage points higher than when the up-
turn began late in 2008.
Labour market
Percentage change
2008 2009 2010 2011
Employment 1.1 -2.1 0.3 0.6
Labour supply 1.2 0.2 1.0 0.4
Unemployment, % 6.2 8.3 8.9 8.8
Average hours worked 0.1 -0.2 0.2 -0.2
Productivity (GDP) -1.4 -2.2 2.4 2.2
Source: Statistics Sweden, SEB
We foresee productivity growth of 2.4 per cent in 2010
and 2.2 per cent in 2011. This is admittedly higher than
the long-term trend, but it still represents the recovery
of only a small portion of the decline in recent years.
Pay increases a bit lower than expected
The 2010 wage round has faced major challenges. The
economic crisis has hit the manufacturing sector hard,
while the demand in many other sectors has been sus-
tained in part by economic stimulus measures. This has
put the traditional wage-setting role of manufacturing in
question.

Large gap between GDP and labour market GDP growth during recent quarters thus contrasts
The sharp decline in output has had surprisingly little sharply with other data about the economic trend. This
impact on the labour market. The rise in unemploy- applies not only to the labour market but also to the
ment has been much smaller than the GDP downturn trend of public sector finances, company financial re-
indicates, and this is reflected in falling productivity. An ports and confidence indicators for both households and
international comparison by the IMF shows that there businesses. Our conclusion is that there is a fairly high
are very large differences between countries in this probability that the GDP figures will be revised.
respect. While unemployment has doubled in the US, it
has not climbed at all in Germany, despite a larger GDP
GDP at turning points
decline than in the US. The IMF’s analyses of “Okun’s Index
Law”, which describes the relationship between GDP 104 104
and unemployment, points to a number of interesting 1993Q3 = 100
explanations with relevance to Sweden. One conclusion 103 103
is that to a greater extent than in other countries, the
trend in Sweden is a break with the historical pattern. 2005Q1 = 100
102 102
One common feature is that countries that have been 1997Q1 = 100
affected by the economic crisis primarily via the global 101 101
trade decline have often noted large drops in GDP but
relatively little growth in unemployment. In countries 100 100
with a damaged financial market and a housing market 2009Q1 = 100
collapse, the consequences for labour-intensive portions
99 99
of the economy have been much worse. Swedish govern- 1 year
ment economy policy largely succeeded in preventing Source: Statistics Sweden, SEB
the crisis in the manufacturing sector from spreading to
the whole economy. This is a major reason for the rela-
tively moderate labour market downturn. Another fac- Employment at turning points
Index
tor is that many companies viewed the unprecedented 102.0 102.0
drop in production as temporary and thus chose not to
May 2005 = 100
reduce their workforce. In addition, there was a certain
101.5 101.5
degree of organised working hour reductions, though March 1994 = 100
this has not been nearly as widespread as in Germany,
for example. 101.0 101.0

May 1997 = 100

Recent developments in Sweden, with falling GDP in
100.5 100.5
the fourth quarter of 2009 but employment that had
already begin to rise, are nevertheless difficult to un-
Sep. 2009 = 100
derstand even in light of the above analyses. The charts 100.0 100.0
show that the upturn in employment during the past six
months has been in line with the turnarounds in 1997 99.5 99.5
and 2005 and not so much weaker than during 1994. But 1 year
Source: Statistics Sweden, SEB
the differences in GDP growth during these periods are
striking. GDP growth was nearly 3 percentage points
weaker in 2009 than during the other periods.

Nordic Outlook – May 2010  |  35

 Sweden

After a sluggish start, in which the Metal Workers’ Union
and the Association of Engineering Industries were unable
to reach a collective contract for months, an agreement
between the Association of Graduate Engineers and the
Association of Engineering Industries broke the ice. After
that, several agreements were achieved at a rather fast
pace. So far, they have covered periods of 18-24 months,
somewhat shorter than the 3-year contracts that have
been standard over the past decade.
Wage agreements
Agreements reached to date. Pay hikes in %, thousands
2010 2011 Employees
Manufacturing 1.1 1.8 250
Distributive trades 2.4 2.0 100
Construction 1.6 2.3 80
Local gov., white-collar 2.3 1.6 127
Krona a downside risk for inflation
Core inflation, defined as CPIF (CPI with a fixed interest
rate) excluding food and energy, showed an upward trend
throughout 2009, driven by a weak krona and falling
productivity. At the end of 2009, core inflation stood at a
full 2.7 per cent.
In the past six months or so, however, the krona has
regained 75 per cent of its decline. With the customary
time lag, the stronger krona is now beginning to have an
impact on the inflation process, and core inflation has
now fallen to 2.1 per cent. This shift in inflation has been
broad-based; for example, service inflation fell clearly
during the first quarter. We expect the core inflation rate
to fall below one per cent by early 2011. The risks are
also on the downside, as indicated among other things by
a record-large 4.4 percent decline in producer prices of
domestic consumer goods in March. Food prices also have
the potential for downside surprises.

Source: SEB The upside risks for CPI inflation come mainly from
international price increases for energy and other com-
With some variations, these agreements provide pay modities plus domestic environmental tax hikes. Lagging
increases equivalent to 1.5 per cent in 2010 and 2.0 per effects from the weak productivity increases of recent
cent in 2011, or somewhat lower than we had anticipat- years are also conceivable.
ed. But many of them specify an increase in mid-2011,
Large divergernces in lending
about six months before they expire. This creates a risk Year-on-year percentage change
of accelerated pay increases in 2012, since the yearly 20.0 20.0
average then will be affected by two pay hikes. 17.5 17.5
15.0 15.0
12.5 12.5
There is little risk that future agreements will be sig- 10.0 10.0
nificantly more generous than those already signed. We 7.5 7.5
5.0 5.0
are thus sticking to our assessment in the February issue 2.5 2.5
of Nordic Outlook that annual pay hikes will end up 0.0 0.0
-2.5 -2.5
averaging 2 per cent in 2010 and 2011. This forecast -5.0 -5.0
-7.5 -7.5
assumes that wage drift will be low in the persistently
03 04 05 06 07 08 09 10
weak labour market that will prevail in the next couple
of years. The uncertainty about the future wage process Total lending Lending to households
Lending to business
was amplified by the fact that the dominant Association Source: Statistics Sweden

of Swedish Engineering Industries (“Teknikföretagen”)

Riksbank will hike its repo rate in July
just terminated the 1997 Industry Agreement (“Industri-
The Riksbank is now moving towards raising its key inter-
avtalet”). However, this will probably not affect the re-
est rate from a crisis level to a more normal recession-
maining negotiations this year.
ary level. The central bank’s April forecast is signalling
that a first rate hike is most likely in September. We are
Lower core inflation
sticking to our forecast that the first hike will be in
Year-on-year percentage change
3,5 3,5
July. This is because we expect a high first quarter GDP
figure and continued strong signals in the labour market.
3,0 SEB forecast 3,0
Rapidly increasing household lending, with the accompa-
2,5 2,5 nying risks of unsustainable price escalation in the hous-
2,0 2,0 ing market, also seems to be an increasing focus of the
1,5 1,5
Riksbank’s analysis. After July, we expect gradual hikes in
the key rate. In December the repo rate will be 1.25 per
1,0 1,0
cent. During 2011 the key rate will continue upward to
0,5 0,5 2.75 per cent.
0,0 0,0
jan maj sep jan maj sep jan maj sep jan maj sep This means that the Riksbank will be raising the repo
08 09 10 11
CPIF CPIF excl energy and food
rate at a considerably faster pace than the ECB will
Source: Statistics Sweden, SEB raise its refi rate. As indicated in the table below, there
are various reasons for this: higher growth, room for

36   |  Nordic Outlook – May 2010

 Sweden

expansionary fiscal policy and livelier housing lending and Faster key rate hikes in Sweden
housing markets. We expect the ECB during the second Repo rate vs refi rate, per cent
half of this year begin a normalisation of monetary policy 5.0 5.0
4.5 4.5
by withdrawing liquidity, causing the Euro Overnight SEB
forecast 4.0
4.0
Index Average of interbank interest rates (EONIA) to 3.5 3.5
begin rising. 3.0 3.0
2.5 2.5

Outlook for monetary policy 2.0 2.0

1.5 1.5
Year-on-year percentage change in indicators
1.0 1.0
Sweden Euro zone 0.5 0.5
0.0 0.0
00 02 04 06 08 10
GDP, 2010 (forecast) 2.7 1.5
Sweden Euro zone
Employment, 2010 (forecast) 0.3 -0.2 Source: Reuters EcoWin

Budget deficit, 2009 -0.8 -6.3
Home prices, Q4 2009 6.0 -3.0
Lending to households, Q1 2010 9.3 1.8
Lending to businesses, Q1 2010 -5.0 -2.4
Source: Riksbank, ECB
Looking further ahead, we foresee various reasons why
the key rate will be at a rather low level. Inflation will
be low, and our forecast for CPIF during next year is
considerably below the Riksbank’s forecast. In addition,
resource utilisation will be low during the next couple of
years. Tighter lending rules, which the Swedish Financial

Home price correction on the way

While home prices in most countries have fallen in posable income in 2011, far higher than earlier record
recent years, in Sweden they have climbed to new levels, but this interest burden is likely to be manage-
record levels. In the OECD countries, home prices able. The chart below illustrates a scenario in which
have fallen by an average of 10-15 per cent. In the the interest rate is gradually normalised over the next
hardest hit countries, such as the United States, the five years, while starting in 2012, debts grow at the
downturn has been around 30 per cent. pace of disposable income. Interest expenses will then
double as a share of income from 3 to almost 7 per
Structural factors like high household savings and a cent, still a bit below their levels around 1990.
low supply of new homes can partly explain the resil-
ience of Swedish home prices. Most important, how- In addition to generally rising interest rates, most in-
ever, is the exceptionally strong transmission mecha- dications are that changes in international regulations
nism from monetary policy. Most households are tak- will intensify the upturn in household borrowing costs
ing advantage of today’s extremely low adjustable by making funding for mortgage institutions more ex-
mortgage rates, which are providing them with loans pensive. Moreover, the Swedish Financial Supervisory
that are far cheaper than in any other country (ex- Authority plans to introduce a mortgage loan ceiling
cept for Norway). in the range of 75-90 per cent of market value in July
2010, which among other things is likely to increase
Household debts and interest burden households’ rate of loan principal payments.
Per cent of disposable income
190 11
It seems likely that we will see some correction in
180
10 home prices when interest rates begin to be raised.
170 SEB
160 9 It is too early to determine whether this will be large
forecast
150 8 enough to have macroeconomic consequences. This
140
130
7 will depend largely on how far prices have time to
120 6 surge over the next few months and how carefully the
110 5 changes in interest rates and rule systems are imple-
100
90
4 mented. In its latest stability report, the IMF singled
80 3 out the Swedish housing market as one of very few
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
overvalued asset markets in the world, which is un-
Debts (LHS) Interest burden after taxes doubtedly a warning signal.
Source: Statistics Sweden, Riksbank, SEB

Viewed from the standpoint of household debt and

interest burdens, it is difficult to draw any clear con-
clusions about the trend of home prices. Household
debts as a percentage of income are now rising rap-
idly and are projected to reach 180 per cent of dis-

Nordic Outlook – May 2010  |  37

 Sweden
Supervisory Authority is about to push through, will con-
tribute to higher household and business lending rates,
which will marginally reduce the need for key rate hikes.
Due to the structural changes in the credit market, we
are sticking to our assessment that the neutral key rate
level needs to be adjusted further downward to 3.75
per cent. In the next few months, however, it is unlikely
that the Riksbank will announce any additional change in
its view of this after making a downward adjustment to
4.0 per cent from 4.25 per cent in February.
Rising bond yields
Yields on 10-year Swedish sovereign bonds are at the
level of German bonds and are lower than in all the other
euro zone countries. The reason is Sweden’s very strong
public finances, with central government debt as a per-
centage of GDP likely to fall as early as next year. The
Riksbank’s key rate hikes will have the opposite impact.
Our forecast implies that Sweden’s repo rate at the end
of 2011 will be 75 basis points higher than the key rate
in the euro zone. We thus believe that the yield spread
against Germany will rise to 10 basis points at the end of
2010. This means that the 10-year government bond yield
will be 3.20 per cent at the end of 2010 and 3.70 per
cent at the end of 2011.
EUR/SEK rate below 9.00
Sweden’s improved fiscal and economic situation has led
to a significant recovery for the krona. The krona is now
only 5 per cent weaker against the euro than it was in
2007, and in trade-weighed TCW terms the difference is
even smaller.
There are many indications that the krona will con-
tinue to strengthen as the economic recovery
progresses. The Riksbank will raise its key interest rate
at a faster pace than the ECB, but also compared to most
other central banks. A more pronounced export upturn
will also help push up the krona. Higher interest rates
combined with calmer financial markets usually favour
“carry trade” investments, which involve buying curren-
cies where the central bank is raising its interest rate.
Krona tracks business optimism
11.5
11.0
10.5
10.0
9.5
9.0
8.5
8.0
98 99 00 01 02 03 04 05 06 07
EUR/SEK (LHS)
Business confidence, net balance (RHS)
Our models for the krona, which have worked well in
recent years indicate that the EUR/SEK exchange rate
38   |  Nordic Outlook – May 2010
today should stand at about SEK 9.40 per euro. Using our
forecasts of interest rate differentials and the economic
situation, the models points to a further shift to SEK 9.00
by the end of 2010. An important driving force for the
krona is the continued improvement in the performance
of industry.
We expect the krona to strengthen to SEK 9.00 per
euro at the end of 2010, which is at the lower end of
the rather narrow interval that prevailed during 2002-
2007. One reason the krona why will reach such strong
levels is the prevailing systemic crisis in the euro zone.
We expect a sideways movement against the US dollar
and a slight weakening to SEK 7.50 per USD in mid-2011.
Unexpectedly strong public finances
The economic crisis has adversely affected Swedish pub-
lic finances. After several years of high surpluses − peak-
ing at 3.8 per cent of GDP in 2007 − the outcome for
2009 was a deficit of 0.8 per cent of GDP. But the impact
of the recession on the budget balance has not been as
powerful as one would normally expect. One reason for
this is that the downturn has been concentrated in the
export and manufacturing sectors, which has helped
soften its effects on the labour market. As a result, un-
employment insurance expenditures and similar costs
have been kept down, while income tax and payroll tax
revenue has been affected to a relatively small extent,
given the magnitude of GDP decline.
The government managed to take advantage of its good
finances at the outset of the recession, letting automatic
stabilisers operate at full throttle while also enacting dis-
cretionary stimulus measures. In 2010, the active dose of
stimulus programmes is equivalent to just over 1 per cent
of GDP. Sweden is one of the few EU countries that will
move through the crisis without needing to implement
austerity programmes to stay below the EU Stability and
Growth Pact’s deficit ceiling of 3 per cent of GDP.
Public finances
Per cent of GDP
2008 2009 2010 2011
Revenue 52.6 52.7 51.7 51.5
Expenditures 50.2 53.5 52.8 52.1
Net lending 2.5 -0.8 -1.0 -0.6
-60
-50 General gov’t
-40 gross debt 38.3 42.3 39.6 39.0
-30 Central gov’t debt 33.7 37.6 35.7 35.2
-20
Central gov’t borrowing
-10
requirement, SEK bn -135 176 46 42
0
10 Source: Statistics Sweden, SEB
20
30
08 09 10
Source: NIER, SEB

In recent months, upside surprises have continued.
The 2009 budget outcome was better than expected,
which will also affect public sector financial forecasts.
Even though we now expect a somewhat more expansion-
ary fiscal policy this year and next than we did in the
February issue of Nordic Outlook, we are revising our
forecast of public finances upward. We expect a total
fiscal stimulus dose equivalent to just over 1 per cent of
GDP this year and 0.6 per cent in 2011. The deficit will
bottom out this year at 1.0 per cent of GDP and improves
to -0.6 per cent of GDP 2011. Correcting for the effects
of the economic situation, net lending is above zero.
Central government debt has also been affected sur-
prisingly little by the crisis. The upturn was only 3 per
cent of GDP, compared to an increase of about 30 per-
centage points during the 1990s crisis. This year, debt
will again drop below 40 per cent of GDP.
Forecasts of the central government
borrowing requirement
SEK billion
2010 2011
SEB 46 42
National Debt Office, March 53 37
National Institute of Economic
Research (NIER), March 39 36
National Financial Management
Authority (ESV), March 49 10
Ministry of Finance, April 63 8
Source: National Debt Office, NIER, ESV, Government
Offices, SEB
Central government finances are the most cyclically
sensitive in the public sector. Last year’s central govern-
ment borrowing requirement was SEK 176 billion, which
represented a shift of more than SEK 300 billion com-
pared to the preceding year. This year, the requirement
will fall sharply. These large fluctuations are partly ex-
plained by one-time effects that drove up the borrowing
requirement by SEK 100 billion in 2009, primarily money
provided to the Riksbank in order to increase its foreign
exchange reserve (about SEK 95 billion). In 2010 and
2011, central government borrowing requirement is
expected to be just over SEK 40 billion.
Sharper dividing lines before the election
The red-green opposition is still slightly ahead of the Al-
liance government in public opinion polls as the autumn
parliamentary election draws closer. The gap is not so
wide, however, and the election campaign is only in its
warm-up phase. Looking back at recent elections, at the
same stage in 2006 the Alliance (then in opposition) had
a lead of 3-5 per cent. Then its lead shrank, and just
before the election public support for the two blocks
was relatively even, although most observers predicted
a victory for the Alliance. In March 2002 (six months
before the election) the leftist block had a comfortable
Sweden
lead of 10-20 percentage points. The gap then narrowed
somewhat; in September the difference shrank to single
digits. The final outcome gave the Social Democratic
government and its parliamentary partners a somewhat
wider margin of victory than according to the last public
opinion surveys.
As expected, the Alliance government’s spring fiscal pol-
icy bill did not reveal so much about its future policies.
But it focused on two important voter categories: pen-
sioners will get a tax cut in 2011, and families with chil-
dren will benefit from an increase in the supplement for
large families starting on July 1, 2010. Instead, the two
main governing alternatives are now focusing on prepara-
tions for the autumn parliamentary election. Both blocks
are working with common platforms that will be unveiled
this spring and summer. In late April, the red-green block
presented a number of proposals and a common shadow
budget, which provide an indication of its common plat-
form. But neither block will show all of its cards now;
they will present initiatives and make election promises
aimed at attracting important voter categories prior to
the September election.
The election tactics of the Social Democrats − the domi-
nant party in the red-green block − are shaped largely by
the incumbent government’s actions. In the two elections
in recent decades where the Social Democrats regained
power (1982 and 1994), competence in governing and
budget responsibility were key weapons in their cam-
paign. In those elections, the party cited its decades-long
experience in governing Sweden and was able to criticise
the incumbent non-socialist government for having al-
lowed budget deficits to explode.
This time around, it will be considerably harder to use
such arguments. The Social Democrats will be campaign-
ing for the first time with the ambition of creating a
coalition government together with two parties (the
Left Party and the Greens) with no experience at all in
government. The Swedish economy is also strong in an
international perspective. Although the real economy has
shown poor growth in recent years, it will be difficult for
the opposition to convincingly blame the government for
this in the election campaign. The government will likely
be able to cite good international reviews of its fiscal
management skills.
In light of this, the opposition will probably rely more
on classic left-right issues as weapons in order to
gain power. To a greater extent than the last Social
Democratic government (2002-2006), for example, the
red-green block will focus on social welfare issues and
vulnerable groups, in the hope that a sufficient number
of centrist voters and middle-income earners will not
vote their pocketbook. The block will call for further tax
cuts for pensioners and the reversal of various Alliance
reforms in the social insurance system. On the revenue
side, at least one step in the earned income tax credit
reform will be reversed. A new wealth tax will be intro-
duced and environmental taxes raised.
Nordic Outlook – May 2010  |  39
 Sweden
The differences between the blocks with regard to
demand-oriented and supply-oriented policies will thus
be extra clear. The leftist block generally has greater
faith in demand-oriented policies. The Alliance, however,
has focused on supply side policies during the current
parliament (2006-2010): primarily in an effort to boost
the labour market participation rate through earned in-
come tax credits and lower compensation levels in social
insurance systems. At the same time, the Alliance has
protected key social, health care and other public serv-
ices by providing extra grants to local and regional gov-
ernments. If the Alliance remains in power, further steps
to strengthen incentives to work, for example through
additional earned income tax credits, will remain an
important element of its policies, but it will probably
also focus on pensioners and other groups that have been
hard hit by the economic crisis.
Regardless of which side wins the election, we expect
the budget bill for 2011 to include about SEK 20 billion
40   |  Nordic Outlook – May 2010
in reforms, and possibly somewhat more in case of a red-
green victory. This will mean a continued expansionary
fiscal policy in 2011, equivalent to 0.6 per cent of GDP.
A situation in which the right-wing populist Sweden
Democrats make it into Parliament and gain a kingmaker
role between the main blocks would mean increased
short-term uncertainty about economic policy, thus giv-
ing rise to an extra risk premium related to interest rates
and exchange rates. In a longer perspective, an agree-
ment between parties from the two main blocks may
provide greater stability and continuity in policymaking.
The strong support enjoyed by the current fiscal policy
framework will also help strengthen stability in the short
and long term.

Modest growth
 Competitiveness is recovering
 Consumption is gradually climbing
 Low interest rate and yield spreads
The Danish economy passed its low point last autumn,
aided in part by stimulus measures aimed at households.
Quarter-on-quarter and seasonally adjusted GDP rose 0.2
per cent in the fourth quarter, the second consecutive
quarter of modest growth.
The strong dynamic in other Nordic countries will
contribute to a decent export upturn ahead. Earlier
competitiveness problems will also diminish because of
restrained pay increases and a weaker krone that will
benefit important Danish exports outside the euro zone,
for example to Sweden and Norway.
Competitiveness is improving
Real effective exchange rate, index 100 = 2005
107.5
105.0
102.5
100.0
97.5
95.0
92.5
90.0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Source: BIS
Meanwhile the inventory cycle is contributing positively
to growth, but recovery remains sluggish. The fall in
home prices and construction investments after earlier
overheating are restraining the upturn in domestic de-
mand. Initially, consumption will rise at a leisurely pace.
We expect households to remain thrifty for a while. The
household savings ratio, which was extremely low a cou-
ple of years ago, rose in the fourth quarter to 6.5 per
cent, its highest since 2001.
We expect GDP to grow by 1.5 per cent this year and
1.8 per cent in 2011, after falling by nearly 5 per cent
last year.
Important to the recovery are stabilisation tendencies in
the housing and labour markets.
Prices for flats are now higher year-on-year for the first
time in three years, according to the Association of Dan-
ish Mortgage Banks. House prices have risen two quarters
Denmark
Denmark
in a row but are still down year-on-year. Partly because
home sales have recuperated significantly, we believe
that residential prices will continue to recover, buoyed
by continued low interest rates.
Unemployment looks set to peak by this summer at 4.5
per cent, six months sooner and half a percentage point
lower than our earlier estimate. In surveys, both the
manufacturing and service sectors are now showing bal-
anced employment plans, though expansion will take
time. Given continued below-trend economic growth, we
find it hard to foresee more than a marginal decline in
unemployment during the coming year.
The upturn in joblessness has not been as sharp in Den-
mark as in many other countries, indicating relatively
low cyclical sensitivity in the labour market. This is
something the IMF also highlighted in its latest World
Economic Outlook, which studied this link over the past
20 years in a number of countries.
107.5
105.0 The inflation rate quickly climbed above 2 per cent this
102.5
winter, largely due to higher energy prices and temporary
tax hikes, for example on alcoholic beverages and to-
100.0
bacco. The weaker krone will push up inflation a bit this
97.5 year, but low pay increases and fading one-off effects
95.0
eventually promise a slowdown. We predict HICP infla-
tion of 2.1 per cent in 2010.
92.5
90.0 The large budget deficit means fiscal tightening is neces-
sary, but given the still fragile recovery, we believe that
the government will postpone this to 2011-2012, though
the 2011 election makes our fiscal forecast extra uncer-
tain.
The central bank will keep the spread between its
lending rate and the ECB’s refi rate at a low 5 basis
points. Next year there will be gradual normalisation
of spreads as the lending rate is adjusted upward in re-
sponse to ECB hikes. The spread against 10-year German
sovereign bonds shrank somewhat this winter to about
30 points. Given relatively low public debt, it should be
possible to halve this spread by year-end.
The question of Danish euro zone accession seems dis-
tant. We expect no referendum during our forecast pe-
riod, but the turbulence surrounding Greece and the euro
do not seem to have had any negative impact on public
opinion. In Statistics Denmark’s March survey, the Yes
side’s lead (including respondents who say “maybe yes”)
had admittedly shrunk to 51.4-47.4 per cent, compared
to 54.2-42.7 in December 2009.
Nordic Outlook – May 2010  |  41
Norway
Recovery will gain momentum in 2010
 Mainland GDP growth 2.3 per cent in 2010
 Inflation will continue to trend lower
 Cautious normalisation of monetary policy
The Norwegian economy continues to expand, but the
recovery has been slower than expected so far. The 0.3
per cent quarter-on-quarter growth rate in mainland GDP
(excluding oil/gas and shipping) in the fourth quarter
of 2009 was surprisingly low, and growth in the previous
quarters was revised lower. In 2009 as a whole, mainland
GDP fell 1.5 per cent, the weakest full-year outcome in
20 years. Given this slow momentum, we are revising our
2010 forecast for mainland GDP downward from 2.9 per
cent to 2.3 per cent, which nonetheless implies accel-
erating expansion during the year, while still expecting
growth of 3 per cent in 2011. Overall GDP should grow by
2.0 per cent and 2.3 per cent in 2010 and 2011, respec-
tively.
Private consumption accelerating
The recovery has been led by non-oil final domestic
demand, which moved into year-on-year growth by end-
2009. Private consumption was up a robust 3.4 per cent
for the year. It was supported by very strong growth in
real disposable income, which was up 4.8 per cent from
2008 to 2009 (almost half of it due to lower net interest
expenses) and by an even stronger 6.0 per cent year-
on-year in the fourth quarter. With income running well
ahead of spending, the household savings ratio more
than doubled to 7.5 per cent in 2009 and stood at 9.9
per cent by year-end, twice its 20-year average.
Strong income supports consumption
% change (4Q) % change (4Q), 2Q average
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Private consumption (LHS)
Real disposable income excl. share dividends (LHS)
42   |  Nordic Outlook – May 2010
Private consumption lost steam over the winter. This
is hard to explain amid solid fundamentals, except for
the unusually cold weather and the fact that electric-
ity prices (a large item in monthly household expenses)
jumped fully 50 per cent in the six months to March.
Although real income growth will be moderate in 2010,
the high savings ratio should support consumption. With
unemployment showing signs of peaking soon and with
Norges Bank hiking its key rate at a slower pace, we still
expect private consumption to climb 4.5 per cent in
2010. Meanwhile we have revised our forecast for 2011 a
bit upward to 3.7 per cent.
Investment on the mend
Oil sector investment has been a key downside risk for
growth and oil companies cut their investment forecast
for 2010 in Statistics Norway’s first quarter survey. Taking
into account last years survey compared to the outcome
and this years price development, the survey suggest at
oil sector investments declining 3-5 per cent in volume
2010, a reversal after a 6.4 per cent increase in 2009.
The negative demand impulses in the rest of the econ-
omy from such a decline will be rather muted (though
suppliers to the oil industry will struggle). As investment
forecasts have historically tended to be revised upward
as projects under consideration are added we believe
that the investment outlook is somewhat better that the
survey predicts; investment in at least one oil field is
likely to come on stream and higher oil prices might per-
suade oil companies to ramp up capital spending plans.
Non-oil private investment has been depressed in recent
years. Business investment plunged 14.5 per cent from
2008 to 2009, while residential investment has declined
for ten consecutive quarters, with the end-2009 level 35
per cent below the peak in mid-2007. However, increas-
ing new residential orders during 2009 to the highest
level in almost two years and recovering housing starts
in early 2010 well above the 2009 average suggest a re-
covery in residential investment going forward. Norges
Bank’s recent lending survey showed banks continuing to
report higher credit demand from non-financial corpora-
tions. Non-oil capital spending by businesses will rebound
later, but the first quarter manufacturing investment
survey suggested that the trough is about to be passed.
Unemployment levelling off
The Norwegian labour market fared better than most
during the recession. While employment turned abruptly
from an average growth rate of 3.3 per cent in 2006-08

(far above trend) to a 0.6 per cent decline in 2009, the
increase in the labour force slowed markedly as well,
denting the impact on unemployment. In fact, according
to the Labour Force Survey measure, unemployment rose
from a 21-year low of 2.4 per cent during most of 2008
to a still low 3.3 per cent in the fourth quarter of 2009
and held steady in early 2010.Morover, registered unem-
ployment including those in labour market programmes
trended marginally lower over the winter.
Unemployment shows signs of peaking
% of labour force % of labour force
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
LFS unemployment rate, 3 mth. average Registered unemployed
We are a bit hesitant to say joblessness has peaked just
yet, while awaiting any signs of a turnaround in employ-
ment. Nonetheless, the LFS unemployment rate seems
to be topping out slightly lower than expected. It should
average 3.4 per cent in 2010 and be broadly unchanged
in 2011 as a growing labour force matches higher employ-
ment.
Wage growth decelerating further
Economy-wide wage and salary growth slowed from 6.3
per cent in 2008 to 4.1 per cent in 2009, the lowest rate
in three years. It looks set to decelerate further in 2010.
The trend-setting negotiations for blue-collar workers
in manufacturing led to a contract calling for 3 per cent
wage growth in 2010, down from 3.9 per cent in 2009 and
the slowest since 1994. However, the 3 per cent rate is
based on certain assumptions for wage drift (local pay).
In 2009, wage drift turned out higher than expected and
as corporate profitability improves we might see a similar
development this year.
Wage growth and unemployment
% change (YoY) % of labour force
10.5 0 position (due to abundant revenue from the petroleum
9.0 1 sector) to provide a massive boost to the economy
7.5 2
6.0 3 budget deficit was expected to swell to NOK 154 billion
4.5 4 this year, representing a structural (or cyclically adjust-
3.0 5
1.5 6 budget deficit over an economic cycle should correspond
0.0 7 to 4 per cent of the Government Pension Fund Global.
87 89 91 93 95 97 99 01 03 05 07 09 11
Annual wages (LHS)
LFS unemployment rate (RHS)
Norway
The manufacturing wage agreement has been copied for
other blue-collar workers in the private sector, but over-
all labour cost growth will be stronger, since increases for
white collar workers (in manufacturing and elsewhere)
and in Norway’s large public sector are likely to continue
being higher. In all, we forecast 3.5 per cent wage and
salary growth in 2010. Some acceleration is likely as the
recovery continues and the labour market improves.
Core inflation to bottom out by summer
Sharply higher electricity prices this winter pushed up
CPI inflation from 0.6 per cent last October to 3.4 per
cent in March. However, CPI-ATE core inflation (exclud-
ing taxes and energy) has eased steadily from its cyclical
high of 3.3 per cent last June to 1.7 per cent, the lowest
year-on-year rate since late 2007, with a broad-based
slowdown in domestic and import price increases.
Core inflation heading lower
% change (12M) % change (12M)
6.0 6.0
4.5 4.5
3.0 3.0
1.5 1.5
0.0 0.0
-1.5 -1.5
-3.0 -3.0
-4.5 -4.5
95 97 99 01 03 05 07 09
CPI excl. taxes and energy
Core CPI domestic goods and services
Core CPI imported consumer goods
The decrease in imported inflation from 1.8 per cent
year-on-year in the second quarter of 2009 to -0.3 per
cent this March reflects the strong appreciation of the
Norwegian krone since last summer, which will push
down such prices further. Core domestic inflation is 2.6
per cent on average in the first quarter but should trend
lower in the near term as well. We expect core inflation
to bottom out at 1.3 per cent by summer and average
1.7 per cent for all of 2010 (versus 2.1 per cent in 2009).
Absent a further marked currency appreciation, core
inflation should move up next year with the 2011-average
at 2.1 per cent.
Lower non-oil budget deficit
The government made use of Norway’s very sound fiscal
in 2009, with further − though much smaller − stimuli
included in its budget for 2010. As a result, the non-oil
ed) deficit NOK 45 billion above what the “fiscal policy
rule” allows: this rule implies that the structural non-oil
The revised 2010 budget to be unveiled May 11 will show
a much smaller non-oil deficit due to higher tax revenue
Nordic Outlook – May 2010  |  43
 Norway
and slower spending increases, among other things be-
cause of lower-than-expected unemployment. There will
be no tightening measures. The overall budget surplus
will also be boosted by higher oil prices. Cyclical fac-
tors will improve the budget in 2011, along with reversals
of last year’s “crisis” measures. Even with only a small
real fiscal tightening, the structural non-oil deficit should
thus be much closer to the fiscal policy rule’s 4 per cent
limit than the 5.7 per cent outcome in 2009.
Norges Bank foresees slower rate hike cycle
Norges Bank hiked its key deposit rate by 25 basis points
last October and December to 1.75 per cent. The March
Monetary Policy Report was surprisingly dovish, lower-
ing the optimal rate path by some 30bp by end-2010 and
more than 50bp on average in 2011. The projected end-
2011 level was lowered from 4.00 per cent to 3.50 per
cent.
Norges Bank deposit rate and rate path
Level, % Level, %
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Norges Bank deposit rate Optimal rate path, MPR 1/10
Optimal rate path, MPR 3/09
According to Norges Bank, inflation and capacity utilisa-
tion “may for a period of time” be lower than expected,
but the changes to the bank’s forecasts for growth and
inflation were comparatively modest: the trough for core
CPI was put somewhat lower, but from mid-2011 the tra-
jectory was the same as previously, with inflation in line
with the 2.5 per cent medium-term target by mid-2012.
Hence, the sharply lower rate path was first and fore-
most due to a stronger NOK than previously expected
and lower global interest rate expectations. Norges
Bank thus emphasised that hiking its key interest rate too
far ahead of its peers “may entail a risk of a considerably
stronger-than-projected krone, resulting in inflation that
is too low.”
The central bank’s fixation with the exchange rate is un-
derstandable, since import prices make up approximately
30 per cent of the core CPI basket. The appreciation of
the NOK since last summer has already slowed imported
inflation markedly, and any further strengthening of the
currency might put core inflation too far below target.
44   |  Nordic Outlook – May 2010
Norges Bank’s modus operandi of avoiding further NOK
appreciation links monetary policy with economic devel-
opments elsewhere: the pace of adjustment will be con-
strained by how quickly, or more precisely, how slowly
the ECB will act. However, Norway is in quite a different
position from the euro zone, with only a small negative
output gap, an unemployment rate one third as high,
stronger wage growth and no need for the severe fiscal
tightening faced by a number of (peripheral) euro zone
countries, which might imply very low key rates for lon-
ger. Keeping the key interest rate well below neutral
for an extended period risks fuelling domestic infla-
tionary pressure in the medium term. Indeed, simple
rules presented in the bank’s Monetary Policy Report,
based on the output gap and inflation relative to target,
suggest that the deposit rate should already be above 3
per cent: only after putting external interest rates into
the equation did the rules align with the bank’s rate
path.
Stronger NOK is denting inflation
% change (12M) % change (12M), reversed
6 -20
-15
4
-10
2
-5
0 0
5
-2
10
-4
15
-6 20
99 00 01 02 03 04 05 06 07 08 09 10
Core CPI imported consumer goods (LHS)
NOK import-weighted index, 6 mth. earlier (RHS)
Consequently, we now expect more gradual rate hikes
and foresee the deposit rate at 2.50 per cent by end-
2010 and 3.75 per cent by end-2011. Our forecasts are
slightly above Norges Bank’s, but imply below-“neutral”
real rates by the end of next year.

Above-trend growth
 Leading indicators climbing higher
 Above-trend growth, despite dock strike
 Pay increases decelerating
Finland was hit very hard by last year’s global economic
slowdown. GDP declined by a full 7.8 per cent, the larg-
est downturn in the entire OECD. Exports fell 25 per
cent and gross fixed investments by nearly 15 per cent,
while the downturn in private consumption was less than
2 per cent.
Service sector leading the upturn
Index
70
50
30
10
-10
-30
-50
-70
00 01 02 03 04 05 06 07
Construction sector Service sector
Manufacturing sector
But today things look better; leading indicators, espe-
cially in manufacturing and services, are climbing higher
and the construction sector has revived despite the cold
weather early this year. Consumer confidence is also con-
tinuing upward, which is already becoming noticeable in
rising retail sales. The upswing in the euro zone, China,
Russia, Sweden and the US, which together buy about 60
per cent of Finnish exports, is benefiting the recovery.
But early 2010 was not problem-free. A protracted dock
workers’ strike − which paralysed about 60 per cent of
the paper and forest product industry and halted 80 per
cent of foreign trade − will lower GDP growth at least
0.5 percentage points this year.
Despite the strike, GDP will grow by 2.6 per cent this
year, a marginal upward revision of our February fore-
cast. Thanks to a weaker euro, exports will rise by more
than 6 per cent. Capital spending will rise by about 3 per
cent and private consumption by nearly 1.5 per cent. The
economy will grow by 2.7 per cent in 2011.
The upturn in output will also help the labour market,
though with a time lag. Last year’s rapid drop in manu-
Finland
facturing jobs has slowed, and such sectors as construc-
tion, information and communications technology (ICT)
and transport even reported rising employment early this
year. The jobless rate, now just above 9 per cent, will
nevertheless keep rising for another few months, then
level off at around 9.5 per cent by mid-year. After that
it will slowly fall, reaching an annual average of 8.8 per
cent in 2011, still well above the non-accelerating infla-
tion rate of unemployment (NAIRU), which is about 7.5
per cent according to the OECD.
Low resource utilisation in the economy as a whole will
subdue pay and price hikes. Total pay hikes decelerated
to just below a 3 per cent rate in the fourth quarter
of 2009. We expect further declines in 2010-2011. Pay
70 increases will average just above 2 per cent this year
50 and next.
30 Increased activity early in 2010
10
Per cent
90.0 16
-10
85.0 14
-30
-50 80.0 12
-70
75.0 10
08 09 10
70.0 8
65.0 6
Source: DG ECFIN
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Capacity utilisation in manufacturing (LHS)
Unemployment (RHS)
NAIRU according to OECD (RHS)
Source: DG Ecfin, OECD, Statistics Finland
Lower value-added tax and interest rates drove down na-
tional CPI late in 2009, helping slow CPI to a record-low
zero per cent for the full year. In March 2010, however,
CPI inflation rose by a surprising 0.5 per cent year-on-
year, largely related to higher energy prices due to the
cold weather. CPI inflation will end up just above 1 per
cent this year and somewhat higher in 2011. Eurostat’s
harmonised inflation measure (HICP), which excludes
interest expenses, will be higher: nearly 2 per cent this
year and 2-2.5 per cent in 2011.
Favourable conditions at the outset, including low gov-
ernment debt and both budget and current account sur-
pluses, will help preserve the stability of the Finnish
economy, despite last year’s GDP decline. The deficit
will reach a modest 3 per cent of GDP in 2010 and 2.5
per cent in 2011, keeping sovereign debt below 50 per
cent of GDP in 2011.
Nordic Outlook – May 2010  |  45
 Nordic key economic data

DENMARK
Yearly change in per cent
2009 level,
DKK bn 2008 2009 2010 2011
Gross domestic product 1,660 -0.7 -4.8 1.5 1.8
Private consumption 817 -0.2 -4.3 1.8 2.2
Public consumption 492 1.5 2.5 1.3 0.6
Gross fixed investment 312 -4.9 -13.2 -3.5 3.0
Stockbuilding (change as % of GDP) 0.4 -2.4 0.5 0.0
Exports 784 2.4 -10.3 3.0 4.0
Imports 727 3.0 -13.2 1.7 4.3

Unemployment (%) 1.8 3.5 4.4 4.2

Consumer prices, harmonised 3.6 1.1 2.1 1.8
Wage cost 4.4 3.1 2.3 2.1
Current account, % of GDP 2.2 4.1 2.5 2.0
Public sector financial balance, % of GDP 3.6 3.6 -5.5 -4.0
Public sector debt, % of GDP 33.0 39.0 43.0 46.0

FINANCIAL FORECASTS Apr 29 Jun 10 Sep 10 Dec 10 Jun 11 Dec 11

Lending rate 1.05 1.05 1.05 1.05 1.65 2.50
10-year bond yield 3.20 3.20 3.20 3.25 3.40 3.55
10-year spread to Germany, bp 20 20 20 15 15 15
USD/DKK 5.63 5.64 5.73 5.96 6.21 6.21
EUR/DKK 7.44 7.45 7.45 7.45 7.45 7.45

NORWAY
Yearly change in per cent
2009 level,
NOK bn 2008 2009 2010 2011
Gross domestic product 2,278 1.8 -1.5 2.0 2.3
Gross domestic product (Mainland Norway) 1,737 2.2 -1.5 2.3 3.0
Private consumption 952 1.3 0.0 4.5 3.7
Public consumption 489 4.1 5.2 2.8 2.2
Gross fixed investment 470 1.4 -7.9 -1.6 3.8
Stockbuilding (change as % of GDP) 0.5 -1.9 0.4 0.1
Exports 1,004 0.9 -4.3 1.4 1.6
Imports 638 2.2 -9.7 4.4 4.7

Unemployment (%) 2.6 3.2 3.4 3.4

Consumer prices 3.8 2.1 2.8 1.8
CPI-ATE 2.6 2.6 1.7 2.1
Wage cost 6.3 4.1 3.5 3.8

FINANCIAL FORECASTS Apr 29 Jun 10 Sep 10 Dec 10 Jun 11 Dec 11

Sight deposit rate 1.75 2.00 2.25 2.50 3.00 3.75
10-year bond yield 3.65 3.70 3.70 3.90 3.95 4.05
10-year spread to Germany, bp 65 70 70 80 70 65
USD/NOK 5.92 5.87 5.88 6.20 6.50 6.50
EUR/NOK 7.83 7.75 7.65 7.75 7.80 7.80

46   |  Nordic Outlook – May 2010

 Nordic key economic data

SWEDEN
Yearly change in per cent
2009 level,
SEK bn 2008 2009 2010 2011
Gross domestic product 3,156 -0.2 -4.9 3.0 2.7
Gross domestic product, working day adjusted -0.5 -4.7 2.7 2.7
Private consumption 1,467 -0.2 -0.8 2.9 2.6
Public consumption 834 1.4 2.1 1.0 0.9
Gross fixed investment 616 2.6 -15.3 3.0 5.0
Stockbuilding (change as % of GDP) 5 -0.3 -1.5 1.2 0.2
Exports 1,711 1.8 -12.5 6.8 7.1
Imports 1,477 3.0 -13.4 9.2 7.9

Unemployment, (%) 4.6 6.5 6.4 6.4

Unemployment, (%) (EU definition) 6.2 8.3 8.9 8.8
Employment 1.1 -2.1 0.3 0.6
Industrial production -3.8 -19.0 4.0 7.0
Consumer prices 3.4 -0.3 1.2 1.9
CPIX 2.7 1.9 2.0 1.0
Wage cost 4.3 3.4 1.9 2.2
Household savings ratio (%) 11.6 13.9 12.1 11.8
Real disposable income 2.7 2.1 0.7 2.3
Trade balance, % of GDP 4.0 3.6 3.3 3.0
Current account, % of GDP 9.5 7.2 6.0 5.5
Central government borrowing, SEK bn -135 176 46 42
Public sector financial balance, % of GDP 2.5 -0.8 -1.0 -0.6
Public sector debt, % of GDP 38.3 42.3 39.6 39.0

FINANCIAL FORECASTS Apr 29 Jun 10 Sep 10 Dec 10 Jun 11 Dec 11

Repo rate 0.25 0.25 0.75 1.25 1.75 2.75
3-month interest rate, STIBOR 0.55 0.55 1.10 1.65 2.15 3.15
10-year bond yield 2.98 3.05 3.05 3.20 3.45 3.70
10-year spread to Germany, bp -2 5 5 10 20 30
USD/SEK 7.25 7.20 7.15 7.20 7.50 7.42
EUR/SEK 9.60 9.50 9.30 9.00 9.00 8.90
TCW 129.6 128.4 126.1 123.0 123.8 122.5

FINLAND
Yearly change in per cent
2009 level,
EUR bn 2008 2009 2010 2011
Gross domestic product 171 1.2 -7.8 2.6 2.7
Private consumption 94 1.3 -1.8 1.3 1.8
Public consumption 43 2.4 0.8 1.5 1.5
Gross fixed investment 34 -0.2 -13.4 2.9 4.3
Stockbuilding (change as % of GDP) -0.4 -0.9 0.3 0.0
Exports 62 6.6 -24.4 6.1 6.4
Imports 57 6.6 -22.3 5.1 5.9

Unemployment (%) 6.4 8.2 9.2 8.8

Consumer prices, harmonised 3.9 1.6 1.9 2.2
Wage cost 5.6 3.9 2.3 2.2
Current account, % of GDP 3.1 1.3 2.1 2.4
Public sector financial balance, % of GDP 4.2 -2.2 -3.0 -2.5
Public sector debt, % of GDP 34.2 44.0 47.1 49.7

Nordic Outlook – May 2010  |  47

 Nordic key economic data

EURO ZONE
Yearly change in per cent
2009 level,
EUR bn 2008 2009 2010 2011
Gross domestic product 8,979 0.5 -4.0 1.5 1.8
Private consumption 5,170 0.4 -1.0 0.2 0.9
Public consumption 1,975 2.1 2.3 1.4 1.7
Gross fixed investment 1,773 -0.9 -10.8 1.4 3.3
Stockbuilding (change as % of GDP) -0.1 -0.1 0.2 0.0
Exports 3,259 0.8 -12.8 4.1 4.9
Imports 3,140 0.9 -11.4 4.0 4.4

Unemployment (%) 7.5 7.5 10.2 9.9

Consumer prices, harmonised 3.3 3.3 1.1 0.8
Household savings ratio (%) 9.5 9.6 9.5 9.3

US
Yearly change in per cent
2009 level,
USD bn 2008 2009 2010 2011
Gross domestic product 14,454 0.4 -2.4 3.6 2.8
Private consumption 10,236 -0.2 -0.6 2.4 2.3
Public consumption 2,959 3.1 1.8 0.6 0.2
Gross fixed investment 1,708 -5.1 -18.4 2.7 8.4
Stockbuilding (change as % of GDP) -0.3 -0.6 1.3 0.2
Exports 1,680 5.4 -9.6 11.1 8.2
Imports 2,1230 -3.2 -13.9 8.5 7.9

Unemployment (%) 5.8 9.3 9.5 8.9

Consumer prices 3.8 -0.3 1.5 0.7
Household savings ratio (%) 2.6 4.3 3.0 3.6

LARGE INDUSTRIAL COUNTRIES

Yearly change in per cent
2008 2009 2010 2011
GDP
United Kingdom 0.5 -4.9 1.5 2.0
Japan -1.2 -5.2 2.4 2.2
Germany 1.3 -5.0 1.8 2.0
France 0.3 -2.2 1.5 1.7
Italy -1.3 -5.1 0.9 1.2

Inflation
United Kingdom 3.6 2.2 2.8 1.2
Japan 1.4 -1.3 -0.6 0.2
Germany 2.8 0.2 0.9 0.9
France 3.2 0.1 1.3 1.5
Italy 3.5 0.8 1.5 1.8

Unemployment (%)
United Kingdom 5.9 7.9 7.8 7.5
Japan 4.0 5.1 4.9 4.6
Germany 7.3 7.5 7.8 7.6
France 7.8 9.5 10.3 10.0
Italy 6.7 7.8 8.5 8.2

48   |  Nordic Outlook – May 2010

 Nordic key economic data

EASTERN EUROPE

2008 2009 2010 2011

GDP, yearly change in percent
Estonia -3.6 -14.1 2.0 5.0
Latvia -4.6 -18.0 -2.8 4.0
Lithuania 2.8 -15.0 1.0 4.0
Poland 5.0 1.7 3.5 4.5
Russia 5.9 -7.9 5.0 5.0
Ukraine 2.1 -15.1 3.5 4.5

Inflation, yearly change in per cent

Estonia 10.6 0.2 2.0 3.0
Latvia 15.3 3.3 -3.2 1.6
Lithuania 11.1 4.2 0.0 2.0
Poland 4.2 3.4 2.5 2.7
Russia 14.1 11.7 7.0 7.5
Ukraine 25.2 15.9 12.0 9.0

FINANCIAL FORECASTS

29 Apr Jun 10 Sep 10 Dec 10 Jun 11 Dec 11
Official interest rates
US Fed funds 0.25 0.25 0.25 0.50 1.50 2.00
Japan Call money rate 0.10 0.10 0.10 0.10 0.10 0.50
Euro zone Refi rate 1.00 1.00 1.00 1.00 1.50 2.25
United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.50 2.00

Bond yields
US 10
Japan 10
Germany 10
United Kingdom 10
years 3.73 3.73 3.65 3.75 4.00 4.10
years 1.29 1.35 1.40 1.50 1.50 1.65
years 3.00 3.00 3.00 3.10 3.25 3.40
years 3.99 4.00 4.10 4.30 4.45 4.50

Exchange rates
USD/JPY 94 95 95 98 105 110
EUR/USD 1.32 1.32 1.30 1.25 1.20 1.20
EUR/JPY 124 125 124 123 126 132
GBP/USD 1.53 1.53 1.51 1.49 1.46 1.50
EUR/GBP 0.86 0.86 0.86 0.84 0.82 0.80

GLOBAL KEY INDICATORS

Yearly percentage change
2008 2009 2010 2011
GDP OECD 0.6 -3.5 2.5 2.4
GDP world 3.0 -0.6 4.7 4.7
CPI OECD 3.5 0.1 1.4 0.9
Export market OECD 2.9 -12.9 7.0 6.9
Oil price, Brent (USD/barrel) 97.2 61.9 77.9 75.0

Nordic Outlook – May 2010  |  49

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50   |  Nordic Outlook – May 2010

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