Nordic Outlook - Hard policy choices ahead
The easing of pandemic-related restrictions has provided growth support in Europe, while expansion in the United States looks set to slow more than expected as households face headwinds from fiscal policy changes and high inflation. Global GDP will grow by 5.9 per cent this year and 4.4 per cent in 2022, followed by slightly above-trend growth in 2023. COVID-19 continues to influence economic developments, but the risk situation is increasingly shifting towards issues related to inflation, supply side bottlenecks and central bank exit strategies. Positive new GDP surprises, record-high sentiment indicators and continued stimulus measures suggest that the Swedish economy will be back at its historical growth trend by mid-2022. The Riksbank will take small steps towards normalisation in 2022 and 2023 by reducing its bond purchases and signalling future increases in the repo rate path. However, the key interest rate will remain at zero even in 2023.
More stable forecasting environment after a strong recovery
After dramatic fluctuations during the pandemic, the forecasting environment has stabilised. Global GDP will grow by 5.9 per cent this year and 4.4 per cent in 2022, which is in line with our forecast in May. GDP growth will slow to 3.4 per cent in 2023 as economies approach a more normal situation at varying speeds. Due to the easing of restrictions in Europe, the recovery was stronger than expected in the second quarter. We have raised our 2021 GDP forecast for the euro area from 3.8 to 4.6 per cent, followed by 4.3 and 2.5 per cent in 2022 and 2023 respectively. In the US, consumption is slowing after an earlier boom, with purchasing power being squeezed by the withdrawal of stimulus measures and high inflation. We have thus lowered our GDP forecast from 6.5 to 6 per cent this year, followed by 4.2 and 2.1 per cent in 2022 and 2023 respectively. We have also slightly downgraded our forecast of GDP growth in the emerging market (EM) sphere this year, mainly in China and India, where new COVID-19 waves are triggering renewed lockdowns.
New risk situation less related to the pandemic
Because of recurring waves of COVID-19 transmission, the pandemic will affect society for a longer period than expected. But this will not interrupt the recovery, since the trend towards milder restrictions will still continue in Europe and the US. Instead, inflation and failures linked to central bank exit strategies are starting to play a larger role among downside risks. In the US especially, the combination of an unexpectedly rapid downturn in unemployment and high inflation is raising questions about the appropriate times for withdrawing stimulus measures. Unexpectedly high inflation figures in recent months, combined with bottleneck problems in production and transport, are causing inflation forecasts to be adjusted upward. But we still believe inflation will fall and thus not force a severe monetary tightening. We also expect the labour supply to increase as various transitory factors ease. The inflation upturn of last spring was mainly driven by temporary price surges linked to the reopening of the economy. Nor do the inflation expectations of financial markets indicate any concern, but labour supply restrictions will be increasingly important, since economies will be reverting to their pre-pandemic trends earlier than expected.
Fed and ECB moving at different speeds, in response to inflation
Because of greater inflation risks in the US, the Federal Reserve (Fed) is moving faster than other major central banks in normalising monetary policy. It will start tapering its bond purchases this December and complete this phase-out in September 2022. It will begin cautious key rate hikes during the first quarter of 2023, and the federal funds rate will reach 0.75 per cent by year-end. In keeping with its new target formulation – combined with an inflation rate that will fall below target – the European Central Bank (ECB) will begin its policy normalisation significantly later. The ECB will launch new bond-buying programmes during 2022 and keep its key rate unchanged throughout our forecast period. The Bank of England will begin cautious rate hikes in May 2022 in response to rising resource utilisation. Long-term bond yields will move higher, but at a moderate pace. Ten-year US Treasury yields will climb to 2.20 per cent by the end of 2023, while equivalent German yields will be slightly above zero. The US dollar will appreciate. The EUR/USD exchange rate will bottom out at 1.13 at the end of 2022. In keeping with tradition, this issue of Nordic Outlook also includes a number of theme articles – taking a close look at e-currencies, the consequences of extreme weather, how long high inflation will last, the situation in emerging market economies and Swedish fiscal policy.
Sweden: GDP continues to surprise on the upside
After unusually strong GDP growth in the second quarter of 2021, the Swedish economy is already back at its pre-pandemic level. Continued large potential for a recovery in household consumption and service exports points to accelerating growth during the second half. We expect GDP to increase by 4.6 per cent this year and 3.9 per cent next year: a small upward revision for 2021 but somewhat lower for 2022, compared to our May forecast. In 2023, GDP will grow by 2.3 per cent, which is still a bit above Sweden’s long-term trend.
Business confidence is at record levels, led by manufacturing, but there has also been a continued upturn in service sector confidence. Bottlenecks and component shortages in the automotive industry pose some uncertainty in the near future, but continued global recovery will create good prospects for industrial production and merchandise exports. The outlook for capital spending is mixed. Residential construction has rebounded, and public sector investments are growing at a healthy pace, but the falling trend for construction of commercial properties is expected to continue. The threat of a concrete shortage – due to the possible closure of Cementa’s limestone quarry for environmental reasons – is difficult to assess; our main scenario is that a solution will be found and that a construction stoppage will be avoided. Normalisation of corporate dividends, strong employment recovery and fiscal stimulus will contribute to very rapid household income growth in 2021 and 2022. Combined with the higher household savings built up during the pandemic, these factors will support a rapid upturn in consumption. Home prices have shown signs of cooling. A slight correction may occur in the near term, but further ahead we believe that prices will continue upward at a yearly pace of around 5 per cent. Labour market indicators are strong, but a recent restructuring of labour statistics makes it hard to interpret the situation. According to our own statistical analysis, employment will return to its pre-pandemic level by the end of 2021 and unemployment will fall noticeably this coming year, then level off at around 7.5 per cent. Resource utilisation will climb to historically high levels over the next year. This will eventually generate upward pressure on wages and salaries, but with collective agreements in place until spring 2023 the effect during our forecast period will be small. Inflation has not increased at the same pace as in other countries. CPIF inflation excluding energy (the consumer price index minus interest rate changes and changes in energy prices) actually fell this summer to its lowest level since 2014, but we believe it has now bottomed out. CPIF will remain below the Riksbank’s 2 per cent inflation target throughout our forecast period.
The likelihood of a key rate cut or expanded bond purchases has decreased. Instead we expect the Riksbank to take small steps towards tighter monetary policy. We believe that because of rising resource utilisation and somewhat higher inflation expectations, over the next six months the Riksbank will adjust its rate path by pencilling in repo rate hikes during 2024. Nor do we anticipate any changes in the key rate until the end of 2023. As early as the second half of 2022, the Riksbank will allow its balance sheet to shrink.
Sweden is in a political situation that has created unique conditions for the last annual budget before the September 2022 parliamentary election. The minority Social Democratic-Green government needs the support of both the Left Party and the Centre Party to ensure parliamentary approval of its budget. In addition, Parliament must vote in November on a new Social Democratic candidate for prime minister. Because of these political circumstances – along with capital spending needs and the continuation of some pandemic-related stimulus measures – the 2022 budget will be highly expansionary. The government has announced that it plans to include SEK 74 billion in unfunded reforms. Whether this total makes sense can be assessed only after concrete proposals are unveiled. Swedish fiscal policy is the topic of a special theme article in this Nordic Outlook.
Upward revisions in Nordic and Baltic forecasts
The easing of restrictions has improved the GDP growth outlook in the Nordic economies. Despite uncertainty about the pandemic, the economic recovery has regained momentum in Norway, mainly driven by strong consumption supported by fiscal stimulus. GDP will grow by 2.7 per cent this year and 3.7 per cent in 2022. Despite below-target inflation, Norges Bank will raise its key rate in September and probably also in December. In Denmark, a fast reopening of the economy has led to an acceleration in growth. We have raised our GDP growth estimate for this year to 3.6 per cent, while lowering our 2022 forecast to 4.1 per cent. A strong currency has forced Danmarks Nationalbank to intervene in the foreign exchange (FX) market, and the bank will probably have to cut its key interest rate next year. Finland experienced a recession in 2020 that was among the most moderate in the euro area, and the same will be true of its recovery. GDP will grow by 3.2 per cent this year and 3.0 per cent in 2022. Slow productivity increases and a shrinking working-age population will hamper growth potential. The situation in the Baltic countries is mixed. The recovery remains generally robust, while some countries are facing capacity restriction. Tensions related to the crisis in Belarus will have certain negative effects in Lithuania, where GDP will grow by 4.3 per cent this year followed by 3.6 per cent in 2022. In Latvia, the recovery is being driven by exports and capital spending, with a downside risk due to slow COVID-19 vaccinations. GDP will grow by 4.3 per cent this year and by 5.2 per cent in 2022. Estonia has seen a surprisingly speedy recovery. Looking ahead, consumption will climb as a result of large disbursements from the pension system, while supply side problems will limit long-term potential. GDP will grow by 6.6 per cent this year, followed by 4.5 per cent in 2022.