Economic Outlook, September 2012 EN

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2 ECONOMIC OUTLOOK │SEPTEMBER 2012 NORDEA MARKETS

Slow speed ahead

Fragile recovery ■ The global economy is still advancing, albeit at a slow pace on a muddy road. The Euro area is again on the brink of recession, while activity in the US and the rest of the global economy slowed over the summer. However, better times are ahead, but the uncer-tainty is high.

OVERVIEW 04 SLOW SPEED AHEAD

SWEDEN 08 HOUSEHOLDS PROP UP THE ECONOMY

USA 16 MOVING SLOWLY FORWARD

EURO AREA 18 RESTORE CONFIDENCE TO END THE RECESSION

RUSSIA 24 INFLATION DÉJÀ VU

CHINA 29 STABILITY, STABILITY AND … STABILITY

OIL AND COMMODITIES 33 OIL PRICES STAY HIGH BUT SPARE CAPACITY BUFFER SHOULD BUILD

TWO ALTERNATIVES 35 RISK SCENARIOS

ECONOMICOUTLOOK

S E P T E M B E R 2 0 1 2

Safe havens may also be hit ■ The Nordics have status as safe havens in financial markets. But while the Norwegian economy shines, darker clouds are gathering over Sweden while Finland and Denmark are on the brink of a new recession. .

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Data overview Key figures ............................. 6

Interest rates ......................... 7

Exchange rates ..................... 7

Visit us at: www.nordeamarkets.com

Editor Helge J. Pedersen, Global Chief Economist [email protected] Tel +45 3333 3126

Editorial deadline 30 August 2012

SWEDEN Households prop up the economy ................................................................. 8

NORWAY Risk of overheating may be the biggest challenge ........................................ 10

DENMARK Languishing economic growth ..................................................................... 12

FINLAND Finnish economy has cooled down across the board .................................... 14

Nordic economies

USA Moving slowly forward ................................................................................. 16

EURO AREA Restore confidence to end the recession ...................................................... 18

UK UK growth stalling – awaiting outside help ................................................... 20

JAPAN The challenges remain in the long term ........................................................ 21

Major economies

POLAND Slowdown under control .............................................................................. 22

RUSSIA Inflation déjà vu ........................................................................................... 24

ESTONIA Economy remains in a soft patch ................................................................. 26

LATVIA Economy keeps delivering positive surprises ............................................... 27

LITHUANIA Showing resilience ...................................................................................... 28

CHINA Stability, stability and … stability .................................................................. 29

INDIA A drought of growth ..................................................................................... 31

BRAZIL Slow BRIC healing ....................................................................................... 32

Emerging Markets

OIL Oil prices stay high but spare capacity buffer should build ........................... 33

METALS Metal prices scratching the bottom for now .................................................. 34

Commodities

Data sources are Reuters EcoWin, national statistical bureaus and own calculations unless otherwise noted.

Data sources:

OVERVIEW Slow speed ahead ......................................................................................... 4

Two alternatives Risk scenario 1: Back on track..................................................................... 35 Risk scenario 2: That sinking feeling............................................................ 36

■ Overview


Slow speed ahead The global economy is still advancing, albeit at a low pace on a muddy road. The Euro area is again on the brink of recession, while activity in the US and the rest of the global economy slowed over the summer. However, we believe that better times are ahead, but the uncertain-ty is high. Monetary policy will remain very accommoda-tive over the forecast period, and fiscal tightening in the Euro area will gradually fade. Deleveraging will remain a key theme in both the public and private sectors, result-ing in weak credit growth. We see global economic growth at a moderate 3.1% this year, rising to 3.5% in 2013 and 3.8% in 2014. Over the summer the European sovereign debt crisis was reignited by the parliamentary elections in Greece and the banking sector crisis in Spain. However, the fire bri-gade responded promptly. At the end-June summit in Brussels the European leaders decided to take further in-stitutional steps towards the formation of a real economic and monetary union and to make EUR 100bn available to the struggling Spanish banking sector through the EFSF/ESM, the European bailout fund. In July the ECB cut rates again by 0.25% point and most recently, ECB President Draghi (“Super Mario”) verbally guaranteed that there would be no disintegration of the euro. It is still unclear exactly how the ECB will ensure the ex-istence of the euro, but there are indications that it will be through large-scale intervention in the government bond market. However, the ECB will make it a condition for the governments whose bonds it is to buy that they apply for assistance from the EFSF/ESM and in that connection agree to a financial stability programme. Especially the latter should make it a less bitter pill for the Bundesbank and German politicians to swallow – again. Germany remains concerned that the rescue plans would only en-courage more profligacy among the decision-makers of the crisis-afflicted countries and trigger long-term infla-tionary risks. Large debt-ridden countries such as Spain and Italy will be the first in line to make use of the new facility, should interest rates rise again to unsustainable levels. However, in principle this option will be available to all countries. ECB proactivity – including further rate cuts – is vital if financial markets’ confidence in the Euro area is to be re-stored. Ultimately, it may also be pivotal to returning growth to the private sector. Despite the current record-low interest rates, consumption and investment appetite is still close to zero. No doubt, the reason is a lack of confidence in the future among households and businesses, as reflected in the current weak credit demand, coupled with the new financial regulations. To meet the tighter capital adequa-

cy and liquidity requirements, banks and credit institu-tions have scaled back their lending activities. This im-pairment to the monetary policy transmission mechanism may be very difficult for the ECB to correct even if a Eu-ropean banking union sees the light of day in early 2013 as expected. Global interdependence With domestic demand at low levels – albeit with large regional differences between south and north – the Euro area will remain highly dependent on exports as a key driver of economic growth. The problem is that the Euro-area crisis has spread to other countries and regions worldwide. For instance, US and Chinese economic indi-cators have shown weakness during the summer and there is still a risk that the situation may deteriorate fur-ther. The risk is especially high in the US ahead of the presidential election in November as the country is tee-tering on a fiscal cliff. Among other things, US policy-makers still have not decided on a possible extension of the Bush-era tax breaks. If they do not find a solution, the expiry of the tax breaks would imply fiscal policy tight-ening to such an extent that the US is bound to slide into a new recession. At the same time Congress has to raise the debt ceiling once again to prevent the US from de-faulting on its payments early next year. These issues will likely be left unresolved until after the presidential election and consequently the political risk to sustained progress in the US should not be underestimated. Our baseline scenario factors in another increase in the debt ceiling and the extension of at least some of the tax breaks by the new president, be it Barack Obama or Mitt Romney. Finally, it should be kept in mind that the Fed-eral Reserve with Ben Bernanke at the helm to a much greater extent than the ECB is prepared to support eco-nomic growth. Consequently, policy rates will remain record-low until 2014, and the door to further quantita-tive easing measures will remain open in case the eco-nomic situation deteriorates further. China eases its economic policy The political situation in China is more predictable alt-hough a leadership change is to take place here also this year. However, when it comes to doing something to support growth, the one-party system appears unrivalled. While export growth is hampered by the international slowdown, economic policy will most likely be eased sufficiently to maintain economic growth around the 8% level required to prevent unemployment from rising. The outlook for growth in Brazil and Russia remains rel-atively bright, underpinned by high commodity prices and new reform initiatives. But the situation in India ap-pears more problematic. Indian exports are affected by the international slowdown, and Indian farmers are

■ Overview


struggling with a weak monsoon. Moreover, with India’s huge public budget deficit it is difficult for the govern-ment to alleviate the situation by increasing public ex-penditure. Higher prices, but no wage-price spiral in sight Also the US is subject to the vagaries of the weather. The worst drought in history has resulted in record-high pric-es on for instance corn and soya beans. The rising food prices – and now again rising oil prices – will send con-sumer prices higher, not only in the US but also in the rest of the world. Even so, at this juncture there is no rea-son to worry much about inflation over the forecast hori-zon. The situation in developed countries is too weak for that, considering the vast amount of idle resources. Con-sequently, the risk of rising consumer prices setting an inflationary wage-price spiral in motion is very small. Moreover, global competition and the persistent crisis limit the extent to which businesses can expand profit margins. Easy monetary policy for a long while yet Against this backdrop, leading market rates will pick up only slightly in the period up to 2014 when the ECB and the Fed will start tightening monetary policy again. By end-2014 we expect the ECB to have hiked its policy rate to 1% and the Fed to have hiked its key rate to 2%. The massive amount of liquidity that the major central banks have pumped into the system in recent years still poses a latent risk of inflation. If it is not withdrawn as the will-ingness of commercial banks to lend money again grows, it could lead to higher interest rates than our forecast suggests. Monetary policy is very important for the direction of exchange rates. Accordingly, we expect the USD to strengthen versus the EUR over the forecast period, alt-hough other issues such as the current account and debt levels may pop up as market themes. As a result of the peg between the USD and the GBP our baseline scenario also factors in GBP strengthening versus the EUR. Late in the forecast period we expect the CHF to weaken against the EUR, while the JPY should weaken against the USD in step with a gradual normalisation of financial market conditions. Safe havens may also be hit Denmark, Finland, Norway and Sweden all belong to the exclusive club of countries with top ratings from the ma-jor credit rating agencies. These countries have status as safe havens in financial markets. As a result, the NOK and the SEK have strengthened markedly, while interest rates in Denmark, with its fixed exchange rate policy versus the EUR, plummeted to new record lows. Actual-ly, the Danish central bank has had to bring its CD rate into negative territory to reduce the capital inflows that caused Denmark’s foreign currency reserves to swell to record-high levels.

Even so, the Danish economy is characterised by low growth and high uncertainty, stuck as it is in stagnation with a largely unchanged level of activity since the au-tumn of 2010. Over the coming quarters Denmark is ex-pected to gradually return to the growth track driven by substantial pent-up demand among households that will gradually show through in rising consumption. Mean-while, growth will also be underpinned by a delayed pos-itive contribution from public sector consumption and investment. Clear skies over Norway Only few signs of weakness are evident in the Norwegian economy, which continues to benefit from the high level of oil prices. Growth will remain high going forward. But thanks to the large immigration of labour, the country will most likely avoid overheating of the labour market and a sharp acceleration in cost pressures. Although wage growth will be markedly above the levels seen in the other Nordic countries, it will not be so high as to threaten Norges Bank’s inflation target. Nevertheless, with strong economic growth and somewhat higher ca-pacity utilisation, interest rates should rise somewhat in the years ahead. But the dilemma for Norges Bank is that the NOK in that case could appreciate too much. Also the Swedish economy has been a positive story so far. Both GDP and employment rose in H1 2012 despite the slowing international economy. Much suggests that growth will decline over the coming quarters, but house-holds are still in good shape. In combination with a slightly more expansionary economic policy and the an-ticipated improvement in international economic activity, this will underpin growth over the forecast horizon. The slowdown over the rest of 2012 will make its mark on the labour market. Unemployment will rise during the win-ter, reducing domestic cost pressures. In combination with continued SEK appreciation, inflation will stay sig-nificantly below the 2% target. Against this background, the Riksbank will be able to cut its policy rate further this year. Towards the end of 2013 when the economy re-gains strength, the bank will embark on a new tightening cycle. Finland is also feeling the effects of the global economic slowdown and is probably heading into recession. Ex-ports and investment activity are slowing in line with the trend in world trade, while weaker imports reflect prob-lems in domestic demand. Consumer spending has lost most of its steam and will lose further momentum once the slowdown also hits the labour market. A new recov-ery driven by a stronger international economic environ-ment will only emerge later in the forecast period. Against this backdrop, we have revised down our growth forecast for 2013, which is still markedly above the Eu-ro-area average. Helge J. Pedersen, Global Chief Economist [email protected] +45 3333 3126

■ Overview


Growth, % Inflation, %2010 2011 2012E 2013E 2014E 2010 2011 2012E 2013E 2014E

World1) 4.6 3.8 3.1 3.5 3.8 World1) 2.8 4.1 2.9 2.9 2.9

USA 2.4 1.8 2.2 2.0 2.2 USA 1.6 3.1 2.1 2.2 2.2Euro area 1.9 1.5 -0.4 0.6 1.7 Euro area 1.6 2.7 2.2 1.6 1.6China 9.2 10.5 8.0 8.3 8.5 China 3.3 5.4 3.1 4.0 3.8Japan 4.6 -0.7 2.5 1.6 1.1 Japan -0.7 -0.3 0.2 -0.1 -0.1

Denmark 1.3 0.8 0.7 1.9 2.1 Denmark 2.3 2.8 2.4 2.0 2.2Norw ay 1.9 2.4 3.7 3.0 2.8 Norw ay 2.5 1.2 0.8 1.8 2.1Sw eden 6.2 3.9 1.2 1.8 2.3 Sw eden 1.2 3.0 1.2 1.2 2.0

UK 1.8 0.8 -0.4 1.0 1.7 UK 3.3 4.5 3.0 2.2 1.4Sw itzerland 2.7 2.1 1.5 1.9 2.4 Sw itzerland 0.7 0.2 -0.7 0.6 1.6

Germany 4.0 3.1 0.9 1.4 2.1 Germany 0.2 1.2 1.9 1.7 2.1France 1.6 1.7 0.1 0.8 1.7 France 0.1 1.7 2.1 1.8 1.9Italy 1.8 0.5 -2.3 -0.5 1.0 Italy 1.6 2.9 3.1 2.1 1.5Spain -0.3 0.4 -1.2 -0.9 1.1 Spain 2.0 3.1 2.4 2.2 0.5Netherlands 1.6 1.1 -0.2 1.2 1.7 Netherlands 0.9 2.5 2.4 1.7 1.8Austria 2.3 2.7 0.9 0.8 1.7 Austria 1.7 3.6 2.2 1.8 1.9Belgium 2.4 1.8 -0.4 0.6 1.8 Belgium 2.3 3.5 2.2 1.5 1.7Portugal 1.4 -1.6 -2.7 0.0 1.2 Portugal 1.4 3.6 2.9 1.5 1.3Greece -3.5 -6.9 -6.6 -0.9 1.2 Greece 4.7 3.1 0.5 -0.5 0.0Finland 3.3 2.7 0.8 1.2 2.8 Finland 1.2 3.4 3.0 2.5 2.3Ireland -0.8 1.4 -0.2 1.5 2.1 Ireland -1.6 1.2 1.8 1.5 1.5Estonia 2.3 7.6 2.3 3.5 3.8 Estonia 3.0 5.0 3.7 3.0 2.9

Poland 3.9 4.3 2.8 2.3 3.1 Poland 2.6 4.3 3.9 2.7 2.2Russia 4.0 4.4 4.2 4.8 5.0 Russia 6.9 8.5 6.3 6.8 7.0Latvia -0.3 5.5 4.2 2.5 3.9 Latvia -1.1 4.4 2.3 2.5 2.8Lithuania 1.4 5.9 2.7 3.3 3.5 Lithuania 1.3 4.1 3.0 2.8 3.0India 9.6 6.9 6.0 6.7 7.2 India 9.6 9.5 7.5 6.8 7.0Brazil 7.6 2.8 2.6 4.6 4.8 Brazil 5.0 6.4 5.2 5.4 5.8

Public finances, % of GDP Current account, % of GDP2010 2011 2012E 2013E 2014E 2010 2011 2012E 2013E 2014E

USA -8.9 -8.6 -7.0 -5.5 -4.1 USA -3.0 -3.1 -3.0 -3.5 -3.0Euro area -6.2 -4.1 -3.7 -3.0 -2.5 Euro area 0.0 0.0 0.3 0.7 1.0China -1.7 -1.1 -1.5 -2.3 -1.9 China 5.1 2.8 2.5 2.2 1.5Japan -9.0 -9.7 -9.9 -9.6 -9.0 Japan 3.6 2.0 2.1 2.5 2.4

Denmark -2.7 -1.9 -3.9 -2.1 -0.5 Denmark 5.5 6.7 5.8 5.1 4.4Norw ay 11.3 13.8 13.7 13.9 13.6 Norw ay 12.4 14.5 14.9 15.4 15.1Sw eden -0.1 0.1 -0.3 -1.0 -0.5 Sw eden 6.8 7.0 7.2 7.6 7.5

UK -10.4 -8.3 -7.6 -6.4 -4.7 UK -2.5 -1.9 -2.3 -2.1 -1.3Sw itzerland 0.7 0.8 0.1 0.1 0.2 Sw itzerland 14.3 10.4 9.3 8.7 9.9

Germany -4.3 -1.0 -0.8 -0.6 -0.5 Germany 5.8 5.3 4.6 4.4 4.0France -7.1 -5.2 -4.7 -3.9 -3.5 France -2.2 -2.7 -2.4 -2.1 -2.0Italy -4.6 -3.9 -2.0 -1.8 -1.0 Italy -3.5 -3.1 -2.0 -1.0 -0.5Finland -2.5 -0.6 -0.5 -0.1 0.5 Finland 1.6 -1.1 -0.2 0.2 0.6Estonia 0.2 1.0 -1.5 -0.5 -0.3 Estonia 3.8 2.1 -2.3 -1.5 -1.3

Poland -7.8 -5.1 -3.3 -3.3 -2.9 Poland -4.7 -4.3 -3.6 -3.0 -3.0Russia -4.0 0.5 0.2 0.5 0.7 Russia 4.8 4.5 4.2 3.0 2.5Latvia -8.2 -3.5 -2.2 -2.0 -2.0 Latvia 3.0 -1.2 -3.2 -3.5 -3.6Lithuania -7.2 -5.5 -2.7 -3.0 -3.0 Lithuania 1.1 -1.6 -2.7 -3.0 -3.0India -3.6 -6.6 -7.0 -7.5 -8.0 India -3.3 -2.8 -4.0 -3.0 -2.2Brazil -2.7 -2.4 -2.0 -2.1 -2.2 Brazil -2.3 -2.1 -2.5 -2.7 -2.81) Weighted average of countries in this table. Accounts for 76.5% of world GDP. Weights calculated using PPP adjusted GDP levels for 2008 according to the IM F's World Economic Out look

■ Overview


Monetary policy rates Monetary policy rate spreads vs Euro area30.8.12 3M 30.06.13 31.12.13 31.12.14 30.8.12 3M 30.6.13 31.12.13 31.12.14

US 0.25 0.25 0.25 0.25 2.00 US -0.50 -0.25 -0.25 -0.25 1.00Japan 0.10 0.10 0.10 0.10 0.10 Japan1 -0.15 -0.15 -0.15 -0.15 -1.90Euro area 0.75 0.50 0.50 0.50 1.00 Euro area - - - - -Denmark 0.20 0.05 0.15 0.25 1.00 Denmark -0.55 -0.45 -0.35 -0.25 0.00Sw eden 1.50 1.25 1.00 1.50 2.00 Sw eden 0.75 0.75 0.50 1.00 1.00Norw ay 1.50 1.50 1.75 2.00 2.75 Norw ay 0.75 1.00 1.25 1.50 1.75UK 0.50 0.50 0.50 0.50 1.00 UK -0.25 0.00 0.00 0.00 0.00Sw itzerland 0.00 0.00 0.00 0.50 1.00 Sw itzerland -0.75 -0.50 -0.50 0.00 0.00Poland 4.75 4.50 4.00 4.00 4.50 Poland 4.00 4.00 3.50 3.50 3.50Russia 8.00 8.00 8.25 8.25 8.25 Russia 7.25 7.50 7.75 7.75 7.25China 6.00 5.75 5.75 6.00 6.00 China 5.25 5.25 5.25 5.50 5.00India 8.00 8.00 7.75 7.75 7.50 India 7.25 7.50 7.25 7.25 6.50Brazil 7.50 7.50 7.50 8.00 10.50 Brazil 6.75 7.00 7.00 7.50 9.50

3-month rates 3-month spreads vs Euro area30.8.12 3M 30.6.13 31.12.13 31.12.14 30.8.12 3M 30.6.13 31.12.13 31.12.14

US 0.42 0.45 0.50 0.60 2.50 US 0.13 0.20 0.25 0.10 1.30Euro area 0.29 0.25 0.25 0.50 1.20 Euro area - - - - -Denmark 0.31 0.35 0.40 0.70 1.45 Denmark 0.03 0.10 0.15 0.20 0.25Sw eden 1.95 1.55 1.50 2.00 2.50 Sw eden 1.66 1.30 1.25 1.50 1.30Norw ay 2.05 2.02 2.27 2.43 3.16 Norw ay 1.76 1.77 2.02 1.93 1.96UK 0.68 0.60 0.60 0.60 1.25 UK 0.40 0.35 0.35 0.10 0.05Poland 5.04 4.85 4.35 4.30 4.80 Poland 4.75 4.60 4.10 3.80 3.60Russia 7.17 7.40 7.50 7.50 8.00 Russia 6.88 7.15 7.25 7.00 6.80Latvia 0.61 0.55 0.50 0.50 1.20 Latvia 0.32 0.30 0.25 0.00 0.00Lithuania 0.89 0.75 0.80 1.10 1.70 Lithuania 0.60 0.50 0.55 0.60 0.50

10-year government benchmark yields 10-year yield spreads vs Euro area30.8.12 3M 30.6.13 31.12.13 31.12.14 30.8.12 3M 30.6.13 31.12.13 31.12.14

US 1.64 2.00 2.50 3.00 4.00 US 0.30 0.25 0.60 0.80 1.35Euro area 1.35 1.75 1.90 2.20 2.65 Euro area - - - - -Denmark 1.08 1.55 1.75 2.05 2.55 Denmark -0.26 -0.20 -0.15 -0.15 -0.10Sw eden 1.38 1.80 2.00 2.60 3.00 Sw eden 0.04 0.05 0.10 0.40 0.35Norw ay 1.97 2.58 2.86 2.96 3.14 Norw ay 0.62 0.83 0.96 0.76 0.49UK 1.48 1.75 2.00 2.25 2.75 UK 0.14 0.00 0.10 0.05 0.10Poland 4.92 4.80 4.90 5.00 5.50 Poland 3.58 3.05 3.00 2.80 2.85

Exchange rates vs EUR Exchange rates vs USD30.8.12 3M 30.6.13 31.12.13 31.12.14 30.8.12 3M 30.6.13 31.12.13 31.12.14

EUR/USD 1.26 1.30 1.20 1.15 1.10 -EUR/JPY 98.8 104.0 98.4 97.8 99.0 USD/JPY 78.6 80.0 82.0 85.0 90.0EUR/DKK 7.45 7.45 7.46 7.46 7.46 USD/DKK 5.93 5.73 6.21 6.48 6.78EUR/SEK 8.36 8.35 8.50 8.60 8.60 USD/SEK 6.66 6.42 7.08 7.48 7.82EUR/NOK 7.31 7.50 7.50 7.40 7.50 USD/NOK 5.81 5.77 6.25 6.43 6.82EUR/GBP 0.79 0.81 0.78 0.77 0.75 GBP/USD 1.58 1.61 1.55 1.50 1.47EUR/CHF 1.20 1.20 1.20 1.25 1.30 USD/CHF 0.96 0.92 1.00 1.09 1.18EUR/PLN 4.19 4.00 3.92 3.80 3.70 USD/PLN 3.33 3.1 3.3 3.3 3.4EUR/RUB 40.6 40.3 36.0 32.8 31.9 USD/RUB 32.3 31.0 30.0 28.5 29.0EUR/LVL 0.70 0.70 0.70 0.70 0.70 USD/LVL 0.55 0.54 0.58 0.61 0.64EUR/LTL 3.45 3.45 3.45 3.45 3.45 USD/LTL 2.75 2.66 2.88 3.00 3.14EUR/CNY 7.98 8.27 7.61 7.19 6.71 USD/CNY 6.35 6.36 6.34 6.25 6.10EUR/INR 69.8 71.5 63.6 55.2 49.5 USD/INR 55.6 55.0 53.0 48.0 45.0EUR/BRL 2.58 2.54 2.22 2.01 1.87 USD/BRL 2.05 1.95 1.85 1.75 1.70

■ Sweden


Households prop up the economy • GDP growth edging higher in coming years …

• … but near term, the labour market will weaken

• Long period of low inflation

• Riksbank to cut rates this year, and the SEK weakens

Good growth The Swedish economy has been surprisingly resilient to the global turbulence. GDP growth did drop towards the end of 2011, but both the GDP and employment rose again during H1 2012. The domestic economy was the key driver of growth, but also foreign trade improved. Growth in H1 2012 was fairly high, we think, despite the possibility of a downward revision to Q2 GDP growth. Although the economy has been able to tackle the global obstacles better than expected, GDP growth is still not sufficiently high to prevent a decline in the demand for labour. We expect unemployment to rise above 8% dur-ing the winter. Prospects for H2 2012 are mixed. We will likely see sub-dued growth. However, longer out there are factors sug-gesting a pick-up in activity. A benign situation for households, a slightly more expansionary economic poli-cy and a global economy that gradually recovers are the factors that will underpin higher GDP growth in coming years. However, due to global weakness growth will only accelerate slowly and unemployment will not decline un-til the latter part of the forecast period

Households keep the wheels turning Household finances are generally stable. A low inflation level and pay rises jack up households’ purchasing pow-er. Real disposable incomes will rise by about 2% annu-ally in 2012-2014. The improved household finances have fed through to the housing market. House prices have started to rise again after having shown a slightly weak trend over the past year. Share prices are also im-portant for households’ propensity to spend, and since the turn of the year stock markets have recovered some-what. The conditions for households are therefore benign so we expect consumer spending to rise noticeably in coming years. Investment activity lost pace in Q2 2012 after rising sharply at the beginning of the year. There are indications that capacity utilisation in several sectors has declined, which reduces the need for new investment. In addition, investment appetite seems suppressed by the dark clouds still hanging over Europe. The number of housing starts has already dropped sharply, and total investment will show a weak trend in coming quarters. We expect the general need for investments to be modest during most of next year and then increase in 2014 in tandem with the overall pick-up in activity. An expansionary fiscal policy partly based on infrastructure investment will contribute to underpinning investment growth over the forecast horizon. Tough times for the export industry Despite some improvement recently, exports of goods have stagnated over the past year. The order intake re-

Sweden: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (SEKbn) 2010 2011 2012E 2013E 2014E

Private consumption 1,533 3.7 2.0 1.7 2.0 2.1Government consumption 860 1.9 1.8 0.8 0.5 1.5Fixed investment 559 7.7 6.2 2.5 1.0 3.5 - industry 74 1.0 7.9 -2.2 2.2 4.4 - residential investment 92 17.2 15.1 -8.7 -2.2 4.5Stockbuilding* -46 2.1 0.6 -1.1 0.1 0.0Exports 1,489 11.7 6.9 1.2 4.2 4.9Imports 1,288 12.7 6.3 -0.4 3.8 5.1GDP 6.2 3.9 1.2 1.8 2.3GDP, calendar adjusted 5.9 3.9 1.5 1.8 2.4Nominal GDP (SEKbn) 3,106 3,331 3,492 3,580 3,703 3,836

Unemployment rate, % 8.4 7.5 7.7 8.0 7.7Employment grow th 1.0 2.1 0.3 -0.2 0.8Consumer prices, % y/y 1.2 3.0 1.2 1.2 2.0Underlying inflation (CPIF), % y/y 2.0 1.4 1.1 1.5 1.5Hourly earnings, % y/y 0.4 2.9 3.3 3.2 2.8Current account (SEKbn) 225 243 259 280 288 - % of GDP 6.8 7.0 7.2 7.6 7.5Trade balance, % of GDP 2.6 2.7 2.9 3.0 2.7

General govt budget balance (SEKbn) -2 5 -12 -38 -18 - % of GDP -0.1 0.1 -0.3 -1.0 -0.5Gross public debt, % of GDP 39.4 38.4 38.1 39.1 39.6* Contribution to GDP growth (% points)

■ Sweden


mains weak, and growth in many key export markets is low. Accordingly, goods exports will likely remain sub-dued during the remainder of 2012. Also the strong SEK is a problem for exporters. However, it probably affects profitability rather than volumes. The situation will im-prove longer out as the SEK will likely weaken and de-mand gradually rise. Sweden’s trade in services, which has increased sharply so far this year, is gaining significance. Exports of ser-vices have risen from 6% of GDP in 1980 to currently 15% of GDP. The export markets for services are largely identical to those for goods – where demand is weak. This suggests that the pick-up in H1 was temporary and will lose momentum going forward. Low inflation puts pressure on the Riksbank Despite an increase in the number of employed this year the labour market still shows signs of weakness. The de-mand for labour has not been sufficiently strong to keep unemployment in check. Labour market indicators are still at benign levels, but have started to soften. We look for a decline in employment and accelerating growth in unemployment during autumn and winter. Labour market weakness is usually accompanied by re-duced domestic inflation. Also, the SEK strengthening helps putting a lid on costs. Inflation pressures thus look set to moderate even further in future, extending the peri-od of core inflation markedly below the 2% target. This may cause some concern for the Riksbank as it could contribute to further accelerating the decline in inflation expectations. The door is thus open for monetary easing. With low in-flation, a weaker labour market, low policy rates interna-tionally and a risk of further SEK appreciation, the Riks-bank should cut rates this year. But when the economy starts to recover in the latter part of 2013, the bank will embark on a hiking cycle. A paradigm shift for the SEK The SEK has become a safe-haven currency in 2012. The reasons are the modest exposure of the Swedish economy to troubled areas, solid public finances and a highly com-petitive business sector that generates surprisingly strong growth and increased interest rate differentials. Going forward, we expect the SEK to weaken versus the EUR in step with a gradual stabilisation of the situation inter-nationally and a narrowing of interest rate differentials. However, EUR/SEK will remain at levels below 9 throughout the forecast period. The USD will continue to strengthen against most currencies, including the SEK. Torbjörn Isaksson [email protected] +46 8 614 8859

Rising incomes and consumption

Weak global demand a drag on Swedish exports

Reduced pressure on domestic market

Paradigm shift for SEK

■ Norway


Risk of overheating may be the biggest challenge • Strong domestic demand growth

• High immigration prevents overheating

• And Norges Bank may proceed with caution

The Norwegian economy is showing few signs of weak-ness and we see no reason to change our optimistic view of the economy going forward. Growth looks set to be high, but with increased labour immigration an overheat-ing of the economy and sharply rising costs will probably be avoided. Wage growth will be much higher than in neighbouring countries, but not so high as to push infla-tion above target. However, strong economic growth and higher capacity utilisation point to higher interest rates during the next couple of years. But fears of excessive NOK strengthening limit Norges Bank’s room for ma-noeuvre in monetary policy. Strong consumption growth Strong wage and employment growth and very low infla-tion currently boost consumer purchasing power. It is therefore no surprise that consumption growth in H1 2012 was very high after last year’s weaker-than-expected trend. And with an initial high level of savings and a sustained strong labour market we see consumption growth continuing unabated during the remainder of the year and into 2013. In 2013 and 2014 consumption growth should slow down as a result of higher interest rates and more moderate employment growth. Higher exports, but lower mainland investment Despite weak growth in export markets, a strong NOK and wage growth well above levels in other countries, mainland exports have remained at a higher level than

feared. Some export industries are facing difficulties, but for instance strong growth in electricity exports has put a floor under total export growth. However, while this trend is probably only temporary, the strong growth in exports within the engineering industry should continue. It reflects the increasing significance of the oil services industry for Norwegian exports. With sustained high oil prices, prospects are good for this type of exports in the years ahead. Over the forecast period we also see growth in traditional exports rising, driven by stronger traditional export market growth. The exceptionally strong growth in Norwegian oil in-vestment has been vital for the oil services industry. Growth will likely slow in coming years, but it will still remain very high. In our view, capacity limitations in many areas will prove the key obstacle to growth in this industry. Pressures in this part of the economy seem to be one of main reasons why the wage negotiations, despite all the talk of competitiveness and the so-called “frontfagmodell” (meaning that the negotiations start in the industries particularly exposed to competition), result in pay rises in manufacturing way beyond those in rival countries. We also see fairly strong growth in mainland investment going forward, although the pace is not likely to match that of oil investment growth. The propensity to invest should be high with strong production gains in large parts of the corporate sector. Higher credit margins and tighter bank credit standards could slightly dampen investment growth, but this effect will likely be largely offset by the overall very low interest rate level. A possible sharp es-calation of the euro crisis and a new financial crisis

Norway: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009(NOKbn) 2010 2011 2012E 2013E 2014E

Private consumption 1,028 3.7 2.4 3.7 3.5 3.0Government consumption 531 1.7 1.5 2.0 2.5 2.5Fixed investment 516 -5.2 6.4 7.2 4.9 3.7 - gross investment, mainland 349 -2.5 8.0 3.2 3.7 3.7 - gross investment, oil 144 -14.3 9.1 20.0 8.0 4.0Stockbuilding* 14 1.9 0.3 0.0 0.0 0.0Exports 929 1.8 -1.4 1.6 1.1 1.3 - crude oil and natural gas 416 -4.8 -6.2 2.5 0.0 0.0 - other goods 277 2.5 -0.4 0.0 2.0 2.5Imports 660 9.9 3.5 3.0 3.9 3.0GDP 2,357 0.7 1.4 3.4 2.4 2.3GDP, mainland 1,876 1.9 2.4 3.7 3.0 2.8

Unemployment rate, % 3.6 3.3 3.0 2.9 2.9Consumer prices, % y/y 2.5 1.2 0.8 1.8 2.1Core inf lation, % y/y 1.4 0.9 1.2 1.5 2.1Annual w ages, % y/y 3.6 4.3 4.2 4.3 4.3Current account (NOKbn) 313.6 393.9 437.1 482.9 497.5 - % of GDP 12.4 14.5 14.9 15.4 15.1Trade balance, % of GDP 12.4 13.8 14.6 15.1 14.8

General govt budget balance (NOKbn) 284.5 375.1 400.0 435.0 450.0 - % of GDP 11.3 13.8 13.7 13.9 13.6

* Contribution to GDP growth (% points)

■ Norway


could, however, result in much tighter credit standards, and this is probably one of the key risks to the Norwe-gian economy. Inflation to edge higher Strong domestic demand growth will contribute to strong production growth in the years ahead. However, thanks to high immigration we do not expect labour shortages to become a major problem. Nor do we expect major bot-tlenecks in the labour market despite shortages in some skilled areas. Consequently, wage growth should not pick up sharply, but still remain relatively high at just above 4% in the years ahead. Wage growth just above 4%, strong domestic demand growth and a relatively stable NOK suggest that inflation will edge higher in coming years. Core inflation may rise to 2% over the forecast period, up from 1% at present, but to drive inflation above the 2½% target, cost growth would have to be higher. Gradually higher interest rates Against the background of strong growth, a relatively tight labour market, somewhat higher inflation and slightly improved prospects globally, Norges Bank will want to hike interest rates during the forecast period. Al-so the steady increases in house prices and credit growth from high levels suggest higher interest rates. However, with below-target inflation and domestic economic growth largely matching capacity growth, Norges Bank will not be in a hurry. In the absence of rate hikes in neighbouring countries, an aggressive monetary policy line would only strengthen the NOK to levels that would cause inflation to drop further below target. At the time of writing the NOK has strengthened quite significantly against the EUR, but measured in terms of the trade-weighted exchange rate, the NOK strengthening is far more modest. We expect Norges Bank to hike its policy rate twice next year, but these moves should not result in a long-lasting period of NOK strengthening. In 2014 the pace of monetary tightening may be increased further, but as interest rates in other countries are also likely to go up, Norges Bank can hike its policy rates without risking excessive NOK strengthening. There is a clear risk that the high domestic demand growth could result in increased capacity problems, high-er wage growth and consequently gradually higher infla-tion than we project. If so, Norges Bank will act more aggressively, accepting the effect on the NOK. And the NOK strengthening would contribute to preventing infla-tion from rising above target. If Norges Bank chooses to focus less on meeting the inflation target and more on preventing surging house prices and household credit growth, the result may be a combination of higher inter-est rates and a stronger NOK. However, judging from the bank’s rhetoric it is not about to change its priorities. Erik Bruce [email protected] +47 2248 4449

Norwegian manufacturing production rises

Higher income growth -> higher consumption growth

Supply and demand growth almost identical

NOK not so strong in trade-weighted terms

■ Denmark


Languishing economic growth • Rising activity towards 2014

• Housing market improvement

• Delayed effect from public money flow

• Negative central bank rates work

Low growth and significant uncertainty characterise the Danish economy; activity has been stuck at largely the same level since the autumn of 2010. Over coming quar-ters, we expect the Danish economy to gradually return to the growth track this year, expanding at a rate of 0.7% this year, accelerating to 1.9% in 2013 and 2.1% in 2014. On the domestic front the expected reversal of economic trends will be driven by households’ large pent-up poten-tial, which will gradually turn into growing consumer spending. At the same time, growth is underpinned by a delayed effect from the public sector, with expected posi-tive contributions from consumer spending and invest-ment. Consumers hang on to their money Although the payout of saved-up early retirement money is close to DKK 20bn (already surpassing official fore-casts), the effect on retail sales and consumer spending has so far not materialised. Instead many have chosen up save up more; total household bank deposits have swelled to an all-time high. The Danish economy there-fore lacks the boost to activity that normally results from consumer spending. Moreover, the government’s scope for stimulating economic activity through its tax policy is limited.

Despite the prospect of a historically high savings ratio our forecast assumes that consumer spending will gradu-ally increase towards the end of 2014. The accelerating consumer spending growth will partly be driven by a pent-up consumption need and partly by generally im-proved sentiment about the Danish economy. Not least the prospect of increasing employment and a pick-up in the housing market will boost Danish households’ pro-pensity to consume over the forecast period. Housing market shows signs of healing Since mid-2008 the ailing housing market has been a millstone around the neck of the Danish economy. The contracting housing wealth, slower credit growth and his-torically low activity in the construction sector are some of the main reasons why consumer spending has stagnat-ed. However, the latest monthly property price data from Statistics Denmark suggest that housing prices have sta-bilised since the start of the year. We believe this devel-opment marks the beginning of a new regime in the Dan-ish housing market where the historically low funding costs and substantial pent-up demand over time will lead to market consolidation. But prices will be kept in check by a still large supply of unsold homes, low turnover and high youth unemploy-ment, which limits the number of first-time buyers. Trapped between these two opposing trends, housing prices are likely to remain more or less unchanged during the rest of the year. Into 2013 we expect housing prices to slowly edge higher, surpassing expected inflation again in 2014. The moderately rising housing prices will first and foremost be concentrated in the large cities where demographics suggest growing upward pressure on demand.

Denmark: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (DKKbn) 2010 2011 2012E 2013E 2014E

Private consumption 815 1.9 -0.8 0.6 1.8 1.9Government consumption 497 0.3 -1.3 0.4 0.8 0.8Fixed investment 314 -3.7 0.2 2.8 4.0 4.7 - government investment 33 8.5 5.2 8.5 -12.0 2.5 - residential investment 80 -7.4 8.8 -5.8 4.7 5.0 - business f ixed investment 201 -4.4 -3.8 5.0 7.1 4.9Stockbuilding* -20 0.1 0.0 0.0Exports 794 3.2 7.0 2.0 2.9 3.5Imports 731 3.5 5.2 2.6 3.6 3.6GDP 1.3 0.8 0.7 1.9 2.1Nominal GDP (DKKbn) 1,668 1,772 1,783 1,818 1,879 1,949

Unemployment rate, % 6.3 6.2 6.3 6.4 6.2Gross unemployment level, '000 persons 164.5 162.1 165.0 168.7 163.2Consumer prices, % y/y 2.3 2.8 2.4 2.0 2.2Hourly earnings, % y/y 2.3 1.8 1.8 1.9 2.1Nominal house prices, one-family, % y/y 2.8 -2.8 -4.3 1.2 1.9Current account (DKKbn) 96.9 119.1 105.0 95.0 85.0 - % of GDP 5.5 6.7 5.8 5.1 4.4General govt. budget balance (DKKbn) -47.4 -34.5 -71.0 -40.0 -10.0 - % of GDP -2.7 -1.9 -3.9 -2.1 -0.5Gross public debt, % of GDP 42.9 46.6 45.5 44.5 43.0


■ Denmark


Negative central bank rates a success During the debt crisis the Danish central bank has been forced to pursue a very proactive monetary policy to keep the DKK stable versus the EUR. As a vital part of this defence, the central bank cut its CD rate to -0.20% in early July. It is the first time in Denmark’s history that the CO rate is in negative territory. So far this move has had the desired effect. The DKK has stabilised at a solid level against the EUR without the central bank needing to intervene in the market. This contrasts sharply with the situation in May and June when more than DKK 36bn was sold to defend the Danish fixed exchange rate re-gime. Public money flow drying out In a bid to break the current economic deadlock the gov-ernment has decided to bring forward public investment projects to the tune of DKK 19bn. At the same time pub-lic spending is budgeted to grow by DKK 18bn this year and an additional DKK 8bn in 2013 – corresponding to real growth of 1.5% and 0.1%, respectively. Despite the-se intentions public spending decreased by 1.0% in H1, while public investment only increased very modestly. So the Danish economy has so far not received the origi-nally planned boost from fiscal policy. The explanation to this sluggishness should be found in the long imple-mentation period for public investment and in the fact that public-sector spending historically has been very dif-ficult to fine-tune. Against this background, there is a likelihood of a strong ketchup effect in coming quarters, which will help pull the Danish economy out of the dol-drums provided that the government fulfils its own plans. Improved competitiveness drive exports forward After a brief dip at the beginning of the year, exports are growing again – partly driven by sustained growth in key export markets, partly by improved competitiveness. This is chiefly a result of a weakening of the trade-weighted DKK, which has made Danish products com-paratively cheaper in international markets. But also the past year’s sharp drop in the pace of wage growth combined with productivity gains means that unit labour costs now increase more slowly than in Den-mark’s key export markets. And although the effect of the lower unit labour costs will not feed though until slightly longer out, it is a vital precondition for maintain-ing the necessary momentum in exports. Helge J. Pedersen [email protected] +45 33333126

Jan Størup Nielsen [email protected] +45 33333171

Stagnant consumption

The central bank’s CD rate is negative

Improved competitiveness

Decoupling between employment and house prices

■ Finland


Finland: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (EURbn) 2010 2011 2012E 2013E 2014E

Private consumption 94 3.3 2.5 2.2 1.3 2.0Government consumption 43 -0.3 0.4 0.3 0.5 0.5Fixed investment 34 1.9 6.8 -3.2 0.6 3.8Stockbuilding* -2 0.5 1.1 -0.3 0.3 0.1Exports 64 7.5 2.6 -1.7 2.6 7.1Imports 62 6.9 5.7 -3.0 2.9 6.2GDP 3.3 2.7 0.8 1.2 2.8Nominal GDP (EURbn) 172.3 178.8 189.4 196.0 201.6 210.1

Unemployment rate, % 8.4 7.8 7.7 8.0 7.9Industrial production, % y/y 8.3 0.9 -3.0 2.0 4.0Consumer prices, % y/y 1.2 3.4 3.0 2.5 2.3Hourly w ages, % y/y 2.6 2.7 3.5 3.0 3.0Current account (EURbn) 2.9 -2.2 -0.5 0.4 1.2 - % of GDP 1.6 -1.1 -0.2 0.2 0.6Trade balance (EURbn) 2.6 -1.2 -0.1 0.1 0.8 - % of GDP 1.4 -0.6 -0.1 0.0 0.4

General govt budget balance (EURbn) -4.5 -1.2 -1.0 -0.1 1.0 - % of GDP -2.5 -0.6 -0.5 -0.1 0.5Gross public debt (EURbn) 90.0 93.0 99.0 104.1 108.4 - % of GDP 50.3 49.1 50.5 51.6 51.6

Finnish economy has cooled down across the board • Exports will not recover until 2013

• Growth in private consumption will slow down

• Employment will fall less than previously forecast

• Public sector deficit will decrease

As expected, economic activity has decreased in Finland across the board after the first quarter of this year. Ex-ports have contracted, investment has continued to de-cline and the growth in private consumption has slowed down. Imports have decreased more than exports, which is, in particular, a sign of weakening in domestic demand. What is positive, is that employment has not yet weak-ened. However, it is probably only a question of time be-fore it does. Based on preliminary data, the economy contracted in Q2 compared to the previous quarter. Our forecast assumes that the decline continues in Q3. This means that we be-lieve the Finnish economy is in recession, just like many other European countries. As in our previous forecast, however, we believe the recession will not last long and there is no need to change the previous GDP growth forecast of 0.8% for this year. On the other hand, interna-tional trade has cooled down more than expected, which indicates that an export-led recovery from the recession will be much slower than previously estimated. That is why we have lowered our forecast for economic growth in Finland in 2013 to 1.2% (previously 1.6%). In 2014, we expect growth to speed up to 2.8% as especially the North-European economies will recover. Exports will not recover until 2013 Finnish goods exports have varied widely over the past year – and the variation has taken place around a decreas-ing trend. New orders received by the industrial sector,

for instance, turned down again in the first half of the year. In our forecast, we assume export volumes to con-tinue declining in the latter part of the year. The decreas-ing world trade growth will weaken production expecta-tions globally and decrease investment needs. This is bad news to the Finnish export industry, as its main products are raw materials, production supplies and investment goods. We expect international demand to strengthen moderately in 2013. Export volumes will increase but growth will still remain modest. Growth in private consumption to slow down Private consumption increased at a brisk pace in Q1 this year compared to Q4 2011. This was a result of the one-off additional salary items based on collective agree-ments, which boosted retail sales, and the car tax hike that entered into force at the beginning of April, which made people purchase new cars earlier than they other-wise would have. The growth in retail sales volumes slowed down markedly in Q2 and in July it stopped alto-gether. Car sales, too, have decreased sharply. Thanks to the strong beginning of the year, private consumption will significantly boost the economic growth this year despite the recent cooling. For the remaining part of the year and for 2013, the out-look for private consumption will remain weak. The in-crease in salaries and pensions as well as the decrease in mortgage interest rates will support households' purchas-ing power. The growth in purchase power will, however, be restrained by tax increases and the expected weaken-ing in employment. Taxes will increase as the value add-ed tax will be raised and no inflation adjustments of in-come limits will be made in the income tax brackets. In addition, the rather rapid growth in consumer prices will continue and erode purchasing power. Consumer prices are expected to rise by 2.5% next year. The household


■ Finland


savings rate continues to decline which means that an in-creasing part of income is used for consumption. The ac-commodating monetary policy is well timed as the con-sumption outlook would be much gloomier without it. Investment to decline, employment to weaken The bleak short-term outlook for exports, production and consumption as well as the major uncertainty over the Euro area developments will eat away economic agents' confidence and thus decrease willingness to invest and weaken employment prerequisites. Machinery and equipment investment increased sharply last year but turned down again already in the beginning of this year. The decline is expected to continue at least for the rest of this year. Construction investment is also expected to de-cline. The decrease in the number of granted construction permits indicates that the decline in residential and other construction will continue and even steepen during the latter part of the year. Reconstruction will compensate for the decline in new construction. We expect both the traditional machinery and equipment investment and construction investment to increase again in 2013. A precondition for this, however, is that the global economy will grow as forecast, the Euro area debt crisis will clear up and confidence will return. The labour market has provided very positive surprises this year. Employment measured with the number of people has not weakened (although the number of work-ing hours has probably started to decrease) and the num-ber of unemployed people has not started to increase. Seasonally adjusted unemployment rate has stabilised at 7.5% in recent months. The unemployment rate for 2012 seems to remain at 7.7% (the previous forecast was 8.0%), which is lower than in 2011. We still expect un-employment to increase, especially in 2013 with the un-employment rate rising to an average of 8%. Slower decrease in public sector deficit Tax revenues will increase at a slower pace due to the sluggish economic growth, even though income taxation will be tightened and value added tax will be raised. The public sector deficit will, however, continue to decline. The deficit is estimated to decrease to 0.1% of GDP in 2013 and turn into a small surplus in 2014. The govern-ment's annual borrowing need will remain at EUR 4–6bn during the forecast period, which will increase the public debt close to 52% of the value of total production already in 2013. Pasi Sorjonen [email protected] +358 9 165 59942

Cooling of world trade brings problems to exports

Weak sentiment points to an outright fall in GDP

A decline in GDP is bad news for employment

Confidence + labour market = weak consumption

■ USA


USA: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (USDbn) 2010 2011 2012E 2013E 2014E

Private consumption 9,845.9 1.8 2.5 1.9 2.0 2.1Government consumption and investment 2,967.2 0.6 -3.1 -2.0 -0.9 -0.3Private fixed investment 1,703.5 -0.2 6.6 9.4 6.9 6.9 - residential investment 354.2 -3.7 -1.4 11.7 9.4 12.4 - equipment and softw are 898.3 8.9 11.0 8.3 6.9 6.0 - non-residential structures 451.1 -15.6 2.8 10.2 4.5 3.5Stockbuilding* -154.2 1.5 -0.2 0.2 0.1 0.0Exports 1,587.5 11.1 6.7 4.3 5.2 5.3Imports 1,976.2 12.5 4.8 4.2 5.7 5.4GDP 2.4 1.8 2.2 2.0 2.2Nominal GDP (USDbn) 13,973.7 14,498.9 15,075.7 15,716.1 16,276.1 16,885.0

Unemployment rate, % 9.6 9.0 8.1 7.7 7.3Industrial production, % y/y 5.4 4.1 4.0 4.0 4.3Consumer prices, % y/y 1.6 3.1 2.1 2.2 2.2Consumer prices ex. energy and food, % y/y 1.0 1.7 2.1 2.2 2.2Hourly earnings, % y/y 1.8 2.0 2.2 2.1 2.2Current account (USDbn) -442.0 -465.9 -471.5 -569.7 -506.5 - % of GDP -3.0 -3.1 -3.0 -3.5 -3.0

Federal budget balance (USDbn) -1,293.5 -1,300.0 -1,100.0 -900.0 -700.0 - % of GDP -8.9 -8.6 -7.0 -5.5 -4.1Gross public debt, % of GDP 95.2 99.5 106.5 112.0 116.2

Moving slowly forward • If a perfect storm of fiscal chaos is avoided …

• ... progress towards full employment in 2014

• Stronger underlying inflation pressures set to emerge

• Fed to start tightening by mid-2014

US economic growth is likely to remain moderate in the next few years through 2014, constrained by household deleveraging, fiscal restraint, subpar global demand, slower working-age population growth and a deteriora-tion of job skills. The US economy clearly lost momentum during Q2 2012, but recent economic data paint a slightly brighter picture, pointing towards GDP growth of 1½-2% in H2 2012. Stronger disposable income growth, easier finan-cial conditions and bank lending standards, continued housing recovery, the end of the payback for the warm winter weather and less drag from seasonal adjustment distortions suggest that economic momentum will pick up slightly in the near term. However, while the threat from the Euro-area crisis cur-rently appears less menacing, US fiscal challenges around the end of this year imply that risks to the US out-look over the next two to three quarters remain tilted to the downside. The probability of another US recession is uncomfortably high at 20-25%, in our view. On the other hand, an orderly resolution of the pending fiscal issues, as assumed in our baseline scenario, should pave the way for stronger confidence and hence brighter economic prospects in 2013, when growth is projected to exceed potential assumed at around 2% annually through most of the year.

After all, the economy’s fundamentals are much im-proved. Businesses are highly profitable, banks have re-capitalised and the deleveraging process in the private sector has come a long way. Still, households – especial-ly younger families – are likely to continue the process of balance sheet repair. Home prices seem to have bot-tomed, but the expected slow price increases provide lim-ited support to household net worth going forward. In 2014 growth is expected to slow to a pace more in line with potential. Full employment, defined as an unem-ployment rate of 7%, should be achieved in late 2014. QE3 only in case of policy errors The effects of the drought in the Midwest on food com-modity prices and a rebound in oil prices are likely to push headline inflation meaningfully higher by mid-2013. With the business cycle adjustment more or less com-pleted in 2014, signs of stronger underlying inflation pressures are projected to emerge in the latter part of the forecast horizon. As a result, we expect the Fed to start raising policy rates and gradual unwind its securities holdings around mid-2014. In the more immediate future, however, the Fed is likely later this month to postpone the expected first rate hike from late 2014 to mid-2015. In our view, the central bank is currently overestimating the labour market slack and hence underestimating the longer-term risk of inflation. Additional asset purchases (QE3) by the Fed are not ex-pected unless the Euro-area crisis blows up again or if US policymakers fail to resolve the pending fiscal issues in an orderly manner.


■ USA


A perfect storm of fiscal chaos hopefully avoided Three US fiscal issues pose a threat to the economic out-look: the so-called fiscal cliff, another increase in the Treasury debt ceiling and the need for longer-term fiscal sustainability. As we approach the end of the year, attention will focus even more sharply on the risk of the fiscal cliff – the un-fortunate coincidence of about USD 600bn in tax in-creases and spending cuts that will take effect next year, should Congress not act to change current law. Failure to scale back the fiscal cliff could knock as much as 4¼% off real GDP in 2013, enough to push the US economy back into recession. Moreover, the Treasury is likely to hit the debt ceiling again in December. Assuming it uses the accounting strategies that have been employed in the past, the Treasury seems likely to be able to finance gov-ernment operations under the current limit until some-time in February 2013, by which point Congress must raise the debt ceiling. Failure to do so would imply de-fault on some of the US government’s obligations. With both political parties in full campaigning mode, none of these issues are likely to be resolved before the presidential elections on 6 November. As seen too often during the past two years, there will most likely be plenty of political brinkmanship and the accompanying uncer-tainty will probably come at a cost to the economy and the financial markets later this year and in early 2013. The longer the uncertainty persists, the more likely it will hurt confidence, hiring, investment and spending. However, our expectation is that when pressured by the threat of another recession, policymakers will take action to reduce the fiscal drag on growth (to around 0.5% of GDP) either during the so-called lame duck session after the election or in January when the new government takes office. Obviously, the outcome of the November elections will be very crucial to how the fiscal debate plays out. In this context, the congressional election re-sults will be at least as important as who wins the White House, Obama or Romney. Extending the otherwise expiring tax cuts and other eas-ing measures and repealing the automatic federal spend-ing cuts would significantly reduce the risk of recession, but at the cost of a substantially larger budget deficit. Thus, with an extension of current policy federal debt held by the public would rise from 70% of GDP today to around 90% by 2022 compared to around 60% if current law is not changed. In other words, apart from resolving the fiscal cliff issue and raising the debt ceiling policy-makers will also soon have to address the need to restore longer-term fiscal sustainability in order to shift the risk to the economic outlook from negative to positive. Johnny Bo Jakobsen [email protected] +45 3333 6178

Moving slowly forward

Slow progress towards full employment in late 2014

Stronger underlying inflation pressures in 2014

Recession if economy is pushed off the fiscal cliff

-5

-4

-3

-2

-1

0

1

-5

-4

-3

-2

-1

0

1

2011 2012 2013

% points% points Fiscal policy impact on GDP growth

Current law Current policy

Source: Nordea Marktes, Congressional Budget Office and Office of Management and Budget

■ Euro area


Restore confidence to end the recession• Gradual recovery from year-end

• Helped by smarter interventions

• Significant downside risks to inflation

• Spain heading for deeper recession

The Euro area is in recession. The second quarter showed GDP contraction and the third quarter most likely will too. We expect a recovery starting around year-end and a very gradual pick-up of momentum during 2013. In 2014 growth will still be somewhat below the pre-crisis “nor-mal” level. We have made a modest upward revision to growth this year, but otherwise kept the Euro-area forecast roughly unchanged compared with our May forecast revision. We have revised down our growth forecast for Spain in 2013 after the announcement of new austerity measures during the summer. Recovery from year-end It is fair to say that signs of recovery have been scant up to this point. However, the most forward-looking indica-tors for growth in the Euro area as a whole have at least stopped falling and stabilised at low levels. The contraction in Q2 was not as severe as one might have expected given the financial stress during that peri-od with Greek post-election chaos and a Spanish bank bailout. Some lagged adverse impact on the economy is likely to be visible in the Q3 growth numbers, but we ex-pect Q3 to mark the bottom of the current business cycle. Another reason that the Q2 numbers were not as bad as feared is Germany. German growth remained resilient during the first half of the year driven to a large extent by the export sector and to some extent also the German consumers. At present, the survey-based indicators point to slightly negative growth in Germany in Q3.

Restoring confidence is key to recovery Why do we expect a recovery when numerous problems remain unsolved and deleveraging has only just begun? Well, because we believe that decisions have been taken and will be taken in the coming months that are decisive and will help gradually restoring confidence in the Euro area. After all, monetary policy is extremely lenient, ex-port markets are growing decently, the EUR is weaken-ing and even if more fiscal tightening will be needed in the years to come at least the pace of tightening will be slower. Confidence is the missing ingredient that will al-low these factors to work and pave the way for a very gradual recovery. Restoring confidence takes more time than eroding it, and we do not in any expect that the debt crisis is about to end. Solving the crisis requires massive deleveraging in the years to come, structural reforms, growth and building new credible institutions to prevent the same kind of crisis from happening again. Restoring confi-dence also requires that Greece starts implementing the reforms agreed with the Troika. Interventions will work this time In terms of the decisive action, the ECB seems ready to bring out Big Bertha – more or less the entire arsenal of instruments is being considered. We believe ECB inter-ventions in the secondary market – done smarter this time – combined with intervention in the primary market by the EFSF/ESM will reduce the level of stress in finan-cial markets and help restore the confidence that is need-ed to embark on a path to recovery. When the ECB intervened through its old programme (the SMP) it did not work very well. Rather it reduced the incentive for eg Italy to do the right thing. Therefore, interventions to reduce financial stress never became credible. This time, the ECB will intervene with strict conditionality – ie only in countries that have a bailout programme with promises to reduce budget deficits and

Euro area: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (EURbn) 2010 2011 2012E 2013E 2014E

Private consumption 5,128 0.9 0.2 -0.8 -0.4 0.3Government consumption 1,987 0.7 -0.3 0.2 -0.9 -0.8Fixed investments 1,735 -0.2 1.6 -3.0 1.1 2.4Stockbuilding* -48 0.7 0.3 -1.2 -0.1 0.5Exports 3,272 11.0 6.3 1.6 4.9 1.6Imports 3,155 9.4 4.1 -2.3 2.9 1.4Net exports* -0.8 0.7 1.0 1.6 1.0 0.2GDP 1.9 1.5 -0.4 0.6 1.7Nominal GDP, EUR bn 8,917 9,155 9,410 9,512 9,725 9,804

Unemployment rate, % 10.1 10.2 11.3 11.6 10.6Industrial production, % y/y 4.3 2.7 -2.6 2.9 5.8Consumer prices, % y/y 1.6 2.7 2.2 1.6 1.6 - core inflation** 1.0 1.7 1.6 1.2 1.0Hourly earnings, % y/y 1.6 2.2 2.3 2.2 2.1Current account, bn EUR -3.2 -1.1 33.1 21.0 17.0Current account, % of GDP 0.0 0.0 0.3 0.7 1.0General government budget balance, % of GDP -6.2 -4.1 -3.7 -3.0 -2.5General government gross debt, % of GDP 85.3 87.2 90.9 93.9 96.4


■ Euro area


undertake reforms – which will make actions on both sides more credible. The ECB can intervene in large amounts and significantly reduce financial stress because the ECB does not have to rely on market pressure. In-stead, the crisis bailout country will have to continuously meet the agreed conditions, or it not only risks losing ac-cess to the cheap bailout loan but also to the “free” ECB interventions. Within the next few months we expect Spain to ask for interventions from the bailout funds and hence from the ECB. Italy could follow late this year, as it could be a way for the current premier to secure budget discipline beyond the April 2013 general elections. Such a political manoeuvre could make the next government obliged to continuously meet the conditions that Mr Monti agrees upon to get ECB support, or the ECB stops intervening. Limited underlying inflationary pressure Consumer price increases are likely to remain above 2% in the coming quarters despite the ongoing recession. Higher food and energy prices as well as indirect tax hikes in some countries will keep the headline numbers elevated. Underlying inflation will, however, gradually fall throughout most of this year and 2013 before picking up modestly in 2014. Risks are skewed significantly to the downside throughout the forecast horizon. Upside risks to inflation from the very easy monetary policy are unlikely to materialise within our current forecast hori-zon. Spain heading for deeper recession Since our most recent forecast update, Spain has taken a EUR 100bn bank bailout and announced new austerity measures totalling EUR 65bn until 2014. The bailout of Spanish banks seems sufficient to cover near-term capi-talisation needs, as it has also been confirmed by inde-pendent consultants. However, the banking sector re-mains a key concern as the economy heads deeper into recession. Key elements of the austerity package include a VAT hike from 18% to 21% from September this year and cuts in benefits and public wages. As a consequence, we have revised down our forecast for growth in both 2012 and 2013. On a more positive note, we do expect intervention in Spanish sovereign bonds by the ECB and the rescue funds and a somewhat reduced level of financial stress. Anders Svendsen [email protected] +45 3333 3951

Gradual recovery from year-end

Confidence is crucial

Consumer price increases remain elevated

Monetary policy is extremely lenient

■ United Kingdom


UK growth stalling – awaiting outside helpThe UK economy has been moving at stall speed lately. Four years after the Great Recession first hit the shores of the British Isles, the economy is still 4% below its pre-crisis peak and the economy has contracted for the past three quarters. Lately, several events have been heavily influencing eco-nomic key figures: The Queen’s Diamond Jubilee gave an extra day off in Q2 that showed up as weakness in the figures; the weather was horrid, which has depressed re-tail sales, and finally the 2012 Olympics is expected to give an extra (albeit temporary) boost to consumption and employment during Q3. We are somewhat puzzled by the development in the la-bour market. Employment has increased by 330k over the past year and while some of those jobs most likely are related to the Olympics, they have come too early. This could be an indication that the GDP figures are un-derestimating actual growth or a sign of labour hoarding, which could pose a downside risk if the economy fails to gain traction. With the UK government’s continued focus on downsiz-ing the public sector, growth is expected to come from a normalisation in exports as export markets recover and a modest recovery in private consumption and growing in-vestment (as an aside, with this forecast total private con-sumption will still be 1% shy of the 2007 level at the end of the forecast horizon). With industrial capacity utilisa-tion above 80%, we expect this to drive investment in new machinery. The Bank of England (BoE) will keep trying to support the economy through more asset purchases (we expect another GBP 50bn to GBP 425bn) and the Funding for Lending Scheme (FLS) which should give incentives for banks to increase lending to the real economy. Steen V. Grøndahl, CFA [email protected] +45 3333 1453

Stalling recovery

Capacity dwindling

Growth slowly recovering

United Kingdom: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (GBPbn) 2010 2011 2012E 2013E 2014E

Private consumption 912.8 1.3 -1.0 0.1 1.7 2.4Government consumption 327.9 0.4 0.1 1.5 -2.0 -1.5Fixed investment 208.7 3.5 -1.4 0.6 3.2 6.3Stockbuilding* 0.9 0.3 -0.1 -0.1 -0.1Exports 404.2 6.4 4.4 -0.4 3.8 3.2Imports 424.8 8.0 0.5 2.3 3.3 4.1GDP 1.8 0.8 -0.4 1.0 1.7Nominal GDP (GBPbn) 1401.8 1466.6 1516.2 1548.1 1592.1 1641.1

Unemployment rate, % 7.9 8.1 8.4 8.7 8.6Consumer prices, % y/y 3.3 4.5 3.0 2.2 1.4Current account, % of GDP -2.5 -1.9 -2.3 -2.1 -1.3General govt budget balance, % of GDP -10.4 -8.3 -7.6 -6.4 -4.7Gross public debt, % of GDP 75.7 82.9 89.3 93.2 95.1


■ Japan


The challenges remain in the long term The Japanese economy is undergoing a domestic-led re-covery. As a result of strong post-earthquake restoration activity, the growth rate in the first half of 2012 averaged 3.2%. The pace of recovery is likely to slow during the remainder of the year, with reconstruction spending dwindling and private consumption decelerating as in-centive programmes expire. In the meantime, sluggish exports to its major trading partners and Japan’s depend-ence on energy imports will continue weighing on its trade balance. As a whole, the economy will expand by 2.5% annually this year. We believe activity will deceler-ate further in 2013 and 2014 to 1.6% and 1.1%. Private consumption has been the major driver behind the robust recovery earlier this year, thanks to incentive pro-grammes for eco-cars. However, the budget for eco-car subsidies is likely to be used up very soon, so auto sales will see a significant drop. As a result, private consump-tion is estimated to be close to zero by the end of 2012. Based on prior experiences, a consumption tax rate hike is likely to accelerate private demand in the quarters pre-ceding its effective date. Thus, we expect to see a consid-erable but temporary upswing in economic activity in the period between late 2013 and early 2014 due to the con-sumption tax rate hike effective from April 2014. Reducing the public debt burden is a top priority, but this task is complicated by low growth, persistent deflation, and a rapidly aging population. The consumption tax rate hike effective from April 2014 is a first step towards fis-cal reforms, but it is far from sufficient to meet the re-quired adjustment of 10% of GDP over the next decade. The debt-to-GDP ratio can be stabilised through deep cuts in social security spending which is the largest and fastest growing component of government expenditure. Alternatively, the consumption tax could be hiked fur-ther. Currently, Japan has the lowest tax rate on con-sumption among OECD countries. However, both op-tions require strong political commitment. Amy Yuan Zhuang [email protected] +45 3333 5607

The recovery is losing speed

The tax hike will cause consumption frontloading

Social security biggest share of public expenditure

Japan: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (JPYbn) 2010 2011 2012E 2013E 2014E

Private consumption 277,209 2.5 0.1 1.8 2.1 1.5Government consumption 93,863 2.2 2.0 1.4 1.3 1.1Gross fixed capital formation 97,914 0.2 0.9 3.6 1.7 1.2Stockbuilding* -5,314 0.7 -0.4 1.0 -0.1 -0.2Exports 59,754 24.5 -0.1 2.2 4.0 4.2Imports 58,094 11.2 6.3 6.7 5.2 5.0GDP 4.6 -0.7 2.5 1.6 1.1Nominal GDP (JPYbn) 471,060 481,857 468,343 487,077 498,279 508,245

Unemployment rate, % 5.1 4.6 4.4 4.3 4.3Consumer prices, % y/y -0.7 -0.3 0.2 -0.1 -0.1Current account, % of GDP 3.6 2.0 2.1 2.5 2.4General government budget balance, % of GDP -9.0 -9.7 -9.9 -9.6 -9.0


■ Poland


Slowdown under control • Economy losing momentum

• Fiscal consolidation likely to be put on hold

• Interest rate cuts just a question of time

• PLN stronger amid yield hunting

Slowdown underway Until the end of 2011 Poland seemed to defy economic gravity, with an acceleration in GDP growth in Q4 last year despite recessionary tendencies in the Euro area, which takes up over 50% of Polish exports. However, in line with our view, the situation has changed early this year as all drivers of Polish growth shifted into lower gear. First, although with some lag, the Euro-area woes have finally started to bite. The weakening external demand has been gradually filtering through to the Polish econo-my and a long-lasting drop in the inflow of new export orders negatively affects exports and industrial output. This time the PLN does not work as an external shock absorber because it has shown an appreciation trend since the start of this year, contrary to sharp depreciation in late 2008 and early 2009 when external demand also slumped. Second, the fiscal consolidation that began in 2011 and continued in 2012 has started to take its toll. Struggling to escape from an excessive deficit procedure imposed by the European Commission, the government sharply cut spending, mainly public investment. This, coupled with the end of preparations for the UEFA Euro 2012, led to a notable weakening in activity in the construction sector. Third, consumption growth is slackening amid a deterio-ration of labour market conditions and adjustments of households’ balance sheets. The latter largely involves a need to rebuild savings (following a decline in the sav-ings ratio to historical lows) as there is no major delever-aging pressure on households given that the Polish pri-vate sector debt to GDP ratio is one of the lowest in the EU.

Fourth, Polish central bankers have ignored threats to economic growth until recently and they raised interest rates in May. This controversial hike made the bank one of a few central banks in the world fighting inflation in-stead of fighting for growth. The move has had an ad-verse effect on investment and consumption decisions and magnifies the negative impact on lending activity of the tightening of regulations by the Polish FSA. Given the prolonged economic downturn in the Euro-area, stronger-than-expected tightening of domestic eco-nomic policy (not only fiscal consolidation, but also in-terest rate hikes), we have revised down our GDP growth forecasts for Poland. Now we predict that the country’s economic growth rate could dip below 3% this year and slow down even further in 2013. Compared with its re-gional peers and other parts of the EU, Poland would still outperform, but the slowing growth to below 2% y/y (and below 0% q/q sa) in some quarters will be a marked change for the country, which was the only one in the EU to avoid recession during the first wave of the crisis in 2008-2009 and grew a robust 4.3% in 2011. Policy response? We think that the Polish authorities have some tools available to avoid a deeper slowdown and to keep it un-der control. First of all, there is room for some monetary policy action. Some central bankers have already sup-ported officially submitted motions to trim rates in July, but they were a small minority (merely one MPC mem-ber out of 10 supported the motion to cut rates by 50 bp and only two members voted for a cut of 25 bp). Hawks raised rates only two months earlier and may not want to be seen performing a dramatic U-turn now. However, we believe that in early 2013 at the latest they will gain a majority on the rate-setting panel. Winning support for earlier cuts could be problematic given the persistently high inflation and new upside risks for the headline infla-tion rate (tensions in the global food markets and with food accounting for a large share of the Polish CPI bas-ket). Positive monetary impulses may be strengthened by a possible easing of regulations on bank lending.

Poland: Macroeconomic indicators (% annual real changes unless otherwise noted)

2009 (PLNbn) 2010 2011 2012E 2013E 2014EPrivate consumption 810 3.2 3.1 1.9 1.9 3.3Government consumption 249 4.1 -1.3 -0.1 0.0 2.0Gross f ixed capital formation 285 -0.4 8.1 3.3 -1.9 4.5Exports 530 12.1 7.5 -3.4 1.9 7.5Imports 529 13.9 5.8 -5.5 -1.4 7.0GDP 3.9 4.3 2.8 2.3 3.1Nominal GDP (PLNbn) 1,344 1,416 1,525 1,625 1,691 1,781

Registered unemployment rate, % 12.4 12.5 13.1 13.2 12.5Consumer prices, % y/y 2.6 4.3 3.9 2.7 2.2Current account, % of GDP -4.7 -4.3 -3.6 -3.0 -3.0General government budget balance, % of GDP -7.8 -5.1 -3.3 -3.3 -2.9

■ Poland


There is some room to support the economy also on the fiscal policy side. Government officials have recently an-nounced that fiscal consolidation would be continued on-ly if it was not detrimental to economic growth. We read this as an intention to revise previous ambitious plans of fiscal deficit reduction to below 1% of GDP by 2015 as it would be a step too far for the slowing economy. The presentation of a further reform drive in September, an-nounced by Prime Minister Donald Tusk before the summer holidays, will most likely be supplemented by an indication of measures aimed at stimulating economic ac-tivity. However, the room for manoeuvre in fiscal policy is constrained by EU deficit rules and domestic pruden-tial limits on public debt. Moreover, any increase in the government’s investment spending would not be very ef-fective given the decreased inflow of EU funds in 2013-2014 (before the new EU financial perspective for 2014-2020 is fully operational from late 2014). Possible policy stimulus will be too little and too late to avoid a further slowdown during the remainder of 2012 and the first half of 2013, but together with the recovery in the Euro area it should be enough to make economic growth in Poland return to an upward trend. Economic growth beyond 2013 could moreover be fuelled by a gradual start of large-scale investment in the energy sec-tor and positive supply side effects of the significant up-grade of the road infrastructure over the past few years. Improved credibility We estimate that Poland will manage to reduce the fiscal gap to 3-3.5% of GDP in 2012, which will be enough for the European Commission to remove the excessive defi-cit procedure imposed on Poland and for rating agencies to affirm Poland’s investment grade rating with stable outlook. By keeping the deficit around 3% in 2013-2014 the government should be able to maintain its restored fiscal credibility. Also the external relations look favour-able with a moderate current account deficit likely to de-cline further amid weakening domestic demand. With improved credibility and no major economic imbalances, Poland has been attracting large foreign capital inflows and become an alternative to such classical safe-havens as Germany where yields dropped below 0%. PLN stronger amid yield hunting As long as the economic slowdown is under control and the fiscal deficit remains in check, Poland will offer for-eign investors a combination of relatively strong funda-mentals and a yield pick-up. Therefore, we expect Polish bonds to keep attracting interest and the PLN to remain on an appreciation path. However, the record-high in-volvement of foreign investors in the domestic debt mar-ket is a significant risk factor for the PLN in the event of a major deterioration of the country’s fundamentals and/or a surge in global risk aversion. Piotr Bujak [email protected] +48 22 521 36 51

Euro-area recession is taking its toll

All growth drivers into lower gear

Ambitious fiscal targets likely to be revised

Elevated inflation delays monetary easing

■ Russia


Inflation déjà vu • Solid growth sustained, but softer H2 expected

• Inflation acceleration will prompt CBR to act in H2

The Russian economy continued to expand by a relative-ly fast pace of 4.4% during H1 supported by internal fac-tors, but we will likely see a soft patch in Q3 due to a lagged response to the slowdown in export markets and expected weather-related losses in the agricultural sector. Household consumption is still the major source of do-mestic growth. Supported by a healthy labour market, consumer confidence is growing, unemployment has fallen below 6%, supporting real wage growth, and household credit growth is expanding above 40% y/y; all factors that support household spending.

The key risk to growth comes from Europe, as more than 50% of exports go to the EU. However, the negative ef-fect for growth from export markets is partially offset by the relatively low impact of net exports on GDP.

Opening up As was widely expected, Vladimir Putin won the presi-dential elections in March for a new 6-year term, and Mr Medvedev was appointed prime minister. The latest sur-veys confirm very high endorsement levels of Vladimir Putin and Dmitry Medvedev. However, the threat of in-creasing dissatisfaction of the middle class along with the oil-oriented economy, force the current government to impose reforms in order to improve financial and busi-ness infrastructure. The WTO entry (23 August) is one of the positive triggers on the way.

Russia is now committed to bringing its laws and prac-tices into compliance with WTO rules. Russia’s com-mitments include non-discriminatory treatment of im-ports of goods and services, reduction of tariffs and bind-ing tariff levels, ensuring transparency when implement-ing trade measures, limiting agriculture subsidies, enforc-ing intellectual property rights of foreign holders of such rights and opening government procurement contract op-portunities to foreign firms. Entering the WTO will make Russia more attractive to foreign direct investment, which will help the Russian industry to become more ef-

ficient. Russia's exporters will gain USD1.5-2bn a year from the removal of existing trading barriers. Lower tar-iffs on imported goods should lead to cheaper goods and boost consumers’ spending power.

The ongoing large government privatisation programme is another vector of the Russian liberalisation policy. The USD 32bn privatisation plan in 2012-2014 and govern-ment intention to sell controlling stakes in such backbone companies as Sberbank, VTB and Aeroflot make us very optimistic about the effect of the reform. Privatisation will continue to improve the country’s investment cli-mate and attract more foreign funds.

Food prices a concern again Having reached historic lows, consumer prices did not stay there for long. As expected, consumer price inflation bottomed out just below 4% y/y in late spring and picked up visibly over the summer. The favourable food price effects waned and postponed tariff hikes were introduced over the summer a few months after the elections. Food prices are escalating particularly fast: having bot-tomed at 1.2% y/y in April, food price inflation has picked up to 5.5% y/y in July. The recent global food price increase on supply shortages, similar to the 2010 food price spike, is a real risk for headline inflation for the rest of the year. The Russian CPI basket is heavily weighted in food prices (37,3%), which leaves headline inflation exposed to further global food prices increases. We expect inflation to accelerate further, with headline inflation rising above 6% y/y as early as in August, but it will remain under 7% in coming months unless the RUB depreciates and other food prices keep accelerating at previous months’ rates. In any case, we expect the central bank action and tighter liquidity to help keep inflation below 8% over the forecast horizon.

Monetary policy to be kept tight in coming quarters The Central Bank of Russia has kept its key rates un-changed in the previous quarter, but the post-meeting communication has shifted from very dovish to rather hawkish in recent months. It seems that the CBR pays

Russia: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (RUBbn) 2010 2011 2012E 2013E 2014E

Private consumption 21,203 3.0 6.0 6.2 6.4 6.5Government consumption 8,067 1.4 1.3 1.4 1.3 1.2Fixed investment 8,536 6.1 6.5 7.2 7.8 8.0Exports 10,992 7.1 3.5 3.8 5.5 6.5Imports 7,954 25.6 14.5 9.5 12.0 12.5GDP 4.0 4.4 4.2 4.8 5.0Nominal GDP (RUBbn) 38,807 45,300 47,293 49,280 51,645 54,227

Unemployment rate, % 7.5 6.5 5.8 5.5 5.2Consumer prices, % y/y 6.9 8.5 6.3 6.8 7.0Current account, % of GDP 4.8 4.5 4.2 3.0 2.5Central govt budget balance, % of GDP -4.0 0.5 0.2 0.5 0.7

■ Russia


more attention to accelerating inflation rather than to signs of slowing domestic growth momentum. The bank will likely tolerate more sustainable credit and consump-tion growth rates going forward, and try to maintain in-flation close to its target of 6% for this year and towards the government’s 4-5% goal for the coming years. Now that inflation is accelerating and the risks are to the upside due to food prices, the CBR will not hesitate to act by hiking benchmark repo rates in H2 if inflation de-viates from target. In the meantime, the CBR will intro-duce effective policy tightening by preventing a rise in interbank liquidity (by reducing provision via repo, less FX intervention), which will keep money market rates at high levels.

RUB wants to break free The moves to more RUB flexibility continue. The Cen-tral Bank of Russia widened the RUB basket (55% USD and 45% EUR) floating corridor band by 1 RUB as of 24 July to currently 31.65 – 38.65. The CBR has scaled down its presence in the FX market significantly over the past two years, which is part of its attempts to move to-wards an inflation-targeting regime.

The widening of the RUB floating band was the fourth such move since 2010 towards the promised “free float” by 2014, and we expect similar steps by 6-month inter-vals by the end of 2013. Allowing more RUB flexibility gives more freedom to change rates without the CBR having to absorb the capital inflows (and increase inter-bank liquidity). With inflation increasing, the CBR will also be biased towards more RUB strength (each 1% in strength of RUB effective exchange rate brings headline CPI down by 0.25%, if sustained), hence expect also “open mouth” operations each time the RUB weakening risks arise. A more flexible RUB will be more reactive to market prices, which creates both strengthening opportunities and risks. We see a much stronger RUB, on average, based on our oil forecast of close to USD 120/bbl this year (above the budget average of USD 100/bbl for the coming years). We also see Russia being more attractive for foreign investors, with sovereign debt/GDP barely around 10%. But the flipside of more RUB flexibility is that any global factors will hit RUB, with episodes of weakening along the way. Aurelija Augulytė [email protected] +45 3333 6437

Dmitry Savchenko [email protected] +7 495 777 34 77 4194

Record-low unemployment supports consumers

Inflation accelerating again

The tightening cycle will continue in H2

CBR keeps widening RUB floating bands

■ Estonia


Economy remains in a soft patch Growth continued to moderate in the first half of 2012 in tandem with weaker prospects in key export markets. According to the flash estimate, growth slowed to 2.0% y/y in Q2 from 3.7% at the beginning of the year. Com-pared to Q1 GDP grew by a still decent 0.4% (sa). The modest export growth is attributable to weaker demand for industrial goods in Europe and reduced energy ex-ports. Compared to Euro-area peers, Estonian manufac-turing performance has proven relatively resilient to the ongoing debt crisis, with production down only 1% y/y by mid-year. To some extent this reflects the business sectors’ integration with stronger Nordic countries as well as an ability to adjust to new economic circumstanc-es. Low investment demand and soft confidence in the Euro-area are likely to depress exports in H2, but a grad-ual recovery is expected from spring next year. As expected, the economy has now entered a soft patch. Growth is driven by domestic demand, which is reflected in higher contributions from the construction, trade and information and communication sectors. The increase in turnover and the favourable cost level continue to support profit growth and hence investment. Private investment is largely driven by a need to expand business volumes and upgrade technologies and production. Two key in-vestment areas are machinery and equipment, and build-ings and structures. Investment demand is also reflected in the gradual pick-up of loan demand. Another bright spot for the economy is consumption and in particular re-tail sales as consumer confidence has recovered to its his-torical average. Stable labour markets and moderate wage growth are likely to support retail sales, with only a slight moderation expected in H2. Overall, the recovery remains vulnerable to the resur-gence of the sovereign debt crisis. The main scenario is, however, a gradual pick-up in stronger export markets such as the Nordics and Germany next year. Tönu Palm [email protected] + 372 628 3345

Annika Lindblad [email protected] + 358 9 165 59940

Manufacturing has stabilized, headwinds remain

Corporate income and profits have largely recovered

Only slight moderation in retail sales expected

Estonia: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (EUR bn) 2010 2011 2012E 2013E 2014E

Private consumption 7.41 -1.7 4.2 3.8 3.4 3.7Government consumption 3.05 -1.1 1.6 2.0 0.9 1.2Fixed investment 2.97 -9.1 26.8 10.0 6.5 7.0Exports 8.96 22.5 24.9 3.7 6.5 6.5Imports 8.15 20.6 27.0 6.5 6.8 6.6GDP 2.3 7.6 2.3 3.5 3.8Nominal GDP (EURbn) 13.84 14.3 16.0 16.9 18.0 19.2

Unemployment rate, % 16.9 12.5 10.8 9.9 8.9Consumer prices, % y/y 3.0 5.0 3.7 3.0 2.9Current account, % of GDP 3.8 2.1 -2.3 -1.5 -1.3

■ Latvia


Economy keeps delivering positive surprises The economy keeps delivering positive surprises for the second consecutive year. After a 6.9% y/y expansion in Q1 2012, the preliminary GDP estimate for Q2 showed an increase of 5.1%. Quarterly growth was estimated at 1.0% (sa), unchanged from Q1. Export demand appears to have been an important driver of growth as the indus-trial volume index grew by 1.8% q/q and the value of ex-ports kept increasing. Fixed investment has likely been driving domestic demand, while retail sales stagnated compared to Q1. While we expect growth to slow in H2 as a result of the Euro-area debt crisis weighing on de-mand in main export markets and statistical base effects, we have increased our growth forecast for 2012 to 4.2%. Public finances are sound. The budget deficit is likely to remain below 3% of GDP even after the VAT base rate cut from 22% to 21% in July, while net public debt is slightly above 30% of GDP. The state treasury’s total deposits with the Bank of Latvia exceed EUR 1.6bn or about 8% of GDP, which is enough to cover the budget deficit and meet other obligations throughout 2012 and 2013. However, the first signs of external imbalances are appearing. Although this is still not worrying, the current account deficit is estimated to be just below 3% of GDP in H1 2012. The reduction of indirect taxes is moreover likely to slightly boost imports in H2. Inflation is slowing largely due to the VAT cut. Lower-ing the VAT can be interpreted as a signal that the gov-ernment is serious about adopting the euro in 2014. Es-pecially the inflation criterion is subject to many risks beyond the government’s control, including global food prices. The 12M average inflation rate in Latvia is still slightly above the 3% currently required. The inflation criterion currently includes for example Greece where in-flation is slowing, which is likely to push the criterion lower. At the same time an increase in food prices would have a significant impact on inflation in Latvia as the weight of food in the consumption basket is among the highest in the EU. Andris Strazds [email protected] + 371 6 7096 096

GDP still on a steady upward trend

Latvian exports gaining market share

Inflation slowing, but above the criterion

Latvia: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (LVLmn) 2010 2011 2012E 2013E 2014E

Private consumption 8,026 0.4 4.4 3.5 2.6 3.8Government consumption 2,557 -9.7 1.3 0.5 1.0 1.0Fixed investment 2,820 -12.2 24.6 15.2 4.5 7.8Exports 5,742 11.5 12.6 6.2 4.0 6.3Imports 5,935 11.5 20.7 6.3 4.5 6.8GDP -0.3 5.5 4.2 2.5 3.9Nominal GDP (LVLmn) 13,070 12,739 14,161 15,080 15,830 16,890

Unemployment rate, % 18.7 16.2 15.7 14.5 12.8Consumer prices, % y/y -1.1 4.4 2.3 2.5 2.8Current account, % of GDP 3.0 -1.2 -3.2 -3.5 -3.6

■ Lithuania


Showing resilience The Lithuanian economy remains resilient to the on-going European sovereign debt crisis and continues to grow albeit at a slower pace than in 2011. Annual eco-nomic growth slowed to 3.9% in Q1 2012 and further to 2.1% in Q2 2012, but is forecasted to remain positive, averaging 2.7% and 3.3% in 2012 and 2013, respectively. Weaker-than-anticipated growth in Q2 2012 was above all the result of a temporary shutdown of the Orlen LiLetuva refinery (from end-April to mid-June) that ac-counts for close to 30% of all industrial production in Lithuania. Consequently, industrial production contract-ed by 2.8% in Q2 2012 whereas excluding the production of refined petroleum products, industrial production con-tinued to grow at a robust 6.2% y/y. After the temporary slowdown in April, retail trade growth accelerated to 4.9% y/y in June with growth of non-food items increasing to 12.1% y/y. Stable house-hold sentiment suggests that retail trade growth should remain in positive territory in coming months. As a re-sult, private consumption will continue to play a leading role in Lithuanian economic growth. Inflationary pressures eased in Q2 2012, but average an-nual inflation still stood at 3.6% in July – well above the Maastricht convergence criterion of approximately 3.0%. Even though inflation is expected to moderate to 3.0% by the end of 2012, there is still a high probability that Lith-uania will not be able to meet the Maastricht inflation cri-terion in early 2013. The budget deficit is gradually declining and is expected to fall below 3% of GDP in 2012. Nonetheless, in case of a more severe recession in the Euro zone, there is a risk that the deficit will exceed the 3% mark and thus fail to meet the euro convergence criteria. Overall, we see euro adoption in 2014 as an unlikely scenario at the moment. Žygimantas Mauricas [email protected] + 370 5 2657 198

Resilience of retail trade and industrial production

Meeting Maastricht inflation criterion is a big “if”

Budget deficit declining in line with expectations

Lithuania: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (LTLmn) 2010 2011 2012E 2013E 2014E

Private consumption 63,497 -4.9 6.1 3.5 3.2 3.3Government consumption 20,180 -3.3 0.2 0.7 1.8 2.0Fixed investment 15,808 1.0 17.1 4.7 7.0 7.2Exports 50,000 17.4 13.7 3.0 6.5 6.5Imports 51,372 17.3 12.7 3.8 6.9 6.8GDP 1.4 5.9 2.7 3.3 3.5Nominal GDP (LVLmn) 91,913 95,074 106,019 112,100 118,800 126,500

Unemployment rate, % 17.8 15.4 14.0 12.8 11.5Consumer prices, % y/y 1.3 4.1 3.0 2.8 3.0Current account, % of GDP 1.1 -1.6 -2.7 -3.0 -3.0General govt budget balance, % of GDP -7.2 -5.5 -2.7 -3.0 -3.0

■ China


Stability, stability and … stability • Stabilising growth is once again top priority

• Leadership change in the spotlight

• A close eye on local government stimulus plans

• CNY volatility persists

Growth target is not imperilled The government-induced slowdown in China as a part of the transition towards a sustainable consumption-driven economy ran into stronger-than-anticipated headwinds in the first half of 2012. The uncertain outlook has prompt-ed the authorities to make stable growth on top priority. The latest monetary and fiscal stimulus measures will support growth in the second half of this year. In the near term, China’s economy remains vulnerable to external risks. According to Commerce Minister Chen Deming, China may risk not achieving 10% export growth this year. Despite emphasis from Beijing, private consumption has not taken the lead in driving growth. While we expect it to take a bigger role in future, this will not happen anytime soon. Looking forward, China will continue relying on investments, the remaining growth engine, to ensure a steady growth rate. We esti-mate GDP to grow by 8-8.5% in our forecast period 2012, 2013 and 2014. Inflation makes room for monetary policy easing Inflation has decreased as expected due to moderating meat prices and basis effects. Full-year inflation will be comfortably below the government’s target of 4%. The record-high global grain prices are likely to have little impact on Chinese inflation. China is self-sufficient in corn and wheat and it had a robust harvest this year. The biggest impact on China's food inflation will be rising soybean prices, since 80% of the domestic consumption is imported. However, based on experience from 2008, the effect will not be significant. With the low inflation and uncertain growth outlook, the political stand has shifted from balancing growth and in-flation towards emphasising growth. We expect to see another rate cut before the end of Q3. Credit demand has

fallen according to People’s Bank of China’s quarterly survey of bankers, so monetary tools may prove to be less effective now. Thus, the central bank will remain cautious in fear of increasing inflationary pressure and misleading the markets regarding real estate controls. Princelings to rule the country The fifth generation of leaders since the establishment of the People’s Republic of China will take over power in the autumn of 2012, when the 18th National Party’s Con-gress is set to take place in Beijing. The Politburo Stand-ing Committee, the most powerful decision-making body in China, will replace all but two of its nine members. A handful of senior officials are seen as the likely candi-dates to join the prestigious and secretive group. Most of them come from prominent families within the Com-munist Party, the so-called “Princelings”. They are better educated and more internationally-oriented than their predecessors. We believe the event will go smoothly, as the internal power struggles are probably resolved during the top official meeting in Beidaihe in early August. We do not expect any major reforms to be launched in the near future after the shift of power, since stability is val-ued over change. Not only will the top leadership be replaced, but in the country’s 31 provinces and province-level municipalities, 361 cities, 2,811 counties and 34,171 townships, millions of party members are also in the middle of being reshuf-fled. Regional GDP has traditionally been a measure to evaluate their performance, so in the upcoming months we will see intensified local emphasis on boosting growth, mainly through investments. Property market – a balancing act China’s property market was once dubbed the “most im-portant sector in the entire global economy”. It remains a big fear hanging over the policy makers. The challenge is to balance between on the one hand bringing down house prices and increasing housing affordability and on the other hand preventing the cooling property sector’s nega-tive spill-over on the domestic economy. The latest mod-est rebound in house prices could be a result of the poli-cies to encourage real housing demand, but it may also reflect a misreading of central government policy. Evi-

China: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (CNYbn) 2010 2011 2012E 2013E 2014E

Private consumption 12,113 9.1 5.8 9.0 9.1 10.0Government consumption 4,569 9.0 12.9 8.9 8.8 9.0Fixed investment 15,668 22.5 11.4 8.5 9.2 9.0Stockbuilding* 778 0.5 0.2 -0.4 0.0 0.1Exports 9,106 -10.3 28.4 8.5 8.5 9.1Imports 7,603 4.1 20.1 8.6 10.0 11.0GDP 9.2 10.5 8.0 8.3 8.5Nominal GDP (CNYbn) 34,632 39,431 45,590 50,655 56,986 64,394

Unemployment rate, % 4.1 4.1 4.1 4.1 4.1Consumer prices, % y/y 3.3 5.4 3.1 4.0 3.8Current account, % of GDP 5.1 2.8 2.5 2.2 1.5General government budget balance, % of GDP -1.7 -1.1 -1.5 -2.3 -1.9


■ China


dence suggests that some local governments have eased property restrictions surreptitiously regarding multiple housing purchases, hoping to revive construction jobs and land sales. We believe the central government will maintain its favourable policies for first-time home buy-ers, while continuing to rein in speculative demand and tighten control of local implementations. Local officials should be kept on a tight leash The only economic anxiety to rival the housing market is the local government’s investment plans which should not be neglected. After recognizing that the 4trn yuan package in 2008 was a mistake that left the country with stubborn inflation, messy local-government finances and skewed investments, the Politburo has rejected that its 2012 stimulus efforts might entail the same loss of disci-pline as in 2008. However, this view is not shared by the local authorities, which have all developed their own ambitious plans. The most remarkable case is the Gui-zhou province’s 3trn yuan investment on culture and tourism, which is more than five times its 2011 GDP. Even though not all projects will be approved by the cen-tral administration, the local authorities have their ways to circumvent the rules. These projects will be financed through local government financing vehicles which have already accumulated huge off-balance-sheet debt. Several unofficial sources have given their estimates on the size of the total local debt, ranging from 50% to more than 100% of GDP (27% by official auditors). The high indebtedness raises concern, as the profitability of these projects and their ability to service the debt is doubtful. Numerous infrastructure pro-jects have been found in poor quality without the ability to withstand bad weather conditions. A government study showed 30% of the 4trn investments from 2008 have failed. In addition, the local investment plans are more likely to cause inefficient resource allocation and overcapacity than if it was managed from the central. CNY to continue its two-way volatility The intensified slowdown in China has had a spill-over on the CNY which has weakened remarkably against the USD since May. Premier Wen Jiabao has reiterated that the CNY is near its fair value and that a liberalised cur-rency is not necessary a stronger currency. With the shrinking current account deficit and sluggish economic outlook, the top officials have an incentive to let the CNY continue its weakening course in the short term. In the longer term, we expect the CNY appreciation to con-tinue, mainly because of the strong underlying growth in China. The appreciation of the CNY is by no means over, although we see a slower and more volatile trend ahead. Amy Yuan Zhuang [email protected] +45 3333 5607

A steady GDP growth is desired

Property prices show signs of mild recovery

Most investment funding through financial vehicles

Continued CNY volatility ahead

■ India


A drought of growth Economic activity in India began decelerating in late 2011 and the conditions have only deteriorated during the first eight months in 2012, hampered by both domestic and global factors. External demand has weakened fol-lowing the slowdown in developed countries and China. The domestic economy is severely hit by the poor mon-soon (20% below normal) that led to falling agricultural production and dropping rural incomes. Despite falling over several months, WPI inflation, In-dia’s key inflation measure, still has not moved closer to the central bank’s comfort level of 5%. The below-normal rainfall this year will hurt the crop output as 60% of the production is rain-fed. The resulting higher food prices and elevated fuel prices will keep inflation above the 5% mark in the short term. Consequently, the Re-serve Bank of India is unable to utilise its monetary tools to support the downward-trending economy. Thus, as in-flation remains a major concern we expect the central bank to leave the repo rate unchanged at 8% this year. The stubbornly high inflation also erodes households’ purchasing power and dampens private consumption. The slowdown in India is not only cyclical but also struc-tural. The unhealthy public finances of the country pre-vent fiscal policy from being eased to boost growth. In fact, the weaker INR from the beginning of the year has further increased the fuel subsidy bill and hence public expenditure, as import prices have surged. Deficit and debt as a percentage of GDP are approaching the levels seen in southern Europe. Standard & Poors and Fitch al-ready cut their outlook for India to negative. With par-liamentary election scheduled for 2014 and the weak po-sition of the current government, it seems likely that it will maintain stability at the expense of reforms in retail industries and a reduction of fuel subsidies. Regardless of the recent decline in the economy, we con-tinue to take a positive view on India’s long-term growth. This is primarily based on the favourable demographics and large pool of available labour. Amy Yuan Zhuang [email protected] +45 3333 5607

Weak domestic economy weighed on growth

WPI inflation kept above the comfort level

Public finances to deteriorate additionally

India: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (INRbn) 2010 2011 2012E 2013E 2014E

Private consumption 37,081 8.1 5.5 5.5 6.5 8.0Government consumption 7,743 7.8 5.1 5.2 6.0 5.5Fixed investment 20,418 -16.8 5.5 5.5 8.0 9.8Exports 13,000 15.6 18.5 9.5 12.0 16.0Imports 16,469 9.6 9.5 12.0 13.0 15.0GDP 9.6 6.9 6.0 6.7 7.2Nominal GDP (INRbn) 64,574 76,741 88,558 100,071 113,080 128,911

Wholesale prices, % y/y 9.6 9.5 7.5 6.8 7.0Current account, % of GDP -3.3 -2.8 -4.0 -3.0 -2.2General government budget balance, % of GDP -3.6 -6.6 -7.0 -7.5 -8.0

■ Brazil


Slow BRIC healing The economy has disappointed in the first half of this year with industrial production again dragging down growth. It seems, however, that the worst is behind us and even though manufacturing indices are still reflecting contraction, recent activity and business confidence read-ings show improvement. The government announced a number of supply-side initiatives to support industry, in-cluding an increase in public infrastructure spending and concessions to the private sector as well as lower energy and payroll tariffs. Private sector demand remains sup-ported by a continuous decline in unemployment, and re-tail sales have rebounded strongly over the past few months helped also by a reduction in credit rates and tax-es. This supports our expectation that GDP growth will move back above 4% y/y by Q4 this year. The central bank of Brazil continued its aggressive monetary policy easing this year, cutting the benchmark SELIC rate from the peak of 12.5% last year to 7.50% currently. With signs of improved economic momentum and more optimistic policymakers, we believe the easing cycle has ended, with the risk tilted towards just one more rate cut. After having approached the central bank’s target (4.5%) earlier this year, inflation has begun to ac-celerate again. This trend will likely continue and even-tually force policymakers to start tightening in late 2013. The Brazilian central bank chose to tolerate further BRL weakness early this year, allowing the USD/BRL to weaken to the 2.00 level which the markets have per-ceived as the bank’s comfort zone (judging from inter-vention patterns). We expect gradual BRL strengthening going forward, supported by commodity prices and the end to the policy easing cycle. Notably, policymakers have achieved a rebalancing of capital inflows because over the past years as portfolio inflows have declined, the more stable foreign direct investment flows have grown. This should help prevent disorderly BRL moves when global capital flows shift. Aurelija Augulytė [email protected] +45 3333 6437

Growth stabilising

Policy easing cycle nearing the end

More balanced capital inflows

Brazil: Macroeconomic indicators (% annual real changes unless otherwise noted)

2009 (BRLbn) 2010 2011 2012E 2013E 2014EPrivate consumption 1,979.8 7.0 4.5 4.3 4.8 5.5Government consumption 687.0 4.0 3.0 3.2 3.0 3.0Gross f ixed capital formation 585.3 22.0 6.0 3.0 6.5 7.4Exports 355.7 11.5 8.5 6.6 7.0 8.0Imports 360.8 36.3 12.8 6.9 7.2 9.0GDP 7.6 2.8 2.6 4.6 4.8Nominal GDP (BRLbn) 3,239.4 3,721.5 3,825.7 3,925.2 4,105.7 4,302.8

Unemployment rate, % 6.7 6.0 5.7 5.6 5.7Consumer prices, % y/y 5.0 6.4 5.2 5.4 5.8Current account, % of GDP -2.3 -2.1 -2.5 -2.7 -2.8General government budget balance, % of GDP -2.7 -2.4 -2.0 -2.1 -2.2

■ Oil


Oil prices stay high but spare capacity buffer should build Oil prices are expected to remain high over the forecast period as the market will remain tight by historical stand-ards. Supply additions are expected to outpace demand growth resulting in slightly softer oil balances in 2013. The market will remain similarly tight in 2014 as supply growth slows and demand accelerates with the global economy. Oil prices will likely remain volatile around high levels given the market tightness and risks to sup-ply. Income growth, economic activity and population growth are vital drivers of oil demand. Global oil demand is ex-pected to increase at a higher pace in 2013-14 than in the prior two years as economic growth picks up. OECD demand will continue to decline owing to efficiency gains, fuel switching and subdued economic growth. Non-OECD countries contribute to all oil demand growth, which averages 1.1mb/d over 2013-14. Structur-ally higher economic growth, rising income and popula-tion growth in emerging economies is expected to out-weigh efficiency gains in oil use and switch to other en-ergy sources. Demand for transportation is expected to remain the primary driver of global oil use, accounting for around 52% of total oil demand. Global oil supply is expected to grow in the forecast pe-riod mainly driven by a healthy expansion of oil produc-tion capacity in North America, Iraq, Brazil and OPEC NGLs. Non-OPEC is expected to account for the lion’s share of new capacity brought online. We expect the past few years’ impressive growth in US shale oil/tight oil and Canadian oil sands production to continue, although infrastructure and environmental issues may restrain fu-ture advances. In Brazil local content requirements and cost inflations could continue to challenge the country’s expansion plans. We only foresee a slight resumption of the oil production in Libya, Yemen and Sudan/South Su-dan in the forecast period after political unrest has cut oil production in total by around 1 mb/d. OPEC capacity is expected to increase in the forecast period. Capacity ex-pansions in Iraq, Angola, United Arab Emirates and the return of Libyan oil are expected to outmatch the natural production /sanctions related declines in Iran and smaller declines in Nigeria and Venezuela. How long Iran could stand the EU/US imposed sanctions is uncertain. We ex-pect production to gradually resume in late 2013, but the political situation could take a twist for the better or worse before/after this time. Political unrest and un-planned production outages are expected to leave global oil supply at risk. Bjørnar Tonhaugen [email protected] +47 2248 7959

Thina M. Saltvedt [email protected] +47 2248 7993

Oil price forecasts Brent – baseline (USD/barrel) Q1 Q2 Q3 Q4 Year

2011 106 115 112 110 1112012E 118 109 112 109 1122013E 108 110 112 114 1112014E 114 114 116 116 115

Source: Nordea Markets Supply growth to outpace demand growth

OPEC spare capacity to increase from low levels

Oil price baseline, high and low risk scenarios

■ Metals


Metal prices scratching the bottom for now Base metals prices have trended lower since March as the economic slowdown gathered pace driven by Euro-zone woes. China’s demand for metals has slowed, but a grad-ual pick-up in the country that consumes 40% of the world’s industrial metals output is expected already in the latter part of this year as infrastructure projects are fast-tracked to support growth. Long-term prospects for metals demand are robust despite the current slowdown, leaving pressure on supply to continue expanding. Metals markets are expected to tighten gradually and prices to rise from the current low levels compared to costs. Aluminium producers are experiencing the second-worst year since 1982 as low prices have persisted longer than expected. The current situation is unsustainable in the medium term and further capacity cuts are expected. Demand outside Europe and Japan is expected to grow robustly as aluminium continues to win market share due to its flexible uses and cost-competitiveness. The project pipeline in the World ex China is practically dry beyond 2013, while Chinese capacity expands strongly. Low prices will persist for longer than previously expected be-fore they realign with industry costs at higher levels. Copper supply is improving and the outlook for supply over the forecast period looks better than in a long time. Demand is expected to recover over the forecast period, led by China, and keep pressure on copper suppliers to deliver according to plans. An increasing share of copper supply will come from new projects (greenfields) espe-cially in 2014, leaving the likelihood for disruptions high. Copper prices are expected to remain high and firmly above the long-term incentive price of USD 6,500 per tonne, thus underpinning greenfield projects. Nickel prices continue to underperform on expectations of steady supply additions. The market is expected to re-main in surplus over the forecast period, leading to in-ventory build-ups despite a gradual recovery in demand. Supply from the new generation of nickel production (HPAL) has been mixed, but is expected to contribute to a larger share of total supply, but with risks of delays and technical setbacks. Nickel prices are expected to increase from current levels which are considered too low com-pared to production costs in the long run. The zinc market will remain in surplus in the first part of the forecast period, but a gradual tightening of the market is expected to commence in 2014 as a number of old mines approach the end of their life. The currently de-pressed zinc prices are expected to recover gradually be-fore higher prices are required to balance supply and de-mand in the latter part of the forecast horizon. Bjørnar Tonhaugen [email protected] +47 2248 7959

Base metal price forecasts (USD per tonne) 2012E 2013E 2014E

Aluminium 1,967 2,225 2,450 Copper 7,865 8,025 7,950 Nickel 17,463 18,625 19,750 Zinc 1,926 2,100 2,300

Source: Nordea Markets Base metals prices

Copper and aluminium forecast

Nickel and zinc forecast

■ Alternative scenario 1


Back on trackWith plenty of negative headlines and few signs of the Great Recession loosening its grip, it is easy to succumb to gloom and doom. Sometimes though, the darkest hour is just before the dawn. In this scenario we try to high-light a few events which could help create a growth sur-prise. The German Constitutional Court rules that the ESM is not in violation of German law and at the same time Eu-ropean officials fast-track the creation of the common banking supervisor, which comes into action before the end of the year. The ESM comes into action and immedi-ately starts to replenish bank capital directly and to buy bond issuances of peripheral Euro-zone countries. • In the US, the fiscal cliff is avoided as a political

solution is found that prolongs the current tax cuts for everybody, military spending and entitlements are cut slightly and work on medium-term balancing of US finances resume.

• Chinese officials loosen fiscal policy, economic growth comes slowly back to life in Europe and China continues its push to grow domestic demand by expanding health insurance and lowering interest rates. Growth moves above 8% again.

• Massive pressure from the US, the G20 and the IMF convinces European politicians that focus needs to be on balancing structural budgets over the medi-um term, allowing fewer tax hikes and few or no cuts in government spending.

• With the negative feedback loop between banks and sovereigns in Europe finally broken, businesses and consumer confidence gets a big boost and business finally dare to invest again. Consumers loosen their purse strings slightly.

• Oil demand increases but continued exploration af-ter shale oil keeps oil prices from moving too high.

Much of the current slowdown can be attributed to the negative feedback loop from shaky government finances, worries about the survival of the Euro zone – and simply fear of what the future has in store. If governments can finally convince investors and con-sumers that they are on top of the situation in Europe, in-vestors might offer governments a bit more time to allow policies to work, interest rates in peripherals will come down, worries about sovereign defaults will subside, businesses will start to invest again and consumers will be willing to increase consumption. A normal recovery will start to unfold with an extra boost from low interest rates and pent-up demand. Steen V. Grøndahl, CFA [email protected] +45 3333 1453

Scenario forecast

World GDP growth % - USA - Euro-zone - ChinaGlobal Inflation (CPI) % - US - Euro-zone - ChinaUnemployment % - US - Euro-zone - ChinaBudget deficits % - US - Euro-zone - ChinaFinancial indicators - US 3M LIBOR - US 10Y Treasury - EZ 3M Euribor - DE 10Y Bund - EUR/USD - Brent Oil

2011 2012E 2013E 2014E3.8 3.2 4.1 4.91.8 2.2 2.8 3.41.5 -0.6 1.2 2.7

10.5 8.2 8.6 9.04.1 2.6 3.1 2.93.1 2.3 2.8 1.92.7 2.4 2.8 3.15.4 3.1 3.8 4.0

9.0 8.1 7.3 6.410.2 11.4 11.7 11.04.1 4.1 4.0 3.9

-8.6 -6.0 -4.2 -3.5-4.1 -3.5 -2.1 -0.9-1.1 -2.6 -2.2 -2.2

0.34 0.45 0.85 2.252.79 1.80 2.70 3.901.39 0.66 0.50 1.602.65 1.55 1.85 2.601.30 1.22 1.10 1.00111 107 125 125

■ Alternative scenario 2


That sinking feelingAs European leaders return from their holidays, they are once more forced to deal with a deteriorating economic outlook. The situation in Southern Europe is dire but many other developed economies are holding up reason-ably well. That might change. In this scenario we try to list a few things that can sink growth further. • Northern European countries are sticking to the

Merkel doctrine of hard austerity. At the same time, voters send clear signals not to allow any more bailouts.

• ECB is unable to intervene in European bond mar-kets due to stiff opposition from the Bundesbank and likeminded central banks. Their only option is to cut rates to zero, do more LTRO and loosen collateral demands, but that is about it.

• With continued turmoil in Europe and worries about the fiscal situation in the US, companies freeze on investments and hirings. The uncertainty and the be-ginning job losses feed directly into private con-sumption and house prices take another dive exag-gerating the drop in consumption.

• Oil prices drop below USD 80 a barrel (but averag-es USD 80 a barrel for the year) which supports dis-posable income growth especially in the US.

• With major export markets slowing, the Chinese economy slows during the first half of the year but more rate cuts from PBoC as well as directed in-vestments from the Chinese government provides a gentle lift to Chinese economy in the second half of the year.

• Flight to safety is in effect with investors fleeing to the Nordics, Germany, the US and the UK (and se-lected other countries). Spreads on peripherals widen further and yield on Spanish and Italian bonds top 8%.

In our downside risk scenario, World GDP is expected to increase by 1.5%. This might seem high but bear in mind that from 1982 to 2007, World growth averaged 3.5% – but also that GDP dropped 0.6% in 2009. An added cause for worry is that much of the fiscal fire-power has been spent in the aftermath of the financial crisis, making it more difficult to arrest the development should growth take a turn for the worse. Steen V. Grøndahl, CFA [email protected] +45 3333 1453

Scenario forecast

World GDP growth % - USA - Euro-zone - ChinaGlobal Inflation (CPI) % - US - Euro-zone - ChinaUnemployment % - US - Euro-zone - ChinaBudget deficits % - US - Euro-zone - ChinaFinancial indicators - US 3M LIBOR - US 10Y Treasury - EZ 3M Euribor - DE 10Y Bund - EUR/USD - Brent Oil

2011 2012E 2013E 2014E3.8 2.8 1.6 3.11.8 1.9 0.8 2.71.5 -0.7 -2.0 0.0

10.5 7.4 6.2 6.7

4.1 2.5 1.6 1.43.1 2.0 1.0 1.22.7 2.5 2.1 1.25.4 3.2 1.7 1.8

9.0 8.4 9.2 8.710.2 11.4 12.1 12.04.1 4.3 5.0 5.6

-8.6 -7.2 -6.5 -6.0-4.1 -3.6 -2.8 -2.6-1.1 -2.8 -3.1 -3.2

0.34 0.40 0.40 0.602.79 1.70 1.20 1.601.39 0.60 0.25 0.252.65 1.50 0.90 1.201.30 1.22 1.18 1.18111 111 82 92

■ Economic Research Nordea


Sweden:

Annika Winsth, Chief Economist Sweden [email protected], tel. +46 8 614 8608

Torbjörn Isaksson, Chief Analyst [email protected], tel. +46 8 614 8859

Andreas Jonsson, Senior Analyst [email protected], +46 8 534 910 88

Bengt Roström, Senior Analyst [email protected], tel. +46 8 614 8378

Linus Lauri, Assistant Analyst [email protected], tel. +46 8 614 80 03

Siri Pettersson, Assistant Analyst [email protected], tel. +46 8 614 80 03

Estonia: Tönu Palm, Chief Analyst [email protected], tel. +372 628 3345

Latvia: Andris Strazds, Senior Analyst [email protected], tel. +371 67 096 096

Lithuania: Zygimantas Mauricas, Analyst [email protected], +370 5 2657 198

Russia: Dmitry A. Savchenko, Analyst [email protected], +7 495 777 34 77 4194

Dmitry S. Fedenkov, Analyst [email protected], +7 495 777 34 77 3368

Poland: Piotr Bujak, Chief Economist Poland [email protected], +48 22 521 36 51

Economic Research Nordea

Denmark: Helge J. Pedersen, Global Chief Economist [email protected], tel. +45 3333 3126

Johnny Bo Jakobsen, Chief Analyst [email protected], tel. +45 3333 6178

Anders Svendsen, Chief Analyst [email protected], tel. +45 3333 3951

Jan Størup Nielsen, Senior Analyst [email protected], tel. +45 3333 3171

Amy Yuan Zhuang, Senior Analyst [email protected], tel. +45 3333 5607

Aurelija Augulyte, Analyst [email protected], tel. +45 3333 6437

Georg von Wowern, Assistant Analyst [email protected], tel. +45 3333 6102

Henrik Lorin Rasmussen, Assistant Analyst [email protected], tel. +45 3333 4007

Daniel Freyr Gustrafsson, Assistant Analyst [email protected], tel. +45 3333 5115

Finland: Roger Wessman, Chief Economist Finland [email protected], tel. +358 9 165 59930

Pasi Sorjonen, Senior Analyst [email protected], tel. +358 9 1655 9942

Annika Lindblad, Analyst [email protected], tel. +358 9 1655 9940

Norway: Steinar Juel, Chief Economist Norway [email protected], tel. +47 2248 6130

Erik Bruce, Chief Analyst [email protected], tel. +47 2248 4449

Thina M. Saltvedt, Senior Analyst [email protected], tel. +47 2248 7993 Katrine Godding Boye, Senior Analyst [email protected], tel. +47 2248 7977

Bjørnar Tonhaugen, Senior Analyst [email protected], tel. +47 2248 7959

■ Economic Research Nordea

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Economic Outlook, September 2012 EN

Economy & Finance

Transcript of Economic Outlook, September 2012 EN