SEB report: World economy close to recession

8/3/2019 SEB report: World economy close to recession

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A world economy on the edge ofrecession

Euro zone approaching a criticalcrossroads

Nordic OutlookEconomic Research November 2011


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Contents

Nordic Outlook November 2011 | 3

International overview 5

Theme 12

The United States 14

Japan 17

Asia 18

The euro zone 20

The United Kingdom 23

Eastern Europe 24

The Baltics 25

Sweden 26

Denmark 29

Norway 30

Finland 32

Economic data 33

Boxes

A 25 per cent probability o deep recession 6

Geopolitical unrest helps keep oil prices up 8

GIIPS economies in dierent crisis stages 13

Living standards have suered a blow 15

Greater risks o a Chinese hard landing scenario 19


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4 | Nordic Outlook November 2011

Economic Research

This report was published on November 22, 2011.

Cut-o date or calculations and orecasts was November 17, 2011.

Robert Bergqvist Hkan FrisnChie Economist Head o Economic Research+ 46 8 506 230 16 + 46 8 763 80 67

Daniel Bergvall Mattias BrurEconomist Economist+46 8 763 85 94 + 46 8 763 85 06

Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist+ 46 8 763 80 77 + 46 8 763 80 93

Andreas Johnson Tomas LindstrmEconomist Economist+46 8 763 80 32 + 46 8 763 80 28

Gunilla Nystrm Ingela HemmingGlobal Head o Personal Finance Research Global Head o Small Business Research+ 46 8 763 65 81 + 46 8 763 82 97

Susanne Eliasson Johanna WahlstenPersonal Finance Analyst Small Business Analyst+ 46 8 763 65 88 + 46 8 763 80 72

SEB Economic Research, K-A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Kbel, SEB Frankurt/M and Olle Holmgren,Trading Strategy. Stein Bruun and Erica Blomgren SEB Oslo are responsible or the Norwegian analysis.Thomas Thygesen and Jakob Lage Hansen are responsible or the Danish analysis.


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International overview


Euro zone approaching a critical crossroads Recession expected in euro zone

US showing cautious signs o strength

Sot landing in EM sphere, but greater risks

New ways must be tried to save the euro

Continued extremely low interest rates

The world economy is still characterised by great uncertainty.The European debt crisis continues to unold. Rescue measuresundertaken so ar have not been enough to restore condence.Necessary austerity programmes are being implemented invarious countries, yet mistrust and the resulting high borrowingcosts remain. Meanwhile the banking system is under pressuredue to higher capital requirements and write-downs o assets.In the United States, macroeconomic gures have neverthelessled to upside surprises in recent weeks and recession worrieshave eased, but the US economy is hampered by high unem-ployment and continued debt retirement needs, especially inlight o a persistent decline in home prices. The banking systemis in better shape, but risks o contagion rom Europe are creat-

ing uncertainty and caution.

Our main scenario or 2012 oresees an overall GDP declineo 0.4 per cent in the euro zone and US growth o 1.7 percent: well below trend. Average growth in the 34 countries othe Organisation or Economic Cooperation and Development(OECD) will be 1.2 per cent, pulled up somewhat by a reboundin Japan ater its 2011 natural disasters. In 2013, too, we predictbelow-trend growth. The US will move up to slightly rmerground, but debt retirement will continue. In the euro zone,dicult adjustment processes remain ahead, though the mostacute pressures on growth will ease somewhat in 2013.

A slowdown is also under way in emerging market (EM)countries.Given the increased role o intra-regional trade andample room to ease economic policy as needed, we are stickingto a sot landing as our main scenario, but the risks o a hardlanding in Chinaor example due to problems in credit andreal estate sectorshave increased. In some respects, thereis also greater uncertainty about Middle East developments(see box). Our main scenario implies global GDP growthin 2012, adjusted or purchasing power parities (PPP), o

3.2 per cent: just above the 3.0 per cent that the InternationalMonetary Fund (IMF) has dened as the upper limit o a globalrecession. In 2013, growth will climb to 3.8 per cent.

The infation rate is now rapidly alling ater an earlier, com-modity price-driven upturn. The next couple o years will becharacterised by low infation, with deation risks. From an

infation perspective, there is thus room or central banks tostimulate economies by using the means let in their toolkits.We thus expect continued exceptionally low key interest ratesand non-conventional monetary policies o various kinds rommajor OECD central banks. In such an environment, bond yieldswill remain depressed to historically exceptional levels.

Global GDP growthYear-on-year percentage change

2010 2011 2012 2013United States 3.0 1.8 1.7 2.3Japan 4.1 -0.3 2.0 1.2Germany 3.7 3.1 0.4 1.3China 10.4 9.1 8.0 8.2United Kingdom 1.8 1.0 0.8 1.8Euro zone 1.8 1.6 -0.4 0.8Nordic countries 2.9 2.5 1.3 2.0Baltic countries 1.4 6.0 2.5 3.5OECD 2.9 1.7 1.2 1.8

Emerging markets 7.3 6.2 5.2 5.6World, PPP* 5.1 4.0 3.2 3.8World, nominal 4.4 3.3 2.5 3.1

Source: OECD, SEB * Purchasing power parities

A deepening euro zone crisisA combination o political turmoil, scal austerity measures anda tighter credit environment is creating a downward economicspiral. The slowdown has accelerated in recent months, andeconomic weakening is evident throughout the euro zone. Itscontagious eects are hurting all parts o the world economyin varying degrees. The measures to combat nancial marketvolatility and to aid countries with acute liquidity problems thatwere proposed at a summit meeting in late October currentlyseem to have ailed. These actions have instead revealed the

faws in todays altering system, with its common currencysystem but weak political coordination and weak institutions atthe euro zone level.

In a separate Theme article, we discuss the background tothese ailures and how conficting interests are acing o witheach other in a way that seems to be blocking a solution. Fiscalausterity measures in crisis-hit countries do not pay o inthe orm o increased condence, as long as there is lingeringuncertainty about the sustainability o such policies. MeanwhileGerman political leaders want to avoid or as long as pos-sible having to provide collateral or other countries without

receiving solid guarantees that programmes to restore nancialorder in crisis-plagued countries will continue vigorously. To thegreatest possible extent, the European Central Bank (ECB)wants to avoid departures rom its treaty mandate or rom its


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task o ensuring price stability. Fearul o losing credibility inits battle against infation or o reducing pressure on nationalgovernments, the ECB is acting cautiously. Meanwhile it seemsdicult or the institutions responsible or restructuring thenancial system to back-pedal rom rule changessuch asstricter capital adequacy requirements or banksthat are

aimed at creating a more stable long-term nancial system butnow threaten to cause an excessively abrupt credit crunch. Itseems as i the crisis must become even deeper beore todaysrigid positions will change. One signal that we are entering anew phase is that the crisis is also leading to rapidly wideningbond spreads between Germany and other core countries inthe euro zone.

10-year government bond spread to Germany, per cent

Euro zone crisis has reached the core

Austria Finland France NetherlandsSource: Reuters EcoWin, SE B

Jan

10

Mar May Jul Sep Nov Jan

11

Mar May Jul Sep Nov

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

O the major euro zone countries, the current negative dynamicis strongest in Italy, where we expect a GDP decline o 1.5 percent next year. Even the previously robust German economyis now weakening. Although the IFO business sentiment indexremains somewhat above its historical average, the trend isclearly downward. We anticipate that German growth willreach only 0.4 per cent next year and that unemploymentwill climb.

GDP lagged 3 months

Italy: PMI indicates clear decline in growth

GDP growth, year-on-year percentage change (RHS)Purchasing managers' index (PMI), composite (LHS)

Source: Markit Economics, National Institute of Statistics

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

-7

-6

-5

-4

-3

-2-1

0

1

2

3

4

5

30

35

40

45

50

55

60

65

Better US outlook despite political deadlockIn recent months, US macro data have mainly provided upsidesurprises. This positive trend has also gained strength in thepast ew weeks. GDP growth recovered during the third quarter,

reaching 2.5 per cent in annualised terms, among other thingsbecause lower household saving helped sustain consumption.

Possibility of recession within one year

Recession indicator for the US

Source: SEB

84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

A 25 per cent probability o deep recessionThe great uncertainty in the euro zone is creating a need todiscuss various alternative growth scenarios. We are assigning

about a 60 per cent probability to our main scenario, in whichthe euro zone enters a recession period during 2012 but therest o the industrialised world muddles through with low butpositive growth. We are assigning a 25 per cent probability toa more serious scenario, in which the euro zone crisis leads toa deep recession, including a large-scale nancial crisis andcontagion. In this scenario, GDP would all in accumulatedterms by about 2 per cent during 2012 and 2013 in theOECD countries as a whole. The corresponding GDP decline inWestern Europe in this scenario would be 4-5 per cent.

A rmer solution to the systemic crisis in the euro zone mightlead to a more avourable trend than in our main scenario.

Another upside risk is that the American economy may experi-ence a more normal recovery dynamic earlier than expected.

Overall, we estimate the probability o a more avourablegrowth scenario as about 15 per cent.

Index 2000 = 100GDP, OECD countries

Recession Recovery SlowdownSource: OECD, SEB

04 05 06 07 08 09 10 11 12 13

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

15%

25%


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The positive US trend has been important in slowing the nega-tive dynamic in the world economy. In particular, the resilienceo American stock exchanges has had a stabilising eect. Yetthere are actors that will hold back growth ahead, preventingthe US economy rom regaining strength to the extent that itcan lit up the entire global economy. The US banking system

is in better shape than in Europe, but stress symptoms dueto risks o contagion cannot be entirely avoided. Householdsneed to continue their debt retirement, especially in light ocontinued home price declines. Fiscal policy is hampered byproound mistrust between political parties. Even though weexpect some progress during the autumn, scal policy will havea tightening eect in the next couple o years. Our conclusionis that the US will avoid a recession but that growth willremain weak or another ew years.

Slower growth and lower ination in AsiaThe poorer OECD outlook will also slow the expansion in Asianemerging economies. The deceleration we have seen willthus continue, yet strong domestic demand will enable thesecountries to maintain decent growth. We are thus sticking to asot landing as our main scenario, but risks o a more dramaticslowdown in China connected to the construction and housingmarket have recently increased. Small companies, especially inthe construction sector, are having greater problems obtainingloans and must increasingly rely on the unocial credit market.Also aecting the risk picture is heavy indebtedness amongChinas local authorities ater the 2009 stimulus programmes.

Infation has now culminated in most countries. Monetarytightening has ended, and policy is starting to shit towards

monetary easing. The central banks in Indonesia and Pakistanhave already begun to lower their key interest rates. In 2012infation is expected to all in emerging Asia, making it possibleto stimulate growth with urther rate cuts.

Below-trend growth in the Nordic countriesDespite relatively good undamentals, the export-dependentNordic countries are being aected by the slowdown elsewherein Europe. Growth will end up well below trend in Sweden, Den-mark and Finland in 2012 but hold up better in Norway.

Due to a cyclically sensitive export sector, combined with all-ing home prices that will restrain consumption, GDP growth

in Sweden will all to 0.7 per cent in 2012. In 2013 we expectthe government to take greater advantage o its scal fex-ibility, which will help growth to recover a bit. The internationalcyclically sensitive Finnish economy will also be hard hit bydampened exports, although domestic demand will hold upsomewhat better than in Sweden. GDP growth will cool downto 1.2 per cent next year, leading to slightly higher unemploy-ment. Growth in Denmark has slowed this year due to weakdomestic demand and has thus signicantly lagged behind theother Nordic countries. Now that weaker international demandwill also hamper exports, GDP growth will hover around oneper cent in the next couple o years, despite expansionary scal

policy. Norway will show the greatest economic resilience inthe Nordic region. Exceptionally good public sector nancesand oil revenue, buoyed by still-high oil prices, will allow roomor scal policies that will help sustain consumption and capital

spending. Capital spending will mainly be driven by a continuedstrong housing market and by the oil industry.

GDP growth, Nordic and Baltic countriesYear-on-year percentage change 2010 2011 2012 2013

Sweden 5.6 4.3 0.7 2.0Norway 0.3 1.3 2.2 2.5Denmark 1.3 1.1 1.0 1.4Finland 3.6 2.9 1.2 2.0Nordics 2.9 2.5 1.3 2.0

Estonia 3.1 7.0 2.0 3.0Latvia -0.3 4.4 3.0 4.0Lithuania 1.3 6.5 2.5 3.5Baltics 1.4 6.0 2.5 3.5

Source: OECD, SEB

Sharp slowdown but no recession in BalticsThe economic downturn in Western Europe is on its way to-wards cooling o the export boom that led the three Balticeconomies out o their 2008-2009 depression. This is occurringin a vulnerable situation, since domestic demand has only cau-tiously begun reawakening during the past year, yet we believethat these economies can avoid a recession. The cyclicallysensitive portions o the economy, such as housing marketsand capital spending activity, are already deeply depressed.Painul scal austerity measures and pay cuts ended in 2010.Estoniaand Lithuaniaare now shiting to slightly expansionaryscal policies. Purchasing power will also benet as the energyand ood price-driven infation upturn o the past year ades.

A clear overall slowdown in GDP growth will occur next year,especially in strongly export-oriented Estonia and Lithuania.Estonian GDP will increase by 2 per cent in 2012 and 3 per centin 2013, ater this years 7 per centthe highest growth in theEU. Lithuanias slowdown will ollow roughly the same patternand pace. Latvia, whose recovery has lagged behind the othertwo countries, will experience a gentler process in which growthwill slow rom more than 4 per cent this year to 3 per cent in2012 and rise again to 4 per cent in 2013.

Deation risks will predominateThe ination rate in the US and Western Europe is set todecline. With earlier commodity price upturns vanishing rom

the 12-month statistics, this decline will be relatively rapidduring the coming six months. Looking ahead, weak growthwill result in persistently low resource utilisation, creatingunderlying downward price pressures. In addition, infationexpectations have allen during the mounting economicworries o recent months, especially in the euro zone.

The picture is not entirely clear, however; several actors willhelp slow the decline in the infation rate. In the euro zone,surprisingly high pay increases will keep cost pressure up. De-velopments in southern Europe, or example, show that costadjustment eorts have hardly begun. Meanwhile certain tax

increases included in scal austerity programmes will contrib-ute to higher infation. In the US, goods-related core infationhas shown a clear upward trend. This is partly a consequenceo rising energy prices being passed on to consumers, but it


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also refects decreased defation pressure in global merchan-dise trade. In addition, we expect relatively stable commodityprices ahead, due to sustained demand rom China and otheremerging economies. Overall, we expect core ination in therange o 1 per cent in the next couple o years.

Year-on-year percentage change

CPI inflation well below 2 per cent

Euro zone USSource: Eurostat, BLS, SEB

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

forecast

SEB

Our assessment is nonetheless that the deation risk will beby ar the biggest headache or central banksover the nextcouple o years. I the recession risk increases urther, or ex-ample, it is likely that commodity prices will all sharply, whichwould strengthen defationary impulses.

The risks o higher infation apply mainly to the longer term andwill be related to airly dramatic changes in economic policies.The idea that todays debt imbalances are too big to managein a low-infation environment is gaining traction. Using highinfation to lower the real value o debts would be a way out o

this dilemma. Despite major risks, this pro-infation strategymay win urther support in public discourse, in a situationwhere traditional ways o achieving lower debt imbalances arebeginning to seem more and more painul and problematic.

Dicult scal policy dilemmaThe debt crisis is continuing to orce various countries andregions to implement major scal austerity measures. The levelo drama has escalated urther, among other things becausethe uture shape o the European nancial saety net is unclear.The terms o Greeces debt restructuring have changed theway investors view the risks o holding European governmentsecurities, probably contributing to the increased pressure oncountries like Italy.

Net lendingPer cent o GDP 2010 2011 2012 Debt*

United States -10.3 -9.2 -8.4 105Japan -9.2 -10.3 -9.1 238United Kingdom -10.2 -8.5 -7.0 85Euro zone -6.2 -4.3 -3.7 92OECD -7.7 -6.7 -5.8 105* Gross debt in 2012Source: European Commission, OECD, IMF, SEB

The uncertainty is on its way towards creating a vicious circle.When growth slows, austerity measures do not have as big ascal impact as the original calculations indicated. This, in turn,leads to calls or greater austerity, thereby urther depressing

Geopolitical unrest helps keep oil prices upWhile prices o ood and industrial goods have allen sharplyduring this autumns nancial turbulence, oil prices haveremained high. Looking ahead, we believe that oil prices willremain more resilient in the ace o an international slow-down than prices o industrial metals, or example. We expectBrent crude oil to average USD 114/barrel during 2012. LowEuropean oil reserves and seasonal eects in the US will helpprop up oil prices in the short term.

Index

Different trends for commodity prices

Industry Energy AgricultureSource: HWWI

Jan

08

May Sep Jan

09

May Sep Jan

10

May Sep Jan

11

May Sep

25

50

75

100

125

150

175

200

25

50

75

100

125

150

175

200

Looking a bit urther ahead, somewhat higher global growthwill contribute to urther oil price increases; we expect an

average price o USD 120/barrel in 2013. More uncertaingeopolitical conditions will also help keep oil prices up. Theseare largely connected to various aspects o developments inNorth Arica and the Middle East.

Saudi Arabia has invested enormous sums to avoid beingdrawn into the currents o political changes generated bythe Arab spring, especially by improving conditions or theSaudi population. In order to balance its budget, Saudi Ara-bia is thus dependent on signicantly higher oil prices thanbeore, and the government is thus trying to keep prices a

bit above USD 100.

There is still very great uncertainty in North Arica. Takentogether, the Islamist success in the Tunisian election, therisk o newly emerging conficts in Libya ater Gaddasdeath and question marks about Egypts uture role in theregion are creating a very unpredictable, complex situation.

The status o the Iran question has denitely changed sincethe International Atomic Energy Agency (IAEA) reportedthat Iran is moving towards producing nuclear weapons.The threat o an Israeli bombing attack or similar actionswill thus become more imminent. Iran will probably also

become a contentious issue in the US presidential election.


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growth. The IMF has repeatedly pointed out that the problem ostrongly synchronised austerity programmes must be taken se-riously. One solution is that countries that have no acute cred-ibility problems should hold o on cost-cutting. Another is toreplace austerity measures to the greatest possible extent withstructural reorms that improve the supply side o the economy,

such as deregulation measures and pension reorms.

We expect the general shape o scal policy to shit according-ly. This implies that the GIIPS countries (Greece, Ireland, Italy,Portugal and Spain) will carry out the very large austerity meas-ures that have already been decided, but that any urther write-downs in growth orecasts will not orce them to enact newbelt-tightening in the short term. The austerity programmesunveiled by France and Italy, totalling 1.0 per cent and 3.6 percent o GDP respectively, will be implemented but ater that wedo not expect urther austerity measuresdespite the risk thatFrances credit rating may be lowered. The dose o austerityin the euro zone as a whole will be about 1 per cent o GDP

annually in 2012 and 2013. Germany is now being subjectedto international pressure to stimulate its economy, in order tooset the austerity measures, but we do not expect this to bedone to any especially large extent. Germanys governmentdebt is relatively high, and political leaders are probably veryreluctant to risk their credibility in a critical situation.

Fiscal tighteningChange in structural balance as a percentage o GDP 2010 2011 2012 2013United States -0.3 0.6 1.2 1.3Japan -0.3 -1.0 0.0 1.0

United Kingdom 0.5 1.8 1.6 1.7Euro zone 0.3 1.2 1.3 1.0

O which GIIPS 2.4 3.3 1.0 0.6OECD 0.4 0.9 1.0 1.1Source: IMF, OECD, SEB

The US and Japan have a certain amount o room to hold o onausterity measures because o their very liquid currencies and,in Japans case, high domestic savings. We believe that scaltightening will start next year in the US and increase over time.In Japan, too, major cost-cutting eorts will be postponed. TheUK has implemented dramatic austerity measures, but a so-tening o these policies is expected next year.

The Nordic countries show relatively or extremely strong publicsector nances. Because o budget surpluses in Sweden andNorway, scal policy in these countries will be expansionary. InDenmark and Finland, where the situation is not as avourable,there is less room or manoeuvre. We expect expansionaryscal policy also in Denmark and neutral policy in Finland overthe next couple o years.

Overall scal policy in the OECD countries will, however,

shit in a contractive direction in 2012. This eect will beequivalent to 1.0 per cent o GDP and o about the same mag-nitude in 2013.

Monetary policy will be loosened againBecause o the gloomier economic outlook, infuential centralbanks have eased their monetary policy. Risks o infation,

uture asset price bubbles or harmul eects on market pricinghave been deemed relatively unimportant, compared to the risko a new deep recession. The methods have varied, however.The Bank o England (BoE) and the Bank o Japan (BoJ) havechosen to expand their quantitative easing (QE) programmes,while the US Federal Reserve (Fed) has instead chosen to work

with communication and the structure o its balance sheet(Operation Twist).

So ar the Fed has not launched any third round o quantitativeeasing (QE3) because it has deemed defation risks less serioustoday than last autumn, when it launched the second round,QE2. However the BoE, despite high infation, has announcedthat British infation will all below its target in the medium termunless new monetary stimulus measures are launched. Thebank thus decided that it should expand its bond purchase pro-gramme to GBP 275 billion (nearly 20 per cent o GDP). Mean-while the BoJ expanded its quantitative easing programme toJPY 55 trillion or 12 per cent o GDP.

Central bank purchases of gov't bonds since 2008, % of GDP

Unconventional monetary policy actions

Source: Federal Reserve, Bank of England, ECB, SE B

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

25.0

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

25.0

Fed

BoE

ECB

According to our orecasts, the Fed will launch QE3 during2012; the most likely date is mid-year when Operation Twistends. Previously implemented programmes have expanded theFeds balance sheet by more than 12 per cent o GDP (rom 6 to18.5 per cent). I the Fed chooses to expand its bond purchasesby another USD 1 trillion (the same assessment as in the Au-gust issue o Nordic Outlook), the increase in relation to the sizeo the US economy would be about the same as the BoEs bondpurchase programme.

There has, however, been some increase in uncertainty as towhether the Fed will implement QE3. A new, large-scale bondpurchasing programme by the Fed would probably run intocriticism, both inside the US and rom other countries. ManyEM countries regarded QE2 as a deliberate strategy to weakenthe US dollar, and QE3 might become a breeding ground orprotectionist currents. Many observers also see QE2 as themain reason why commodity prices climbed sharply. This ledin turn to soaring infation and undermined purchasing power,especially in the US. Taken together, this indicates that the Fedmay seek more gentle ways o easing monetary policy, at leastas a rst step. The Fed can infuence expectations by linking its

uture key interest rate hikes to a certain unemployment level.Another possibility is to publish key rate orecasts. Such meas-ures might postpone market pricing well into the utureand thereby shit the entire yield curve downward.


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The ECB and the Nordic central banks still have a certainamount o room or traditional interest rate cuts. We expect theECB to lower its re rate to 1.0 per cent in December. Theeects o urther ECB rate cuts are more unclear. During 2009the ECB chose not to cut the re rate to below 1.0 per cent be-cause the Euro Overnight Index Average (EONIA) rate was still

being pushed down towards zero. Given the severe situationin the euro zone, the ECB will try all means o strengthening itsstimulus dose, but we expect the level o its re rate to be olesser importance. We also assume that the ECB will leave there rate at 1.0 per cent and instead try out other strategies. Thismeans that we expect the ECB to continue its liquidity-manage-ment measures and bond purchases and will thus be compelledto move beyond its treaty mandate (see Theme article).

In Sweden, we expect the Riksbank to begin lowering its keyinterest rate within the next ew months in response to risingunemployment, the absence o infation threats and increas-ingly clear signs o a weakening labour market. We believe that

the Riksbank will lower the repo rate rom 2.0 per cent to1.25 per cent by mid-2012. We also expect Norway to lowerits deposit rate by 25 basis points late this year. Because odecent economic growth and high capacity utilisation, however,we assume that Norwayunlike other OECD countrieswillhike its key interest rate by the end o our orecast period.

Continued very low long-term yieldsYields on long-term sovereign bonds in core markets haveremained sharply depressed ater their dramatic downturn inthe spring and summer. Recently long-term US Treasuries haveshown a stabilisation trend in the wake o improved short-term

economic data, while German, Swedish, Norwegian and otheryields have been pushed downward.

Per cent

10-year government bond yields

US Germany JapanSource: Reuters EcoWin, SEB

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

SEBforecast

Our yield orecast implies that 10-year German governmentbondswill trade in an interval around 2 per cent duringthe next couple o years. In the short term, key interest ratecuts, European recession worries, ading infation pressure andgeneral risk aversion will bring some urther downward pres-sure. According to our main scenario, however, the very gloomi-est macroeconomic scenarioswhich are being treated by themarket as having a certain level o probabilitywill not materi-alise. Combined with tentative steps towards a solution to theEuropean debt crisis, this will lay the groundwork or yields torise somewhat to 2.20 per cent by the end o 2012. During 2013a urther marginal upturn to 2.30 will occur. American 10-yearyields are around 10 basis points above German ones today.

This gap will gradually shrink to zero, and a bit urther aheadwe expect American long-term yields to be at the same levelas German ones. The assumption that the Fed will launch a Q3programme in mid-2012 will help keep US yields down.

The downward trend in government bond yields during thepast ew years raises the question o whether Western corecountries are on their way towards a Japanese scenario opermanent exceptionally low yields. Over the next couple oyears, there will undoubtedly be important similarities. Centralbanks in Western countries will probably need to pursue excep-tional monetary policies or quite an extended period. The Fedhas already signalled that it will keep its key interest rate closeto zero until mid-2013, which will mean a period o 4-5 yearswith the key rate close to zero. But there are many indicationsthat the Fed will need even more time to combat defation andasset price declines.

But the US and German trend still deviates in important

respects rom that o Japan. Above all, the dierence in theinfation trend makes it hard or us to oresee signicant roomor US and German yields to all urther. This divergence is dueto the act that a continuous appreciation in the yen has madegradual defation possible without major changes in competi-tiveness. Demographic trends also dier greatly, especiallybetween Japan and the US.

We expect Swedish 10-year yields to shadow German devel-opments, since both the ECB and the Riksbank will be loweringkey interest rates. Today Swedish 10-year yields are about 20basis points below their German equivalents, and the gap willnarrow slightly during the coming year to around 15 points.

Because o good public sector nances, combined with a rela-tively robust krona, Swedish government securities will con-tinue to appeal to investors. Norwegian government securi-ties have been attractive to investors seeking a combinationo high credit quality and good returns. The yields on mostmaturities have been below Norges Banks key interest rate,and the spread against Germany has been narrow. We expectthe spread to remain at a historically low level and amount to55 basis points in December 2012. During 2013 the spread willwiden to 70 points because Norges Bank will be raising its keyrate.

European stock markets losing groundThe escalating euro zone sovereign nancial crisis and thesubdued growth outlook have dealt a severe blow to globalstock market perormance. The downturn began late in July andcontinued during the autumn, with most markets bottomingout in late September. Since then there has been some recoverydespite continued market turmoil and high volatility.

US stock exchanges have shown considerably better re-

silience than stock markets elsewhere in the world. Relativelybetter economic perormance and a declining risk o recession,combined with a more stable nancial sector, have providedsupport. In Europe, stock markets have been pushed down by

weakening economic signals combined with the ailure o res-cue actions to end the nancial crisis. US stock exchanges areclose to their levels at the beginning o 2011, while downturnsin Europe are around 15-20 per cent; the decline or nancial


10/36



sector shares has been especially dramatic. Stock markets inemerging countries have generally been unable to resist thedownturn, despite decent economic undamentals. The down-turn has been about the same as in Europe.

Index 100 = 2011

US stock exchange have been resilient

USEuro zone

Emerging marketsSweden

Source: Reuters EcoWin, SEB

Jan

11

Feb Mar Apr May Jun Jul Aug Sep Oct Nov

70

75

80

85

90

95

100

105

110

70

75

80

85

90

95

100

105

110

Nordic stock exchanges have been pulled down as well. TheNasdaq OMX Stockholm has underperormed leading stockmarkets. Cyclical sensitivity, comparatively weak liquidity anda relatively weighty banking sector are important explanationsor this.

In recent weeks the stock market has lacked a clear trend.Signals o an American recovery and hopes that more resolutemeasures in Europe will nally catch up with ever-worseningthreat scenarios have oset the constant fow o negative newsrom the European debt crisis. As long as there is not a morepermanent solution to the sovereign nancial crisis, the volatiletrend will probably continue. Deeper problems or the Euro-

pean banking sector and a disastrous trend or the euro projectremain a clear downside risk. In themselves, the downside riskso weaker economic growth are limited; a sizeable downturnhas apparently already been priced in. Overall, however, weexpect it will take a relatively long time beore the questionmarks are resolved in a way that will make a stable, last-

ing upturn possible.

FX market ar rom a normal situationThe oreign exchange (FX) market is in an exceptional situation,accentuated by the act that central banks in ve o the worldsmost important economies are now carrying out extraordinary

measures. In Japan and Switzerland, the central banks are inter-vening directly in the FX market, while the Fed, the BoE and theECB are making large government bond purchases.

The Swiss National Bank (SNB) has gone to the greatest lengthsin eorts to weaken its currency, the ranc (CHF). In Septemberit announced that it was introducing a foor o 1.20 or theEUR/CHF exchange rate. This means that the SNB itsel willbuy unlimited amounts o oreign currency to deend its foor.The bank may possibly also raise the foor to 1.25 at its nextmonetary policy meeting on December 15. Last springs coordi-nated G7 intervention to weaken the yen has been ollowed bymassive FX purchases by the Bank o Japan. In spite o this, the

Japanese currency will remain desirable, and our downwardlyrevised growth orecasts underscore the FX market theme o

fight to traditionally sae currencies. We thus expect the USD/JPY rate to continue downward to 73 by December 2013.

In an environment o great risk aversion and European

debt crisis, however, the USD will continue to gain ground

against the euro. We expect the euro to decline to a long-termEUR/USD equilibrium exchange rate o 1.25. One reason whythe euro has not weakened more is that the euro zone as awhole has a balance in oreign trade due to Germanys strongcompetitiveness. Beyond global economic slowdown, a sub-stantially tougher environment awaits the USD, given the largeAmerican budget and current account decits. The US decitswill require 40 per cent o global savings to be invested in USD,making the USD vulnerable in a longer perspective since cur-rency reserve managers want to reduce the role o the USD(which now accounts or 60 per cent o global portolios).

The recovery in the USD is one reason why we believe thatChinese authorities will ease their rate o currency appre-

ciation, since the yuan will still ollow the dollar upward againstthe euro. Because o subdued infation pressure and domesticslowdown, China is more inclined to prop up export volume.Partly because o this, we expect an annual appreciation rateor the yuan o 3-4 per cent ahead.

During the coming six months cyclically dependent curren-ciessuch as Scandinavian and commodity-related oneswillencounter a tough environment, given a world economy on theverge o recession. But this will be oset to some extent by theact that these are normally the currencies o undamentallystrong economies with relatively good public nances. Webelieve the cyclical disadvantage will predominate in the short

term, but these currencies will be attractive in a slightly longerperspective.

For the Swedish krona, this means that we expect short-termweakening as export order bookings deteriorate. Because thekrona has gained the status o a saer investment, we do notexpect any powerul speculative wave against the currency.At year-end, the EUR/SEK exchange rate will be 9.30. In trade-weighted terms, the downturn will be only 3-4 per cent in thecoming months. Looking urther ahead, we expect the kronato appreciate, with the EUR/SEK rate approaching 8.60 by late2013.

The outlook or the Norwegian krone is very avourable inthe long term, based on widening key interest rate spreadsand expected high oil prices. We expect the EUR/NOK rate tostrengthen gradually to 7.50 at the end o 2012 and to 7.40 atthe end o 2012. In the short term, however, weak fows andan interest rate cut by Norges Bank will prevent the krone romappreciating.


11/36

Theme


Conicting interests are deepening the euro zone crisis Strong mistrust o the EFSF solution

ECB orced to assume greater responsibility

Risks that the euro will disappear

Recurring rescue eorts have ailed to stop the negative dy-namic in the euro zone. These actions have instead revealedthe faws in todays altering system, with its common currencysystem but weak political coordination and weak institutionsat the euro zone level. It is obvious how divergent interests andviewpoints are now creating obstacles to crisis management.

National governments in crisis-hit countries acemajor strains. International pressure and acute deaultthreats have orced Greece and other countries to enactar-reaching austerity measures. New governments led byMario Monti in Italy and Lucas Papademos in Greece nowhave special mandates to ensure their implementation.But there are limits to how much real decision-making canbe handed over to other countries or institutions withoutlosing democratic legitimacy to the extent that it causes the

political system to break down. For as long as they can, German political leaders want to

avoid providing ull collateral or other countries withoutreceiving solid guarantees that programmes to restorenancial order in crisis-plagued countries will continuevigorously. They are thus likely to continue opposing solu-tions that increase Germanys obligations in an increasinglyuncontrolled way, or example by issuing euro bonds oraccepting unlimited ECB commitments.

To the greatest possible extent, the ECB wants to avoiddepartures rom its treaty mandate or rom its task oensuring price stability. Fearul o losing credibility in its

battle against infation or o reducing pressure on nationalgovernments, the ECB is acting cautiously. Because o itsresponsibility or nancial stability, the ECB is also reluctantto orce banks to accept excessively drastic debt write-down requirements.

Banks in the euro zone are naturally hesitant about ac-cepting large debt write-downs, but also have reasons tooppose a recapitalisation o the banking system that takesplace under excessively unavourable conditions or at anunsuitable time. Shrinking their balance sheets and therebycreating a tighter credit environment may oten be themost rational solution rom a business perspective. Mean-

while it seems to be dicult or the responsible institutionsto back-pedal rom rule changesor example strictercapital adequacy requirements or banksthat are aimedat creating a more stable long-term nancial environment,

but that now threaten to result in an excessively abruptcredit crunch.

The proposal presented at the October 26-27 summit to stabi-lise the situation o countries in acute liquidity crises looks setto ail in important respects. Private investors as well as centralbanks and government unds are obviously very sceptical othe strategy now in eect. This ailure is due to both technicallimitations and shortcomings in the proposed solution, as wellas more underlying condence issues.

The unding requirement o the GIIPS countries during 2012(budget decits and maturing loans) can be estimated at EUR500 billion or more. The size o this requirement will dependon growth and additional bank recapitalisation needs. Thecredibility o the European Financial Stability Facility (EFSF),now responsible or Irelands and Portugals borrowing under acollective guarantee rom the euro zone countries, is increas-ingly being questioned. Relatively soon, the EFSF will also startborrowing money on behal o Greece. The EFSFs actual bor-rowing capacity today is EUR 440 billion. When the permanentEuropean Stability Mechanism (ESM) replaces the currentsystem, its lending capacity will be EUR 500 billion. In addition,

the IMF is prepared to supply another EUR 250 billion.

Per cent

Amended EFSF Guarantees

Source: European Financial Stability Facility

2.4%

12.7%

19.2%

6.1%

29.1%

21.8%

1.9%3.7%3.0%Austria

BelgiumFinlandFranceGermanyNetherlandsItalySpainRest

These emergency unds may be used or direct loans or to buygovernment bonds in primary and secondary markets, but thisis hardly an ecient utilisation o EFSFs capital, since there isa risk that emergency needs will grow rapidly i more and largercountries need bail-outs. The act that three countries arealready covered by its borrowing programmes has reduced eurozone countries guarantee commitments to the EFSFs by about7 per cent. I Italy and Spain should also need to apply or nan-cial bail-outs, guarantees would diminish by a urther 30-35 per

cent. A minor reduction can be accepted without EFSF lendingcapacity is aected, but i guarantees are reduced more signi-cantly, EFSF lending capacity might also be aected. I Francecredit rating is worsened, it might lead to large consequencesor EFSF ability to unction as planned.


12/36


Theme

The October 26-27 agreement thus proposes two strategies

1. The EFSF will use its capital to guarantee a certain percent-age o the nominal value o new bonds issued by crisis-hitcountries. Hopeully this will give these countries a borrow-ing capacity o more than EUR 1 trillion in the best case.

2. The EFSF will also be able to invest in, or guarantee, part othe value o special purpose vehicles (SPVs). These SPVs,each perhaps tied to a specic crisis-hit country, will attractinternational capital rom both private and governmentsources. The SPV will then invest, or example, in govern-ment bonds issued by the country in question.

Politically, the hope was that the October 26-27 crisis solu-tion would not need to be implemented, but that internationalcondence and thus international capital would instead return.At present, however, we can see a number o actors that throwthis condence into serious doubt: 1) The details o the agreedstructure have still not been provided. 2) The solution requires

political stability in the crisis-hit countries. 3) The way theGreek debt haircut was handled is rightening; it implied thatpolitical leaders can break agreements and change the size o acontractual write-down. 4) There are concerns about the cred-itworthiness o the EFSF itsel. Obviously investments in EFSFbonds or SPVs will be regarded as riskier than lending via theIMF, or example. As or China, expanding the capital o the IMFwould also boost that countrys international infuence.

In particular, the consequences o the voluntary privatedebt haircut that was part o the Greek debt agreement havebecome a problem. One outcome o this agreement that theECB and others are aiming or, is that credit deault swap (CDS)contracts will not be activated. That may have contributed tothe recently increased pressure on Italy, since investors todaydo not know whether their insurance contracts will be valid iproblems spread. Debt write-downs might also occur in othereuro zone countries. Actual downgrades and threats o urtherchanges in credit ratings have also created greater pressure orinvestors in the sovereign debt market to sell their holdings.

5-year spread, basis points

Rising EFSF yields

To Germany To EIB bondsSource: Bloomberg, SEB

Jan

11

Mar Apr May Jun Jul Aug Sep Oct Nov

25

50

75

100

125

150

175

200

25

50

75

100

125

150

175

200

Our assessment is that that the problems o the euro zone can-not be solved unless the ECB is prepared to launch a very

large-scale government bond purchasing programme,similar to those implemented in the US and the UK. In principle,a central bank has no balance sheet restrictions on purchasinggovernment securities and thenas neededdraining the

banking system o undesired surplus liquidity. So ar the ECBhas bought nearly EUR 200 billion (2,2 per cent o euro zoneGDP) worth o government securities rom crisis-plagued coun-tries. A new programme must be in the range o EUR 500 billion(5,4 per cent o GDP) to have a sucient impact.

Such a strategy would require overcoming the resistance ocountries like Germany and o the ECB itsel. Today the ECB jus-ties its purchases o securities by saying that it must protectthe unctioning o the market as well as the monetary policytransmission mechanisms. I the ECBs normal role is expandedto include an extraordinary role as a lender to governments,there is a risk that the boundary between scal/sovereign debtpolicy and monetary policy may be erased. This means that thecredibility o the central bank and its ability to maintain pricestability may be undermined to some extent in the utureaprice that the ECB must probably be prepared to pay.

Our conclusion is thus that the euro project does not yet

have solid ground under its eet. It will be subjected tosevere tests ahead. A role or the ECB as the lender o lastresort will allow some time or political manoeuvring, but itis not the solution to Europes solvency and competitivenessproblems. This autumns events have conrmed that the worldmust recognise the possibility that the euro in its current ormmay disappear.

Spread against Germany, percentage points

10-year government bond yield

FranceIreland

ItalyPortugal

Spain

Source: Reuters EcoWin

Oct

09

Dec

10

Feb Apr Jun Aug Oct Dec

11

Feb Apr Jun Aug Oct

0

1

2

3

4

5

67

8

9

10

11

12

0

1

2

3

4

5

67

8

9

10

11

12

GIIPS economies in diferent crisis stagesThe situation o individual countries remains depressed, andin varying degrees these countries will be dependent on bail-outs. Greece is acing an extremely deep crisis. Further debtwrite-downs will probably be required, and there is a highprobability o withdrawal rom the euro zone. Portugal is alsoin a situation so severe that debt write-downs will probably benecessary. The situation o Ireland has improved, since thecountry has managed to implement the measures it prom-ised at the time o its bail-out package and has also enactedimportant structural reorms. Spain has major problems withregional decits and sizeable oreign debt and will presum-ably need to apply or a bail-out, but the countrys politicalstability has improved because o the decision to build bud-get discipline into the constitution. Italy has better underlying

potential to manage its situation, but crisis awareness amongthe people seems lower and political risks are thus higher. Atpresent, our assessment is still that Italy will not have to applyor a bail-out.


13/36

The United States


Fiscal policy dangers lurking around the corner Growth slowdown with risk o recession

Gloomy households holding back recovery

Fed will continue easing monetary policy

Since this past summer, US macroeconomic statistics haveexceeded expectations. The main reason seems to be thathouseholds have cut back greatly on their saving. Lower energyprices and a rebound in industrial production ater the down-turn ollowing the Japanese natural disasters last March havealso contributed. Year-on-year GDP growth was 2.5 per centduring the third quarter, compared to 0.8 per cent in the rsthal. Unlike the situation in many other countries, US GDP ishigher than its previous peak at the end o 2007.

Index, basis points

Financial conditions and signs of bank stress

SEB financial conditions index (LHS)12 month LIBOR OIS spread (RHS)

Source: Reuters EcoWin, SE B

07 08 09 10 11

-100

-50

0

50

100

150

200

250

300

350

99

100

101

102

103

104

105

106

107

108

As earlier, our assessment is that the US economy will slowduring 2012. The risk o recession remains high: according toour model projections it has allen to about 25 per cent, butbetting companies are pricing in a signicantly higher probabil-

ity o recession in 2012. The sources o concern are numerousand dicult to assess: tighter nancial conditions, an uncertainscal policy playing eld, weaker global markets or manuac-tured goods, a recession in the euro zone and deep householdpessimism. GDP will grow by 1.8 per cent this year, 1.7 percent in 2012 and 2.3 per cent in 2013, slightly lower than con-sensus. Below-potential growth implies that unemployment willcreep higher, but a alling labour supply will limit this upturn. Asearlier, our assessment is that the most important key inter-est rate (the ederal unds rate) will remain unchanged

throughout our orecast period and that the Fed will try tostimulate the economy in other ways.

Indicators pointing to weaker consumptionHousehold consumption has recently been ar stronger thanboth indicators and income justiy. In troubled times it is

natural or households to save more, but this autumn we haveseen the opposite behaviour. The household savings ratio hasallen sharply, and the gap between consumption and incomechanges has rarely been wider. The consumption upturn duringthe third quarter was driven by necessary expenditures such aselectricity, water, gas and health care.

US economy muddles through

Annualised Year-on-yearSource: BEA, SEB

07 08 09 10 11 12 13

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

SEB forecast

Yet it is worrisome that the uture expectations o households

are at historically low levels, since they are highly correlatedwith actual consumption during the next quarter or so. Asiderom our indicator model, our consumption orecast is usuallybased on estimated associations between wealth and saving.This time, however, we have assumed a more cautious savingsadjustment than the models indicate: the savings ratio willclimb rom 3.6 to 5 per cent by the end o 2012. A sharperupturn in this ratio cannot be ruled out. Our overall orecast isthat household consumption will grow by 2.3 per cent thisyear and by an annual average o 1.4 per cent in 2012-2013.


Wages are falling in real terms

Real average weekly earningsSource: BLS, SEB

65 70 75 80 85 90 95 00 05 10

-8

-6

-4

-2

0

2

4

6

-8

-6

-4

-2

0

2

4

6


14/36


The United States

Living standards have sufered a blowAmerican GDP per capita has regained about hal its reces-sionary decline and is at its 2005 level. In the household sec-tor, the decline is even larger: adjusted or infation, medianincome ell by 7 per cent during the rst decade o the 21stcentury and now stands at the same level as in 1996.

Index 2000 = 100

Median income down 7% in the last decade

Source: Census Bureau, SEB

70 75 80 85 90 95 00 05 10

75.0

77.5

80.0

82.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

Household debts have declined by USD 1 trillion during thepast three years; indebtedness has allen rom 135 to 119 percent o disposable income. According to the S&P/Case-Shillerindex, home prices have allen to the same level as in 2002,when indebtedness stood at 108 per cent o income. Debtretirement will thus continue or several more years aectinggrowth. It will consequently be some time beore real medianincome again reaches its 1999 peak. According to a study inThe Wall Street Journal, income will not reach this peak until2021, illustrating how persistent these problems are.

Good growth in corporate capital spendingThe weakness in the household sector is partly being oset bypositive news in the corporate sector. According to the Insti-tute o Supply Management (ISM) index, manuacturing sectorcondence has deed expectations o a downturn and hasstabilised in recent months. Meanwhile the Philadelphia Fedsbusiness outlook survey, historically one o the most reliableeconomic signals, climbed sharply in October. Ater a six-month drop, the National Federation o Independent Business(NFIB) index o small business condence also bounced back inSeptember-October, but it remains depressed.

Corporate capital spending or machinery and sotware is nowgrowing rapidly; the rate o increase was a ull 17 per cent in thethird quarter. One reason may be the incentives or accelera-tion o investments launched by Congress last winter. Anotherreason could be that ater several lacklustre years, replacementspending has picked up. Reversals during 2012 thus cannot beruled out, but we oresee continued decent growth in capitalspending. Companies will boost their investments by anaverage o more than 8 per cent in 2012-13.

There are also bright spots in the housing market. In No-vember, the National Association o Home Builders (NAHB)

condence indicator climbed to its highest level since last sum-mer. This upturn has recently been refected in constructionsector share prices. For the rst time since 2005, residentialinvestments grew or two quarters in a row. Housing starts also

climbed sharply in September, thanks to a surge in construc-tion o multiamily buildings, but the situation or single-amilyhomes remains dicult. Despite a low construction level, ex-cess supply was nearly 40 per cent (compared to sales o newsingle-amily homes). A new downturn period thus cannot beruled out. Mortgage applications are at their lowest level since

the mid-1990s, indicating weak sales gures in the near uture.Our overall assessment is that construction investments willgrow by an annual average o 5 per cent in 2012-13.

Index

Business surveys do not point to recession

Philadelphia Fed (LHS) ISM Manufacturing (RHS)Source: Reuters EcoWin, SE B

05 06 07 08 09 10 11

25

30

35

40

45

50

55

60

65

70

75

-50

-40

-30

-20

-10

0

10

20

30

40

50

The labour market is treading waterYear-on-year productivity growth has slowed sharply and isnow ar below its historical average. Slower productivity growthhas oten preceded economic downturns and weaker labourmarkets. I companies believe that a slowdown will not beshort-lived, they must adjust their costs by cutting back onwages and salaries, their largest expenditure item. Nev-ertheless leading indicators such as data on initial claims orunemployment benets have improved somewhat recently. Ouroverall assessment is that job creation will continue at a slowpace. The upturn will average about 90,000 jobs per month in2012 and about 110,000 in 2013. Unemployment will be 9per cent the same level as today at the end o 2013.

Fiscal policy risks are mountingSince the 2012 presidential campaign is already under way,the political situation remains tense. It is thus very uncertainwhether Congress will extend long-term unemployment ben-

ets and household tax cuts, which expire at year-end. I suchprogrammes are not renewed, ederal budget tightening willtotal USD 270 billion (1.7 per cent o GDP), but our workinghypothesis is that these measures will be extended or anotheryear. Fiscal tightening at the ederal level will thus be justbelow 1 per cent o GDP in 2012. Meanwhile belt-tighteningwill continue at state and local government levels, where con-sumption has allen in eight o the past nine quarters.

Another open question is whether the Congressional scalpolicy committee appointed last summer as part o the ederaldebt ceiling agreement can come together and crat a cred-ible plan or reducing the budget decit. Its task is to agree onexpenditure cuts o at least USD 1.2 trillion or scal 2013-2022.I Congress ails to adopt the committees proposal beoreDecember 23, discretionary expenditures will be slashed auto-


15/36


The United States

matically starting in 2013. Entitlement-related spendingsuchas health care costswill not be aected at all.


Falling government expenditures

State and local (12% of GDP) Federal (8% of GDP)Source: BEA, SEB

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

Ater President Barack Obamas big jobs package was derailed,

the administration searched or other ways to stimulate theeconomy that do not depend on Congressional approval. It hasrecently announced nancial relie or students, home ownersand entrepreneurs, though the size o these measures has beenmodest. Judging rom betting-company odds, Obama has aneven chance o being re-elected in 2012, despite the bad

economy. The Republicans seem to have diculty in nding astrong candidate who can take advantage o the situation; rightnow, ormer Massachusetts governor Mitt Romney is heavilyavoured to be the Republican candidate.


Lower inflation in 2012

Core inflation InflationSource: BLS, SEB

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6SEB

forecast

Ination headed downward againIn the US, price ormation is more sensitive to energy pricefuctuations than in Europe. The CPI has consequently climbedaster in the US during 2011, but it wil l all more sharply in 2012.Core infation is now in line with the Feds target level, but heretoo we oresee a downturn. The weak labour market is an im-portant orce in holding down prices, with average hourly wag-es trending downward. Core infation will peak at 2.2 per centin December and then all slowly, according to our orecasts.As annual averages, core ination will end up at 1.6-1.7 percent in 2011-12 and 1.2 per cent in 2013.

Further monetary policy easingMost Federal Open Market Committee members still seemto view a third round o quantitative easing (QE3) as a way o

avoiding defation rather than boosting GDP growth. Given ourinfation and growth scenario, new Fed bond purchases during2012 are thus an uncertain orecast. The act that it is an elec-tion year will also marginally lower the probability o quantita-tive easing.

In spite o this, we are sticking to our orecast that the Fedwill implement new bond purchases during 2012, which someFOMC members have also advocated. The most likely timingor QE3 is mid-2012, once Operation Twist ends. Since hous-ing market problems are again a ocus o attention, mortgagebond purchases are a logical complement to Treasury bonds,but it is uncertain how big an eect this wil l have in a situationwhere mortgage interest rates are close to historical lows.

Meanwhile there are other ways to ease monetary policy. I theFed wants to infuence expectations, or example, a uture keyrate hike can be tied to a given unemployment level. Anotherpossibility is to publish key rate orecasts. Such measures might

shit market pricing ar into the uture and thus pushdown the entire yield curve.

USD trillion

Nominal GDP well below trend

Potential GDP Nominal GDPSource: CBO, BEA, SEB

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

78

9

10

11

12

13

14

15

16

17

78

9

10

11

12

13

14

15

16

17

A new recession, with accompanying defation risks, mightmeanwhile trigger the Feds heavy artillery. One possibility thatis gaining ground in public discourse, although Fed ChairmanBen Bernanke remains unenthusiastic, is to introduce a nomi-nal GDP target, with the aim o reverting to the long-termtrend. Such a monetary policy target is compatible with theFeds dual mandate (maximum employment and stable prices),but rom a Taylor rule perspective, employment would be as-signed ar greater importance. A nominal GDP target wouldalso shit the ocus rom infation rates to price levels. Giventhe sizeable gap between actual and potential nominal GDP, anominal GDP target is compatible with massive monetarystimulus measures.


16/36

Japan


Bank o Japan intervening again to slow rise in yen Global economic gloom is hurting growth

but reconstruction will sustain it in 2012

Record-strong yen + deation = BoJ action

The Japanese economy is being aected by the global slow-down. We are thus revising our GDP orecast downward. But inthe short term, reconstruction ater last Marchs natural disas-ters and nuclear accident will sustain economic activity, spillingover into decent growth gures next year. Ater this years de-cline, GDP will grow by 2 per cent in 2012 and 1.2 per centin 2013. This means there will still be plenty o idle resourcesin the economy: the output gap will be 4 per cent at the end o2013, with GDP 2 per cent below its 2008 peak. Deation willthus persist despite government and central bank attemptsto stimulate the economy. Last autumn the Bank o Japan (BoJ)decided to expand its quantitative easing programme onceagain. But according to the banks orecasts, price stability1per cent core infationwill not be achieved during our ore-cast period, indicating the urther monetary policy easingwill occur. The key interest rate will remain at a record-low 0.1

per cent throughout our orecast period.

Consumer condence has recovered since bottoming outin April but remains below historical averages. We orecastconsumption growth averaging 0.7 per cent in 2012-2013:in line with the average in the 2000 decade. Because savinghas climbed sharply in recent years, the household sector isresilient.

Industrial production has bounced back to some extent sincethe natural disasters but remains 15 per cent below its 2008peak. The purchasing managers index in manuacturing is justabove the neutral 50 mark, and machinery order bookings

one o the most important industrial leading indicators

pointtowards continued recovery driven by reconstruction work. Weanticipate that industrial production as an annual average willbe 2.5 per cent higher in 2012.

Weak exports are holding back an even stronger industrialresurgence. Aside rom weaker global demand, manuacturersare handicapped by sky-high exchange ratesthe yen hasgained more than 35 per cent against the US dollar since

2007. For major exporters, especially companies with large USsales, current exchange rates are close to becoming unbear-able, as indicated by both stock market indices and exportgures. While exports to the EU (12 per cent o the total) are

still growing by a decent 7 per cent year-on-year, export growthto the US (16 per cent) has approached zero.

The BoJ continues to intervene in the oreign exchange mar-ket in order to slow the yen appreciation, especially i a newwave o risk aversion due to the euro zone debt crisis pushesthe yen even higher. Although there is some international sym-pathy or these actions, recurrent large-scale dollar purchasesand yen sales similar to those carried out in 2002-04 are likelyto cause irritation in other countries. Another method suggest-ed by the IMF is or the BoJ to greatly increase its purchaseso long-term government bonds. So ar, however, the centralbank has proceeded rather cautiously. Overall, we believe thatthe USD/JPY exchange rate can be stabilised at current levels,but the path to exchange rates more justied by undamentalsis being blocked by American weaknesses and the Feds lowinterest rate policy. In December 2012 the USD/JPY rate willbe 73. Under these circumstances, we expect oreign trade toprovide a weakly negative contribution to GDP growth in 2012.

Year-on-year percentage change and exchange rate

Exports and the yen

Total exports (LHS)USD/JPY (RHS)

EUR/JPY (RHS)

Source: Ministry of Finance, Reuters EcoWin, SEB

05 06 07 08 09 10 11 12 13

70

80

90

100

110

120

130

140

150

160

170

-50

-40

-30

-20

-10

0

10

20

30

40

50

SEB forecast

Among OECD countries, Japans public sector debt (220 percent o GDP in 2010) is by ar the largest, but due to years olarge current account surpluses the situation is nevertheless

stable rom a unding standpoint. Domestic investors holdmost Japanese government bonds and see ew investmentalternatives. Budget decits have been around 8-9 per cento GDP in recent years and will remain high or the next ewyears. A third supplementary budget to nance reconstructionis being drated, and public sector investments will growby 15 per cent in 2012 and 7 per cent in 2013. A bit urtherahead the question is what the new prime minister, YoshihikoNoda, can do to restore order to public nances. Steps to dealwith Japans long-term challenges, such as its ageing popula-tion, cannot reasonably be postponed indenitely.


17/36

Asia


Slowdown to below-trend growth Ination has culminated

Worsening risk picture in China

Continued key interest rate hikes in India

Asian emerging countries continue to sustain the global econ-omy, although their growth slowed down urther in the thirdquarter o 2011. Purchasing managers indices together with

other indicators have kept alling in recent months, reinorcingthe impression that this deceleration will continue.

GDP, year-on-year percentage change

Growth is slowing in Asia

ChinaIndia

IndonesiaMalaysia

South KoreaThailand

Source: National statistical offices

07 08 09 10 11

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

The weak outlook in the euro zone and the US will have anadverse eect on exports rom Asia, although intra-regionaltrade has become increasingly important. Growth will thuscontinue to slow, ending up below trend in the next ew

quarters. The eects will be greater or open economies likeMalaysia, while more closed economies like Indonesia will bemore resilient, but strong consumption and private investmentswill buoy the economies o most countries. Severe fooding inThailand will hurt economic growth in the ourth quarter but isnot expected to aect the region as a whole.

Infation pressure remains high but has peaked in most econo-mies. Ination will all during 2012 due to slower growthand culminating ood and commodity prices. Key interest rateshave been hiked during 2011, but culminating infation meansthat monetary tightening has come to a halt in most countries.Falling infation pressure next year will stimulate householdconsumption but also give central banks room to cut key ratesas necessary to stimulate growth.

This autumn many Asian currencies have been pushed down-ward as the nancial crisis has helped strengthen the USdollar. Meanwhile earlier heavy capital infows to the regionhave turned into outfows. In the short term, Asian currencies

will remain depressed, but due to good economic growth andstrong undamentals, appreciation pressure and capital infowswill resume urther ahead.

China: Increased risks to economic growthChinese growth continues to decelerate; third quarter year-on-year GDP growth o 9.1 per cent was the slowest since 2009.The purchasing managers index ell again in October to 50.4,a historically very low level. The rst signs o a slowdown inexport growth ollowing recent nancial market turmoilare discernible. In October, year-on-year export growth was justbelow 16 per cent, the lowest increase since 2009. The tradesurplus was also below expectations. Chinas Ministry o Com-merce has warned o a deteriorating export trend. There aremany indications that the slowdown during the autumn waslargely due to a drop in exports to the EU, but Chinese export-ers have become less and less dependent on Western buyers,with sales to the GIIPS countries totalling less than 5 per cento exports.

Domestic demand still looks stable, with retail sales increasingat around 17 per cent year-on-year. There are clear problems in

the construction sector, however; together with a general dete-rioration in the credit supply to companies, this will contributeto lower overall growth compared to earlier gures exceeding10 per cent. We expect GDP to rise by 9.1 per cent in 2011,8.0 per cent in 2012 and 8.2 per cent in 2013.


China: Inflation has culminated

CPI Core inflation Food pricesSource: National Bureau of Statistics

06 07 08 09 10 11

-5

0

5

10

15

20

25

-5

0

5

10

15

20

25

The infation rate has culminated but remains high. In October,infation ell urther to 5.5 per cent, still well above the ocialtarget o 4 per cent. Unlike India, rising ood prices this year donot seem to have led to price increases elsewhere in the econ-omy. Core infation has indeed climbed since early 2011 but hasstayed around 2.5 per cent in recent months. We expect ull-year 2011 ination o 5.5 per cent. Due to base eects anda clear deceleration in growth, ination will slow to 4.2 percent in 2012. Prices will rise 4.0 per cent in 2013.


18/36


Asia

Greater risks o a hard landing scenarioThe risks are related to the threat o a negative dynamic con-nected to the housing market, the nancial sector and localgovernment debt. The housing market is continuing to cool. InSeptember, prices measured as averages or 70 cities were 3.7per cent higher than a year earlier. The number o sales has

allen. Chinese authorities triggered the slowdown by tighten-ing their economic policies. While the housing market hasslowed, monetary tightening has restricted the credit supplyto companies. These problems are especially severe or smallbusinesses, especially construction companies that havediculty getting conventional bank loans. This orces themto resort to lending channels outside the regular bankingsystem whicht evade ocial credit tightening measures. Theconstruction sector, representing around 7 per cent o GDP, isthus being squeezed by a slowdown in the housing market aswell as diculty obtaining loans, leading to a clear decelera-tion in activity. The problems o this sector, in turn, aect local

authorities that went into debt in conjunction with the 2009stimulus programme and whose revenue largely derives romland sales: a source o income strongly linked to activity in theconstruction sector.

Lending outside o the banks balance sheets is short-termand volatile, creating the risk o a scenario where an abruptdrop in this lending combined with lower external demandwould quickly lead to big problems or export-oriented com-panies, small businesses and construction companies, whichwould risk dealing growth a major blow.

Our main scenario, however, is that China can avoid

a hard landing. A more lengthy process, in which capitalspending-driven growth is now starting to draw to a close, ismore likely. The authorities have already begun taking action.For example, they have unveiled an action package or smallbusinesses and have proposed allowing local authorities toissue bonds. But this will not prevent construction sector andcredit supply problems rom now beginning to hurt growth.

The Peoples Bank o China has raised its key interest ratethree times during 2011, most recently early in July. Since risksto growth have increased while infation has culminated, webelieve that the hiking cycle that began in October 2010 is nowover. But beore the bank moves to cut its key rate, infation

must rst all clearly and approach the 4 per cent target. Ourorecast is thus that the key rate will remain at 6.56 per centin the next ew quarters. Meanwhile heavy local governmentdebt means that the potential or scal stimulus is limited.

The US Senate has breathed new lie into the currency confictwith China by approving a proposal or punitive taris on Chi-nese goods. The senators believe that the appreciation o theyuan is moving too slowly and Chinese imports are costing US

jobs. The proposed actions will probably be ineective, sinceother countries in Asia and Latin America are ready to replace

Chinese exports i the taris are imposed. The proposal is alsounlikely to be implemented, since both business organisationsand the Obama administration oppose it. As earlier, China hasreacted strongly with talk o counter-measures and trade war.The most likely scenario is that the yuan will keep appreciatingagainst the dollar. However, the marked slowdown in Chinese

growth along with a decelerating rate o infation and thestrengthening o the dollar implies that the pace o apprecia-tion will decrease. We expect a USD/CNY exchange rate o6.10 at the end o 2012.

India: High ination despite slower growthSigns o deceleration have become clearer. The composite pur-chasing managers index dropped urther to 50.6 in October.Leading indicators have also allen. Industrial production hascooled in recent months, and the slowdown in the automotiveindustry is especially clear, but manuacturing accounts or onlysome 20 per cent o GDP. Unlike most other Asian countries,however, Indian exports have perormed strongly in recentmonths. Exports have surged as the currency has weakened;since early August the rupee has lost more than 10 per centagainst the dollar. GDP will increase by 7.4 per cent in 2011,by 7.5 per cent in 2012 and 8.0 per cent in 2013.


India: Continued high inflation

Key interest rate (%) Inflation Food pricesSource: Ministry of Commerce and Industry, Reserve Bank of India

07 08 09 10 11

-2

0

2

4

6

8

10

12

14

16

18

20

22

24

-2

0

2

4

6

8

10

12

14

16

18

20

22

24

The infation rate remained at 9.7 per cent in October. A normalmonsoon season has not yet markedly slowed the rise in oodprices. The weakening o the rupee has also helped buoy theinfation rate. Infation is expected to all during 2012 but willstill end up ar above the Reserve Banks 5-6 per cent comort

zone. In October the bank hiked its key interest rate or theseventh time this year; it is now 8.50 per cent. Since the currenttightening cycle began in March 2010, the key rate has beenraised by 3.75 percentage points. We expect two urtherhikes, bringing the key rate to 9.0 per cent at the end o

the rst quarter o 2012. This will bring the key rate back to itspeak level beore the 2008-2009 crisis.


19/36

The euro zone


Recession awaits in 2012 Dicult choices in wake o debt crisis

Clear signs o German slowdown

Ination will all unemployment rising

ECB will continue its stimulus measures

The euro zone growth outlook has turned considerablygloomier this autumn due to the escalation o the sovereign

debt crisis. Financial market turmoil has orced various coun-tries to enact urther austerity measures, while indicators andhard data are showing a clear deceleration in growth. It is alsoincreasingly evident that the banking crisis will make it moredicult or companies to borrow money.

Percentage change

Recession in the euro zone 2012

Quarter-on-quarter, annualisedYear-on-year percentage change

Source: Euroframe, Eurostat, SEB

03 04 05 06 07 08 09 10 11 12 13

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

forecastSEB

Even in Germany, which resisted the downturn or a long time,the deceleration is becoming ever clearer. Exports, industrialproduction and order bookings have lost momentum and thelabour market is showing signs o weakening. Although the IFObusiness sentiment index remains above its historical average,

it has allen sharply. The composite purchasing managers index(PMI) is barely above the 50 level that indicates growth.

GDP lagged 3 months

Italy: PMI indicates clear decline in growth

GDP growth, year-on-year percentage change (RHS)Purchasing managers' index (PMI), composite (LHS)

Source: Markit Economics, National Institute of Statistics

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

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

30

35

40

45

50

55

60

65

The other major euro zone economiesFrance, Italy and Spainhave already experienced serious growth problems, and thesituation is being made worse by urther austerity measuresand tightening credit conditions. We expect both Italy andSpain to end up in a clear recession during 2012.In Francewe expect slightly negative growth, while Germany looks asi it can achieve weakly positive growth. All GIPS economies(Greece, Ireland, Portugal, Spain) except Ireland will be in re-cession in 2012. The euro zone will grow by 1.6 per cent thisyear. In 2012 we expect GDP to all by 0.4 per cent. In 2013

growth will be 0.8 per cent: still below trend.

GDPYear-on-year percentage change 2010 2011 2012 2013Germany 3.7 3.1 0.4 1.3France 1.5 1.6 -0.2 0.7Italy 1.5 0.7 -1.5 0.3Spain -0.1 0.7 -0.9 0.4Greece -4.4 -5.7 -3.6 0.3Portugal 1.4 -1.9 -3.4 0.4Ireland -0.4 1.1 0.7 1.1

GIPS countries -0.6 -0.5 -1.4 0.5Euro zone 1.8 1.6 -0.4 0.8

Source: Eurostat, SEB

The sovereign debt crisis continuesThe agreement reached by the euro zone countries late inOctober initially led to some sense o relie in nancial markets.Such measures as a 50 per cent write-down o Greek sovereigndebt to private lenders and expansion o the European Finan-cial Stability Facility (EFSF) represented a step orward butsubstantially more ar-reaching actions will be required. Politi-cal and nancial market uncertainty is likely to continue or along time to come.

In recent weeks, the ocus has been on Greece and Italy. InGreece, downward adjustments in previous overly optimisticgrowth orecasts made urther austerity measures necessaryearlier this autumn. These measures, in turn, are slowing eco-nomic activity even urther, while popular discontent is makingthe political process chaotic.

Now that Italy is in the spotlight, the problem has multipliedin size. Italy accounts or 17 per cent o euro zone GDP and isthree times larger than Greece, Portugal and Ireland combined.The undamental problem is lack o condence in the way Italymanages its sovereign debt, which is equivalent to 120 per cento GDP. The political process in Italy, too, has been chaotic,causing delays in belt-tightening decisions. The result hasbeen sharply rising Italian bond yields, which reached record


20/36


The euro zone

highs even though the ECB has kept buying Italian governmentbonds in order to calm the market. Yields are now on a par withthose where Greece, Ireland and Portugal lost market con-dence and were orced to ask or bail-outs.

Spread against Germany, percentage points

10-year government bond yield

FranceIreland

ItalyPortugal

Spain

Source: Reuters EcoWin

Oct

09

Dec

10

Feb Apr Jun Aug Oct Dec

11

Feb Apr Jun Aug Oct

0

1

2

3

4

5

6

7

8

9

10

11

12

0

1

2

3

4

5

6

7

8

9

10

11

12

Spains decision to build budget discipline into its constitutionhas been relatively well received. The oppositions landslidevictory in the November 20 parliamentary election will setthe stage or continued austerity measures and reorms, butSpain has major problems managing its large regional decitsand appears likely to miss its 2011 budget target. In Portugal,the situation remains serious. Further austerity measures willbe needed, among other things to cover debt that Madeirahad been under-reporting since 2004. Ireland has managedto carry out the measures agreed to at the time o its bail-outpackage and is also beneting rom a more fexible labourmarket, as well as structural reorms.

Large decits and rising sovereign debtsThis autumn, some euro zone countries have been orced to ex-pand their austerity measures due to overly optimistic growthorecasts and nancial market turmoil. In the euro zone as awhole, these measures will total just over 1 per cent o GDP peryear during our orecast period.

Public budget balance, selected countriesPer cent o GDP 2010 2011 2012 2013Germany -4.3 -1.4 -1.3 -1.1France -7.1 -5.9 -5.4 -5.1Italy -4.6 -4.1 -3.0 -1.9Spain -9.3 -6.5 -5.2 -4.3Greece -10.6 -9.7 -7.8 -7.1Portugal -9.8 -6.2 -4.8 -3.5Ireland -31.3 -10.5 -8.4 -7.5Euro zone -6.2 -4.3 -3.7 -3.2

Source: European Commission, SEB

We have revised our budget decit orecasts upward since theAugust issue o Nordic Outlook. Compared to the US, which isalso grappling with serious government nancial problems, thedecit or the euro zone is nevertheless ar lower. The eurozone budget decit will end up at 4.3 per cent o GDP this

year, 3.7 per cent in 2012 and 3.2 per cent in 2013. Central

government debt will climb rom 86.5 per cent o GDP in

2010 to 93.5 per cent in 2013. In Germany, public sector -

nances will improve, thanks to higher tax revenue plus a correc-tion o an error equivalent to 2.6 per cent o GDP. Germanysbudget decit will amount to 1.4 per cent o GDP this year

and approach 1 per cent per year in 2012 and 2013.

Tighter credit supply or companies

The ragile euro zone banking system and the liquidity prob-lems o the banks are in danger o harming growth. The ECBslatest Bank Lending Surveypoints out that nancial institutionstightened their credit conditions considerably in the third quar-ter. They will probably tighten them urther in the ourth quar-ter. Liquidity constraints and unding diculties are the mostimportant reasons behind these actions by banks. Corporatedemand or loans ell during the third quarter, or the rst timein a year. The slowdown in bank lending thus seems to be dueto a combination o more restrictive lending at the same timeas a gloomier growth outlook is causing both companies andhouseholds to lower their demand or loans.

Year-on-year percentage changeBank lending is levelling out

Non-financial companies HouseholdsSource: ECB

04 05 06 07 08 09 10 11

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Further deterioration in the supply o liquidity to banks wouldhurt both corporate capital spending and household consump-tion. There is a risk that the situation will worsen due to require-ments that banks boost their core capital to 9 per cent by June30, 2012. I banks greatly reduce lending as a way o achievingthis target, it will seriously hamper growth.

Weak labour market will get worseBecause o weak GDP growth, the labour market situation willnow deteriorate. We have revised our unemploy

SEB report: World economy close to recession

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