Swedbank Economic Outlook · Global growth – impressive so far, pitfalls ahead As we enter 2018,...

Swedbank Economic Outlook

January 2018

Completed: January 23, 2018, 17:00 CET

Disseminated: January 24, 2018, 08:00 CET

Welcome to SwedbankEconomic Outlook!Swedbank Economic Outlook presents the latest economic forecasts for Sweden, the Baltics and the major global economies. In a series of in-depths, current issues that have a bearing on the economic developments are analysed.

Swedbank Economic Outlook is a product made by Swedbank Macro Research.

Sweden

Anna Breman [email protected]

Group Chief Economist

+46 70 314 95 87

Oscar [email protected]

Junior Economist

+46 8 700 92 85

Martin Bolander [email protected]

Senior Economist

+46 8 700 92 99

Cathrine Danin [email protected]

Economist

+46 8 700 92 97

Jana [email protected]

Senior Econometrician

+46 8 5859 46 04

Josefin [email protected]

Assistant

+46 8 5859 03 05

Åke Gustafsson [email protected]

Senior Economist

+46 8 700 91 45

Knut [email protected]

Senior Economist

+46 8 700 93 17

Alexandra [email protected]

Research Assistant

+46 73 999 42 15

Maija [email protected]

Research Assistant

+358 50 4688 759

Jörgen Kennemar [email protected]

Senior Economist

+46 8 700 98 04

Ingrid Wallin Johansson [email protected]

Economist

+46 8 700 92 95

Estonia

Tõnu [email protected]

Chief Economist Estonia

+372 888 75 89

Liis [email protected]

Senior Economist

+372 888 72 06

Marianna Rõ[email protected]

Economist

+372 888 79 25

Latvia

Mārtiņš Kazā[email protected]

Deputy Group Chief Economist/Chief Economist

Latvia

+371 6744 58 59

Agnese [email protected]

Economist

+371 6744 58 75

Lija [email protected]

Senior Economist

+371 6744 5844

Linda [email protected]

Junior Economist

+371 6744 42 13

Lithuania

Nerijus Mač[email protected]

Chief Economist Lithuania

+370 5258 22 37

Laura Galdikiené[email protected]

Senior Economist

+370 5258 22 75

Vytenis Š[email protected]+370 6945 71 95

Norway

Øystein Bø[email protected]

Chief Economist Norway

+47 99 50 03 92

Ingvild Almestad [email protected]

Economist

+47 48 12 63 30

Kjetil Martinsen [email protected]

Senior Economist

+47 92 44 72 09

Macro Research

Swedbank ResearchOlof [email protected]

Head of Research

+46 8 700 91 34

Summary____________________________________________________________________________ 4 RegionsUnited States ________________________________________________________________________ 6Europe _____________________________________________________________________________ 7Asia/Emerging markets ________________________________________________________________ 9Sweden _____________________________________________________________________________ 11Nordics _____________________________________________________________________________ 14Baltics ______________________________________________________________________________ 17

Interest and exchange rate forecasts _____________________________________________________ 20

In-depthsSustainability Indicators _______________________________________________________________ 22 Sweden vs. Norway housing – similar yet different __________________________________________ 24Demographics and the reversal of falling interest rates _______________________________________ 26

Appendices: Forecast tables ____________________________________________________________ 28Information to client __________________________________________________________________ 30

Recording date of price data 2018-01-18The Swedbank Economic Outlook is available at: www.swedbank.com/seo.

Table of content

Cover image: Getty Images

Global growth – impressive so far, pitfalls ahead

As we enter 2018, the outlook for global growth is on a stronger footing. Euro area growth keeps improving, while the US has kept up speed. Emerging mar-kets are enjoying a positive momentum. The global cyclical upswing benefits the Nordic and Baltic economies. Political risks have abated somewhat, in particular in Europe. The rise of populism, however, still warrants concern as increased protectionism and geopolitical instability pose a risk to the short-run outlook. In the long run, populist policies could undermine political and economic institutions that are crucial for long-run growth prospects.

LEADER AND SUMMARY

4

The euro area recovery is gaining speed. Households have deleveraged after the financial crisis and the euro crisis. They are enjoying a firming labour market. Employment is growing at 1.7% in annual terms, which helps boost disposable incomes and household consumption. Firms are investing, and exports have picked up markedly. France, Spain, and Germany are all expected to deliver growth at 2% or above in 2018. The firming labour market has been slow to deliver higher wages, and core inflation remains low. Still, the ECB is sending increasingly upbeat signals, and asset purchases have been scaled back. Towards the end of the year, we expect QE to stop, and rate hikes to start in the second quarter of 2019.

The US labor market remains robust, and the temporary factors that pushed down inflation in 2017 will be reversed in 2018. This year, Jerome Powell, nominated to replace Yellen as Chair of the Federal Reserve, is expected to stay on course and deliver three rate hikes. The US midterm elections towards the end of the year ensure that politics will remain in focus. The US administration’s attacks on the judicial system, the democratic process, and the free press in the United States risk harming the political and economic institutions important to growth.

Growth is rebounding in several of the larger emerging economies. In Brazil, the economic recovery, supported by higher global commodity prices, is expected to continue in 2018-2019. The Russian economy stalled in the second half of 2017, mostly due to weak manufacturing. The upward trend in the oil price, however, is benefitting Russia, and we expect growth to reach about 2% in 2018-2019. In India, the temporary negative effects of reforms in 2017 have seemingly begun to wear off, and growth is set to rebound in 2018-2019. In China, growth is stabilising around 6.5% as the country benefits from stronger export growth; meanwhile, the transition towards a more services- oriented economy is progressing.

The Nordics are all benefitting from stronger growth in the euro area. In addition, trade flows among the Nordic and Baltic countries are strong, reinforcing a positive feedback loop. Notably, Finland is growing at a ro-bust 3%. Denmark is still lagging somewhat, with growth expected to be

Euro area coming out of a 10-year slump

Federal Reserve raises rates as US business cycle is maturing

Emerging markets show better growth prospects

Nordics and Baltics enjoy strong export demand, but domestic fac-tors pose a risk

LEADER AND SUMMARY

5

about at 2% in 2018-2019. Sweden and Norway are enjoying high levels of growth, but both countries face risks in terms of the cooling down of the housing market. The Baltics are benefitting from high productivity growth, strong exports, and high domestic demand. This bodes well for these countries, which are progressing well to catch up with the Nordics in terms of GDP per capita. For the Baltics and Sweden, Swedbank’s new Sustainability Indicators (see p.22) provide a comprehensive review of structural preconditions for medium-term growth and progress towards the UN Sustainable Development Goals.

The risks to the economic outlook stem predominantly from political fac-tors. High indebtedness and asset price correction, e.g., in the US, follow-ing years of low interest rates, also pose a risk. Many European countries remain heavily indebted. In China, it is the corporate sector that needs to deleverage, whereas in Sweden and Norway household debt has risen, a risk to growth if the labour market were to unexpectedly weaken and the fall in housing to accelerate. We expect, however, the current downturn in the housing market to stay contained to the larger cities in both Norway and Sweden and have limited effects on overall growth (see p.24).

In terms of political uncertainties, heightened geopolitical tensions, such as an escalation of the US-North Korea tensions, or in the Middle East, pose a risk. Turkey is in a geographically sensitive area, and an escalation of conflicts in this region could affect stability in Europe. The Italian elec-tion in March could cause market turmoil, but, overall, we judge that the risks related to the election have diminished. Another risk is populism and potentially weaker institutions in the US and parts of Europe; this could shift global power towards less democratic nations. This will not slow near-term growth, but it remains a threat to long-run prospects for well-being.

Swedbank’s global GDP forecast1/ (percentage change)

2016 2017F 2018F 2019F

US 1.5 2.3 (2.2) 2.6 (2.2) 2.0 (1.7)EMU countries2/ 1.8 2.5 (2.3) 2.3 (2.1) 1.9 (1.8) Germany 1.9 2.5 (2.3) 2.4 (2.2) 2.0 (1.8) France 1.1 1.9 (1.8) 2.1 (1.8) 1.9 (1.9) Italy 1.1 1.5 (1.5) 1.4 (1.3) 1.2 (1.1) Spain 3.3 3.1 (3.1) 2.7 (2.6) 2.2 (2.3) Finland 1.9 3.1 (2.8) 2.5 (2.2) 1.9 (1.8)UK 1.9 1.8 (1.6) 1.6 (1.5) 1.6 (1.6)Denmark 2.0 2.0 (2.4) 2.0 (2.2) 2.0 (2.0)Norway (mainland) 0.9 1.9 (1.8) 2.1 (1.8) 1.5 (1.4)

Japan 0.9 1.8 (1.6) 1.4 (1.3) 0.9 (0.8)China 6.7 6.9 (6.7) 6.6 (6.6) 6.3 (6.3)India 7.9 6.5 (6.3) 7.3 (7.3) 7.6 (7.9)

Brazil -3.5 1.1 (0.9) 2.5 (2.7) 2.4 (2.4)

Russia -0.2 1.6 (2.0) 2.3 (2.3) 2.0 (2.0)

Global GDP in PPP 3/ 3.3 3.7 (3.6) 3.9 (3.8) 3.7 (3.7)

1/ Previous forecast in parentheses. 2/ Calendar adjusted.3/ IMF PPP weights (revised Oct 2017)

Sources: IMF and Swedbank

Risks to global outlook still stem from political factors and high indebtedness

UNITED STATES

6

As expected, US growth turned higher in 2017 after a weak start. For 2017 as a whole it is expected to reach a healthy 2.3%. We have revised our growth forecast notably higher in coming years, partly because 2018 has begun with a tailwind. The tax reform that Congress passed just before the holidays should, moreover, provide a fiscal stimulus in 2018. The tax cuts boost our 2019 GDP forecast as well. On the other hand, the medium-term impact of the reforms is likely to be negative, partly because the reforms exacerbate the already large fiscal challenges.

Consumer spending, which represents about two-thirds of US GDP, has continued to grow at a good speed, and consumer confidence remains high. Growth will probably hold steady in the light of wage increases and tax cuts, although rising inflation and interest rates will be mitigating factors. Changes to social programmes (“entitlements reform” in US parlance) are a risk factor. Business investment picked up in 2017, and investment plans remain expansive. The tax reform, which includes lower corporate tax rates, is likely to provide further support. We see investment contributing more to GDP growth going forward.

Full employment has essentially been reached in the US. According to many indicators, one would have to go back to the early 2000sto find a similar situation in the labour market. Unemployment has hit a 17-year low, while the job vacancy rate remains at levels also not seen since 2001. Companies are having a hard time recruiting at the same time even though they want to hire. While it is true that jobs are still being created at a high pace, labour shortages will become a more pronounced concern in the not too distant future. The missing link is low wage inflation. While there are signs of acceleration, this is from a low rate. Inflation was also low throughout 2017, though it, too, seems to be gradually rising. We believe that the PCE (personal consumption expenditure) deflator, the Federal Reserve’s preferred measure of inflation, will clearly rise, starting this spring. Growth is also expected to speed up. Against this backdrop, we now expect the Federal Reserve to raise the target interval for the federal funds rate three times in 2018.

Uncertainty revolving around US politics, including economic policy, remains high. Controversy continues over the possible collusion of the President and his close associates with Russia, and over how business is being handled at the White House. The recent government shutdown is a further symptom of the political polarisation. On top of this, a midterm election will be held in November. The entire House of Representatives and one- third of the Senate are up for re-election. While indications are that the Democrats will see gains, this does not necessarily mean there will be a power shift on Capitol Hill.

US – Tax reform gives short-term boost

The economy is enjoying a strong momentum with cheerful consumers and investment plans suggesting that growth will turn higher. Tax reform provides a further stimulus. The Fed will be raising its policy rate at a slightly quicker pace. Political uncertainty remains, especially leading up to the midterm election.

Growth forecast revised higher, but tax reform will produce only a short-term stimulus

Consumption and investment are jointly driving the US economy

A tight job market and rising inflation will encourage the Fed to continue with policy tightening

Political uncertainty remains as attention turns to the midterm election this autumn

EUROPE

7

Euro areaThe economy is firing on all cylinders and continues to surprise positively. Annual GDP growth accelerated to 2.6% (seasonally and calendar adjust-ed) in the third quarter of 2017 – the fastest growth rate in more than 6 years. Leading indicators are pointing towards continued strong growth momentum this year. The composite PMI increased to 58.1 in December– the highest level in almost 7years, while the economic sentiment indicator reached its highest level in 17 years.

Growth last year was supported by recovering global demand and, thus, strong export growth. Rising trade volumes boosted industrial confidence to all-time highs in December. Export order-book levels continued rising despite the recent euro appreciation; however, “Ifo” export expectations moderated somewhat towards the end of last year. We expect export growth to ease somewhat this year, not least due to deteriorating price competitiveness, but also due to looming capacity constraints and, especi-ally, large labour shortages in numerous EA countries.

After a temporary setback, growth in investment picked up in the third quarter. Productive investments, like those in machinery and equipment, exhibited the fastest growth. Supported by improved corporate balance sheets, still-cheap credit, high global demand, and high capacity utilisa-tion rates, growth in business investments is expected to accelerate this year. However, unexpected turns in political events remain the main risk to higher investment growth.

Euro area glitters while UK sputters and stutters

Strong and broad-based expansion in the euro area (EA) was a welcome surprise last year. The economy is expected to sustain the momentum this year, before decelerating in 2019. The ECB will end its asset purchases in September and will start hiking rates gradually in 2019. Brexit uncertainties continue to loom over the UK economy, but the Bank of England (BoE) will again react to the persistently overshooting inflation and hike rates.

EA economy – firing on all cylin-ders

Export growth will ease somewhat on the back of appre-ciating euro and serious capacity constraints

Picking up investment growth – additional pillar to economic growth

EUROPE

8

No asset purchases beyond September; expect first hikes next year

Households are ripe for a splurge; wage growth to pick up

BoE responds to overshooting inflation and will hike rates again despite Brexit worry

Household consumption picked up as well, supported by an improving la-bour market and rising consumer sentiment. Growth in private expenditure is expected to rise further this year - the lack of labour will finally translate into higher wage growth, while the continued economic recovery will boost employment growth. Meanwhile, reduced leverage and increased housing wealth will limit consumers’ caution when opening their wallets.

Considering all the aforementioned factors, core inflation is expected to pick up to 1.2% this year, while higher oil and other commodity prices will help push headline inflation to 1.6%. Inflation will be much closer to the ECB’s target; thus, the governing council will not have enough arguments to extend asset purchases beyond this September. This intention can already be witnessed in comments by some high ECB officials. The ECB may formally drop a pledge to keep QE open-ended as early as the March meeting. We forecast that core inflation will increase to 1.6% in 2019 and the ECB will gradually start raising its main refinancing rate in the second quarter of 2019.

United KingdomAfter an initial setback in 2017, growth regained strength but is still below previous years’. Private consumption rebounded in the third quarter, but the data probably are erratic, and the underlying pattern of a slowdown, given weak real income, persists. Despite moving forward in Brexit nego-tiations companies’ expectations have fallen, and business investments may be modest due to remaining uncertainties. Stronger global demand and a weak sterling; however, support export growth and dampen the investment downturn. At present, Brexit negotiations are protracted, and it seems that some former supporters have doubts and regrets. The best and most likely outcome for the UK is a transition period during which it will stay an EU member. However, we expect the deals to be agreed upon in the last minute, and the UK will probably have to give in to EU demands. Assuming an orderly Brexit and persistently overshooting inflation, the BoE will hike the Bank rate again this year.

ASIA AND EMERGING MARKETS

9

JapanEconomic growth will remain above potential in 2018-2019, supported by healthy global growth and an expansive monetary policy. Exports and investment will remain supportive and consumption should strengthen, once real wages start growing. Economic growth is expected to slow as compared with 2017 due to capacity constraints. In 2019, retail sales will be affected by a planned sales tax hike. Inflation is slowly accelerating but is not even half way towards the central bank’s target; therefore, a hike in interest rates remains distant.

ChinaGrowth stabilised in 2017, and it is expected to gradually fall going into 2018-2019. We also expect that the renminbi will stabilise in 2018 and app-reciate in 2019. As exports turned higher in 2017, China’s need for a weaker renminbi decreased. In the longer term, China aims to increase the global use of its currency, as well as its capital inflows. The Chinese leadership is therefore pleased with the stabilised renminbi.

Supply-side reforms that resulted in increased industrial profits translated into a stabilisation of total credit growth in 2017. The Financial Stability and Development Committee held its first meeting in November, addressing the priority task of risk prevention. Total debt stabilised during 2017 and deleveraging is progressing, though this remains at an early stage. The new aim is to direct credit towards more productive sectors. The formerly over-heated housing market has cooled. Growth rate targets are now slightly compromised in favour of more sustainable growth.

With the trade surplus against the US once again trending upwards, the risk for renewed trade frictions has returned in 2018, especially given the app-roaching midterm elections in the US, where this development may serve as an electoral issue. Currently, this issue, as well as the situation with North Korea, poses a risk, in addition to the evolving outlook on financial stability in the Chinese economy. President Xi Jinping further consolidated his power at the 19th National Congress of the Communist Party of China in October 2017.

India We expect that the growth dampening in 2017 will be reversed in 2018-2019. Third-quarter data showed that growth had returned, suggesting that, the temporary negative effects of tax and demonetisation reforms in the beginning of 2017 have begun to wear off. Inflation seems to have

Asia/Emerging Markets – Stabilisation in ChinaGrowth is returning in several of the larger emerging economies. In China, growth is stabilising near the new, more sustainable growth target. Economic recovery continues in Brazil and Russia. In Japan, growth will continue above potential, though at a slower rate in 2019 as compared with 2017. In India, the temporary negative effects of reforms in 2017 have seemingly begun to wear off. The possibility of renewed US-China trade frictions and the situation with North Korea pose a risk, along with the outlook for Chinese financial stability.

Growth in Japan will slow in 2019 as compared with 2017

Growth stabilising in China with new sustainable focus, but financial stability still a risk

Growth returning in India after ne-gative effects of reforms in 2017, but credit growth is still weak

ASIA AND EMERGING MARKETS

10

Russian recovery stalled in second half of 2017, but to resume in 2018

Recovery on the way in Brazil, but the general election in October poses a risk to growth

bottomed out. The Reserve Bank of India, therefore, kept its policy rate unchanged at the latest meeting in December. On the positive side, the government proposed a plan in October to recapitalise the fundamentally weak banking sector, aimed at addressing the limited lending capacity and weak credit growth. Furthermore, the credit rating institute Moody’s un-expectedly increased its rating for India in November. On the negative side, the recovering oil price is weakening India’s terms of trade.

Brazil The recovery that began in 2017 was supported by higher global commo-dity prices, and we expect that it continues in 2018-2019. In 2017, exports turned up, which supported industrial production and growth. At the same time, fiscal cuts addressing the growing public debt have further weakened households in an economy with high unemployment and falling wages. Low inflation has raised real wages, though, offering households and private consumption some support. However, with an overall lower domestic de-mand, investments have declined. To address the low inflation and further boost a weak but recovering economy, the Central Bank of Brazil lowered its policy rate by 6.75 percentage points in 2017. Political turbulence stem-ming from political leaders’ involvement in corruption scandals remains; this continues to halt the reforms, e.g., the budget-heavy pension reform, requi-red to meet the budget deficit target. With the general election coming in October, the challenge of passing necessary and efficient reforms will likely increase, presenting a risk to growth.

Russia The recovery stalled in the second half of 2017, mostly due to weak manu-facturing. Hence, we cut the 2017 real GDP growth estimate to 1.6% (from 2%) but retain 2-2.3% growth for 2018-2019. Other sectors are slowly im-proving: construction is bottoming out, the investment rebound continues, and the tighter labour market supports retail. With inflation at a historic low of 2.5%, the Central Bank of Russia will continue to ease, cutting its policy rate from the current 7.75% to 6.5% by end-2018. The banking troubles have so far had a minor impact on other sectors. Watch out for the risk of new, individually targeted sanctions after the US Treasury report in February. Putin will be re-elected President - no change in foreign policy expected.

SWEDEN

11

Prospects for Swedish growth are good in the short term. Employment con-tinues to rise, fiscal policy is expansionary, with hefty spending on families with children and pensioners, and the global economy continues to make progress. This suggests that the Swedish growth rate will stay high this year, even as housing investment declines.

Lower house prices of late and general uncertainty about the housing mar-ket are expected to continue. A large supply of new housing in 2018 and the stricter amortisation requirements mainly affect metropolitan areas, whe-re prices could fall further, mainly for tenant-owned flats. But with a solid increase in disposable incomes and a strong job market, we see house prices stabilising for Sweden as a whole in 2018. For single-family homes outside metropolitan areas, we expect a slight price increase this year.

A subdued housing market is affecting GDP growth through fewer housing starts. The decline in housing investment is cushioned, however, by in-vestments in renovations and the completion of building projects begun in 2016-2017, which are generating investment throughout the construction process. It is not until 2019, therefore, that we will see the impact of lower construction, when we estimate housing investment will drop by nearly 2% on an annual basis. The Swedish economy has thus timed the global economic turnaround well, especially since it supports business invest-ment, which had already turned higher last year – a trend we anticipate will continue.

Sweden – Soft landing due to strong exports

Last year ended with positive economic signals from outside the country and rising global growth - both of which are benefitting Sweden. The industrial pro-duction has accelerated at the same time as the services sector is staying strong. Yet, 2018 contains several domestic uncertainties. Will the Riksbank raise the repo rate this year? What will happen to the housing market? 2018 is also an election year – how will that affect financial markets and the economy?

The Swedish economy stands strong, and a notable slowdown in housing investment is not antici-pated to have a significant effect this year

Lower housing investment is com-pensated for by robust business and public investment

SWEDEN

12

Exports turn higher thanks to improved global demand and favourable mix of goods

The heyday for consumers is not over yet – good disposable income, partly thanks to strong labour market

Internal and external security, education, and health care will top the agenda in this year’s parliamentary election

A fragmented parliament and dif-ficulty forming a strong govern-ment are a likely outcome after the election

To achieve sustainable develop-ment, Sweden has to speed up its reform process

Stronger global economic conditions and a favorable mix of investment and intermediate goods will pave the way for higher export growth in 2018. In 2018 and 2019, foreign trade is expected to positively contribute to GDP, as exports grow for more sectors, while domestic demand slows. The challenge for exporters will be to address likely higher unit labour costs and a slightly stronger krona in 2019, which will make them less competitive.

In the annual budget, spending increases were targeted at, among oth-ers, pensioners and families with children – i.e., households with a high propensity to consume. In combination with a strong labour market and inflation that is staying just above target, we expect a generally strong trend in disposable incomes this year. We see good consumer spending growth, which shifts over to housing and “necessities”; at the same time, service consumption will stay robust. Instead, it is spending on durables that will lose ground, with car sales leading the way. Another reason for the slowdown is the very high savings rate. An increase in amortisations, high contractual savings, given the labour market’s strength, and an aging population will support savings in the near term.

Despite the expansionary fiscal policy this year, Sweden has a large budget surplus. We expect public investment to stay at high levels as defense spending grows. In addition, demographic factors and a population increase are contributing to continued high investment in municipalities and county councils. These entities are also expected to continue raising their spen-ding, since most new immigrants who arrived in 2015 have by now been placed in municipalities. Public services catering to this group will therefore count as municipal consumption rather than central government consump-tion.

A parliamentary election will be held in September. Recent polls indicate that voters are split. A complicated outcome is likely. In light of the govern-ment’s strong finances, this could mean more expansionary fiscal policy than usual after an election.

The turmoil around the world in recent years has proved that political events can be just as important to the financial markets as statistics and rate decisions. The Swedish election is not expected, however, to provi-de the same drama as those in the UK and the US. In the short term, it is

SWEDEN

13

unlikely that the Swedish election will affect economic development or the financial markets at all. Instead, the risk is that a divided parliament will not be able to get the needed reforms done. A poorly functioning housing market, slow integration of immigrants, and an education system that does not match the needs of a competitive economy are all major challenges. Swedbank’s new “Sustainability Indicators” (see page 22) clearly show that Sweden has to speed up the reform process to achieve sustainable develop-ment.

Repo rate hike in sight The rest of the world is firing on more cylinders, at the same time that do-mestic resources are being stretched. Compared with the picture the Riks-bank painted a year ago, when risks were mainly negative, this is entirely different. Wage increases picked up slightly last year and will continue to rise in 2018 and 2019. The combination of an increase in other labour costs with a labour force that is getting only marginally more productive means that unit costs will rise in coming years. This increase, combined with higher oil prices, will contribute to rising price pressure in 2019. We estimate that inflation will reach 2% at the end of next year after falling in 2018 due the comparatively high inflation during the same months in 2017.

We think the Riksbank is ready to raise the repo rate even if inflation this spring temporarily stays a bit below the 2% target. An upward inflation trend, coupled with cautious tightening by global central banks, supports this course of action. Taken together, we therefore see the repo rate being raised in July to -0.40%. In October, the rate is expected to be raised again, to -0.25%, to be followed with three hikes of 25 basis points each in 2019.

The Riksbank is likely to announce its first rate hike in July

NORDIC S

14

NorwayGrowth in the Norwegian economy has picked up significantly as the down-turn in the oil sector has ended. Oil investments and manufacturing produc-tion stabilised last year, and surveys now indicate growth. This outlook is supported by rising oil prices in recent months. With strong global demand and a weak Norwegian krone, tourism and other export-related businesses will continue to grow. Unemployment is falling, consumer confidence is rising, and household demand has gained in strength even as house prices fall.

House prices fell through most of last year, but mostly for apartments in the three largest cities; meanwhile, prices in areas outside the cities are actually rising. This suggests developments are not the start of a broad downturn in the housing market, but rather a function of high construction activity, as well as tighter credit constraints. Recent data show that both existing home sales and credit growth are keeping robust, indicating strong demand.

Nordic countries – Continue to improveThe economies of the Nordic countries continue to improve. Growth in the Norwegian economy has strengthened even as house prices fall. Household demand and a tightening labour market are bolstering the Danish economy. Improved price competitiveness is contributing to Finland’s export growth, while robust private consumption comes in support of a diminishing saving rate. The Nordic economies continue to gain from stronger growth in the euro area.

Growth has strengthened even as house prices fall

NORDICS

15

Growth outlook is good

Capacity utilisation is rising but no signs of overheating

Several policy issues must be addressed to ensure continued growth and stability

We judge the longer-term fundamental factors as sound and supported by improving macroeconomic developments; however, we expect apartment prices to decline further in the short term in the major cities as many units under construction will be completed. New home sales will take time to pick up, and, as a consequence, construction activity will peak and likely dampen GDP growth going forward. But we expect other parts of the economy to remain strong, such that overall GDP growth will keep up quite well.

DenmarkThe Danish economy has enjoyed robust growth in recent years on ac-count of household spending, business investments and growing exports. The expansion looks set to continue, due to high consumer confidence and improving business barometers. The export outlook remains good as growth has strengthened further in the euro area. Employment continues to expand. We see the reported fall in GDP in the third quarter of last year as transitory and expect growth to remain at 2% in the years ahead.

Falling underlying unemployment is evidence of higher capacity utilisa-tion. Signs of a shortage of labour have become more widespread but are not acute. Wage growth remains modest, just as in many other countries. Although total consumer price inflation has been below 1% most of the time since 2013, it rose over the past year towards 1.5% on account of higher energy prices. We expect inflation to be sustained by gradually tighter conditions in both product and labour markets as resources become increasingly scarce.

To ensure continued growth and stability in the coming years, the govern-ment must address several policy issues. It is critical to stimulate labour supply, otherwise fiscal policy will have to be tightened more to keep the economy from overheating. The continuing house price growth and high household indebtedness raise concerns for financial stability. The govern-ment has enacted several measures to dampen house price growth and reduce vulnerabilities, but more can be done with respect to taxation, valuation schemes, and macroprudential policies.

Lower housing construction acti-vity will dampen growth

NORDICS

16

Finland In 2017, economic growth in Finland accelerated to 3.1%, the fastest pace of the last nine years. Production capacity and the turnover of Finland’s business sector have expanded, whereas improved price competitiveness and stronger foreign demand are contributing to export growth. Although demand from Finland’s trade partners peaked last year, it is expected to remain relatively strong in 2018 and offer good growth opportunities for exporting sectors. Increased new orders in manufacturing confirm the continuation of export growth momentum, at least in the short term.

Investment growth in construction is decelerating, while foreign demand, the expanded production, and several major industrial projects will maintain robust growth in private investments. Private consumption has increased at the expense of households’ diminishing saving rate. Increased consumer confidence, gradually rising employment, and decreasing unemployment rates are expected to keep household consumption strong this year, but wage moderation and gradually accelerating inflation will slow it down in 2019.

According to our forecast, Finland’s GDP growth decelerates to 2.5% in 2018 and to 1.9% in 2019. The strong economic growth and comprehen-sive reforms will help to reduce Finland’s government debt and budget deficit in the coming few years, but the increased expenditures related to the ageing population will be a major challenge for public finances from the longer-term perspective.

Export outlook for Finland rema-ins favourable in 2018

Private consumption maintains good growth in 2018

Longer-term perspective of Fin-land’s public finances is challen-ging

BALTICS

17

EstoniaEconomic growth in Estonia accelerated to 4.4% in 2017, the fastest pace since 2011. The growth was broad based and supported both by foreign demand and economic activity on the domestic market. Stronger economic activity has increased the demand for labour. At the same time, the number of job vacancies has risen, and the shortage of labour has become an increa-singly serious problem.

We expect that GDP growth will remain strong in 2018, increasing to close to 4% in real terms. Robust foreign demand and rising export prices are allowing Estonian enterprises to increase their export turnover. The govern-ment sector will continue to raise its investments with the support of the EU structural funds. However, at this point in the growth cycle, such a strong fiscal stimulus to the Estonian economy is wrongly timed.

Robust demand and increased investments contribute to productivity growth. Although the tight labour market will maintain fast wage growth, the changes in income taxation could lower wage growth expectations. We expect that productivity growth will exceed wage growth in 2018 and 2019. This will help to improve Estonian enterprises’ profitability and slow the deterioration of their price competitiveness against trade partners. The households’ financial situation is expected to remain strong. Average pur-chasing power of households will improve with the support of the increase in their nontaxable income, and this should give stronger momentum to the growth of private consumption in 2018.

In 2017, economic growth in Esto-nia accelerated to the fastest pace of the last five years

We expect that GDP growth will remain strong in 2018

Robust demand and increased in-vestments contribute to produc-tivity growth

Baltic countries – peaking growth, but balanced and resilientGrowth has peaked for this cycle, but it will remain above potential this year before slowing to more sustainable rates in 2019. Exports and investment will continue to benefit from global tailwinds. Domestic demand will increasingly contribute to growth. Labour markets will keep tightening, but rising productivity partly helps to outweigh strong wage growth. Inflation has accelerated due to global commodity price growth, local tax hikes, and wage growth.

BALTIICS

18

Broad upswing continues; do-mestic demand takes over as key driver of growth

Strong investment activity to continue to limit labour market pressures and cover for past underinvestment

Tight labour market and pro-cycli-cal fiscal policy to boost consumer spending

We forecast that GDP growth will decelerate to 3% in 2019, primarily due to cyclical factors. Because of the openness of the Estonian economy, the main downward risks to the current baseline scenario are related to the external environment.

LatviaThe strong cyclical upswing continued in Latvia throughout 2017 and into 2018. Real GDP growth of 5.8% in the third quarter was the peak of the cycle. Confidence is robust across the board. With the business cycle maturing, growth will go downhill but in 2018-2019 will still remain strong and above its medium-term potential of 2.5-3%.

All sectors are expanding, except for financial intermediation (transitory fall caused by offboarding of nonresidents due to tighter know-your-client and anti-money-laundering regulations) and agriculture (hurt by rainfall). Heavy rainfall hampered log supplies to the wood processing industry in 2017, which may weaken exports in early 2018, but, with strong global demand continuing, the general outlook for exports of goods and services is good, and we forecast solid 4-4.5% volume growth in 2018 and 2019.

Gross fixed capital formation has shot up by 20%. About 40% of the rise is likely due to Air Baltic’s renewing its fleet; thus, the investment recovery for the overall economy is less spectacular. High capacity utilisation, inflows of EU funds, and an upturn in the mortgage credit cycle will yield double-di-git investment growth also this year and the next. Construction, which was the fastest-growing sector in 2017, will remain such in 2018.

The labour market remains the hotspot of this business cycle. In 2017, the growth in wages was matched with a rise in productivity, but productivity is unlikely to keep up the pace, and risks to competitiveness will build up. Tighter labour market supports consumer spending, which in 2018 will be additionally boosted by a rise in the minimum wage (up 13%) and labour tax cuts. Fiscal policy is mildly pro-cyclical as politicians gear up for the October 2018 general election. We do not foresee major U-turns in economic policy post-election, but with the election approaching, the reform agenda is likely to suffer. No major imbalances are present, and strong growth is set to continue. Hence, do not worry, be happy… for now.

Growth peaked at 3.8% last year and is set to ease towards potential output

Household consumption growth is being dragged down by demo-graphics, but the worst of emigra-tion is in the past

LithuaniaThe Lithuanian economy remained on strong footing at the end of 2017 and probably expanded for the year at a rate of 3.8%. The main source of growth last year and in the final quarter was an impressive expansion of foreign trade – estimated real annual growth of exports of goods and servi-ces was 12%. Even more impressive was the growth of exports of services last year, when its value increased more than 20%. Investments grew slightly more slowly last year – at an estimated 7% - but this was still a nice recovery after the contraction in the previous year. During the past two years, investments were dragged down by the public sector, but it seems the trend has been broken – nominal public sector investments increased by 25% in the third quarter of last year. Investments are likely to continue boosting overall GDP growth in 2018, as the pace of distribution of the EU structural funds finally picks up.

Household consumption increased by an estimated 4% last year. Although consumption growth somewhat eased in the second half of last year, it is expected to continue growing at a similar pace in 2018. Overall household consumption is dampened by negative demographic trends, but, on an individual level, most households are doing fine – average wage growth was close to 8% last year. Emigration seems to be easing, while immigration continues picking up. In December 2017, for the first time in this century, immigration was higher than emigration. Even though this may have been a blip, the worst of net emigration is in the past.

The overall economy remains very well balanced and resilient. Foreign trade was close to a record surplus last year – at 1.9% of GDP – while the current account was in balance. The general government budget was in surplus for the second year in a row and is planned to remain in surplus again in 2018. The private sector has very low debt-to-income ratio, while housing affordability and other indicators show that there are no bubbles in the residential real estate market. Unlike in 2008, the private and public sectors are very well positioned to withstand even large external shocks.

BALTICS

19

EXCHANGE AND INTEREST RATES

20

Central banks’ cautious normalisation of policy continuesThe US central bank, the Fed, has begun normalising monetary policy by raising the federal funds target 125 basis points (bp) since its post-crisis low. The central bank has also started reducing its bond holdings. We expect this to continue in the near term, and, with a slightly more ”hawkish” FOMC committee, we foresee that the Fed will increase its policy rate three times in 2018. This is a slight upward revision compared to our previous forecast. A somewhat higher inflation rate, combined with the tight labour market, will be a central focal point for the Fed. A pickup in economic growth within the euro zone will also make the ECB slightly more hawkish, and we expect the ECB to end net asset purchases by September. The ECB will continue to focus on inflation developments and the strength of the recovery, as well as the euro exchange rate. The Riksbank will maintain an eye on the krona ex-change rate and imported inflation. However, we expect that the Riksbank will begin lifting the repo rate in mid-2018. It will start cautiously, with a hike of 10 bp, followed by a further hike in October of 15 bp, thereby ending the year with a repo rate of -0.25 percent. In 2019, we foresee three hikes of 25 bp each.

Monetary policy sets tone in fixed-income marketsThe central banks’ varying pace in normalising monetary policy will be the key factor affecting long-term interest rates. In the short term, we expect yield curves to steepen as short-term rates are anchored by policy rates. Thereafter, as policy rates are raised, we expect yield curves to flatten aga-in. The differences in timing of the central banks’ actions will be important to determine interest rate spreads and curvature developments. Throug-hout the forecasting horizon, long-term interest rates will, however, remain low by historical standards. Swedish government bond yields will also be held down by a limited free float of bonds. In terms of peripheral spreads, the political risks in Europe have diminished, and the cyclical upswing in the euro area has gained momentum. Nonetheless, one should not completely rule out the political risk, which could widen peripheral spreads.

Policy rate differentials and short-term market rates affect ex-changes ratesCentral bank policy also continues to be the major driving force in the cur-rency markets. In the short term, interest rate differentials will support the US dollar, although recent strong developments in euro area and a slightly more hawkish ECB will limit the downside in the euro-dollar movements. In the longer term, we foresee a gradually strengthening of the euro. As the Riksbank will begin to raise the repo rate, we also expect the Swedish krona to strengthen. The Norwegian krone will stabilise in the near term, suppor-ted by a higher oil price and stabilising house prices. Uncertainty surroun-

Exchange and Interest RatesThe policy direction of central banks is clear: a gradual removal of policy stimu-lus has begun. This normalisation is expected to continue and will affect market interest rates, as well as exchange rates. Interest rates are rising, and we see a progressively stronger krona, as well as euro, during the forecast period.

The Riksbank will start hiking rates very cautiously

Raising long-term rates, but rates will stay low by historical standards

Gradual strengthening of the krona and euro

ding Brexit will cloud the outlook for the UK pound. We moreover expect emerging market currencies to strengthen gradually, supported by brisker global growth and higher commodity prices.

Commodity marketsThe oil market returned to balance last year, and stock levels continue to decline. Stronger global demand and continued production restraint in OPEC and Russia have driven up the Brent oil price to almost 70 USD/barrel. Increased tensions in the Middle East have also contributed to push up pri-ces. We have revised up our estimates for the oil price to 64 USD per barrel in 2018 and 59 in 2019, as US shale oil is now growing at a high rate again and US petroleum exports are booming. At the same time, investments in conventional production have been severely reduced, and the production shortfall could turn out to be larger than expected.

Interest and exchange rate forecasts

Outcome Forecast2018

18.JAN2018

30.JUN2018

31.DEC2019

30.JUN2019

31.DEC

Policy rates (%)

Federal Reserve, USA 1/ 1.50 1.75 2.25 2.50 2.50

European Central Bank 2/ 0.00 0.00 0.00 0.25 0.50

Bank of England 0.50 0.50 0.75 1.00 1.25

Riksbank -0.50 -0.50 -0.25 0.00 0.50

Norges Bank 0.50 0.50 0.50 0.75 1.00

Bank of Japan -0.10 -0.10 -0.10 -0.10 -0.10

Government bond rates (%)

Sweden 2y -0.34 -0.10 0.35 0.70 0.90

Sweden 5y 0.26 0.65 1.25 1.45 1.55

Sweden 10y 0.86 1.15 1.60 1.90 2.00

Germany 2y -0.59 -0.45 -0.10 0.35 0.65

Germany 5y -0.12 0.10 0.60 1.05 1.35

Germany 10y 0.52 0.80 1.20 1.65 1.85

US 2y 2.05 2.20 2.60 2.65 2.65

US 5y 2.43 2.75 3.00 3.10 3.10

US 10y 2.62 3.00 3.20 3.30 3.30

Exchange rates

EUR/USD 1.22 1.20 1.22 1.24 1.25

EUR/SEK 9.81 9.50 9.35 9.25 9.10

USD/SEK 8.03 7.92 7.66 7.46 7.28

KIX (SEK) 3/ 112.8 109.6 107.4 106.1 105.7

EUR/NOK 9.60 9.41 9.17 9.07 9.01

NOK/SEK 1.02 1.01 1.02 1.02 1.01

EUR/GBP 0.88 0.92 0.94 0.94 0.92

USD/CNY 6.44 6.60 6.55 6.60 6.50

USD/JPY 110.3 115.0 115.0 120.0 115.0

USD/RUB 56.8 55.0 53.0 51.0 50.01/ Upper Bound2/ Refi Rate 3/ Trade-weighted exchange rate index for SEK. A higher value of the index means that SEK has depreciated.

Sources: IMF and Swedbank

EXCHANGE AND INTEREST RATES

21

Oil prices have risen as demand strengthens

IN-DEPTHS

Sustainability indicators

Swedbank has developed a new methodology, Sustainability Indicators, to monitor the progress towards the 2030 Agenda. There is much unused business potential in Sweden and the Baltics in advancing sustainability, e.g., in making the transition to cleaner and more energy-efficient economies. The aim is to support business looking at ESG (environmental, social, governance) criteria and help to identify weaknesses and strengths in Sweden and the Baltics. We find that Sweden has to speed up to remain among the leaders in Europe, while the Baltics have a lot of catching up to do.

22

Progress towards UN SDGs, % of benchmark*Estonia Latvia Lithuania Sweden

Preconditions for sustainable medium-term growth1/ 71 61 64 90

Social inclusion2/ 56 55 55 89

Environmental protection3/ 58 72 70 82

Governance and institutions4/ 70 51 62 97

Downward/stable trend during last 5 years (4 years for governance) – ↓

* Benchmark is 90/10th percentile of EU28 in 2015. In total 40 indicators covering 14 from 17 SDGs, aggregated to four pillars. Cut-off points for traffic lights - Sweden: >90% for green, 70-90% for yellow, Baltics: >80% for green, 60-80% for yellow

1/ SDGs #4, 8, and 9: education, labour force participation, employment, and innovations2/ SDGs # 1, 3, 5, and 10: income and gender inequality, poverty, and health3/ SDGs # 6, 7, 11, 12, 13: water supply, energy intensity, renewable energy, sustainable cities, waste generation, and GHG emissions4/ SDGs # 16, 17: government effectiveness, rule of law, corruption perception, regulatory quality, AML, and official development assistance

Sustainable business is going mainstream worldwide. Demand for en-vironmentally friendly products and services is growing, as well as socially responsible investments, especially among millennials. There is also a push from new regulations and global arrangements (e.g., the Paris climate agreement). New business/investment opportunities in many sectors are being created as a result – renewable energy capacity is expanding, electric cars are soon to be the norm, big data are used for sustainability ratings of companies, and new finance instruments are being developed.

To assess long-run sustainability in Sweden and the Baltics and to see where the biggest potential for improvement is, we take the 17 UN Sus-tainable Development Goals (SDGs), a part of the 2030 Agenda, as a point of departure. We have selected 40 indicators, covering 14 out of 17 SDGs, and grouped them into four sustainability pillars: sustainable medium-term growth, social inclusion, environmental protection, and governance. To assess and compare progress in these areas, we use EU28 90th or 10th per-centiles (depending on whether a maximum or minimum is relevant) in 2015 as a benchmark and calculate how far the countries have come towards the benchmark. We calculate the average for each of the four pillars. We assign a traffic light colour, depending on how likely countries are to reach these benchmarks by 2030. This shows which areas require the biggest action and simultaneously provide the largest opportunities. A more detailed methodo-logy/analysis can be found in our Macro Focus here.

Focus on sustainable development creates many business opportu-nities

UN SDGs as a point of departure to assess sustainable development

https://www.swedbank-research.com/english/macro_focus/2018/january/sustainability_indicators_2018-01-23.pdf

IN DEPTH

23

Largest potential in environmen-tal protection in Sweden

Largest potential in social inclu-sion in Lithuania, environmental protection in Estonia, and gover-nance in Latvia

Peer pressure (sustainability as a part of a competitive offer) and policy pressure (sustainability disclosure) for the companies are growing. Among the potential benefits of integrating sustainability into business (including measuring sustainability-related performance) are the following:

• cost efficiencies (e.g., energy) and better risk management (legal claims and reputational risks);• innovation and productivity growth, leading both to cost savings and better revenue streams (access to new markets, new product deve-lopment); and• talent development and retainment (employee satisfaction and engagement, equal opportunities).

Opportunities, though, do not present themselves without risks. The ne-cessary shift to a low-carbon economy results in a reallocation of resources and a revaluation of assets, which can pose risks to financial stability and present challenges for regulators and central banks in safeguarding the resi-lience of the financial system and developing a proper framework to finance the transition. The shift itself does not come for granted – emission targets to moderate climate change are ambitious, and there are already backslas-hes in commitment from some politicians (read: Trump).

The Sustainability Indicators show that Sweden has to speed up to remain among the leaders in Europe. Three out of the four traffic lights are yellow, and the only green one, governance, shows a negative trend. Sweden enjoys high scores for social inclusion, but the situation with respect to income inequality and poverty has been worsening in the last few years. As for the growth pillar, education is a challenge – for some indicators, Sweden even lags some of the Baltic countries. For the environmental protection pillar, the largest improvements are necessary in the areas of resource productivity and waste generation.

The Baltic countries have a longer way to go. Still, the improvements, partly driven by economic recoveries, during the last five years in all pillars, except social inclusion, have been remarkable. The largest differences between countries are for the governance pillar, while the smallest differences and lowest scores are for the social inclusion pillar. Gender inequality seems to be a larger challenge for Estonia, while Latvia and Lithuania struggle more with income inequality, poverty risk, and maternal mortality. As for the growth pillar, innovations and lifelong learning for adults constitute the most pressing problems for both Latvia and Lithuania; meanwhile, in Estonia, the number of patents is very small despite higher R&D expenditure. For the environmental protection pillar, Estonia scores the worst on many indicators due to its polluting shale oil industry.

Overall, Swedbank’s Sustainability Indicators show that the state, civil socie-ty and business sector must work together for strengthened environmental protection and social cohesion in order to attain Agenda 2030. Long-term sustainable economic development goes hand in hand with better pre-con-ditions for a sound environment, social cohesion and strong democratic institutions.

IN-DEPTHS

The overall macroeconomic environment is favourable in Sweden and Norway. The global economy is enjoying a synchronised cyclical upswing, benefitting the Scandinavian economies. Strong labour markets and expan-sionary fiscal and monetary policy imply high growth in disposable income. Household confidence and consumption growth remain strong. The interest burden is a historically small share of income; it will remain small despite hou-seholds’ strong preference for floating mortgage rates and the anticipation of slowly rising interest rates. Banking systems in both countries are well capitalised and well supervised, with generally sound lending practices. In addition, strong public finances in both Sweden and Norway can be mobili-sed if push comes to shove.

The cooler housing markets in Sweden and Norway are thus not a consequ-ence of changes in fundamental demand. Instead, the downturn is primarily driven by the increase in supply and tightened macroprudential policies, limiting mortgage credit. As a result, the downturn is mainly concentrated in metropolitan areas, where new construction of, especially, flats is high, and debt-to-income ratios are the highest. For example, prices are down more than 11% from the peak in Oslo, while Stockholm flat prices have fallen 10 % from their seasonally-adjusted peak . Swedbank’s forecast for the year ahead remains that a stabilisation of housing prices is likely for the two countries as a whole. However, favourable external factors can shift. It is, therefore, important to assess risks in the Scandinavian markets.

Severe macroeconomic effects from the housing market downturns can generally be seen as emanating from three channels: (1) the impact on the banking sector from falling collateral values, resulting in a credit crunch; (2) the direct and indirect impact of a reduction in residential investment in the wake of uncertainty regarding prices; and (3) the impact of households reducing consumption as their preferences for savings increase.

First, although the conventional banking channel of transmission from the housing market to the real economy appears limited for both Sweden and Norway, authorities in both countries have in recent years tightened regulations on the banking sector. These include macroprudential policies that directly target mortgage lending. Most recently, Norway tightened limitations on mortgage lending in early 2017, while in Sweden higher amortisation requirements based on debt-to-income ratios will soon enter into force. These restrictions can, in a qualitative sense, be compared with a

Sweden vs. Norway housing – similar yet different

After years of strong growth, Norway and Sweden both saw a downturn in house prices in 2017. We expect that a large supply of new homes and tighter mortgage credit regulations will continue to dampen house prices this year. But the overall economic situation is good, and spillover effects to the real economy will be limited in both Norway and Sweden. However, favourable external factors can shift. Therefore, in terms of risks, differences in the housing markets suggest that the Norwegian economy is more vulnerable than its neighbour.

A shift in the market balance, with large supply of housing in both countries

Strong banking systems in both countries works as a buffer, but macroprudential tools may backfi-re in short run

24

IN-DEPTHS

Residential construction likely to slow, but large share of rental flats a mitigating factor in Sweden

Higher savings in Sweden than in Norway

25

credit crunch, as borrowers cannot access debt financing to the same extent, regardless of whether they can afford the running costs. Restrictions are substantial in both countries and are especially binding in metropolitan areas. However, they are arguably harsher in Norway, where enforcement is by strict limits as opposed to changed incentives. Thus, the potential impact on the economy is larger. In addition, a 40% down payment requirement on second homes in the Oslo area restricts the buy-to-let market, which helped fuel Oslo home prices.

Second, residential construction has been a formidable growth engine in recent years in both countries. In Norway, residential construction is at its highest in more than 30 years, and in Sweden construction has risen almost threefold in the last four years with a high concentration to flats. Swed-bank’s forecast is that new construction will slow in both countries in light of slower sales and capacity constraints. Concerns about oversupply and the risks of buying a new home in a market with falling prices may ampli-fy the slowdown. This will reduce the GDP contribution from residential investment going forward. A key difference between Sweden and Norway, however, is the latter’s much higher degree of homeownership. Sweden, on the other hand, has a much larger rental market: 62% of all flats (incl. special housing) and about half of newly constructed flats are rentals. In Norway, there are few designated rental flats, although there is a fairly large buy-to-let market. These factors arguably make the Norwegian economy more vulnerable to shifts in the housing market, as there are fewer buffers to withstand a slowdown in new construction.

Third, a key concern is that the housing downturn will slow consumption growth. A higher level of home ownership makes Norway more vulnerable in this respect, as any wealth and credit effects become more pronounced. Another central difference, which also suggests a higher vulnerability for Norway, is the savings channel. Sweden’s aggregate household savings rate of more than 15% is very high by both historical and international compari-son. (Abstracting from increases in real property values and pension schem-es, qualitative conclusions remain.) The Norwegian savings rates, however, are lower. On a cash-flow basis, they are in negative territory. Moreover, they have also declined notably since 2015. Hence, Norway appears more vulnerable to a substantial reversal in households’ preferences for savings over nonessential consumption.

Finally, we conclude that, if the housing downturn accelerates, both countri-es are vulnerable with high levels of household debt. Norway has more option to stimulate the economy with both monetary and fiscal policy, while Sweden arguably cannot lower interest rates much from today’s level. Still, Norwegian households are more sensitive to changes in housing wealth and savings are relatively low. It should be noted that in both Sweden and Nor-way household confidence levels have remained upbeat. Swedish confidence levels are at multiyear highs. Norwegian private consumption growth in 2017 showed not only resilience but strength.

IN-DEPTHS

Low real interest rates are closely linked to the increased global propensity to save. As global savings should equal global investment, a higher pro-pensity to save should push down the clearing price for savings, which is a lower real interest rate. In this connection, population and demographics are important for the propensity to save; moreover, savings will differ across the life cycle. Studies have found that a country’s propensity to save exceeds its propensity to invest when the ratio of the middle-aged working population (aged 35-64) is relatively high. These are the peak earning years for most workers, enabling them to save a lot of their income. Concurrently, their need for public investment in education will be lower, and most families will have bought their own homes. Hence, their propensity to invest will decline. Individual countries will in this situation export capital to other countries, where the savings/investment ratio is lower.

The world has seen some dramatic changes in demographic composition since World War II. After the war, population growth increased markedly. Later on, in the 1960s and 1970s, more women entered the labour market, population growth declined, and the introduction of China’s one-child policy led to an increase in China’s savings rate, as parents in that country could to a lesser degree expect their descendants to care for them in their old age. Additionally, the IMF has pointed to two other important aspects that could have led to increased savings globally. Reduced job security may raise precautionary savings, and health reforms, with a higher cost carried by the individual, would naturally lead to more savings. Owing to this, since the 1980s there has been a relatively high proportion of the world’s popula-tion with a high propensity to save. This trend has coincided with low real interest rates.

Now, however, an aging global population could, in turn, lower global savings. Falling population growth is due to lower fertility rates in both advanced and emerging economies. As life expectancy is increasing, the result is an aging population, where the ratio of working-age population to total population most likely will level off and, possibly, fall over the coming decades (see chart).

Demographics and the reversal of falling interest ratesGlobal real interest rates have been falling over the past 35 years and are currently close to the lowest levels ever recorded. While there are several factors explaining the current low interest rate levels, both structural and cyclical, high savings in preparation for retirement and the entry of China into global markets are among the most important factors. At the current junction, one important question is whether real interest rates will increase over the coming decades owing to the aging global population. As aging workers retire, they become dissavers, and the global savings glut may be reversed.

Low real interest rates are linked to increased propensity to save

Dramatic changes in global demo-graphic composition since WWII

An aging population could lower global savings

26

As larger parts of the population enter retirement, they will be consuming their own savings and drawing on national pension plans and health care systems. With rising life expectancies, health expenditure is also expected to continue increasing. This will result in a decline in the propensity to save, and this drop will most likely be larger than the drop in the propensity to invest. Although countries are at different aging stages, aging is neverth-less a global phenomenon. Thus, an aging global population with a reduced propensity to save, relative to the propensity to invest, should have a positive impact on real interest rates.

Based on population projections from the World Bank, the ratio of wor-king-age population to total population should peak around 2020. In other words, the prolonged period of falling interest rates could soon be behind us. However, other factors could also certainly affect interest rates. First, an aging global population could lead to lower potential growth and lower productivity. Indeed, one counterargument to higher future interest rates could be that lower productivity and lower potential growth require lower real interest rates. Second, the full effect of technology is likewise un-known, and it is also unknown whether more automatised production in the future will require less labour supply. Third, India and large countries in Africa have a large potential labour supply – should they enter the global economy more formally. Fourth, a higher pension age and continued higher labour force participation among women could also increase the labour supply in the decades to come. Fifth, underfinanced public pension systems in several countries could lead to more private saving – thereby postponing or dampening the rise in real interest rates for a while.

The conclusion is that demographics will be an important factor in shaping long-run trends in interest rates. Several factors speak for higher interest rates, as aging populations retire and become consumers rather than sa-vers. Still, the only clear example so far, Japan, with the most aging society in the world, has not seen a rise in real interest rates (yet!). Weak growth, low inflation, and the risk of fiscal dominance are proving to be strong countervailing factors.

IN-DEPTHS

The ratio of working-age popu-lation to total population should peak around 2020

Demographics will be an impor-tant factor in shaping long-run trends in interest rates

27

Appendices: Forecast tablesSWEDEN: Key economic indicators, 2016–2019 1/

2016 2017F 2018F 2019F

GDP growth (calendar adjusted), % 2/ 3.0 2.6 (3.0) 2.7 (2.8) 2.1 (1.9)GDP growth, % 2/ 3.2 2.4 (2.7) 2.6 (2.7) 2.0 (2.0) Household consumption 2.2 2.3 (2.4) 2.5 (2.4) 2.0 (2.0) Government consumption 3.1 0.5 (0.4) 1.6 (2.3) 1.5 (1.9) Gross fixed capital formation 5.6 7.3 (7.9) 4.1 (3.6) 2.2 (2.2) Change in inventories, contribution to GDP growth 0.0 -0.1 (-0.1) -0.1 (-0.1) 0.0 (0.0) Exports of goods and services 3.3 3.5 (3.4) 5.4 (5.2) 4.6 (4.2) Imports of goods and services 3.4 5.1 (4.5) 5.6 (5.3) 4.6 (4.6)Industrial production growth (calendar adjusted), % 2.6 3.2 (2.8) 5.1 (4.8) 3.8 (3.7)CPI, % (average) 1.0 1.8 (1.8) 2.1 (2.1) 2.8 (2.8)CPI, % (end of period) 1.7 1.7 (1.8) 2.5 (2.5) 3.0 (2.8)CPIF, % (average) 3/ 1.4 2.0 (2.0) 1.9 (1.7) 1.9 (1.9)

CPIF, % (end of period) 3/ 1.9 1.9 (1.9) 1.8 (1.7) 2.0 (1.9)Riksbank policy rate, end of period -0.50 -0.50 (-0.50) -0.25 (0.00) 0.50 (0.50)Unemployment rate (15-74), % 6.9 6.7 (6.7) 6.4 (6.4) 6.3 (6.3)

Change in labour force (15-74), % 1.0 2.0 (2.1) 1.2 (1.2) 0.8 (0.8)

Change in employment (15-74), % 1.5 2.3 (2.3) 1.5 (1.5) 0.9 (0.9)

Nominal hourly wage (NMO), % (whole economy) 2.4 2.7 (2.7) 3.1 (3.1) 3.4 (3.4)

Household savings ratio, % 16.5 16.1 (15.3) 16.9 (15.4) 16.5 (15.1)

Household real disposable income, % 3.3 2.1 (2.0) 3.3 (2.7) 1.5 (2.3)

Current account balance, % of GDP 5.1 4.8 (5.3) 4.6 (5.3) 4.8 (5.2)

General government budget balance, % of GDP 4/ 1.2 1.3 (1.2) 0.9 (0.7) 0.6 (1.0)

General government debt, % of GDP 4/ 42.2 39.2 (38.7) 36.9 (36.9) 35.0 (35.1)

1/ Previous forecast in parenthesis. Annual percentage change if not stated otherwise. 2/ GDP in real terms 3/ CPI with fixed mortgage rate4/ According to Maastricht definition

Sources: Statistics Sweden and Swedbank

ESTONIA: Key economic indicators, 2016–2019 1/

2016 2017P 2018F 2019F

Real GDP growth, % 2.1 4.4 (4.2) 3.9 (3.5) 3.0 (3.0) Household consumption 4.3 2.3 (2.0) 4.5 (4.0) 2.7 (2.5) Government consumption 1.9 1.0 (1.8) 2.0 (2.0) 2.0 (2.0) Gross fixed capital formation -1.2 14.5 (15.5) 6.0 (5.5) 4.5 (5.5) Exports of goods and services 4.1 2.8 (4.0) 4.5 (4.5) 4.0 (4.0) Imports of goods and services 5.3 3.8 (5.0) 5.0 (5.0) 4.0 (4.5)Consumer price growth, % 0.1 3.4 (3.4) 3.0 (3.0) 2.5 (2.5)Unemployment rate, % 2/ 6.8 6.0 (7.0) 7.0 (7.5) 7.2 (7.3)

Change in employment, % 2/ 0.6 1.6 (0.5) 0.0 (0.2) 0.2 (0.2)

Gross monthly wage growth, % 7.6 6.8 (6.5) 6.0 (5.3) 5.5 (5.0)Nominal GDP, billion euro 21.1 22.9 (22.8) 24.7 (24.4) 26.3 (25.9)Exports of goods and services (nominal), % growth 4.1 7.2 (7.7) 8.3 (7.2) 6.6 (6.1)

Imports of goods and services (nominal), % growth 4.3 7.0 (7.9) 8.4 (7.4) 6.6 (6.6)

Balance of goods and services, % of GDP 3.9 4.4 (4.2) 4.0 (3.7) 4.0 3.4

Current account balance, % of GDP 1.9 2.8 (2.2) 2.4 (2.0) 2.2 1.6

Current and capital account balance, % of GDP 4.9 6.4 (5.7) 5.8 (5.0) 5.4 4.1

FDI inflow, % of GDP 3.2 3.6 (3.5) 3.0 (3.0) 3.0 3.0

General government budget balance, % of GDP 3/ -0.3 -0.3 (0.0) -0.3 (-0.1) -0.3 (-0.3)


1/ Previous forecast in parenthesis2/ According to Labour Force Survey 3/ According to Maastricht definition

Sources: National statistics and Swedbank Research

APPENDICES

28

LATVIA: Key economic indicators, 2016–2019 1/

2016 2017F 2018F 2019F


Change in employment, % 2/ -0.3 0.0 (-0.1) 0.0 (0.1) -0.3 (-0.4)


Imports of goods and services (nominal), % growth -0.5 13.3 (13.3) 9.2 (9.4) 8.6 (8.6)

Balance of goods and services, % of GDP 0.9 -1.8 (-1.6) -3.2 (-3.3) -4.9 (-4.9)

Current account balance, % of GDP 1.4 -1.0 (-0.7) -2.6 (-2.6) -4.3 (-4.3)

Current and capital account balance, % of GDP 2.4 -0.2 (0.2) -0.3 (-0.5) -1.7 (-2.0)

FDI inflow, % of GDP 0.9 3.0 (2.2) 2.6 (2.2) 2.4 (2.1)

General government budget balance, % of GDP 3/ 0.0 -0.8 (-0.8) -0.8 (-0.8) -0.8 (-0.8)




LITHUANIA: Key economic indicators, 2016–2019 1/

2016 2017F 2018F 2019F


Change in employment, % 2/ 2.0 -0.4 (-0.4) -0.3 (-0.4) -0.3 (-0.4)


Imports of goods and services (nominal), % growth -1.0 17.5 (17.0) 10.0 (10.0) 6.0 (6.0)

Balance of goods and services, % of GDP 1.2 1.7 (0.9) 0.2 (-0.6) -0.6 (-1.3)

Current account balance, % of GDP -1.1 0.0 (-0.8) -0.9 (-1.7) -1.2 (-2.0)

Current and capital account balance, % of GDP 0.4 1.0 (0.4) 0.9 (0.1) 0.7 (-0.1)

FDI inflow, % of GDP 2.2 1.5 (1.0) 1.5 (1.0) 1.5 (1.0)

General government budget balance, % of GDP 3/ 0.3 0.1 (0.1) 0.5 (0.5) 0.2 (0.2)




APPENDICES

29

What our research is based onSwedbank Macro Research, a unit within Large Corporates & Institutions, bases

the research on a variety of aspects and analysis. For example: A fundamental

assessment of the cyclical and structural economic, current or expected market

sentiment, expected or actual changes in credit rating, and internal or external

circumstances affecting the pricing of selected FX and fixed income instruments.

Based on the type of investment recommendation, the time horizon can range

from short-term up to 12 months.

Recommendation structureRecommendations in FX and fixed income instruments are done both in the cash

market and in derivatives. Recommendations can be expressed in absolute terms,

for example attractive price, yield or volatility levels. They can also be expressed

in relative terms, for example long positions versus short positions. Regarding the

cash market, our recommendations include an entry level and our recommendation

updates include profit and often, but not necessarily, exit levels. Regarding recom-

mendations in derivative instruments, our recommendation include suggested

entry cost, strike level and maturity. In FX, we will only use options as directional

bets and volatility bets with the restriction that we will not sell options on a net

basis, i.e. we will only recommend positions that have a fixed maximum loss.

Analyst’s certificationThe analyst(s) responsible for the content of this report hereby confirm that

notwithstanding the existence of any such potential conflicts of interest referred

to herein, the views expressed in this report accurately reflect their personal views

about the securities covered. The analyst(s) further confirm not to have been, nor

are or will be, receiving direct or indirect compensation in exchange for expressing

any of the views or the specific recommendation contained in the report.

Issuer, distribution & recipientsThis report by Macro Research, a unit within Swedbank Research that belongs to

Large Corporates & Institutions, is issued by the Swedbank Large Corporates &

Institutions business area within Swedbank AB (publ) (“Swedbank”). Swed-

bank is under the supervision of the Swedish Financial Supervisory Authority

(Finansinspektionen). In no instance is this report altered by the distributor before

distribution.

In Finland this report is distributed by Swedbank’s branch in Helsinki, which is under

the supervision of the Finnish Financial Supervisory Authority (Finanssivalvonta).

In Norway this report is distributed by Swedbank’s branch in Oslo, which is under

the supervision of the Financial Supervisory Authority of Norway (Finanstilsynet).

In Estonia this report is distributed by Swedbank AS, which is under the supervision

of the Estonian Financial Supervisory Authority (Finantsinspektsioon).

In Lithuania this report is distributed by “Swedbank” AB, which is under the super-

vision of the Central Bank of the Republic of Lithuania (Lietuvos bankas).

In Latvia this report is distributed by Swedbank AS, which is under the supervision

of The Financial and Capital Market Commission (Finanšu un kapitala tirgus

komisija).

This document is being distributed in the United States by Swedbank AB (publ)

and in certain instances by Swedbank Securities U.S. LLC (“Swedbank LLC”), a U.S

registered broker dealer, only to major U.S. institutional investors, as defined under

Rule 15a-6 promulgated under the US Securities Exchange Act of 1934, as amen-

ded, and as interpreted by the staff of the US Securities and Exchange Commission.

This investment research is not intended for use by any person or entity that is

not a major U.S institutional investor. If you have received a copy of this research

and are not a major U.S institutional investor, you are instructed not to read, rely

on or reproduce the contents hereof, and to destroy this research or return it to

Swedbank AB (publ) or to Swedbank LLC. Analyst(s) preparing this report are

employees of Swedbank AB (publ) who are resident outside the United States

and are not associated persons or employees of any US registered broker-dealer.

Therefore the analyst(s) are not subject to Rule 2711 of the Financial Industry

Regulatory Authority (FINRA) or to Regulation AC adopted by the U.S Securities

and Exchange Commission (SEC) which among other things, restrict communica-

tions with a subject company, public appearances and personal trading in securities

by a research analyst.

Any major U.S Institutional investor receiving the report, who wishes to obtain

further information or wishing to effect transactions in any securities referred to

herein, should do so by contacting a representative of Swedbank LLC. Swedbank

LLC is a U.S. broker-dealer registered with the Securities and Exchange Commis-

sion and a member of Financial Industry Regulatory Authority and the Securities

Investor Protection Corporation.

Its address is One Penn Plaza, 15th Fl., New York, NY 10119 and its telephone num-

ber is 212-906-0820. For important U.S. disclaimer, please see reference: http://

www.swedbanksecuritiesus.com/disclaimer/index.htm

In the United Kingdom this communication is for distribution only to and directed

only at ”relevant persons”. This communication must not be acted on – or relied

on – by persons who are not ”relevant persons”. Any investment or investment

activity to which this document relates is available only to ”relevant persons” and

will be engaged in only with ”relevant persons”. By ”relevant persons” we mean

persons who:

• Have professional experience in matters relating to investments falling within

Article 19(5) of the Financial Promotions Order.

• Are persons falling within Article 49(2)(a) to (d) of the Financial Promotion

Order (”high net worth companies, unincorporated associations etc”).

• Are persons to whom an invitation or inducement to engage in investment

activity (within the meaning of section 21 of the Financial Services and Mar-

kets Act 2000) – in connection with the issue or sale of any securities – may

otherwise lawfully be communicated or caused to be communicated.

Limitation of liabilityAll information, including statements of fact, contained in this research report

has been obtained and compiled in good faith from sources believed to be reliable.

However, no representation or warranty, express or implied, is made by Swedbank

with respect to the completeness or accuracy of its contents, and it is not to be re-

lied upon as authoritative and should not be taken in substitution for the exercise

of reasoned, independent judgment by you.

Be aware that investments in capital markets – such as those described in this do-

cument – carry economic risks and that statements regarding future assessments

comprise an element of uncertainty. You are responsible for such risks alone and we

recommend that you supplement your Decision-making with that material which is

assessed to be necessary, including (but not limited to) knowledge of the financial

instruments in question and the prevailing requirements as regards trading in

financial instruments.

Opinions contained in the report represent the analyst’s present opinion only and

may be subject to change. In the event that the analyst’s opinion should change

or a new analyst with a different opinion becomes responsible for our coverage of

the company, we shall endeavor (but do not undertake) to disseminate any such

change, within the constraints of any regulations, applicable laws, internal proce-

dures within Swedbank, or other circumstances.

If you are in doubt as to the meaning of the recommendation structure used by

Swedbank in its research, please refer to “Recommendation structure”.

Swedbank is not advising nor soliciting any action based upon this report. If you are

not a client of ours, you are not entitled to this research report. This report is not,

and should not be construed as, an offer to sell or as a solicitation of an offer to buy

any securities.

To the extent permitted by applicable law, no liability whatsoever is accepted by

Swedbank for any direct or consequential loss arising from the use of this report.

Conflicts of interestIn Swedbank Research, a unit within LC&I, internal guidelines are implemented

in order to ensure the integrity and independence of the research analysts. For

example:

• Research reports are independent and based solely on publicly available

information.

• The analysts are not permitted, in general, to have any holdings or any

positions (long or short, direct or via derivatives) in such Financial Instruments

that they recommend in their investment analysis.

• The remuneration of staff within the Swedbank Research department may

include discretionary awards based on the firm’s total earnings, including in-

vestment banking income. However, no such staff shall receive remuneration

based upon specific investment banking transactions.

Planned updatesAn investment recommendation is normally updated twice a month. This material

may not be reproduced without permission from Swedbank Research, a unit within

Large Corporates & Institutions. This report is not intended for physical or legal

persons who are citizens of, or have domicile in, a country in which dissemination is

not permitted according to applicable legislation or other Decisions.

Produced by Swedbank Research, a unit within Large Corporates & Institutions,

Stockholm.

AddressSwedbank LC&I, Swedbank AB (publ), SE-105 34 Stockholm.

Visiting address: Malmskillnadsgatan 23, 111 57 Stockholm

Swedbank Research’s disclaimer

30

Swedbank Economic Outlook · Global growth – impressive so far, pitfalls ahead As we enter 2018,...

Documents

Transcript of Swedbank Economic Outlook · Global growth – impressive so far, pitfalls ahead As we enter 2018,...