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Economic recovery but higherrisks, depressed key rates andbond yields
Nordic countries well equipped forupturn
Nordic OutlookEconomic Research August 2010
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Nordic Outlook August 2010 | 3
Contents
International overview 5
The United States 16
Japan 22
Asia 23
The euro zone 25
The United Kingdom 31
Eastern Europe 32
The Baltics 33
Sweden 35
Denmark 43
Norway 44
Finland 48
Economic data 49
Boxes
Downside risks have increased 7
Stable commodity prices 8
Basel III postponed 9
Moving towards Japanese yields? 12
An unusual recovery 19
Falling unemployment even with slow growth 28
Stress tests dispel uncertainty despite shortcomings 30Why is Sweden doing so well? 36
Major Swedish GDP revisions 38
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This report was published on August 31, 2010.
Cut-off date for calculations and forecasts was August 27, 2010.
Robert Bergqvist Hkan FrisnChief Economist Head of 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 JohanssonEditorial 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 of Personal Finance Research Global Head of 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, Klaus Schrfer, SEB Frankfurt/M andOlle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwegiananalysis.
Economic Research
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International overview
Nordic Outlook August 2010 | 5
Continued economic recovery but increased risks
US growth below trend for the next year
Strong recovery in Sweden and Germany
Low ination will allow extreme low-interest policies
Dilemmas for Nordic central banks
Japanese-style global long-term yields
In recent months the world economic outlook has dete-
riorated, mainly due to clear signs of weakness in the
American economy. Increased worries about a slowdown
in the United States and Asia, combined with contin-
ued uncertainty about the scal situation in southern
Europe, have led to lower risk appetite in nancial
markets and sharply falling interest rates, among other
things. The growth rate was unexpectedly strong in
many countries during the second quarter, and the
emergency response to the southern European crisis has
been successful, but this has not sufced to offset the
negative news.
Ination has continued downward, and ination expec-
tations have fallen. It is becoming increasingly clear
that the risks of undesirably low ination are the domi-
nant problem for major central banks in the 32 member
countries of the Organisation for Economic Cooperation
and Development (OECD). This is creating room for
continued record-low interest rates in the next couple
of years.
We expect the US Federal Reserve (Fed) and the Euro-
pean Central Bank (ECB) to maintain todays record-
low key interest rates throughout 2011 and to begincautious rate hikes only in 2012. Due to low key rates in
the foreseeable future and diminished growth and ina-
tion expectations in the long term as well, government
bond yields will remain at historically very low levels in
the next couple of years.
There is a renewed focus on the potential for central
banks to stimulate their economies by means of quanti-
tative easing (QE). We expect that because of low long-
term yields, central banks will be satised with keeping
their balance sheets at current levels and thus not
implement new QE programmes. The Basel Committee
on Banking Supervision has presented a proposal whichimplies that tightening of nancial regulations will be
postponed, creating an economic stimulus effect that
will also reduce the need for unconventional monetary
policies.
In our judgement, the deceleration signals in the Ameri-
can economy will have consequences for the recovery
dynamic in the coming year. Renewed weakness in both
the labour and housing markets will block a traditional
recovery dynamic. We have thus adjusted our forecast
downward and expect GDP growth somewhat below
trend in the US during late 2010 and early 2011. This
will mean major economic strains, including persistent-ly high unemployment and continued nancial stress.
At the global level, however, extremely loose monetary
policy and continued good growth capacity in many
parts of the world economy will contribute to decent
growth in the next couple of years. Fast-growing Asian
economies will remain an important driving force,
although some deceleration is on the way. We believe
that Chinese authorities, for example, have sufcient
tools to ensure an economic soft landing.
In the OECD, differences in the underlying balance
situation have become increasingly important. Germany
and Sweden are among countries where the strength of
the upturn has been surprising. A strong German econ-
omy is not enough to keep up the momentum of the
entire euro zone, though. There will thus be wide gaps
within the currency area as the full effects of powerful
austerity programmes are felt in southern Europe.
Global GDP growthYear-on-year percentage change
2009 2010 2011 2012
United States -2.6 2.6 2.2 2,9Japan -5.2 2.5 1.5 1.5
Germany -4.7 3.3 2.1 1.8
China 8.7 10.0 9.0 8.0
United Kingdom -4.9 1.7 2.0 2.2
Euro zone -4.1 1.6 1.3 1.5
Nordic countries -4.4 2.5 2.4 2.4
Baltic countries -15.6 0.4 4.2 4.5
OECD -3.3 2.2 2.0 2.3
Emerging markets 2.4 6.8 6.0 6.4
World, PPP* -0.6 4.4 3.8 4.3
World, nominal -1.3 3.7 3.1 3.6
Source: OECD, SEB * Purchasing power parities
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International overview
We are sticking to the main scenario from our economic
analyses of recent years: the after-effects of the deep
crisis will hamper economies for a rather long period.
Debt retirement in both the private and public sectors,
combined with lingering weaknesses in the nancial sys-
tem, will mean slower growth for some time to come.
Low interest rates may ease the adjustment, but theirstimulus effect will be weaker than normal in todays
ravaged economic environment.
Amid a fragile economic situation, international
economic policy makers face major challenges, for
example in restructuring the nancial system, coordi-
nating global scal policies and rebuilding condence in
joint European institutions. Belt-tightening in southern
Europe will put the political system under severe strains
there, but political authority is being questioned even
in leading industrial countries. In the US, for example,
President Obamas popularity has plunged and this
autumns congressional election may lead to furtherrestraints on the governments ability to make and
implement decisions. In Germany, Chancellor Angela
Merkels position has weakened and her governing
coalition is going through a rough patch. In the UK, a
new and inexperienced coalition government is facing
painful spending cuts.
Shifting the emphasis to nal demandThe ongoing slowdown trend in the global economy is
largely due to the fading of stimulus effects from the
inventory cycle and scal policy measures. Inventory
movements have been pivotal to the recovery in themanufacturing sector. Since most merchandise invento-
ries are traded across national boundaries, this means
that exports take off rst.
As a percentage of GDP, current prices
US: Non-residential fixed investments
Source: US Department of Commerce
70 75 80 85 90 95 00 05 10
9.0
9.5
10.0
10.511.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
9.0
9.5
10.0
10.511.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
It is thus not illogical for all parts of the world economy
to begin their recovery with export-led growth. The
trend in net exports, when imports are also included, is
another question. Early in the crisis, the effect of
international trade was to ease global imbalances.
Domestic demand, and thus imports, fell sharply incountries with large domestic imbalances, such as the
US. In recent months, this pattern has reversed to some
extent. For example, net US exports accounted for a
large negative contribution to growth in the second
quarter, among other things due to stimulus measures
and a stronger US dollar.
To ensure a sustainable recovery, it will now be crucial
for nal demand in the form of capital spending and
consumption to take over when the inventory cycle
ceases to serve as an economic engine. The box entitled
Recovery at a crossroads in the November 2009 issue
of Nordic Outlook discussed this take-over. One conclu-
sion was that mid-2010 would be the critical period. But
the outlook is mixed.
Capital spending took off in many countries early in
2010. Growth gures are high, in part because the xed
investment level was exceptionally depressed. But
there are also factors that point towards a sustained
recovery.
Non-residential xed investment is deeply de-
pressed, even in a longer time perspective. Unlike
normal economic expansions, the capital spending
level in the OECD countries remained rather low
during the boom years 2006-07.
Balance sheets, especially in large American corpo-
rations, are much stronger than normal. This will
make larger self-nancing of capital investments
possible, facilitating the upturn while the nancial
system remains relatively fragile.
Historical associations signal that capital spending
growth is more dependent on the change in capac-
ity utilisation than on its actual level. This indicatesthat a recovery in xed investments may begin
relatively soon.
One important factor that may delay an upturn is that
many small businesses are still having difculty obtain-
ing loans. The credit market is performing sub-optimally
in this respect, both in the US and Europe.
Per cent of disposable income
US: Uniform pace of debt retirement
Household debts (LHS) Household saving (RHS)Source: Federal Reserve
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
1
2
3
4
5
6
7
89
10
11
12
60
70
80
90
100
110
120
130
140
On the consumption side, the outlook is gloomier.
There is still a major need for debt retirement. New US
gures point to substantially higher household saving
than previously reported. The adjustment process is
thus occurring faster than expected. Given new labour
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International overview
market disappointments and a housing sector that again
seems to be on its way down, the underlying prerequi-
sites for a normal American consumption recovery are
missing. In the UK, southern Europe and elsewhere,
consumption is also being held back by scal tighten-
ing. In Germany and Japan, consumers are cautious
despite their strong balance sheets. In Asian emergingeconomies, there is an impending shift towards greater
emphasis on consumption, as illustrated by accelerat-
ing pay increases, but this is too lengthy a process to
facilitate a decisive shift to nal demand as the main
economic engine.
Our overall conclusion is that, in part because of sub-
dued nal demand, the OECD countries will move into
a slower growth phase during the second half of 2010
and the rst half of 2011. This means that for several
quarters, growth will again end up below trend. The
output gap will thus widen. At present, however, most
indications are that growth will remain well aboverecessionary levels.
Very strong recovery in SwedenThe Nordic economies have generally shown good resil-
ience against the global crisis. In Denmark, Sweden and
especially Finland, GDP indeed fell sharply during 2009,
but the impact on domestic demand was rather minor
and the upturn in unemployment surprisingly small.
Public nances are thus in relatively good shape, and
central government debts are at a low level. Combined
with sizeable current account surpluses, this is creating
a favourable platform for recovery. The weakening ofthe euro is helping to ease competitiveness problems
which have hampered growth in Finland and Denmark
to some extent.
In Sweden, growth has been surprisingly vigorous in re-
cent months, and we expect a 4.7 per cent upturn this
year. Exports have recovered strongly after their sharp
decline. Expansionary scal policy and strong housing
market have beneted domestic demand.
In the other Nordic countries, growth will be far more
moderate. The Danish economy is still being hampered
by the repercussions of the housing market crash.
In Finland there is good potential for an export-led
manufacturing upturn similar to Germany and Swe-
den. So far, the upturn has been modest, but a weaker
euro will contribute to an acceleration over the next
few quarters. In Norway, the economy has also been
held back by an appreciating currency. A strong labour
market and expansionary scal policy have not sufced
to get domestic demand moving. Because of the very
mild downturn in 2008-09, resource utilisation is also
high in Norway compared to other countries, and this
will dampen long-term growth potential from the supply
side.
GDP growth, Nordic and Baltic countriesYear-on-year percentage change
2009 2010 2011 2012
Sweden -5.1 4.7 2.9 2.3
Norway -1.4 0.7 2.1 2.1
Denmark -4.7 1.8 1.8 2.2
Finland -7.8 2.5 2.6 2.7
Nordics -4.4 2.5 2.4 2.4
Estonia -14.1 2.0 5.0 4.0Latvia -18.0 -1.5 4.0 5.0
Lithuania -14.8 1.0 4.0 4.5
Baltics -15.6 0.4 4.2 4.5
Source: OECD, SEB
Downside risks have increasedAs earlier, our main scenario implies a relatively slug-
gish global recovery, with medium-term growth being
held back by scal tightening, continued debt adjust-
ment needs and tighter nancial sector rules.
Since last spring, the risk picture has changed in
some respects. The crisis-ridden countries of southern
Europe continue to face major challenges, but the
overall picture looks less threatening. With a credible
bail-out mechanism in place and after the completion
of stress tests in the European banking system, risks
that southern European problems might cause a global
recession have receded. The International Monetary
Fund (IMF) and euro zone countries have approved
a second emergency loan disbursement to Greece,
another sign that the structural adaptation process has
begun.
Yet the deterioration in the American economy has
increased the overall risks of a global recession. We
now estimate the probability of such a scenario at
around 25 per cent, compared to 15 per cent in the
May issue of Nordic Outlook. Conversely, the prob-
ability of upside surprises has naturally diminished.
Despite signs of strength in such countries as Germany,
a rapid recovery in the world economy is relatively un-likely without support from a more dynamic American
economy.
Index 2000=100
GDP OECD countries
New crisis waveRaprid recovery
SEB's main scenario
Source: OECD, SEB
04 05 06 07 08 09 10 11 12105.0
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%
SEB forecast
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International overview
Baltic countries slowly on the way upThe Baltic economies have now slowly begun to re-
bound from the deep declines they experienced after
the credit bubble burst. The three countries internal
devaluation policy appears likely to be successful. Their
competitiveness has improved, mainly via pay cuts. Also
making the situation easier is that the euro, to whichtheir currencies are pegged, has weakened and the
currencies in several important competitor countries in
Eastern Europe have appreciated. Their external bal-
ance has improved radically, and the deation process
is coming to an end. They have also shown political
rmness in implementing major scal belt-tightening.
Estonia will join the euro zone on January 1, 2011. This
has also helped restore condence, some of which has
spread to Latvia and Lithuania. But there is a degree
of lingering uncertainty about the political situation in
Latvia connected among other things to this autumns
parliamentary election and to some extent also inLithuania.
Looking ahead, we expect a modest growth rate of 4-5
per cent, well below the previous trend. Continued pri-
vate sector adjustment needs, combined with a less ex-
pansionary credit environment, will contribute to this.
It will also take time to restore condence in Baltic
investment projects among long-term foreign investors.
We expect Latvia and Lithuania to have an opportunity
to join the euro zone in 2014.
New labour market patternsIn recent months, the differences in labour market
trends between various countries have become more
pronounced. In Germany and the Nordic countries, for
example, the labour market situation has begun to
improve, whereas the situation in the US is plagued by
new disappointments.
Index = 100 januari 2008
Divergent employment trends
Sweden US Germany SpainSource: Reuters EcoWin
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr08 09 10
89
90
91
92
93
94
95
96
97
98
99
100
101
89
90
91
92
93
94
95
96
97
98
99
100
101
During the economic downturn phase, the decline in
employment was substantially sharper in the US than,
for example, in Germany and the Nordic countries
despite a milder GDP decline. In part, this followed
traditional patterns coupled to such factors as how easy
it is to hire and re employees. Especially in Germany,
Stable commodity pricesCommodity prices have followed the pattern of theglobal recovery. A turnaround came early in 2009 and
was probably initially strengthened by Chinas need to
ll structural stockpiles. Since last spring, commod-
ity prices have tended to level off at the same time
as global manufacturing has reached a more mature
phase, or somewhat ahead of this.
Index, monthly date, USD
High commodity prices
Agriculture Industrial metals EnergySource: HWWI
00 01 02 03 04 05 06 07 08 09 10
50
100
150
200
250
300
350
400
450
500
50
100
150
200
250
300
350
400
450
500
Given our scenario of continued moderate global
growth, with a slight weakening in the short term,
continued price hikes are also likely to be modest. Inparticular, a calmer growth dynamic in fast-growing
Asian economies points in this direction.
Oil prices will rise somewhat from current levels.
At present, reserve oil production capacity is rela-
tively large. Increases in demand next year will not
be large enough to change this. Saudi Arabias large
production reserves will give it a key inuence on the
future price strategy of the Organisation of Petroleum
Exporting Countries (OPEC). Saudi Arabia can boost
production and squeeze oil prices if it turns out that
global growth is slowing too quickly. Iran and Iraq also
have major potential to increase the oil supply, but
in the prevailing uncertain political situation, it is
hardly likely that any large production changes will be
implemented. We are thus assuming that Brent oil will
continue to trade in the USD 70-90/barrel interval.
Agricultural commodities will level off, but there is
a risk of further upturn in the short term. Extreme
weather in two key wheat-producing countries, Rus-
sia and Ukraine, led to a 70-80 per cent price spike
in July and August. Russia has decided to halt grain
exports during the rest of 2010, aimed at ensuring
domestic supplies and counteracting price increases to
consumers. This will pose risks of a new wave of price
increases and might spread to the maize (corn) and
soya markets. But in our assessment, global wheat and
other grain stockpiles are large enough to avoid price
shocks. This is very different from several few years
ago, when low grain stockpiles led to major price
hikes that affected food prices worldwide.
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International overview
employment was also sustained by special economic
policy programmes.
Since employment gures have already begun to
increase in a number of European countries, while
remaining weak in the US, it is clear that other expla-
nations for these labour market trends are needed.
One pattern seems to be that in countries with milder
nancial imbalance problems, the labour market has
rebounded faster. Because the need for restructuring
measures is smaller in these countries, when demand
takes off again, companies can rather easily begin
rehiring.
Ination will remain lowDiscussions of ination have shifted emphasis in recent
months. As long-term bond yields have fallen and
concerns about the economy have mounted, there has
been a focus on worries about undesirably low ination.
Meanwhile fears that ination will be driven by mone-tary expansion have faded. Actual ination gures have
not been especially dramatic. Rising energy and food
prices have caused some upside surprises in Consumer
Price Index (CPI) ination, while core ination has
continued to fall.
For some time, our view has been that disinationary
forces caused by large output gaps will dominate the in-
ation trend. The continuous downturn in core ination
over the past year has conrmed this picture. A new IMF
study also shows that the level of the output gap has
historically been crucial in determining ination pres-
sure. The study provides no support either for ination
being a consequence of rapid growth in individual years
(speed limit ination) or being generated by monetary
expansion, without the presence of underlying condi-
tions related to factors such as capacity utilisation or
wage formation.
Year-on-year percentage change
Core inflation is continuing to fall
Euro zone USSource: Eurostat, BLS, SEB
98 99 00 01 02 03 04 05 06 07 08 09 10 11 120.0
0.5
1.0
1.5
2.0
2.5
3.0
0.0
0.5
1.0
1.5
2.0
2.5
3.0
forecastSEB
Our forecast is that core ination in the OECD countries
will continue downward in the coming year. Economic
growth is not strong enough to generate any signicant
improvement in the labour market situation. The out-put gap will not close during our forecast period. Pay
increases will thus be low and unit labour costs will also
be pushed down by a recovery in productivity.
Year-on-year percentage change
Rate of pay increases is stabilising
Euro zone USSource: ECB, BLS
98 99 00 01 02 03 04 05 06 07 08 09
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
On the other hand, we see no major risks of a danger-
ous deationary trend either. The rate of wage and sal-
ary increases has stopped falling. This will reduce the
risks of a deationary spiral of falling pay and prices. Atthe same time, there are reasons why the disination-
ary forces of globalisation will lose energy compared to
the previous decade. The level of wages and salaries in
fast-growing emerging economies seems to be rapidly
on the way up, while currency appreciation and produc-
tivity growth potential will help narrow previously wide
gaps in the cost situation.
Basel III postponedDuring the summer, the Basel Committee for Bank-
ing Supervision approved various amendments to the
proposal it submitted late in 2009 for comments byinterested parties. The purpose of the reform package
is to strengthen the resilience of the banking sector by
tightening capital and liquidity requirements, and to
thwart excessive risk-taking, diminish gearing effects
and reduce pro-cyclicality.
The reform package includes denitions of capital and
leverage ratios, liquidity coverage ratios, net stable
funding ratios and management of counterparty risk.
The details will be presented later this year, and a
formal decision is expected in November.
Generally speaking, the standards have been eased,while the deadline for implementing them has been
extended from December 2012 to January 2018. Our
conclusion is that the Committees decision was inu-
enced by last springs sovereign debt crisis, combined
with the picture of a sluggish global economic recov-
ery with downside risks as well as a nancial system
that remains weakened.
All else being equal, these amendments will have a
positive impact on our economic scenario. A slower
adjustment process will substantially reduce risks of
poorer access to capital and higher borrowing costs,
which were inherent in the original proposal. Mean-while, milder capital/credit standards both station-
ary and exible will mean placing greater respon-
sibility on interest rate policy to maintain nancial
stability.
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International overview
Central banks will wait until 2012Increased worries about the economy, combined with
falling ination expectations, are giving central banks
strong motives for continuing their extremely low inter-
est rate policies. Due to the economic slowdown in the
US, deationary forces will predominate over the next
couple of years. The crisis-ridden countries of southernEurope will be strongly dependent on low interest rates
for a long time in order to deal successfully with imbal-
ances in competitiveness and government nances.
Asymmetric risks on the growth side will also help
ensure that central banks will be very cautious. The
consequences of interrupting a nascent recovery by
raising interest rates too early may be relatively large
in a situation where room for scal policy manoeuvring
is sharply circumscribed in many countries and the
monetary policy arsenal is also relatively exhausted. We
thus anticipate that the central banks in major OECD
countries will not begin hiking their key interest ratesuntil early 2012.
Per cent
Key interest rates
Euro zone USSource: ECB, Fed, SEB
00 02 04 06 08 10 12
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
forecastSEB
A long period of extreme low interest rate policy entails
certain potential risks. Asset prices may once again be
pumped up to unsustainable levels. Economic players
may also be given an inaccurate picture of the normal
cost of capital, which may lead to inefcient capital
allocation. In addition, the banking system may become
too dependent on liquidity supplied by central banks,
with a more poorly functioning interbank market as aconsequence. The postponed launch of Basel III com-
plicates the situation of the central banks, eliminating
instruments for controlling credit growth and asset
prices that might have eased the pressure on interest
rate policy.
At present, the potential problems of low interest rate
policy are relatively minor in relation to the macroeco-
nomic risks of raising interest rates.
Policy dilemma in Norway and SwedenThe differences in the conditions surrounding major
OECD central banks and the central banks in Norwayand Sweden are becoming increasingly clear. For a
long time, Norges Bank has had to deal with a situation
where differences in terms of resource utilisation, the
direction of scal policy and the state of the credit and
housing markets have pointed to a substantially higher
key interest rate than that of the ECB. Having begun
its rate hikes as early as October 2009, Norges Bank has
gradually adopted a more cautious strategy. Due to con-
cern about the strong krone and the competitivenessof Norwegian manufacturers, the bank has not wanted
to open up an excessive interest rate spread over the
ECBs re rate.
The Riksbank is now beginning to face a similar dilem-
ma. Resource utilisation in Sweden is admittedly lower
than in Norway, but rapid economic growth is quickly
changing that situation. Unemployment has fallen rap-
idly, while home prices and household borrowing have
continued upward as in Norway.
Per cent
Key interest rates
Euro zone Norway SwedenSource: ECB, Norges Bank, Riksbank, SEB
00 02 04 06 08 10 120
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
forecastSEB
In some respects, the Nordic central banks are playing
a pioneering role when it comes to learning from the
mistakes that preceded the crisis and then applying the
new guidelines that are emerging from the international
monetary policy discourse. What the major countries
mainly perceive as problems in the distant future is
starting to be fairly urgent in the Nordic countries.
Minutes of Riksbank policy-making meetings show major
disagreements of principle within the Executive Board,
which the bank does not try to hide either.
Our scenario is that the Riksbank will hike its key inter-
est rate at each monetary policy meeting until Febru-
ary 2011, when the rate will reach 1.50 per cent. After
that, rate hikes will be more cautious. An international
slowdown, continued low spot ination and an ever-
stronger krona may be arguments for a more cautious
strategy. At year-end 2011 the repo rate will be 2.25
per cent, and at the end of 2012 it will be 3.0 per cent.
Our forecast is thus lower than the Riksbanks rate path
but higher than market expectations.
Norges Banks deposit rate will remain at 2.00 per cent
up until the second quarter 2011. A closing output gap
and rising core ination will thereafter lead to furthergradual hikes. At the end of 2011 we see the deposit
rate at 2.75 per cent and at the end of 2012 at 3.75 per
cent.
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International overview
Different scal strategiesThe acute crisis in southern Europe last spring led to a
change in view about scal policy. The main approach
in earlier recommendations from the OECD and IMF, for
example, has been to focus on credible medium-term
programmes, but implementation could be delayed
until recovery was on rmer ground. It now becameobvious that many countries lacked such room for
manoeuvre. Large-scale austerity packages became
necessary, especially in southern Europe. In France and
Germany, however, austerity measures are rather small.
As a result, the total dose of austerity in the euro zone
will be no more than about 1 per cent of GDP annually
in 2010-12.
Recent budget gures in a number of countries have
been better than expected.In Germany the decit can
probably be reduced to less than 3 per cent of GDP as
early as 2011. The government had previously aimed at
achieving this level only in 2013. As for the effects ofthe austerity packages in southern Europe, it is too ear-
ly to draw any reliable conclusions. The improvements
in Greece, for example, have been sufcient to per-
suade the IMF and EU institutions to approve a second
disbursement of emergency loans. Most of the success
in stopping the bleeding has been on the expenditure
side, while attempts to improve the efciency of tax
collection have yielded smaller results so far.
Given more pessimistic economic prospects, we are
not likely to see further belt-tightening in the major
OECD countries during the coming year. In the UK, thenew government has admittedly decided to deal with
its large scal decits at an early stage. In the US and
Japan, however, new stimulus measures are the focus
of attention, although in our judgement such measures
will hardly be implemented.
Net lendingPer cent of GDP
2010 2011 2012
United States -10.9 -8.2 -5.9
Japan -9.8 -9.1 -8.5
United Kingdom -11.4 -9.4 -7.6Euro zone -6.2 -5.5 -5.0
OECD -7.8 -6.7 -5.5
Source: OECD, IMF, SEB
At the global level, we expect scal policy to have a
weakly tightening effect in the next couple of years.
This means that decits will only shrink slowly and
that government debt will continue to grow. The sharp
downturn in government bond yields in major countries
indicates that mistrust from nancial markets will not
force belt-tightening either. Not even threats of down-
grading by credit rating agencies are likely to change
the picture. Given continued weak economic condi-
tions, high private saving and supportive central banks
many countries will to a large extent postpone scal
adjustment needs.
Low bond yieldsThe decline in long-term bond yields has been very
sharp, and yields are now exceptionally low. American
10-year government bond yield has fallen from 4.0 percent in April to 2.60 per cent, while equivalent German
bonds have now declined to an exceptionally low level
of 2.25 per cent.
There have been several driving forces behind this
yield trend: concerns about economic growth, falling
ination expectations and promises of continued low
key interest rates. The search for safe investments has
also beneted the xed income market, despite large
and growing government debts on both sides of the
Atlantic. A very rapid increase in private savings dur-
ing the economic crisis, savings in the OECD countries
have risen by about 10 per cent of GDP has offsetthe increased public sector borrowing requirement and
helped squeeze interest rates.
The box below discusses how asymmetric downward
risks both on the growth and ination side will probably
lead to long-term uncertainty about the ability of cen-
tral banks to normalise monetary policy. We expect this
uncertainty to help keep long-term yields depressed,
especially in the coming year. German 10-year yields
will bottom out at about 2.20 per cent around year-end
2010 and remain below 2.50 per cent well into next
year. Only when it begins to be apparent that central
banks can actually begin interest rate hikes do we be-
lieve any signicant upturn will occur. Long-term yields
will remain depressed, however. At the end of 2012,
German 10-year government bond yields will stand at
3.20 per cent and American ones at 3.50 per cent.
Per cent
10-year government bond yields
US GermanySource: Reuters EcoWin, SEB
99 00 01 02 03 04 05 06 07 08 09 10 11 12
2.0
2.5
3.0
3.5
4.04.5
5.0
5.5
6.0
6.5
7.0
2.0
2.5
3.0
3.5
4.04.5
5.0
5.5
6.0
6.5
7.0
SEBforecast
Cautious stock market valuationsThe stock market has recently reacted negatively tosignals of an American economic slowdown. Surpris-ingly strong company earnings reports have not beenenough to offset this. There are both threats andopportunities ahead. The simple phase when thestock market was driven upward by positive surprises
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International overview
Moving towards Japanese yields?The key interest rates set by central banks are at
exceptionally low levels. But bond yields are also
historically very low, with American 10-year Treasuries
yielding 2.6 per cent and equivalent German bonds 2.2
per cent. By way of comparison, a Japanese 10-year
bond is at just below 1 per cent and has uctuated
between 1 and 2 per cent for the past 13 years.
Above we discussed the forces that have pushed down
long-term yields to these levels. One crucial question
is how long they will last, and to what extent todays
interest rates in the Western world are abnormally low
or completely normal. This can be analysed in terms
of normal key interest rates and the normal steepness
of the yield curve.
The level of a normal key interest rate can be based
on the level of the real interest rate plus ination
expectations. A proxy for the real interest rate is
long-term GDP growth. Given the need to adjust
imbalances, there is reason to expect lower growth
potential, which will push down the real interest rate.
In the medium term, ination pressure will remain
low. Given asymmetric negative risks for both growth
and ination, uncertainty will continue as to whether
central banks will actually achieve their ination
targets. Ination expectations may thus fall below
ination targets, which will also push down the normal
interest rate.
Short- and long-term interest rates in US and Japan
Japanese interest rate squeeze
Japan: 10-year government yieldJapan: Key interest rateUS: Key interest rate
US: 10-year government yieldSource: Reuters EcoWin
88 90 92 94 96 98 00 02 04 06 08 100
12
34
56
78
910
0
12
34
56
78
910
Given exceptionally low key interest rates during the
next couple of years Japan can serve as an example
the average key interest rate will have been very
low for a rather long time. The markets assessment
of what should be viewed de facto as a normal key
interest rate will probably move downward as the
period of low interest rates is extended. In addition,
it is reasonable to assume that new regulatory toolsfor dealing with such problems as pro-cyclical forces
in the nancial sector will make it easier for central
banks to maintain low interest rates and to instead
devote monetary policy energy to price stability.
Japans average GDP growth since the early 1990s is
1.2 per cent. Even if we assume that growth moves
higher, for example close to 2 per cent, there is still
reason to believe that continued imbalances justify
a lower real interest rate than 2 per cent. If we also
foresee that ination expectations may become lower,
for example 1 per cent, the normal key interest rate
will be pushed down further. In a medium- term per-
spective, the normal key interest rate might be in the
1.5-2.5 per cent interval.
Normal long-term yield is based on the level of the
normal key interest rate. The historical average for
the steepness of the yield curve (10-year yield minus
the key interest rate) has been about 130 basis points.
This applies to most countries the US, Germany and
Japan. This differential also includes an ination risk
premium. Studies of the Fed show that the ination
risk premium is about 50 basis points. A low-ination
environment may justify lowering the risk premium.If in our example we assume that this premium is
halved, the differential between the key interest rate
and the low-term yield will be about 100 basis points
(130 minus 25 basis points).
Based on this reasoning, long-term bond yields would
be at 2.5-3.0 per cent. Arguments that the market
will adjust expectations of a normal key interest rate
downward are relatively strong in a medium-term ve-
year perspective, where the elements of similarities
with the Japanese situation may be clear. What may
be regarded as abnormally low interest rates, viewed
in a historical perspective, may be rather normalinterest rates viewed in a future perspective.
in sales and improved leading indicators is over. Thenext phase will be characterised by a maturing mar-ket for industrial products, with major macroeco-nomic challenges, especially in the US. Companiesmust now deliver good prots driven by sales growth
rather than cost savings, in order for share prices to
continue rising.
So far the stock exchanges in the Nordic and Balticcountries have generally performed better than ex-changes elsewhere this year. There are several rea-
sons why they may continue to do so. SEB Enskildascompany analyses indicate a 56 per cent increasein prots this year for companies listed in the
Nordic countries and 17 per cent next year. Stronggrowth in key Nordic markets, Germany and Asiawill improve the prot outlook in the next couple
of years. Low company valuations also allow roomfor good share price increases. Shares on the Nordicexchanges are now trading at a price-earnings ratioof 10.5 (based on expected 2012 prots) well be-
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Nordic Outlook August 2010 | 13
International overview
low their historical average. Worth adding is that theratio between share prices of listed companies andtheir book values is 25 per cent below its 10-yearaverage.
Stock market indices, 2010
-30 -20 -10 0 10 20 30 40 50
Latvia (OMX)
Estonia (OMX)
Lithuania (OMX)
Iceland (OMX)
Denmark
Finland
Sweden
Germany (DAX)
USA (S&P500)
U.K. (FTSE100)
Norway
Japan (Nikkei 225)
Spain (MadSE)
The yield on listed shares in the Nordic countriesduring the next couple of years looks set to be atalmost 4 per cent, or twice the yield on 5-year go-vernment bonds. This also illustrates the exchangescautious valuations. But valuation analyses arenot better than the forecasts that are used in themodels. The assumption is that next year, prots will
have rebounded above their previous record levelsin 2007/2008. The uncertain macroeconomic envi-ronment raises the question of whether this pace
in improved prots will continue. If investors are tofocus again on fundamental valuations, a number ofbasic questions about future developments must beanswered.
P/E ratios in Nordic exchanges
96 98 00 02 04 06 08 10 120.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Fair valuations, more stable currenciesIn the past year, the foreign exchange market hasundergone a normalisation process after major tur-bulence during the most acute phase of the nancial
crisis. Many currencies have again reached more
neutral levels, based on long-term valuation mod-els. Today the G3 currencies (EUR, USD and JPY) areclose to historical average levels in trade-weighted,ination-adjusted terms (real effective exchange
rates). In the short term, uncertainty about theglobal economic recovery will dominate the for-eign exchange market, but we believe that marketpositioning is now more neutral than for a long time,which will restrain movements in the future. We thussee various reasons why the trend towards smaller
uctuations in the foreign exchange market willcontinue.
The risk aversion evident in the market over the pastfew months has led to heavy demand for defensivecurrencies like the JPY and CHF. Shrinking interestrate spreads against the US and euro zone will leadto continued upward pressure on these currencies,but the Swiss central bank has not repeated itsforeign exchange market interventions of last spring,despite an ever-stronger CHF. Nor do we regard thisas likely in the future. In Japan, the issue of inter-vention is heating up. Our assessment is that if the
USD/JPY exchange rate approaches its historicallow of just under 80 (in 1995), this will be critical indetermining whether the Bank of Japan intervenes inthe foreign exchange market.
Overall, our forecast implies small movements inleading currencies during the coming year. The EUR/USD exchange rate may again fall below 1.20 in thenext six months, driven by continued low risk ap-petite in the world economy, then rise somewhat.In the long term we expect the EUR/USD rate to beat levels around 1.20-1.30. The US economy willadmittedly remain weak and continue to show ex-ternal trade imbalances, but on the other hand theeuro system is facing long-lasting uncertainties andquandaries. The yen will gain some strength againstthe USD in the short termbut will then decline asthe interest rate spread between Japan and othercountries widens again in the future.
Real effective exchange rates. Index 100 = average 1980-2010
EUR and USD
USD EURSource: Bank of England
1980 1985 1990 1995 2000 2005 2010
70
80
90
100
110
120
130
140
70
80
90
100
110
120
130
140
The question of further quantitative easing by cen-tral banks is a source of uncertainty in the foreignexchange market. If the Fed or Bank of England were
to expand their balance sheets further, it wouldweaken the dollar and pound, but this is not ourmain scenario at present.
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International overview
Policy Committee (FPC) is now being established along-
side the existing Monetary Policy Committee (MPC).
The FPC will oversee economic developments and
identify macro trends that may threaten economic and
nancial stability, then take relevant action.
Our conclusion is that the interesting reform task in the
area of economic-policy is continuing, but that its ambi-
tions and pace seems to have been lowered. A fragile
economic situation, but also the weakened authority of
political leaders in many countries, is contributing to
this.
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The United States
16 | Nordic Outlook August 2010
Recovery continuing, but at a slower pace
Faster debt retirement
New labour and housing market slump
Sustained upturn in capital spending
Ination will continue to fall
Fed will not hike its key rate until 2012
The American economic recovery is now becoming
weaker, as scal stimulus measures fade and the growth
contribution from the inventory cycle diminishes.
The improvement in the labour market has slowed in
recent months, and the housing market has become
shaky again now that the federal tax credit for rst-
time home buyers has expired. GDP rose 1.6 per cent
in the second quarter on an annualised basis, a clear
slowdown from 3.7 per cent in the rst quarter. Sharply
higher imports provided a strong negative contribution
to growth and inventory build-up also slowed, compared
to the rst quarter. Capital spending by businesses
showed strong growth, however.
Yet the low Federal Reserve key interest rate is still
propping up the economy. We thus believe that the
recovery will continue, but at a slower pace than esti-
mated in our May forecast. GDP growth will climb 2.6
per cent in 2010 and by 2.2 per cent in 2011. 2012
GDP will grow 2.9 per cent. The risk in this growth
forecast is on the downside. The slowdown has opened
the way for the Fed to provide further economic stimu-
lus by expanding its balance sheet and postponing key
rate hikes until 2012.
Quarterly percentage change, annualisedSlower GDP growth
Source: BEA, SEB
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q309 10 11 12
-5
-4
-3
-2
-1
0
1
2
3
4
5
-5
-4
-3
-2
-1
0
1
2
3
4
5
SEB forecast
Many signs of decelerationAside from slower GDP growth and a lukewarm labour
market, various indicators have weakened in recent
months. Consumer condence has fallen and is now
lower than at the beginning of 2010. The ISM purchasing
managers index for manufacturing has fallen during the
past few months, while the service sector index has lev-
elled off, but both indices remain well above 50, which
indicates growth. Weaker optimism is also reected in
retail sales, which recovered strongly early this year
but have stagnated during the past months.
Index
Small firms are lagging behind
ISM Manufacturing (LHS) NFIB (RHS)Source: ISM, NFIB
86 88 90 92 94 96 98 00 02 04 06 08 100
5
10
15
20
25
30
30
35
40
45
50
55
60
65
There is a persistent condence gap between large and
small businesses. While the ISM, which is dominated
by large companies, continues to show a rather bright
picture of the situation, the National Federation of In-
dependent Business (NFIB) index of small business senti-
ment is at a record low. This may partly reect the fact
that small businesses are still having difculty obtainingloans and that depressed construction companies weigh
heavily in the NFIB index.
Higher saving holds back consumptionThe latest national accounts show substantially weaker
consumption and higher saving than the previously
reported gures. In the second quarter, the household
savings ratio was 6.1 per cent, an upward revision of
several percentage points. A higher level of saving indi-
cates a faster pace of adjustment in household balance
sheets. In the long term this will set the stage for a
sustainable recovery in consumption, but over the next
couple of years we believe that the need to pay down
debts will cause the savings ratio to continue upward a
bit, thereby holding back consumption.
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The United States
Our current assessment is that the savings ratio will
gradually rise to around 8 per cent during 2011, far
above the average of the past 15 years. This is also
consistent with our model projections, which have sig-
nalled for some time that the savings ratio will rise to
a level closer to the average for the past 50 years. We
thus believe that overall consumption will increaseby 1.5 per cent in 2010 and 2.2 per cent in 2011, a
downward revision compared to our assessment in
the last Nordic Outlook.
Per cent of disposable income
Uniform pace of debt retirement
Household debts (LHS) Household saving (RHS)Source: Federal Reserve
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
1
2
3
4
5
6
7
8
9
10
11
12
60
70
80
90
100
110
120
130
140
Housing market unsteady againDespite record-low interest rates, pushed down partly
by the Feds mortgage bond purchases, and a subsidy in
the form of a USD 8,000 federal tax credit to home buy-
ers, the housing market recovery has not really taken
off in earnest. In May 2010, the S&P/Case-Shiller home
price index was only some 5 per cent higher than when
it bottomed out one year earlier. The number of home
sales and housing starts are also at historically very low
levels. In July the number of housing starts was only
546,000, less than one third of the July average from
2003 to 2005. Despite the low number of homes being
built, during 2010 inventory has uctuated around eight
months. In July, inventory rose to 12 months. Such a
high level will help hold prices and new construction
down. Because the home buyer tax credit expired at
the end of April, both residential construction and the
number of contracted home sales have weakened mark-edly during the past few months. Mortgage applications
are at a record low. The National Association of Home
Builders index of construction industry condence has
also declined.
It is difcult to foresee any immediate improvement
in the housing market. We anticipate that the rapid
decline in the number of sales will drive down prices
during the next few months. Housing market activity
will also be hampered by the slow recovery in the la-
bour market, but low mortgage rates should be able to
serve as a oor under the housing market. The 30-year
mortgage rate has decreased from around 5 per centin April to just below 4 per cent. Many households also
accelerated their home purchases to take advantage of
the tax credit. Once this effect has faded, the number
of home sales transactions will stabilise. During 2011 we
thus expect slightly rising home prices.
Index 2004:1 = 100
The housing market recovery decelerates
S&P Case-Shiller 20 FHFASource: OFHEO, Standard & Poor's
04 05 06 07 08 09 10
90
95
100
105
110
115
120
125
130
135
140
90
95
100
105
110
115
120
125
130
135
140
The July issue of the Feds Beige Book points out that
the commercial real estate market remains weak.
Assessments of future trends ranged from continued
decline in activity to weak growth, but one bright spot
is that corporate capital spending on commercial real
estate appears to have stabilised.
Company capital spending a bright spotOne bright spot during the recovery this year is capital
spending by businesses, which has climbed sharply in
2010. During the second quarter, the annualised in-
crease was 17.6 per cent. This growth in capital spend-
ing focused on machinery and software. Commercial
real estate investments were stable. The sharp increase
during the second quarter was partly a consequence of
earlier very depressed levels. Our assessment is thus
that capital spending growth will slow during the rest
of the year, but in a longer perspective there are fac-
tors that indicate good capital spending growth. In a
historical perspective, the capital spending ratio in the
business sector remains very low. Meanwhile companies
are earning good prots and their balance sheets are far
stronger than during any previous economic downturn.
Per cent
Capacity utilisation and company capital spending
Capacity utilisation (LHS)
Company capital spending, annualised Q growth (RHS)Source: BEA, Federal Reserve
70 75 80 85 90 95 00 05 10
-40
-30
-20
-10
0
10
20
30
40
67.5
70.0
72.5
75.0
77.5
80.0
82.5
85.0
87.5
90.0
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The United States
High imports weaken trade balanceDespite a sharp deterioration in public nances, in the
past few years there has been a trend towards improve-
ment in the US current account balance, due to sharply
higher saving by both businesses and households.
Recently, however, trade imbalances seem to have
widened again. The improvement in the balance oftrade has been replaced by rising decits. In June the
trade decit was nearly USD 50 billion, the largest since
October 2008. The much-publicised decit with China
has increased greatly in recent months and was just
above USD 26 billion in June. If it does not fall during
the autumn, the slow appreciation of the Chinese yuan
may become a hot issue in the campaign leading up to
Novembers congressional elections.
Procent of GDP
Current account and budget balance
Current account Federal budget balanceSource: BEA, US Department of the Treasury
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
-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
Because imports rose far more rapidly than exports,foreign trade made a large negative contribution to GDP
growth during the second quarter. Export growth is ex-
pected to decelerate faster than import growth, which
means that US economic growth seems unlikely to get
any help from foreign trade in the next few quarters.
Labour market disappointmentsAfter a fairly positive trend during the spring, the
labour market has now lost momentum and the most
recent reports have been clearly disappointing. The
recovery is moving slowly, and unemployment remains
very high. From a peak of 10.1 per cent in October
2009, the jobless rate had only fallen to 9.5 per centin July: far from the equilibrium unemployment level,
which is around 5 per cent.
Total employment increased sharply during the spring,
but this was primarily due to the large number of peo-
ple with temporary jobs with the 2010 US Census. For
example, around 410,000 people out of a total increase
of 432,000 jobs in May could be explained by Census
effects. Employment in the private sector is showing a
substantially more subdued trend, although the number
of people with jobs has now risen for seven months
in a row. In the most recent three-month period, job
growth has been only 50,000 people per month, far
lower than the underlying increase in the labour supply.
Actual unemployment has nevertheless continued to fall
slightly, because the increase in the labour force that
was discernible early in 2010 was followed by a decline
during the past three months.
Unemployment and private sector employment
Unemployment, per cent (LHS)Private sector employment, millions of individuals (RHS)
Source: BLS
07 08 09 10
107
108
109
110
111
112
113
114
115
116
0
1
2
3
4
5
6
7
8
9
10
Because of their weak nances, state governments can-not contribute to the labour market recovery. In July,
the number of state and local government employees
fell by nearly 50,000. The federal government has ap-
proved a USD 26 billion aid package to ease the scal
plight of state governments, but many of them will
need to continue trimming their payrolls.
One new phenomenon during the latest American eco-
nomic downturn is the scale of chronic unemployment.
The share of unemployed people without a job for 27
weeks or longer is now around 45 per cent. This is the
highest level recorded since such statistics began to be
collected in 1948. In response to this chronic unemploy-ment, the maximum period for benet payments has
been extended.
One positive sign in the labour market is the increase in
the number of hours worked during the past year. This
increase indicates continued expansion in employment.
Forward-looking indicators also hold out some hope of
future improvements in the labour market. The employ-
ment sub-index of the ISM survey clearly indicates that
manufacturing employment will continue to increase.
There is also job creation in the private service sector.
The construction sector, however, remains depressed
and its number of employees has again begun to fall in
recent months. Our overall assessment is that employ-
ment will continue to increase, but at a slow pace.
Unemployment will continue to fall and will be just
above 9 per cent at the end of 2010 and 8.5 per cent
at year-end 2011.
Ination will continue to fallThe slow labour market recovery and high unemploy-
ment are holding down ination pressure. Despite an
increase in manufacturing activity, capacity utilisation
remains well below normal. Unit labour costs have fall-
en rapidly in recent years, and the historical associationbetween unit labour costs and ination is strong. Falling
bank lending and the low rate of increase for M2 money
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The United States
supply reinforce the picture of continued low ination
pressure.
Year-on-year percentage change
Strong connection between inflation and unitlabour cost
CPI inflation Unit labour costsSource: BLS
50 55 60 65 70 75 80 85 90 95 00 05 10
-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
During the last four months core ination has been at
0.9 per cent. Such a low level has not been recordedsince the 1960s. CPI ination has fallen during 2010 and
was at 1.2 per cent in July. Our forecast is that core
ination will fall a bit further, bottoming out at 0.5 per
cent in mid-2011. Then core ination will slowly climb
again, ending up just above 1 per cent at the close of
2012. CPI ination may climb somewhat in the immedi-
ate future, but we also expect it to bottom out dur-
ing 2011 and then slowly rise. Altogether, we expect
ination to end up at 1.6 per cent this year and 0.8
per cent next year. In 2012, ination will rise to 1.2
per cent.
Year-on-year percentage change
Low inflation pressure
Core inflation Headline inflat ionSource: US Department of Commerce, SEB
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
-2
-1
0
1
2
3
4
5
6
-2
-1
0
1
2
3
4
5
6
forecastSEB
A dilemma for the FedBecause of large US government debt, the chances of
further scal stimulus are slim. If the recovery con-
tinues to weaken, the Fed will thus be under increas-
An unusual recoveryThe National Bureau of Economic Research (NBER)
is the agency that ofcially establishes the dates of
US economic cycles. Although the agency has not yet
declared that the recession is over, the general per-
ception is that it ended in the summer of 2009. The
recovery has thus lasted four quarters so far. On the
other hand, economic developments have diverged
from the normal cyclical pattern, which is probably
the reason why the NBER is hesitant to declare that
the recession is over.
Since the Second World War, annualised GDP growth
has averaged 6 per cent at this point in the economic
cycle, compared to 1.6 per cent during the second
quarter of 2010. Looking back at more than half a
century of data, two and a half years after a recessionstarted the GDP level has averaged 8 per cent above
the previous peak.
Todays weak labour market also diverges from the
historical pattern. The previous two recessions were
admittedly also characterised by relatively long
periods before job creation began to prevail, but the
latest recession is unique in terms of its combination
of depth and length. And without the support of a
stronger labour market, the American economy will
have a difcult time reverting to its normal recovery
dynamic.
This recovery does not resemble others, due to the
causes of the economic crisis. Short, shallow post-war
recessions have often been caused by excessive inven-
tories and exaggerated optimism among investors. This
time, the recession has instead centred on a severelywounded banking system as well as on household bal-
ance sheets and debt retirement. When the dotcom
(IT) bubble popped in 2001, household balance sheets
experienced a shock, but an expansionary monetary
policy quickly helped the housing market to soar.
Total number of employed, index=100 in the quarterpreceding the beginning of the recession
An unusually sluggish recovery
Source: BLS0 5 10 15 20 25 30 35 40 45
92.5
95.0
97.5
100.0
102.5
92.5
95.0
97.5
100.0
102.51974
1981
1990
2001
Current
The NBER focuses mainly on four variables in assess-
ing economic cycles: sales, employment, industrial
production and income. Of these, the rst two have
fallen in recent months while the latter two have
levelled off at slow speed. In such a situation, it isnatural to be cautious in making assessments.
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20 | Nordic Outlook August 2010
The United States
ing pressure to act, but the central bank has limited
potential for increasing its stimulus. The federal funds
rate is in the 0-0.25 per cent interval and cannot be cut
further. As early as March 2009 the Fed also pledged to
keep its key rate at an exceptionally low level for an
extended period. The remaining weapon in the Feds
arsenal is thus to expand its balance sheet by purchas-ing securities.
USD trillion
The Fed's balance sheet
Source: Federal Reserve
07 08 09 10
0.75
1.00
1.25
1.50
1.75
2.00
2.25
2.50
0.75
1.00
1.25
1.50
1.75
2.00
2.25
2.50
At its interest rate meeting in August, the Fed con-
rmed that the US economic recovery has slowed down
and outlined a new monetary policy strategy. The
central bank decided that it will keep its balance sheet
at the current level, instead of shrinking it over time.
Its interest revenue and the principal it receives back as
its existing stock of mortgage bonds matures will thus
be reinvested in government securities. In itself, this
decision does not signify any new stimulus, but it sends
a clear signal that monetary policy has now become
more dovish and that a key rate hike is very distant.
The Fed has shifted from a situation where it had begun
preparing for normalisation of monetary policy to one
of paving the way for possible further stimulus.
If the recovery should weaken even more, the shift in
Fed strategy has opened the door for further quantita-
tive easing (QE), thereby pushing down market interest
rates. Ination pressure remains very low, and the risk
of deation has not disappeared, but there is reasonfor the Fed to hold off on QE for the time being. To
begin with, interest rates are already falling due to
market forces. Furthermore, ination expectations are
admittedly low, though they have not yet approached
deation levels. By purchasing government securities,
the Fed also risks being criticised for monetising the
US federal budget decit. A more far-reaching ques-
tion is how much stimulus effect the Fed can expect
to achieve by further squeezing interest rates that are
already extremely low.
Our assessment is thus that the Fed will hold off on
further stimulus during the next several months butmay implement such measures later this autumn if the
state of the economy deteriorates substantially. Our
forecast is that the Feds rst key interest rate hike
will occur during the rst quarter of 2012 and that
the federal funds rate will stand at 1.25 per cent by
the end of 2012.
Obama faces uphill political battle
President Barack Obamas public approval rating hasfallen sharply. When he took ofce in January 2009,
a Gallup poll on whether the president was doing a
good job or a bad job gave him a 68-21 per cent score.
Todays polls give him 41-52. Despite the passage of
historic health care and nancial sector reforms, the
new president has not managed to live up to peoples
expectations. High unemployment and last years bank-
ing sector bail-out have soured many voters on the
Obama administration.
This decline in public condence is so large that it is
jeopardising continued Democratic control of the House
of Representatives following the November 2 mid-term election. It is nothing unusual for an incumbent
presidents party to lose seats in Congress, but our
analysis (see chart) shows that the Democrats will only
barely retain control of both houses. With a weakened
president, Washington risks political paralysis until the
autumn 2012 presidential election. This is occurring in a
situation where both the American economy and global
cooperation efforts are in great need of clear US politi-
cal leadership.Democratic control of House of
Representatives in jeopardy
-60-50-40-30-20-10
01030 35 40 45 50 55 60 65 70
Democratic projectedseat loss
Source: Gallup.com, SEBNumber of seats gained/lost (vertical axis)Presidential approval rating, per cent (horisontal axis)Todays US domestic political scene is dominated by
discord and by Republican attempts to stop or at leaststall reforms. There is also disagreement as to whether
the economy needs further stimulus, or whether belt-
tightening is required. The Republicans oppose further
scal stimulus and question the size of the positive im-
pact from earlier stimulus packages. Even among Demo-
crats and the general public, there are doubts about
the need for further stimulus measures. The pendulum
thus seems to be swinging towards support for greater
austerity. Obamas plan for another large-scale stimulus
package has undergone radical cuts. The extension of
unemployment benets to 99 weeks was pushed through
only with great difculty.
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Nordic Outlook August 2010 | 21
The United States
Fiscal policy difcult to assessThe political situation has made it more difcult to as-
sess US scal policy. For example, it is unclear whether
the tax cuts implemented by President George W. Bush,
which expire at the end of 2010, will be extended.
The Republicans want to retain the tax cuts, while
the administration and most Democrats only want toretain the cuts for people who earn a maximum of USD
250,000 per year. In August, the independent Congres-
sional Budget Ofce warned that extended tax cuts
for all income groups would seriously worsen the scal
outlook, but our overall assessment of scal policy has
not changed especially much since May. We expect
federal stimulus measures to contribute 1 percentage
point to 2010 growth and -0.5 points in 2011. Given our
US economic forecast, the phase-out of scal stimulus
will put the Fed under additional pressure to continue
pursuing an exceptionally accommodative policy, in-
cluding zero interest rates and a possible expansion of
the central banks balance sheet.
The budget decit during the scal year 2009 ended up
at just above USD 1.4 trillion, equivalent to nearly 10
per cent of GDP. The budget decits in scal 2010 and
2011 will be lower than in our May forecast. The de-
cit will end up around USD 1.4 trillion this year and just
below USD 1 trillion next year. In scal 2012 the decit
will shrink further.
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Japan
22 | Nordic Outlook August 2010
Strong currency leads to policy dilemma
Brisk exports, but strong yen an obstacle
Continued deation pressure
BoJ will hike key rate only in 2012
The Japanese economy showed unexpected strength
around year-end and early in 2010, but second quarter
growth was a big disappointment. GDP growth was a
mere 0.1 per cent, raising questions about the strengthof the recovery. The GDP gure should not be over-
interpreted; quarterly statistics are often erratic, and
leading indicators like the Tankan Survey from the Bank
of Japan (BoJ) point to continued decent growth in
the near future. But there are also worrisome signs,
among them that the housing and construction industry
as well as retail sales seem to have lost momentum.
Exports and industrial production have bounced back
after last years dramatic fall. Due to high growth else-
where in Asia, combined with a favourable product mix
in trade with the US, exports will rise by about 20 per
cent this year.
Despite the weak second quarter, we foresee that
consumption will continue to be sustained by govern-
ment stimulus measures totalling about 7 per cent of
GDP over the period 2008-2010. Private consumption
will increase by nearly 2 per cent this year, the fast-
est rate since 1996. We predict GDP growth of 2.5 per
cent this year, the same forecast as in May.
A slight cooling in global demand, the lagging effects
of yen appreciation so far this year and the phase-out
of stimulus measures will lead to a deceleration late
this year and in 2011. Export growth will slow to about5 per cent in 2011, capital spending growth to about
4 per cent and consumption growth to less than 1 per
cent. Overall, GDP growth will fall to 1.5 per cent in
2011 as well as 2012.
Unemployment has risen in recent months (currently
5.3 per cent), which risks blunting the consumption
upturn. We expect GDP growth to be close to or just
above trend during the next couple of years, which
means that unemployment will move sideways.
Ination pressure will remain very low. CPI will decline
by 1.0 per cent this year and end up around zero in2011. A lower ination trend than in other countries is
reected in the long-term strengthening of the yen (in
keeping with the theory of purchasing price parity,
PPP). The euro zone economic crisis, combined with
uncertainty about the American economy, has quickly
resulted in a clear appreciation of the yen. The USD/
JPY exchange rate has moved from over 90 in January
to just above 85 today. The yen has also strengthened
against the euro: from about 130 per EUR in January
2010 to about 112 today. In spite of this, the yen is
not unjustiably expensive at present, but given our
forecast that the USD/JPY will approach 80 (the yens
highest value since 1995), ofcial intervention in theforeign exchange market cannot be ruled out.
USD/JPY rate follows relative prices
USD/JPY, Yen per dollar (LHS)Relative prices, Japan compared to US, Jan. 2010=100 (RHS)
Source: Reuters EcoWin
75 80 85 90 95 00 05 10
80
105
130
155
180
205
230
255
75
100
125
150
175
200
225
250
275
300
325
Due to the strong yen and the trend towards weaker
global demand, Japanese policy makers will face new
challenges. The government, also confronted by falling
stock prices, will seek to have new stimulus measures
outlined by late August. We expect a budget decit
equivalent to about 8 per cent of GDP this year,
somewhat lower in 2011-2012. Government debt is ap-
proaching 200 per cent of GDP. This difcult situation
must be managed in an uncertain political landscape.The Social Democratic Party recently withdrew from the
governing coalition and in June the former nance min-
ister, Naoto Kan, became Japans fth prime minister
since 2006. The Bank of Japan will raise its key interest
rate to 0.5 in 2012.
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Asia
Nordic Outlook August 2010 | 23
Slight deceleration in growth
Slowdown from high level
Balanced growth in China
Monetary tightening needed in India
Asias emerging countries have shown good resilience
in the face of global recession, recovering far more
rapidly than the OECD countries. Good central govern-
ment nances have made it possible for them to launchstimulus packages, and their export-driven economies
have beneted from the global trade recovery. Howev-
er, there are signs that the recovery that started during
the second half of 2009 is now slowing a bit. In China,
there was a welcome deceleration in economic activity
during the second quarter of 2010. The latest outcomes
for industrial production, exports and purchasing man-
agers indices also indicate a slowdown in such econo-
mies as Malaysia, South Korea and Taiwan. Despite this
deceleration, we expect good growth in the region
during both 2010 and 2011.
Year-on-year percentage change
Industrial production
Thailand
South Korea
Taiwan
India Source: Reuters EcoWin
Jan May Sep Jan May Sep Jan May Sep Jan May
07 08 09 10
-40
-30
-20
-10
0
10
20
30
40
50
60
-40
-30
-20
-10
0
10
20
30
40
50
60
Rapid wage increases, partly in response to an increas-
ing number of strikes in various Asian countries, repre-
sent a certain short-term inationary threat. In some
countries, such as India, the authorities will need to
respond with continued monetary policy tightening. In a
longer perspective, rising wages are a natural develop-
mental step in the region that will help reduce global
imbalances, both by narrowing cost differences and by
shifting these economies towards a larger consumption
element.
China: Slowdown but no crash landingGDP gures for the second quarter conrmed our
forecast of a soft landing in China. Year-on-year growth
slowed from 11.9 per cent in the rst quarter to 10.3
per cent. The governments tightening measures during
the spring, including restrictions on bank lending and
regulation of home sales, seem to have had an effect.
Various indicators are also showing continued decelera-
tion. The purchasing managers index has continued
to fall, in July reaching its lowest level since February
2009. Industrial production, retail sales and car sales
have also decelerated. Exports have also slowed, but
the rate of increase remains high; their level is nearly
40 per cent higher than in 2009.
The upturn in CPI ination has slowed, and although
core ination has climbed in recent months it was only
2.4 per cent in June. This will probably mean that the
authorities will be cautious about further tightening
measures.
Year-on-year percentage change
Inflation in China and India
China IndiaSource: National Bureau of Statistics of China, Ministry of Commerce and Industry, India
07 08 09 10
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
There is a continued focus on the risks of overheating
in the housing market. A sharp decline in home prices
would impact the real economy mainly through falling
activity in the construction sector. Government-con-
trolled Chinese banks nevertheless have sizeable
reserves, and the home loan-to-value ratio is very low,providing a substantial cushion against falling home
prices and reducing the risks of a broader nancial
crisis.
A certain slowdown in the housing market now seems
to be on the way. Construction investments and the
number of home sales have diminished. The rate of
price increases has also cooled somewhat but remains
above 10 per cent. In our assessment, the risk of a
sharp decline in home prices is fairly small. Chinese
authorities will try to respond to an initial price slide.
Overheating is also largely a local problem. There have
been major price hikes in cities like Shanghai and Shen-zhen, but in the housing market as a whole the increase
is more limited. Looking a little further ahead, there is
also a large underlying demand for housing.
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The euro zone
Nordic Outlook August 2010 | 25
Doing better, but increasingly divided
Germanys strong competitive positiondriving rapid growth
Debt reduction tough on southern Europe
Unemployment has peaked low ination
ECB will not hike re rate until 2012
The economic trend in the euro zone has been favour-able in the past few months. GDP growth was strong in
the second quarter, leading indicators have continued
to climb especially in Germany, while nancial market
worries about sovereign debt problems have eased
somewhat.
The next couple of years will be characterised by big
gaps within the euro zone. Germany is beneting from
very strong global competitiveness and comparatively
good balances in its domestic economy. Southern
European countries face continued major challenges
in consolidating their central government nances and
restoring their competitiveness.
Low ination will enable the European Central Bank to
keep its key rate very low to support adjustment proc-
esses in southern Europe. We expect it to begin hiking
the re rate only in 2012.
Year-on-year percentage change (GDP), IFO index 2000=100
IFO climbs higher
GDP, Germany (LHS)Business conditions, IFO (RHS)Expectations, IFO (RHS)
Source: Federal Statistics Office, IFO
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
75
80
85
90
95100
105
110
115
120
-7.0
-5.0
-3.0
-1.0
1.0
3.0
5.0
Strong short-term indicatorsSecond quarter GDP gures provided upside surprises,
but also illustrated increasingly obvious gaps betweencountries. Euro zone economic growth totalled 1.0 per
cent quarter-on-quarter, and the upturn in Germany
was a full 2.2 per cent (3.7 per cent year-on-year). In
France, GDP grew by 0.6 per cent and in Italy 0.4 per
cent while other southern European countries lagged
behind: Spanish GDP grew only 0.2 per cent, while the
Greek economy shrank by 1.5 per cent.
Especially in Germany, short-term indicators also sup-
port a scenario of continued strong growth. For exam-
ple, order bookings in the German manufacturing sector
rose by 3.2 per cent in June compared to May, and bya full 24.6 per cent year-on-year. Germanys IFO index
has continued upward at a rapid pace, and its current
level indicates an upside risk to our growth forecast.
The purchasing managers index (PMI) has also pro-
vided upside surprises in most countries and is now
signalling a clearer recovery. The widening gap between
Germany and other parts of the euro zone is especially
apparent from the OECDs leading indicator, which has
continued to climb in Germany but has turned down-
ward in France and the PIIGS countries (Portugal,
Ireland, Italy, Greece and Spain).
Composite leading index
Germany in the lead, PIIGS lagging behind
Germany France PIIGSSource: OECD
00 01 02 03 04 05 06 07 08 09 10
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
107.5
110.0
112.5
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
107.5
110.0
112.5
Can domestic forces take the lead?As in many other countries, exports have been the
engine of the recovery. For some time, German manu-
facturers have been improving their competitiveness. In
the past six months they have received extra help from
a weak currency. With an EUR/USD exchange rate of
around 1.30, the growth stimulus in 2010 from the euro
is equivalent to about