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2016-05-18

SEB: Nordic Outlook: Difficult policy choices amid slow global growth - Sweden is on a roll, but its path ahead is not risk-free

Parallel with new downward adjustments in most growth forecasts, some global
sources of concern from early 2016 have partly faded. For example, oil prices
and stock markets have regained part of their earlier sharp declines, and
central banks have made their policies even more expansionary - or postponed
normalisation processes. Some of the worries about China have also
diminished. Yet global economic growth will remain anaemic and fragile in
2016: GDP growth in the 34 mainly affluent countries of the Organisation for
Economic Development and Cooperation (OECD) will reach 1.9 per cent this
year, down from 2.1 per cent in 2015. In 2017, OECD growth will accelerate to
2.3 per cent.

Downside risks continue to dominate the outlook, though to a slightly lesser
degree than before. Political risks in the United States (the presidential
election) and the European Union (a potential British exit or "Brexit" - as
well as elections in such countries as Spain, France and Germany in
2016-2017), a possible Chinese hard landing, global indebtedness and lack of
credibility and limited manoeuvring room for economic policymakers - are
factors that are causing concern.

Multi-dimensional policy challenges as economic associations weaken

The concept of secular stagnation - a lengthy period of slower growth, along
with low interest rates and low inflation - is gaining a firmer foothold in
economic discourse. Clear global signs of a high propensity to save and weak
willingness to invest are pushing down real interest rates. Interest rate
policy is actually accommodative rather than proactive, with nominal key
interest rates being forced downward by falling real interest rates. The role
of fiscal policy is also likely to expand as monetary policy ammunition runs
out and its effectiveness weakens. The question is whether political leaders
have the strength, and the fiscal manoevring room, to seize the initiative.

Meanwhile there are growing questions about the long-term sustainability of
the economic policy system. After decades of financial and economic
deregulation, the market economy's dependence on policy decisions has never
been greater. Price signals in the financial market are being obscured by the
enormous securities purchases of central banks, which in turn are driving up
asset prices, despite lethargic economic growth. Central banks have gained
increasing influence on the credit supply, which implies obvious risks of
poorer resource allocation. Monetary policy has also contributed to greater
economic inequality, but we are now seeing negative interest rates assuming a
political dimension in the opposite direction: being interpreted as a hidden
wealth tax, especially in countries with a tradition of large-scale saving in
interest-bearing accounts - such as Germany. The boundaries between central
banks and political systems are becoming more and more fluid, which also
raises questions about the independence of central banks.

Weak wage response confuses central banks

Japan, Germany, the United Kingdom and - to some extent - Sweden are examples
of countries where tighter labour markets have so far not triggered normal
wage and salary acceleration. In various countries, both political leaders
and central banks have signalled that speedier pay increases would be
desirable. Higher legal minimum wages, for example in the US and the UK, are
signs of weakening confidence in the ability of market forces to create
equilibrium and balance. Looking ahead, there are still signs that a tight US
labour market will finally push wages upward. We expect US pay increases of
3.5 per cent in 2017, resulting in rising inflation to an extent that the Fed
will find rather comfortable. In a number of countries, however, mounting
competition due to globalisation and digitisation - as well as surplus
production capacity - will hold down the inflation rate. We predict that
Brent crude oil prices will move a bit higher, to around USD 45-50 per barrel
in 2016-2017, which will reduce deflation risks.

Inflation is not dead, but it will be difficult for central banks to achieve
their inflation targets. Our US inflation forecast is sufficient for the Fed
to continue hiking its key interest rate - next time to 0.50-0.75 per cent in
September. By the end of 2017, the federal funds rate will stand at 1.00-1.25
per cent. This will help push down the EUR/USD exchange rate to 1.10 at the
end of 2016, before the euro rebounds slightly in 2017 towards its underlying
equilibrium exchange rate. Despite doubts about the effectiveness of monetary
policy, a number of central banks will continue their stimulus programmes.
Because of troublingly low inflation in both the euro zone and Japan, the
European Central Bank (ECB) will keep the door open to more securities
purchases, while the Bank of Japan will cut its key interest rate from
today's -0.10 per cent to -0.30 per cent, among other things in a desperate
effort to weaken the yen. We believe that the UK and Sweden will follow the
US and begin their rate hiking cycles during the first half of 2017. We
expect monetary policies to become more coordinated within the framework of a
re-assessment of the International Monetary System, in order to avoid
destabilising capital flows and competitive devaluations.

Good Chinese growth outlook - worse US outlook, especially in 2016

China's deceleration path is relatively close to our forecasts that its
economy will avoid a hard landing. Beijing's easing of fiscal and monetary
policies is softening the negative effects of surplus production capacity and
housing inventory, as well as high indebtedness among both state-owned and
private companies. China's domestic economy has good potential to take over
as the economic engine of the future, but there is great uncertainty as to
when this rebalancing will have a bigger impact. We expect GDP growth of 6.5
per cent in 2016, down from 6.9 per cent in 2015, and slowing to 6.3 per cent
in 2017. In the other BRIC countries, economic performance will be highly
divergent. While India will grow by 7.5 per cent, both Russia and Brazil will
be mired in deep recession this year due to structural problems, low oil
prices and political worries, but we generally expect some degree of
stabilisation in the emerging market (EM) sphere during 2017.

We do not believe that the broad-based US growth slump early this year
reflects underlying weaknesses. Financial conditions have recently loosened,
due to such factors as low interest rates, rebounding share prices and a
weaker dollar. Households can look forward to better economic conditions
related to the labour market, earnings and wealth effects. Combined with
somewhat higher oil prices, the situation in the manufacturing sector will
stabilise. Economic growth will bounce back in the second half of 2016. Yet
full-year GDP growth will reach only 1.9 per cent, down from 2.4 per cent in
2015. Next year, growth will amount to 2.5 per cent.

In the November US presidential election, we believe that Republican candidate
Donald Trump has a 35-40 per cent chance of being elected. Despite his
confrontational and largely unrealistic protectionist programme, Trump
attracts voters by playing on their underlying frustrations about current
economic policy and the role of the United States in the world. If Trump's
economic policies were implemented, US and world economic growth would be
threatened by reversals.

Recovery in Western Europe despite political fears

Western Europe's recent economic performance has been relatively stable. Early
in 2016 the euro zone reached the same level of GDP as before the Lehman
Brothers collapse of 2008. In our view, the euro zone has the potential for
GDP growth above its trend rate (1.0 per cent) during the next two years. We
expect euro zone GDP to increase by 1.7 per cent in 2016 (marginally higher
than in 2015) and to reach 1.8 per cent in 2017. But the euro zone is a
currency union with imbalanced growth and is surrounded by major political
concerns. Germany faces growing criticism from the International Monetary
Fund (IMF), the US and the other euro zone countries because of its EUR 290
billion yearly financial savings surplus (8 per cent of GDP) and overly
cautious economic policies. The banking sector, especially in southern
Europe, is being squeezed by high corporate debts, doubtful loans and a low
interest rate environment. This is hampering growth. Populism is gaining
ground in an increasing number of countries, causing major tensions for the
EU project. How the refugee crisis is managed - both in the short and long
term - and how relations with Turkey will evolve are important and unanswered
political questions, although their economic impact will be minor.

The UK's "Brexit" referendum on June 23 represents a political crossroads for
Europe and the EU project. We foresee a 65 per cent chance that the Remain
side will win. If there is a weak majority in favour of the Leave alternative
(which is a 25 per cent probability), there is likely to be room for new
negotiations with the EU followed by another referendum.

Nordic divergence - Baltic convergence

The Norwegian economy has bottomed out, with domestic demand gaining strength
despite falling oil investments. The labour market and the manufacturing
sector are showing some bright spots. The government's fiscal policy will
become even more expansionary - the biggest stimulus programme since 2009 -
and we foresee one more key rate cut to 0.25 per cent by Norges Bank. We
expect overall Norwegian GDP to grow by 1.2 per cent this year, down from 1.6
per cent in 2015. In 2017, growth will be marginally higher: 1.5 per cent.
Last year's disappointing economic growth in Denmark is difficult to explain,
but the current outlook is favourable - helped by stronger domestic demand.
We expect Denmark to show a 1.5 per cent growth rate in 2016 and 2.2 per cent
in 2017. The Finnish economy has also passed its low point but faces a long
uphill struggle. Exports will show some improvement, while households are
being squeezed from several directions. Yet low inflation is allowing an
improvement in purchasing power, which is being offset by continued public
sector austerity. We expect Finland's GDP growth in 2016 to reach 0.7 per
cent, marginally higher than last year. Next year the economy will grow by
1.1 per cent.

The outlook for Estonia, Latvia and Lithuania is improving, but downside risks
remain. Private consumption is an important driver of economic growth and is
benefiting from strong labour markets. Expected wage and salary increases
will give households more purchasing power in an environment where inflation
remains low, but at the same time these increases pose a threat to the
competitiveness of the Baltic countries. In 2017, Estonia and Latvia will
experience inflation that exceeds the ECB's target. Public sector finances
are strong, serving as a potential shock absorber and giving the three...

Författare Hugin

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