december 5, 2013 macro forecast -...

Macro Research

December 5, 2013

Macro Forecast

Central banks on divergent tracks

US: Unemployment to hit Fed’s threshold in H2 2014

Eurozone: Heading for deflation?

China: Growth stabilising, reforms on the way

Sweden: Let it grow, let it grow, let it grow...

Norway - a warning bell for Sweden?

Contents Introduction Central banks on divergent tracks 4

FX markets Policy shifts bode for a USD rally 8

US Unemployment to hit Fed’s threshold in H2 2014 10

Eurozone Heading for deflation? 14

United Kingdom Turning the corner 18

Japan Fastest growing economy – so far 20

China Growth stabilising, reforms on the way 22

India RBI to liberalise India’s financial system 24

South East Asia Cyclical pick-up ahead, yet long-term challenges 25

Brazil Persistent pressures 27

Central and Eastern Europe Future convergence at risk 29

Sweden Let it grow, let it grow, let it grow... 31

Sweden Norway - a warning bell for Sweden? 35

Norway Possible interest rate cut in March 38

Finland Recovery despite structural headwinds 40

Denmark Better, but still not great 42

Key figures 44

Disclaimer 47

Contact information

Jan Häggström, +46 8 701 1097, [email protected]

Petter Lundvik, +46 8 701 3397, [email protected]

Gunnar Tersman, +46 8 701 2053, [email protected]

Helena Trygg, +46 8 701 1284, [email protected]

Anders Brunstedt, +46 701 54 32, [email protected]

Eva Dorenius, +46 701 50 54, evdo01@ handelsbanken.se

Knut Anton Mork, +47-2239-7181, [email protected]

Kari Due-Andresen, +47 223-97007, [email protected]

Marius Nyborg Hov, +47-223 97 340, [email protected]

Jes Roerholt Asmussen, +45 4679 1203, [email protected]

Tiina Helenius, +358 10 444 2404, [email protected]

Tuulia Asplund, +358 10 444 2403, [email protected]

http://www.handelsbanken.se/research

mailto:[email protected]


http://research.handelsbanken.se/Macro-Research/

Macro Forecast, December 5, 2013

4

Introduction

Central banks on divergent tracks

The global monetary policy landscape has seen diverging tendencies this year, with rate hikes in several

emerging economies while the ECB has cut rates and the Bank of Japan and the US Federal Reserve have

pursued aggressive quantitative easing. Next year, policies in developed countries will be on diverging tracks,

with the Fed starting to move towards less accommodative policies, while the ECB will be on the opposite

tack. Sweden and Norway are more likely to follow the Fed than the ECB.

One of the themes of recent Macro Forecasts has been the divergence of economic out-

looks. The implication has been that monetary policies face very different challenges across

the globe. Rising inflationary pressure has already produced monetary policy responses in

many emerging economies and has also been a factor in the reluctance of the People’s

Bank of China to add stimulus this year and the willingness to accept a stronger renminbi.

That has held back the strength of recoveries in emerging economies.

The challenges facing the central banks in Western Europe, the US and Japan have been

rather similar up until now, but that is gradually changing. The US is leaving many problems

behind, supporting a shift in Fed policy, which we think is imminent. If monetary policy is left

in place for too long in a recovering economy, there is a risk that new bubbles start to form.

The UK has surprised favourably this year, leading markets to price in rate hikes in the not

too distant future. In Japan, the aggressive monetary policy put in place a year ago has

helped push inflation upwards, but the Bank of Japan has to keep buying government bonds

to prevent interest rates from rising. The ECB is years behind and needs to focus on pre-

venting deflationary tendencies and help mend the dysfunctional eurozone credit market.

In the Nordic countries, Denmark is probably still happy to keep very low interest rates to

help household finances and real estate markets recover. Finland is still in a weak recovery

and credit growth is trending down, so the country will likely not find it problematic for some

time that the ECB keeps rates close to zero. Norway and Sweden are different. Recoveries

from the great recessions were relatively strong; low interest rates have contributed to

booming housing markets and rising household debt. Inflation is still well below targets in

both countries, but both central banks forecast rate hikes within a year.

We argued in our August Macro Forecast that rate hikes in Sweden next year are very

unlikely unless the Fed starts to signal hikes and help the dollar appreciate versus the euro

and the Swedish krona. Unilateral rate hikes in Sweden would probably strengthen the cur-

rency too much and wreak havoc on the Riksbank’s forecast of inflation returning to target. If

Emerging economies

fighting inflation and

currency appreciation

A three-way fork in

the road

Two camps in the

Nordics

Sweden waiting for

US action


5

we are right about the Fed next year, we will likely also see the Riksbank diverge from ECB

and Bank of England policies.

Will the Fed spoil the party again for emerging markets?

As the US labour market continues to improve, conditions will soon be in place for the Fed to

start scaling down its monthly purchases of treasuries and mortgage bonds. We look for that to

happen within the coming months. Towards the end of the year, the US economy will most

likely not need ultra-low rates either. That shift will probably be signalled well in advance, fol-

lowing the communications policy adopted by the Fed under Chairman Ben Bernanke.

When Bernanke started to talk in late May about the likelihood that the Fed would start ta-

pering asset purchases within the next couple of FOMC meetings, it came as a big surprise

to most market participants. Readers of our Macro Forecast should not have been surprised,

as we wrote a year ago that such a signal from the Fed was likely to come before the sum-

mer of 2013. Bernanke’s comments in May were not a slip of the tongue, we think, but were

probably intended both as a guide on where Fed policy was heading and as a trial balloon to

see the impact of the policy change signal on financial markets.

The Fed’s view on the impact of bond purchases has been that the effect comes as the pro-

gramme is announced rather than at the time when it is executed. The market reaction to Ber-

nanke’s talk about the end of tapering seemed to confirm that view, as bond yields rose

sharply in the following weeks. The negative term premium, as we estimate it (see our Global

Macro Forecast from August 2013 for details), switched to positive and approached the aver-

age level seen during the five years preceding the start of the Fed’s QE programmes.

The FOMC’s decision on September 18 came as a surprise and bond yields fell back again,

but not by as much as they had risen since May. That would seem to be a logical response,

as the Fed only postponed the start of tapering. Consequently, we do not expect a new ma-

jor leap upwards for bond yields once the Fed actually starts to reduce purchases. Rather,

we see a gradual rise in yields as markets start to prepare for the next shift in Fed policy,

which will be rate hikes.

But what about emerging markets? Those experienced a dramatic reaction in May after

Bernanke started to talk about tapering: currencies fell in tandem with stock markets. At the

Kansas Federal Reserve conference in Jackson Hole, central bankers and leading politi-

cians from emerging economies voiced concern that the Fed did not pay attention to the

impact outside the US of changes in monetary policy. Will we see a repeat of all of that once

the Fed actually starts to move? Will money once again rush out of emerging markets?

We are not so certain. First of all, causality is not so clear. If Bernanke’s tapering talk was

the real reason for emerging market currencies and stock markets falling, why did they re-

cover again in late summer yet developed world bond markets did not? Some would say that

Tapering likely to

start in the coming

months - really

Impact of bond pur-

chases comes on an-

nouncement

Emerging markets

hit by investor exo-

dus at first tapering

announcement…

…but this is unlikely

to happen again

http://research.handelsbanken.se/Attachments/19934/Global%20Macro%20Forecast%2029%20august%202013.pdf

http://research.handelsbanken.se/Attachments/19934/Global%20Macro%20Forecast%2029%20august%202013.pdf


6

is because the FOMC chose not to start tapering on September 18. But the problem with

that line of reasoning is emerging market currencies and stocks turned around almost one

month prior to the Fed meeting. Were they more forward-looking than the US bond market,

which was taken by surprise on September 18? That is hardly likely.

One plausible explanation is that there were other factors at work, provoking first a decline

and then a recovery for emerging markets. For instance, China started to deliver data that

were worse than expected in May. That would be important for many emerging economies,

especially those selling commodities to China, such as Brazil and Indonesia. In August, Chi-

nese economic data started to turn better than expected. That happened to coincide with

recoveries in emerging market currencies and stock markets. So there are factors other than

the Fed that might explain why emerging markets started to underperform in May and also

why they started to perform better again in August, well before we knew that the Fed would

not start tapering in September.

There is also a second reason why we are not so sure that emerging markets will be so

sensitive once the Fed’s policy shift occurs. The emerging market turmoil in May and June

served to highlight underlying problems with inflationary pressures and lack of reform. Cen-

tral banks in many cases responded by tightening monetary policy to hold back inflation,

helping bring investors back to those markets and boosted their currencies. So credibility for

monetary policy in emerging markets seems to have returned.

However, discussions about the need for structural reforms have also intensified. We cannot

be so sure about the results. Two of the big emerging economies in Asia, India and Indone-

sia, also have elections before the summer, making the outlook for structural reforms still

uncertain. Opinion polls indicate that more reform-oriented politicians are advancing. It

would seem that the market unrest in early summer, for whatever reason it came, was a

warning bell to politicians in emerging economies and one can only hope that it leads to an

increased focus on necessary reforms.

A shift in Fed policies would help the eurozone avoid deflation

There are several reasons why there are deflationary risks in the eurozone. Historically-high

unemployment, especially in the south, is a major factor pushing down wages and prices. It

will take a long time to bring unemployment down to levels where those downward pres-

sures disappear. We do not think that rising inflation in Germany and possibly a few smaller

economies in the eurozone will be enough to offset deflationary tendencies elsewhere.

The ECB is trying to speed up the eurozone recovery but rate cuts do not always help when

households, firms and governments are all trying to consolidate their finances. The weak-

ness of banks, especially in the south, is another reason why low policy rates are not stimu-

lating credit growth. Making banks stronger must be part of the recipe for keeping deflation-

ary risks at bay, but it might take another year before there is any action on this front.

Weak Chinese data

likely hurt in May

Emerging market

monetary policy

credibility is back

Structural reforms a

hot topic

Weak banks…


7

Inflation in the eurozone has also been held back by the appreciation of the euro. The gen-

eral price level in the eurozone relative to the US and other trading partners has risen this

year. If the euro rises further, deflationary pressures are likely to intensify, so a weaker euro

would be a welcome contribution to reduce risks for deflation.

Short-term interest rates in the eurozone and the US moved in tandem during 2013, but,

even so, the dollar has weakened versus the euro. One of the reasons might be the simulta-

neous expansion of the Fed’s balance sheet and the contraction of ECB’s. An end to QE in

the US and some kind of move towards expanding the ECB’s balance sheet might thus help

reverse euro strength. Signals from the Fed of a change in rate policy would probably

strengthen the dollar versus the euro. We forecast a large decline in the euro next year (see

separate article) for this very reason, so the ECB should not have reason to complain if the

Fed shifts towards less accommodative policies. The longer the Fed delays tapering or the

start of rate hikes, the bigger is the risk of deflation in the eurozone.


…and strong EUR,

slow recovery

No complaints from

the EU if the Fed

gets accommodative


8

FX markets

Policy shifts bode for a USD rally

Monetary policy has not reflected fundamental economic conditions in the US or the eurozone, in our view.

However, that seems to be about to change in a direction that supports the USD versus the EUR. We have

built an econometric error-correction model that indicates the USD will appreciate by more than 15 percent

versus the EUR in the next 12 months.

We expect differences in economic conditions and policy between the US and the eurozone

to sharply strengthen the USD versus the EUR. Our forecast is that the EUR/USD rate will

hit 1.10 within twelve months and parity within twenty-four months. At present, US GDP is 6

percent higher than its pre-financial-crisis level, while the average q-o-q growth rate for the

first three quarters of 2013 is 2.2 percent in annualised terms. The corresponding numbers

for the eurozone are much worse. The level of GDP is 2.4 percent lower than before the

crisis, while the average annualised growth rate for 2013 is 0.2 percent. The unemployment

rate is 7.2 percent and declining in the US versus 12.2 percent and likely still not at its peak

in the eurozone. Moreover, deflation risks are much higher in the eurozone.

Credit to non-financial businesses, a fundamental factor for economic growth, is currently

expanding in the US and contracting in the eurozone. In the past 12 months, the debt-to-

GDP ratio for those businesses increased steadily in the US but declined in the eurozone.

The difference in credit demand of course is an important reason, but structural factors are

also important. In general, US banks are in good shape, while banks in the eurozone are

undercapitalised. Moreover, monetary policy in the US is still much more expansive than in

the eurozone. The real policy rate is lower, but in addition, the policy rate relative to nominal

GDP growth is also lower.

In the middle of 2009, household debt was elevated relative to GDP. Since then, it normalised

sharply in the US but declined only modestly in the eurozone. Consequently, in the eurozone,

deleveraging will likely continue to weigh on growth, while in the US, residential construction is

already an economic driver, as households are leaving debt problems behind.

For at least the past 6-12 months, monetary policy has not reflected fundamental economic

conditions in the US or the eurozone, in our view. However, that seems to be about to

change in a direction that supports our EUR/USD forecast. The interest rate cut by the

European Central Bank (ECB) on November 7, to a record-low of 0.25 percent, is likely a

starting point for a new, more accommodative policy in the eurozone. At the press confer-

ence after the meeting, ECB President Mario Draghi restated the ECB’s commitment to

keep interest rates at or below current levels for “an extended period” and emphasised that

the bias of monetary policy remains on the downside.

USD to strengthen

sharply vs. the EUR

on differences…

…in economic condi-

tions…

…in financial condi-

tions for businesses

…and in household

debt

Monetary policy is

shifting in the euro-

zone…


9

On the other hand, the Fed will likely start tapering asset purchases over coming months.

Although such a step will probably be combined with an extension of forward guidance to

maintain the prevailing policy accommodation and prevent longer-term bond yields from ris-

ing, financial markets are likely to interpret such a policy shift as a tightening.

An error-correction regression supports our EUR/USD forecast

We have built a parsimonious econometric error-correction (EC) model that fits data well

and has predictive power outside the estimation sample. The EC model consists of a long-

run equilibrium relation between the EUR/USD rate, the difference in the unemployment rate

between the US and the eurozone and the slope of the German government yield curve (10-

year minus 2-year bonds), where the latter two variables are exogenous. Thus, in our model,

the long-run equilibrium EUR/USD rate is a linear function of the two exogenous variables1.

The short-term dynamics are designed so that part of the gap between the actual and the

long-run equilibrium EUR/USD rate is closed in the following period. Specifically, in the re-

gression, the percentage change y-o-y in the EUR/USD rate is the dependent variable, while

the gap mentioned above, lagged by 12 months, is the explanatory. The actual regression is

of course made in one step to increase efficiency.

If the actual EUR/USD rate is equal to the long-run equilibrium rate, the expected EUR/USD

rate 12 months ahead will not change. If the actual rate is higher than the long-run equilib-

rium rate, the expected EUR/USD rate 12 months ahead will decline (the USD strengthens

versus the EUR). The model accounts for 74 percent of the actual variation during the sam-

ple period (2004-13); the rest is due to a stochastic error term. The predictive power outside

the estimation sample is shown in the left-hand graph above. The out-of-sample forecast for

2011-13 when the estimation sample is shortened to 2004-10 is roughly as good as for the

within-sample forecast.

Our EC model indicates that the USD will appreciate by 16 percent versus the EUR in the

next 12 months. That would correspond to a change from the current EUR/USD rate of 1.35

to 1.13 in 12 months, which is relatively close to our forecast of 1.10.

Only minor changes to our EUR/USD and EUR/SEK forecasts

We make only minor changes to our forecasts, as we foresaw the ECB easing on November 7

that surprised financial markets. Consequently, we maintain our EUR/USD and EUR/SEK fore-

casts. Although Swedish economic prospects are reminiscent of the US in many respects, we do

not expect the SEK to strengthen by as much versus the EUR as the USD. In the future, once the

SEK stabilises, we expect the EUR/SEK rate to fluctuate in a band between 7.75 and 8.25.


1 Long-run equilibr. EUR/USD = 1.571 + 0.0471*difference in unemployment rate – 0.0993*German yield curve

…as well as in the US

An EC model of the

EUR/USD rate

Equilibrium gaps

shape short-term

dynamics

Predictive power

outside the sample

Model forecast close

to our EUR/USD

forecast

EUR/SEK in a band

between 7.75 and

8.25


10

US

Unemployment to hit Fed’s threshold in H2 2014

The past three recessions have been caused by financial exuberance. To put a damper on risk-taking, the Fed

will likely start tapering in coming months to weaken the idea in financial markets of a Fed put. We think the

unemployment rate will continue to decline faster than the FOMC is expecting, hitting the Fed’s threshold to

start hiking rates in the second half of 2014 and putting the first Fed hike on the cards for late next year.

GDP growth seems to be back on track after a soft patch in the fourth quarter of last year,

when it almost stalled. Though the fear of falling off the fiscal cliff did not fully materialise at

the end of 2012, tax hikes and automatic sequestration spending cuts created headwinds

that weighed on growth over the first half of 2013. However, those measures also helped get

federal finances in order. The headwinds abated: growth hit 2.8 percent in the third quarter

and will likely remain at rates slightly below 3 percent in the coming years.

Data-dependent Fed to taper in coming months

The FOMC has frequently stated that monetary policy is data-dependent and that forward

guidance, including thresholds to start hiking rates, is not a binding commitment. Thus, at

every meeting the Committee is free to make the appropriate policy decision regardless of

previous guidelines and market expectations. Moreover, the Committee is well aware that

the past three recessions have been caused by financial exuberance and that the seeds of

the next recession are likely already planted in financial markets. At the moment, hardly

anyone believes that the next recession will be prompted by high inflation and the Fed’s

tightening policy to cool the economy. Consequently, searching for information about exces-

sive risk taking or any other form of exuberance is probably a top priority at the Fed.

The costs of the current asset purchasing programme are likely rising as the Fed’s asset

holdings increase. In our view, the Fed should stop all further asset purchases as soon as

possible. Financial markets tend to see them as a Fed put – the idea that the Fed will arrest

increases in bond yields2 by raising the pace of its asset purchases or postponing rate hikes.

That implicit Fed guarantee is lowering the compensation for risk and encouraging exces-

sive risk-taking. At present, complacent investors are focusing more on how much longer the

current monetary policy regime will last and what mix of policy tools the Fed will use in the

future than on the real economy. However, belief in a Fed put is likely an illusion, especially

on a longer horizon. Investors will eventually have to face the real risks of their investments,

which could lead to sharp selloffs of risky assets and a substantial rise in the level of com-

2 The Fed has explicitly stated its ambition to press down longer-term bond yields, on residential mortgages in

particular, while no corresponding assurances have been made for equity markets.

GDP growth back on

track

Past three recessions

due to financial exu-

berance

Investors focusing

more on Fed than on

the real economy


11

pensation for risk. That is a scary scenario that has the potential to rock the economy.

Moreover, a Fed put could result in a serious misallocation of capital, as it implies that the

pricing of risk does not reflect true risks or even perceived risks. Too much capital could be

allocated to risky financial investment, crowding out productive real-economy investment.

We expect the FOMC to start tapering in the next three meetings. The unemployment rate,

which is likely to continue declining faster than the Committee expects, will probably hit the

Fed’ threshold to start hiking rates in the second half of 2014. A first Fed hike will likely come

late next year. The fact that super dove Janet Yellen is expected to become the next Fed

Chairman after Ben Bernanke is of minor importance. A Fed Chairman has to do whatever it

takes. The present Chairman was nominated by a republican president and hardly anyone

expected him to become a super dove. Under other economic conditions, he might have

been characterised as a hawk. In our view, it is impossible to guess which label Janet Yellen

will get in the future. She might even be characterised as a chameleon.

Sub-par US recovery

The Fed’s aggressive policy response to the financial crisis of 2007-08 likely prevented a

really deep economic contraction. Bernanke has often stated the importance of massive

monetary accommodation to arrest feedback-driven downward sloping spirals that could end

in a 1930s-like depression. The longer a large output gap persists, the more permanent

damage is done to the supply side of the economy and to the working-skills of long-term

unemployed people in particular. According to him, the implication is straightforward. Eco-

nomic policy should be as aggressive as possible in order to minimise the loss of potential

output in the long run. However, Bernanke has driven that perspective to an extreme. In an

unprecedented experiment to fight unemployment, an exceptionally expansive monetary

stimulus has been maintained much longer than ever before.

Fed officials claim that the prevailing monetary policy is working, as, according to them, the

output gap is primarily due to weak aggregate demand. However, we have for some time ar-

gued that the decidedly weak recovery and persistent high unemployment are partly due to

structural factors and not only to cyclical ones. Consequently, boosting aggregate demand by

only monetary measures is not optimal. Our view is definitely not unique. All economists would

welcome structural reforms as a complement to loose monetary policy. Unfortunately, such

reforms have no chance of passing Congress. President Obama has not even tried. Bernanke

has on several occasions appealed to Congress to do its share to speed up recovery, but

overall pressure on Congress has been weak. A major reason is likely the strong focus on

monetary policy and the Fed. Appropriate structural measures could take the form of retraining

programmes for the unemployed and improvements in the education system, including access

to higher education for children from low-income homes and investment in new infrastructure

(for instance, broadening access to high-speed internet).

A Fed Chair has to

do whatever it takes

As aggressive policy

as possible, accord-

ing to Ben Bernanke

Bernanke in favour

of structural reforms


12

To widen our perspective, we compare the US situation with the Swedish economic crisis in

the early 1990s, which had a very different policy response. In Sweden, a dysfunctional la-

bour market led to high wage increases and inflation, which, combined with a fixed ex-

change rate, eroded global competitiveness. Export-dependent businesses closed down and

unemployment skyrocketed. Public finances, the banking system and the housing market

were hit hard. Eventually, the fixed exchange rate was abandoned and a series of structural

reforms were launched. Ultimately, that led to low and stable inflation, sustainable public

finances, financial stability and high productivity growth. Real bond yields were high during

most of both the economic decline and the recovery, but after the introduction of a floating

exchange rate, the SEK weakened sharply, boosting exports and curbing imports.

In the US, aggressive monetary policy and capital support to the banking system via the

TARP programme fixed the financial system and prevented a really deep contraction, but

the measures did not kick-start business investment and employment. Structural reforms

(i.e. fixing fundamental economic problems) seem necessary to create the conditions for a

strong recovery. The Swedish focus on structural reforms in the early 1990s likely deepened

the economic contraction and made it more protracted, but it did kick-start the recovery.

Expect bond yields to rise but remain historically low

To prevent bond yields from rising sharply, the Fed will likely combine the tapering of its asset

purchases with a change in its forward guidance to maintain the prevailing accommodative pol-

icy. One possibility is to lower the unemployment threshold for starting to hike rates to 6 percent,

from the current 6.5 percent, which would expand the period of low policy rates. However, finan-

cial markets would likely still interpret tapering as the start of a tightening cycle. In May-June of

this year, when the Fed signalled that tapering was imminent, financial markets interpreted that

as a signal of more rapid rate hikes too and long bond yields rose significantly.

When the conditions that affect asset prices change, the price adjustments often take place

in two steps. First, prices adjust partly on the expectation of a change. Then, as the change

is realised, the rest of the price adjustment occurs. The stronger the expectations, the larger

the share of the price adjustment that takes place before the change is actually realised. At

present, financial markets are not pricing in any Fed hikes at all in the coming two years.

The two-year government bond yield (a rough estimate of average short interest rates over

the next two years) is 0.22 percent. If the credit market were to fully price in our Fed forecast

(0.50 percent within twelve months and 1.50 percent within twenty-four months), the two-

year government bond yield would rise to 0.6-0.8 percent. However, it is unlikely that finan-

cial markets would fully price in expectations. In the summer of this year, when financial

markets expected the Fed to taper in October, the two-year government bond yield peaked

at 0.5 percent. Moreover, the 10-year government bond yield topped out at 3 percent.

The longer the Fed waits to taper and hike interest rates, the higher the likelihood that ag-

gressive hikes will be part of an appropriate policy in the future. On the one hand, financial

The US crisis vs. Swe-

den’s in the 1990s

Structural reforms to

kick start recovery

Tapering will be seen

as the start of a

tightening cycle

Moderate rise in

yields if Fed tapers in

coming months…

Bumpy ride if Fed

waits


13

markets seem to be almost addicted to the Fed put and low interest rates. On the other

hand, they seem to fear sharp selloffs of longer-term bonds and risky assets, which indi-

cates support for a timely start of the tightening cycle. Awareness is growing that interest

rates cannot remain low forever and that the exit from the current monetary regime will likely

become more turbulent the longer the Fed waits to start the long, difficult journey to more

normal and sustainable monetary conditions.

When will the unemployment rate hit 6.5 percent?

The unemployment rate, which peaked in late 2009 at 10 percent, declined faster than the Fed

expected and hit 7.3 percent in October of this year. If the decline were to continue at the

same pace, the unemployment rate would hit 6.5 percent, the Fed’s threshold for starting rate

hikes, in 12 months. In other words, a simple linear extrapolation of the unemployment rate

decline points to a first Fed hike in late 2014, which is exactly in line with our Fed forecast. Be

that as it may, the Fed has emphasised that an unemployment rate of 6.5 percent is not a trig-

ger for hiking rates. If appropriate, policy rates could stay unchanged at their present low levels

long after the unemployment rate has dropped below 6.5 percent.

There is a good chance of the unemployment rate hitting the threshold rate of 6.5 percent

sooner than in 12 months; in other words, in the second half of 2014. The monthly increase

in non-farm payrolls needed to keep the unemployment rate unchanged (the break-even

pace) has declined in recent years. In 2009, the break-even pace was roughly 100,000, but

it has now declined to 50,000. A major reason is slower growth in the labour force due both

to demographic factors and to an increasing number of distressed workers leaving. We es-

timate that dropouts at present amount to 1-2 percent of the labour force.

Key macro indicators

Sources: Macrobond and Handelsbanken Capital Markets


Percentage change 2011 2012 2013f 2014f 2015f

GDP 1.8 2.8 1.7 2.7 2.9

Public spending -1.0 -1.0 -1.9 1.3 2.0

Household spending 2.5 2.2 1.9 2.0 2.3

Residential investment 0.5 12.9 14.2 12.9 12.6

Non-residential investment 7.6 7.3 2.2 3.8 4.1

Inventory investment -0.2 0.2 0.1 0.1 0.0

Net exports* 0.1 0.1 0.1 0.1 0.0

Unemployment** 8.9 8.1 7.5 6.8 6.2

Core inflation (PCE) 1.4 1.8 1.3 1.8 2.1

*Contribution to GDP growth **Percent of the labour force

Unemployment de-

clined faster than the

Fed expected

Unemployment rate

to hit 6.5 percent in

H2 2014


14

Eurozone

Heading for deflation?

A surprise drop in October inflation forced the ECB’s hand. Risks of deflation must be taken very seriously

when the policy rate is close to zero. The eurozone is now in a similar bind as Japan has been in for many

years. The price level relative to main competitors is too high but the currency refuses to weaken, so the

domestic price level has to adjust downwards instead. Unlike Japan, unemployment is very high,

contributing to deflationary tendencies. Consequently, we expect the ECB to ease monetary policy further

while the Fed moves in the opposite direction, so a substantial decline in the euro will help prevent deflation.

The eurozone economy bottomed out before the summer, but growth did not accelerate ma-

terially in the third quarter. Sentiment indicators have disappointed a little in recent months,

suggesting that the recovery will remain sluggish. We look for around 1 percent GDP growth

in 2014, implying that growth rates continue around 0.2-0.3 percent per quarter. The upside

is limited by several factors. Weakness in the banking sector is holding back the supply of

credit and the need to reduce debt burdens the private sector, holding back demand. The

ECB’s rate cuts will not do much to stimulate either credit supply or demand, except in

economies that are not saddled with bank or debt problems.

The need for fiscal consolidation is also a factor for weak recoveries in many countries. Fol-

lowing the recommendations from the IMF last autumn, European leaders agreed to hold off

from budget cuts while economies were in recession. As a result, there have been very lim-

ited budget improvements. That will come back to haunt governments now that economies

are recovering.

The budget problems are most acute in Spain, where the central government deficit so far in

2013 is actually larger than in the previous year, despite the implementation of budget cuts and

tax hikes in the second half of 2012. For the Spanish regions and local communities, we only

have data for the first half of 2013, but that is not a pretty picture either. The European Com-

mission now forecasts that the general government deficit in Spain will remain around 6-7 per-

cent of GDP in 2014-16, even though it expects an economic recovery. One of the reasons is

that some of the tax hikes implemented in recent years were temporary and will expire.

That puts the Spanish government in a very awkward position in the run-up to the general

elections in the autumn of 2015. But the alternative, to let deficits keep on running, risks put-

ting Spain in a similar position as Italy, which has a government-debt-to-GDP ratio well

above 100 percent. That would necessitate even tougher budget cuts later on in order to

reach higher primary surpluses. Otherwise, the budget situation would spin out of control.

We look for around 1

percent GDP growth

in 2014

European leaders

agreed to hold off on

budget cuts

Budget problems

most acute in

Spain...


15

The need for budget cuts also looms large in many other eurozone economies. Even if fiscal

austerity is deferred, the general public knows that they will eventually be hit, which is con-

tributing to holding back consumer spending. It also makes for a situation where political

support for governments remains weak. In France, President Hollande is plumbing new

depths in opinion polls. His policy proposals are met with protests from left and right, farmers

and entrepreneurs. Whether that is a factor behind the recent declines in economic senti-

ment indicators is hard to tell, but government policies certainly do not seem to be helping

the recovery.

The upcoming EU parliamentary elections in May will present an ideal opportunity for voters

to show their discontent with current policies. That overlaps with a period when important

decisions need to be taken about a banking union. As a consequence, there could be re-

newed market tensions. The current calm in bond markets is partly the result of the ECB’s

policies and commitments, but it also reflects no real disturbances to the political process

aiming at a banking union. The big hurdles on that front still lie ahead.

How big are the deflationary risks?

Surprisingly-low inflation numbers in October were one of the factors triggering the ECB rate

cut. Several eurozone countries are already in negative territory, most notably Greece,

where inflation is currently -1.9 percent. Spain just dipped below the zero line on core infla-

tion, but the underlying deflationary tendencies were masked by the VAT hike last year tem-

porarily lifting consumer prices. Both countries have massive unemployment, so downward

pressures on wages is likely to persist for a long time, contributing to falling unit labour

costs, weak income growth and weak domestic demand.

...but budget cuts

also needed in many

other eurozone

economies

New flare-up of mar-

ket tensions?

Greece in deflation,

Spain also dipped

below zero


16

Germany faces the opposite situation. Unemployment may decline to below 5 percent in

coming quarters, which is certain to put upward pressure on wage costs and prices. The

recently-agreed minimum wage will also contribute to rising inflationary pressures. The

pockets of upward pressures on wage costs and prices are probably too small presently to

offset the downward pressures elsewhere. The ECB did the right thing by cutting the policy

rate, but more needs to be done in order to reduce the risk that the eurozone aggregate

ends up in deflation. There is not much room left to lower policy rates, but there is a lot of

room to push down borrowing rates for households and firms, especially in the weaker

economies. Gaps between bank lending rates and the ECB policy rate have widened in

many countries due to the weakness of their banks.

There is not that much the ECB can do about the financial fragmentation of the eurozone

other than to support efforts to create a functioning banking union. Low funding costs for

banks will certainly help banks’ profits. But an important offsetting factor is that returns on

bank assets will continue to be depressed by write-downs for bad debt. When and how a

banking union will be implemented is still uncertain, so it is unlikely to have much of an im-

pact in the short term on financing conditions in the countries facing deflationary tendencies.

Consequently, the negative impact from bank weakness on employment and domestic de-

mand is likely to persist.

However, the ECB can still make an impact on the general deflationary tendencies for the

eurozone. The exchange rate is an important factor influencing the relative price level be-

tween the eurozone and the rest of the world. The lesson from the UK since 2009 and Japan

during the past year is that quantitative easing can have a dramatic impact on the currency.

For the UK and Japan, a falling exchange rate led to rising import prices and an upward

push for consumer prices. The immediate impact on inflation from currency depreciation is

much larger than the impact from a monetary policy expansion on inflation via higher aggre-

gate demand.

We have argued in previous macro research reports that persistent deflationary tendencies

in Japan were a reflection of the fact that the currency, and consequently the relative price

level, got stuck at too high a level. If relative price level depreciation cannot take place via

the exchange rate, it has to come about via a lower relative rate of inflation. With very low

rates of inflation in the US and Europe, inflation in Japan had to turn negative. Please note

that throughout the long period of deflation, Japan did not really have big slack in the labour

market: the rate of unemployment has been relatively low.

The situation in the eurozone is now similar to Japan’s situation in the years before the big

monetary policy shift started to push down the yen a year ago. That analogy is relevant for

the eurozone relative to other economies and for individual countries within the eurozone.

The euro has remained strong and the price level is too high. Unless the currency drops

sharply, inflation has to be pushed down relative to other countries and the eurozone as a

The ECB did the

right thing by cutting

policy rate, but more

needs to be done

Still uncertain when

and how banking

union will be imple-

mented

Lesson from the UK

and Japan: QE can

have a dramatic im-

pact on the currency

Eurozone now in a

similar situation to

where Japan was...


17

whole might thus end up in deflation. But between countries in a monetary union, exchange

rate adjustments are by definition impossible, which explains why wages and prices have to

fall in the countries that need to restore their competitiveness – unless they rise in Germany,

of course.

Unlike Japan, the eurozone has large slack in the labour market. Stripping out Germany,

where unemployment may soon lead to higher wage inflation, the unemployment rate in the

eurozone is close to 15 percent, a record-high by a wide margin. Including Germany, unem-

ployment is just over 12 percent, which is also a record. In 2014 and 2015, we do not think

that unemployment will fall by very much, so the deflationary force will remain. The IMF, in

its October economic outlook, actually forecast that the eurozone will not fall below 10 per-

cent in 2018, so downward pressure on wages and prices will be in place for a very long

period unless the ECB acts aggressively.

If the ECB were to undertake some kind of QE and/or the Fed winds down QE and starts

hiking rates, the euro is likely to drop against the US dollar and other major currencies. That

is actually our forecast (see separate article). Moreover, once markets begin to expect Fed

hikes, rates will also move in favour of the dollar versus the euro. Therefore, it is not our

main scenario that the eurozone will find itself in a long period of deflation. But our assump-

tions for the ECB and the Fed, or the exchange rate impact of a shift in relative monetary

policies, could turn out to be wrong, so deflation risks remain. In our view, the ECB is al-

ready paying close attention to those risks and will adjust policies accordingly. We will wit-

ness an extended period of low ECB rates, possibly into 2018, and the ECB is also likely to

adopt measures to expand its balance sheet. That will reduce deflationary risks for the euro-

zone as a whole, but downward pressure on prices and wages in the countries riddled with

mass unemployment are likely to persist.


...but eurozone also

has high unemploy-

ment, so downward

pressure on wages

and prices set to per-

sist unless ECB acts

aggressively

We forecast that

EUR will drop vs.

USD and other cur-

rencies


18

United Kingdom

Turning the corner

A broad-based recovery within all sectors is now a fact. GDP is driven by private consumption, but the

outlook for investments has improved as financial conditions have eased. Productivity growth has been

absent, but we expect productivity to rebound sharply. Reaching the forward guidance threshold will not

necessarily trigger rate hikes by the Bank of England.

National account statistics for the third quarter showed robust economic growth. GDP was

reported at 0.8/1.5 q-o-q/y-o-y. So far, the recovery has been driven by household consump-

tion and investments, but exports cut a staggering 0.9 percentage points off Q3 GDP. De-

spite the gloomy external sector, barometers and economic indicators are more positive,

inflation expectations are at a record-low and all industrial sectors are growing. So where

does the economy go from here?

Comparing economic growth this year with 2010 (mainly because the household sector did

some rebalancing during that period) shows that the household sector’s debt-to-income ratio

decreased from approximately 140 percent in 2010 to 132 percent last year. During the

same period, the savings ratio decreased from just above 7 percent to 6 percent, meaning

that the consumption-driven economy has so far not increased the debt burden of house-

holds. The housing market recovery seen so far has caused concerns about a housing price

bubble. But as long as the debt burden has not increased, the number of mortgage approv-

als is far below the long-term average and lending secured on dwellings remains at fair lev-

els, pointing to no worries about increasing house prices. The recent joint statement by

Governor Carney and Chancellor Osborne regarding the Funding for Lending scheme,

which will be refocused towards only businesses, will silence worries about a housing price

bubble. It seems as though first-time buyers are the ones entering the property ladder

sooner due to the Help to Buy programme.

Employment expectations are on a downward trend. That supports our view of muted em-

ployment growth ahead. At the same time, output expectations are heading upwards, imply-

ing that productivity will increase. Optimism is also increasing in the industrial sector within

both domestic and export manufacturing. Low productivity has been an issue for quite some

time and unit labour costs for the whole economy have increased by 15 percent since Q1

2008, while GDP has fallen by 2.5 percent. Productivity measured as output per hour in the

whole economy has fallen by more than 5 percent during the same period. As said before,

we do not expect a fast and strong rebound due to falling real wages and the fact that em-

ployment has risen faster than economic growth. That in turn would imply that productivity

should increase at least to some extent while employment growth will be muted during our

The recovery has

been driven by do-

mestic demand

Lower savings ratio

and slightly better-

balanced households

Productivity growth

as output per hour in

the whole economy

has fallen


19

forecast period. If corporations use higher productivity to raise wages instead of increasing

their own margins, consumption could get an extra boost. However, our forecast is that in-

creased productivity will instead result in increased profits.

Despite the household sector doing quite well, it has been difficult for companies to increase

investments. Investment intentions are more optimistic in both the services sector and the

manufacturing sector, according to the Bank of England survey. “Agents’ summary of business

conditions” and growth within the construction sector should boost investments in other areas

too. The external sector of the economy has made small contributions to overall growth in the

past couple of years. The outlook for exports looks brighter, as major export destinations in the

eurozone are recovering and exporters should get an extra boost from the pound sterling. But

the current account deficit has widened and the deficit will likely remain, as the economy has

sizeable net assets abroad and as exports deteriorated in Q3.

Consumer prices have been above the two percent target for three years. The rise in tuition

fees, planned fuel duty and duties on alcohol and beverages are pushing inflation higher

while the pound sterling’s appreciation has the opposite effect. The fact that fewer firms are

expected to not raise prices ahead makes the pressure on inflation look even smaller. We

expect inflation to approach the target during our forecast period. The forward guidance

adopted by the Bank of England stated that the MPC will keep the policy rate low as long as

unemployment is above 7 percent. Governor Carney highlighted at the Inflation Report press

conference that if the unemployment threshold were to be reached sooner than the MPC

forecast, rates will not be hiked if the MPC finds it inappropriate at that time: “The 7 percent

is a threshold, not a trigger for rate increases”.

The British economy is growing fast but still faces some problems. Real earnings growth is

not positive due to high inflation and some household rebalancing is yet to be done. The

fiscal squeeze has caused 100,000 more jobs to be lost in the public sector and the debt

crises in the eurozone are not yet solved. And for British growth to be better balanced, the

external side must improve in line with domestic demand. But for now, domestic demand

has lifted UK growth to one of the better-performing G7 countries.

Key indicators

Source: Handelsbanken Capital Markets



GDP 1.1 0.1 1.3 1.5 1.7Household consumption -0.5 1.2 2.0 2.1 1.8Gross investment -2.4 0.9 -2.6 5.0 4.1Unemployment rate* 8.0 7.9 7.7 7.5 7.3Consumer prices 4.5 2.8 2.7 2.3 2.1

* ILO measure

Investments inten-

tions are more opti-

mistic

Fewer firms expected

to not raise prices

“7 percent is a

threshold, not a trig-

ger for rate in-

creases”

Better-balanced

economy needs ex-

ternal demand


20

Japan

Fastest growing economy – so far

As one of the fastest-growing economies among the G7 countries, Japanese GDP has finally reached the same

level as at the peak in Q1 2008. So far, growth has been driven by private consumption due to stimulative

fiscal policy. Monetary policy will remain accommodative until consumer prices reach the 2 percent target.

The third arrow of Abenomics, the process of implementing structural reforms, is hopefully on its way.

Third quarter GDP confirmed the economic performance so far this year, despite slower

growth in the third quarter compared to the first two quarters due to weaker consumption. As

the fastest-growing economy among G7 – at least for now – Japan finally managed to reach

the same GDP level as at the peak in Q1 2008. So far, growth has been driven mainly by

private consumption, but business spending has also contributed to overall growth. Since

March 2011, the trade balance surplus has turned into a deficit, as imports growth is

stronger than exports. Exports to China have increased by more than 20 percent since Q1

2011 and imports are growing by more than exports due to higher domestic consumption.

However, as the JPY has weakened against most currencies, we expect exports to grow

slightly stronger ahead.

With more than 15 years of deflation, the Bank of Japan has been very clear that the central

bank has the tools to escape falling prices and that inflation will reach the target of 2 percent

within two years. Since the implementation of the inflation target, consumer prices have in-

creased due to improvements in aggregate supply and demand balance, increasing inflation

expectations and the effect of currency movements. However, as deflation has been going on

for so long, there is a high degree of uncertainty as to whether inflation will remain on an up-

ward trend (i.e. if prices will respond in the right way to aggregate demand and supply bal-

ance). Finally, developments in domestic inflation expectations should be watched carefully.

For more than two decades, investments as a share of GDP have been significantly higher

in Japan than in other developed countries. Will this pattern continue and, if so, how will ex-

pected inflation affect investment plans? So far, machinery orders, which are a good indica-

tor of investments, have improved and domestic orders are improving by even more than

foreign orders. The Tankan barometer also shows that the financial situation for companies

has recovered for all sizes of industries, both in terms of financial conditions and actual prof-

its. So, overall sentiment looks good for investments ahead. The economic situation has

changed, as inflation is finally turning positive: headline CPI has reached 1 percent while

core inflation is still hovering around zero. And as inflation is increasing, real rates are de-

clining, making it even more convenient for companies to invest.

Japanese GDP finally

managed to reach

the Q1 2008 peak

Consumer prices

have increased…

…but high degree of

uncertainty remains

Domestic orders im-

proving even more

than foreign orders


21

Abenomics contributes to better conditions for business investments, as the purposed corpora-

tion tax cut will ease investments even further. Public investments will likely continue to make a

high contribution to growth due to an additional boost from economic measures. However, re-

cent data show a trend within investments that policymakers probably did not count on: Japa-

nese exporters are increasing their capital spending. For example, carmakers Mazda and

Honda chose not to build new factories in Japan but instead turned to Thailand. Japanese di-

rect investment in South East Asia in the first half of this year nearly tripled and Japanese

banks have lent a record amount into the region, beginning last year. So in a sense, Abenom-

ics is working abroad, but if increasing profits are to boost economic domestic growth, there

must be an improvement in domestic investments and increasing wages at home.

However, it could take many years before we see if Abenomics has boosted investments.

The decisions by the carmakers were actually made long before Abenomics even existed.

Still, it is important to monitor these developments carefully. Exports and industrial produc-

tion are expected to increase moderately as overseas economies pick up, which will most

likely boost business fixed investments and profits. Hopefully, increasing profits will boost

wages and investments at home, supporting economic growth ahead. Looking ahead, we do

not expect strong growth to continue. As economic growth so far has been driven by private

consumption, that pattern is unlikely to continue as we enter 2014 and the tax increase in

April will most likely dampen household spending. If Abenomics succeeds, it is time to im-

plement purposed reforms, such as the reduction of taxes on business fixed investments (to

stimulate private investment to encourage firms’ efforts to raise wages) and the overhaul of

the social security and taxation system.

The Bank of Japan’s efforts to double the monetary base is starting to show results. In Oc-

tober, the monetary base increased by 45 percent compared to October last year and the

increasing amount of money being fed into the system lifted consumer prices somewhat.

However, will prices respond in the right way to the aggregate demand and supply balance?

Developments in domestic inflation expectations should be watched carefully. As Governor

Kuroda at the Bank of Japan has said more than once that the central bank is willing to ad-

just monetary easing policy to handle downside and upside risks to the 2 percent target,

monetary policy will continue to be accommodative during our forecast period.

Key indicators




GDP -0.6 1.9 1.9 1.5 1.2Household consumption 0.5 2.4 1.6 0.8 0.8Business investment* 3.3 1.8 -1.5 1.9 1.4

*Non-residential investment

Japanese exporters

are increasing their

capital spending

Exports and indus-

trial production are

expected to increase

moderately

Will prices respond

in the right way to

aggregate demand

and supply balance?


22

China

Growth stabilising, reforms on the way

Although growth stabilised and achieved a better balance during the autumn, challenges remain in terms of

consumer inflation, house prices and credit growth, which has made the People’s Bank of China tighten

liquidity. More important, however, is the big slate of reforms announced after the Third Plenary Session of

the CCP Central Committee. The success of those reforms depends on implementation. Even if Chairman Xi’s

plans are crowned with success, the reforms are likely to slow growth in the short run.

After some fluctuations over the summer and early autumn, growth now seems to have sta-

bilised. Compared to last summer’s surge led by the SOE-dominated heavy industries, it is

also better balanced. The slowdown in construction activity, especially housing, reinforces

that impression. We thus revise our 2013 growth forecast from 7.5 percent to 7.6 percent.

Challenges remain

Yet all is not well. CPI inflation continues to accelerate. House prices continue to rise and

credit expansion remains a serious concern, as do non-performing loans, especially loans to

local government funding vehicles. Those issues are related, as local governments continue

to rely on land sales for much of their revenues. The People’s Bank appears to have re-

sponded by tightening liquidity. Monetary policy is difficult to monitor in China because of the

absence of a key policy rate or some other central policy instrument. After the liberalisation

of bank lending rates, we can no longer read anything from the benchmarks decided by the

State Council. Reserve requirement ratios are also no longer used as high-frequency policy

instruments. The remaining possibility is to look at short-term money-market rates. Although

those tend to move with the calendar, with typically end-of month peaks, persistent trend

changes signal policy changes. Such an upward trend has been clearly discernible for the

seven-day repo and the one-month SHIBOR rates. Although their recent peaks have been

lower than the one in June, that is not the case for the 12-month Treasury bill rate, which lies

at its highest rate since the beginning of 2006.

Third Plenum

For the leadership, it was no doubt important to have the economy in reasonable order be-

fore the Third Plenary Session of the 18th

Meeting of the CCP Central Committee. For

longer-term growth sustainability, however, the reforms announced in the wake of that ses-

sion will be way more important, even though they may slow growth in the short run. First

and foremost, the liberalisation of a number of rules and regulations will encourage private

entrepreneurship in competition with the large SOEs, even in sectors where the SOEs are

now completely dominant. Although SOE privatisation is not on the agenda, market forces

Growth forecast re-

vised slightly upward

Upward pressure on

house prices and CPI

inflation has been

met with liquidity

tightening

Market liberalisation

and SOE reform


23

are now expected to play a “decisive” role in resource allocation, upgraded from the former

“basic” role. Furthermore, the SOEs will themselves undergo major reforms in terms of gov-

ernance and management, to encourage profit-making rather than expansion and the accu-

mulation of physical assets. SOEs will also be asked to pay higher dividends.

Financial reform has been well on its way for some time, so the Plenum provided few new

initiatives. It is important, however, that the establishment of private financial institutions is

being encouraged and that the FX system is moving towards convertibility on the capital

account, albeit slowly. The managed appreciation of the renminbi (RMB) against the USD

seems to have slowed, probably due to a belief that the rate is now close to equilibrium. We

thus predict no big changes from here, as we believe movements in either direction are be-

coming more or less equally probable.

Shadow banking is a sticky point for Chinese policy. On the one hand, the government sees

the need for innovation in the financial system, but on the other hand it fears systemic insta-

bility. The People’s Bank is now seeking to allay these fears by introducing important meas-

ures of macroprudential regulation. Banks’ maturity and currency mismatches are to be

monitored, as are short-term capital flows. A plan for deposit insurance will be worked out

and a resolution mechanism will be put in place for failing banks.

Social and political reforms

The two most important social reforms announced after the Third Plenum include a liberali-

sation of the hukou residential registration system for third- and fourth-tier cities. As a result,

urbanisation is expected to turn towards these smaller cities, of which there are more than

4,000 with a total population exceeding 300 million. The other is the relaxation of the one-

child policy for parents who are themselves only children. Both of those reforms will add to

labour supply, although the relaxation of the one-child policy will naturally need time to work.

The most spectacular political reform is the abolition of the system of detention without due

process, called “reform through re-education”. On a different front, the fiscal system is to be

improved and expanded, hopefully making local governments less dependent on land sales.

A third important change will come in the assessment system for government leaders, which

will add a number of soft criteria in addition to regional or local GDP growth rates.

Finally, Chairman Xi reinforced his own power by putting the oversight of the reform process

in the reins of a small group that he chairs. Although the success of the reform plans re-

mains uncertain, he has, at least, put his own personal prestige at stake.

Knut Anton Mork, +47 2239 7181, [email protected]

Financial reform

continues

Gradual hukou re-

form, relaxation of

the one-child policy


24

India

RBI to liberalise India’s financial system

The agenda of new central bank Governor Raghuram Rajan is to boost competition and challenge vested

interests in India’s financial sector. Although the RBI mandate allows him to liberalise the financial system,

he cannot take on the real economy and deficient infrastructure. Those are up to lawmakers to address, but

until supply-side problems are resolved, the road to recovery will likely remain slow and bumpy.

Indian GDP growth seems to be bottoming out. It accelerated to 4.8 percent y-o-y in Q3 of

this year from a four-year record-low of 4.4 percent in Q2. To restore growth, the govern-

ment has to address bureaucratic bottlenecks, deficient infrastructure and fading investor

confidence. However, we do not expect any structural reforms involving lawmakers before

the next general election (in May 2014). In our view, government policy could only change in

a more populist direction as the election approaches. To secure victory, the ruling Congress

Party will likely increase subsidies to rural India, further damaging fiscal finances.

Still, we have become more optimistic. New central bank Governor Raghuram Rajan has so

far done an excellent job. Since he took over leadership, the Reserve Bank of India (RBI)

has relaxed some capital restrictions, reintroduced the repo rate as the main policy instru-

ment to restore transparency and promised to deregulate financial markets in India, but he

has also raised the repo rate to fight stubbornly high inflation. The measures ended an on-

going exchange rate crisis and stabilised the Indian currency at around 63 INR per USD.

That is an impressive record, but perhaps his most important achievement is to have in-

jected hope into the economy through his agenda to boost competition and challenge vested

interests in India’s financial sector, which is a complete break with his cautious and risk-

adverse predecessors. His goal is a “dramatic remaking” of the banking system over the

next few years to free it from the morass of state controls introduced after Indira Gandhi na-

tionalised many private banks when she was Prime Minister in the late 1960s.

The RBI plans to grant new banking licences and allow foreign institutions to take a broader

role. Moreover, it also plans to overhaul rules relating to state-backed banks, which control

roughly three-quarters of lenders’ assets, partly by encouraging swifter recognition of bad

loans, which have hampered the financial system during India’s economic slowdown.

Even though the RBI mandate allows Raghuram Rajan to liberalise the financial system, he

cannot take on the real economy and deficient infrastructure. Those are up to lawmakers to

address, but until supply-side problems are resolved, the road to recovery will likely remain

slow and bumpy.


Economy still in a

slump

RBI not only fighting

inflation…

…but also challeng-

ing vested interests…

…by freeing the fi-

nancial system

Supply-side prob-

lems persist


25

South East Asia

Cyclical pick-up ahead, yet long-term challenges

As growth in developed markets picks up, exports from emerging asia should strengthen in 2014. The firming of

Chinese growth and weakening of exchange rates in most of the region further supports a moderate export-led

recovery. However, GDP growth is unlikely to return to levels seen before the recent financial crisis.

Asian trade responding to global pick-up

World GDP growth accelerated in the third quarter of this year on the back of a rebound in

China and faster growth in the US, UK and Japan. Asian exports and industrial production

clearly responded to this acceleration, with the three-month moving average in y-o-y growth

of Asian exports excluding Japan picking up from 3.3 percent in July to 6.6 percent in Sep-

tember. The outlook for growth in the developed world looks fairly positive, as the fiscal drag

in the US should diminish, the UK economy has reached a sustainable recovery and the

eurozone rises from recession to modest growth. Despite a modest slowdown, Japan should

also contribute positively to global demand next year.

The improvement in developed world growth conditions will benefit the export-driven Asian

economies the most, the very same ones that have suffered from weak external demand

during the past couple of years. The recent increase in US IT sector activity is a positive sign

for Asian producers of electronics, including South Korea, Thailand, Malaysia and Taiwan.

Due to somewhat stronger global economic growth in 2014e, we expect the coming year to

be better for South East Asia and the export-driven economies in particular.

GDP growth not likely to return to pre-crisis pace

An important explanation for the global growth slowdown in 2011-13 has been the simulta-

neous deceleration of GDP growth in the BRIC countries (Brazil, Russia, India and China).

The IMF, in its latest World Economic Outlook of October 2013, describes that slowdown as

partly cyclical and partly structural. The cooling down of cyclical factors partly explains the

slowdown in BRICs, but for China and India, about half of the slowdown is structural in na-

ture. The cyclical part of the slowdown follows from the unwinding of post-crisis stimulus,

notably in China but also in other parts of the world, and from changes in commodity prices,

which rose after the stimulus efforts but started to fall around 2011. Lower commodity prices

had an asymmetrical and disproportional effect on various Asian economies. In the recovery

phase, when commodity prices rose, Asian commodity importers suffered from declining

purchasing power and corporate profitability; later on, when the business cycle started to

deteriorate and commodities fell, the Asian commodity exporters’ economies were naturally

hit by a negative commodity shock.

Asian exports picked

up in the third quar-

ter

The export-driven

Asian economies

benefit the most

from global accelera-

tion

Half of the growth

slowdown since 2011

is structural in China

and India


26

The structural slowdown that has explained a large part of the deceleration in China and

India can be traced to various structural impediments, such as regulatory framework in key

sectors of production, permits and project approvals, and overstretched corporate balance

sheets, all of which are bottlenecks to growth in India, according to the IMF. In China, the

IMF expects structural issues to permanently lower growth, as China can no longer rely on

its current capital-intensive growth model, which needs vast migration from the countryside

to urban industrial production. Accordingly, the IMF forecasts China’s GDP growth at only 7

percent in the coming five years (2014-18), a marked slowdown from the 1998-2013 aver-

age growth of 9.6 percent.

Weaker growth in India and China, especially permanently weaker growth in the case of

China, has major implications for Asia as a region. The linkages to the rest of Asia material-

ise through inter-regional trade and financial markets, but also through indirect channels via

developed world growth that affect Asia as a whole. Those long-term effects are likely to be

larger for Asian economies with strong trade ties to China, in particular Malaysia, Singapore,

South Korea, Thailand, Hong Kong and Taiwan. For those economies, the value-added from

exports to China amount to around 4.0-5.5 percent of GDP.

As China is a major market for almost all other Asian economies and as it also has such a

large weight in the global economy, its weaker growth potential will be reflected in other

parts of Asia. Nevertheless, the long-term trends in China will not derail the cyclical out-

bursts and drops that are present in all market economies.

Key risks to the cyclical outlook of South East Asia in 2014

Developments over the past few years have made it clear what the key risks are to stable

economic conditions in South East Asia. The importance of Chinese growth is obvious, as

already stated; hence, a hard landing remains at the top of the risk list.

The economic performances of this past summer clearly showed that South East Asia is

vulnerable to sudden rises in interest rates in the developed world. Since then, investors

have focused more on the fundamentals of individual emerging market countries. Econo-

mies with larger current account deficits and external financing needs have faced the largest

falls in capital flows and currency values, and in equity and bond prices. Of the emerging

Asian economies, India and Indonesia belong to that category, as does Thailand, as its cur-

rent account has fallen to a deficit of 5 percent of GDP in Q2 2013 from a surplus of 1.2 per-

cent in the previous quarter.

The interest rate shock led to a series of mini-crises in the balance of payments for a few

countries, notably in India and Indonesia. In a typical balance of payment crisis, capital in-

flows fall and current account deficits can no longer be financed. That causes a noticeable

weakening of the currency, which reduces residents’ purchasing power through higher im-

port prices. It is exactly that process that, after a time, restores the current account back to

balance as domestic demand and imports adjust. In the short term, the loss of purchasing

power dominates and economic activity suffers, but in the medium term, improvements in

competitiveness are likely to stimulate exports and overall growth. As capital inflows deterio-

rate, lending conditions tighten considerably in the most-affected economies. To break the

vicious cycle of depreciating currency and accelerating inflation and to reduce the outflow of

foreign capital, the Indonesian central bank hiked policy rates between June and September

five times by a total of 175 basis points. That tightening of monetary and fiscal policy implies

slower growth for Indonesia in 2014.

Lately, portfolio flows have recovered in the region as a whole, but the more fragile global

emerging market economies – South Africa, Brazil, India, Turkey and Indonesia – still face

headwinds and their currencies continue to be weaker than at the beginning of the year. In

comparison, the Korean won hardly weakened during the summer turbulence. The coming

year will most likely show that the South East Asian economies are not a homogenous bunch.


In China, the IMF

expects structural

issues to perma-

nently lower

growth…

…and effects are

likely to fall on those

Asian economies

with strong trade ties

to China

The key risks to

Asian region are

Chinese growth

slowdown…

…and an interest rate

shock from higher

rates in developed

world

Fundamentals

among the region’s

economies differ:

some are more vul-

nerable than others


27

Brazil

Persistent pressures

Like many other economies, economic activity in Brazil is in for a modest recovery. However, against the

backdrop of Brazil’s still-low average income and productivity levels, the prospects for the near future are

disappointing. Growth is being held back by a combination of labour shortages and weak investment activity,

and, given the elections next year, Brazil’s underlying problems are unlikely to be addressed in the near term.

Meanwhile, inflationary pressures will likely force further monetary tightening.

Like other emerging economies, Brazil has been recovering gradually from the slowdown

that started in mid-2011. However, the recovery is weak and uneven, while inflation remains

elevated. The poor growth performance, coupled with a tight labour market, squares well

with the hypothesis that the economy is being held back by a lack of production capacity.

The supply-side constraints are not easily overcome. The overall picture is consistent with

the notion of a fall in the underlying growth rate of potential output. For a country in Brazil’s

circumstances, investment and savings would seem quite low. The current level of capital

accumulation is clearly not consistent with substantially higher growth. Given the very limited

slack in the economy, it falls on the central bank to focus its attention on controlling inflation.

To some extent, Brazil’s trouble is a reflection of changing global trends. Activity is picking

up in overseas markets. In the US, the economy seems to have performed better than many

have expected, in line with our view. The deep political infighting in Washington was clearly

not enough to derail the recovery. Against that background, there is renewed talk about

when the Fed will start tapering its bond purchases. In China, growth seems stable and also

somewhat stronger than previously thought. The early analysis from the just concluded ple-

nary meeting of the Communist Party suggest that initiatives are underway to address some

of the issues that may weigh on the economy’s performance going forward. Even the euro-

zone seems to be in for a muted recovery.

Despite these positive developments, one would think that commodity markets would also

be seeing a turnaround. Not so. While stock markets are testing new highs, commodity

prices have been soft, a clear negative for countries like Brazil. The country’s exports have

increased lately, in dollar terms, partly as a reflection of a significant downward slide in the

country’s real effective exchange rate. However, exports are still lower than before the start

of the most recent slowdown. Like Russia, another big commodity exporter, Brazil is facing

global market conditions that are less fertile now than before. The evolving nature of growth

in China, global rebalancing and the threat of Fed tapering are likely some of the negatives

when Brazil’s commodity exporters consider adding to existing capacity.

Brazil’s recovery

weak and uneven

Changing global

trends part of the

picture

Commodity markets

have remained soft


28

Under these circumstances, even if the weaker exchange rate for the real helps making the

manufacturing sector more competitive, the case for investment-driven growth seems quite

limited. Consumption, by contrast, has held up rather well. Domestic demand has outpaced

GDP, which means that the current account has moved from surplus to a sizeable deficit.

The deficit is not large enough to cause significant concern, but it is indicative of the state of

overheating that Brazil finds itself in. The unemployment rate has, according to the official

statistics, sunk to an all-time low. Clearly, a general lack of productive capacity is limiting the

supply response to continued buoyant consumption, and, as a result, inflation has failed to

come down.

The Brazilian authorities are facing a policy dilemma that looks very similar to what their

counterparts in Russia are dealing with. Fiscal and monetary stimulus is not working. If more

expansionary policies are adopted, the likely result is further overheating and, in the end,

inflationary pressures. The Brazilian authorities are aware of this and the central bank, quite

appropriately, is taking steps to tighten its monetary policy stance. What is lacking, however,

like in Russia, is the political will to move ahead with a more ambitious structural agenda

aiming at encouraging investment, particularly in parts of the tradable goods sector other

than commodities.

There may be reason to believe that such a strategy has greater chances of success in Brazil

than in Russia. The economy is less one-sided and Brazil’s brand of politics is perhaps not as

destructive. However, one should not underestimate the challenges, especially in the near

term. Elections are scheduled for next October, both for the office of president and for the Na-

tional Congress. In the current political landscape, no bold moves can be expected before

then. Widespread protests during the past summer signalled strong discontent with various

aspects of public policy, including with regard to the level of administratively set prices, the

quality of public services provided, and the lack of progress on the corruption front.

Beyond the election, things may change; however, in the near term, markets will likely focus on

short-term problems such as inflation. Last week, the key SELIC interest rate was raised to

10.00 percent. More may come if Fed tapering triggers renewed weakness in the BRL. Expec-

tations for real GDP suggest growth of 2.5 percent for both 2013 and 2014, followed by 3.0

percent in 2015. Underscoring the fairly negative view on potential output growth, we believe

that unemployment will rise only slightly, while CPI inflation is set to fall gradually, from slightly

over 6 percent in 2013 to 5.5 percent in 2015. Markets will thus remain focused on the over-

heating problem. The deterioration in public finances presents yet another worry and this trend

may not be reversed until 2015, after the elections. While that may be viewed as a temporary

phenomenon, serious underperformance could trigger volatility at some point.


Brazilian economy

clearly overheated

The authorities face

a policy dilemma

Elections next year

likely to deter any

structural reforms

Slow growth and

high interest rates on

the cards


29

Central and Eastern Europe

Future convergence at risk

In most of the economies in Central and Eastern Europe, economic conditions seem to be improving,

mirroring developments elsewhere. While the better global economy plays a major role in this, domestic

factors are also at work. Nevertheless, growth is likely to be quite modest, capped by various structural

impediments. Future convergence is clearly at risk. So far, however, policymakers have either not realised

this or wanted to take sufficient steps to reinvigorate the development process.

Financial markets, sentiment indicators and hard data all suggest that the global economy is

indeed poised to pick up. In the US, we have seen a stream of positive signals, despite the

civil war mentality that seems to characterise the politicians in Washington. While growth

remains low in a historical context, especially considering the slack in the labour market, the

US still looks set to outperform Western Europe. In China, data has also surprised on the

upside, dispelling fears about a possible hard landing. The early analysis of the Communist

Party’s recently-concluded plenary meeting also suggests some positive conclusions that

point in the same direction. The situation among other major emerging economies is more

mixed. While capacity constraints and structural problems are holding back growth in some

places, growth remains buoyant in others. Nevertheless, as a group, emerging economies

may play a more limited role in supporting global growth than we have been used to during

recent years.

Even in the eurozone, things are slowly looking better. Economic activity and employment

have at least stabilised in the troubled south. In the north, we are likely to see a quicker and

more tangible improvement. Germany is a leveraged play on global trade and there is also a

potential for greater spending at home. Clearly, the backdrop of record-low unemployment,

real wage gains, robust company profits and extremely low interest rates, as well as solid

public finances, provides fertile soil for significant growth in domestic demand. So far, the

attitudes among firms and households have been rather cautious, but that could change.

There is already a buzz about how activity has picked up in Germany’s traditionally sleepy

housing market. And given the economic weight of Germany among its neighbours, other

countries in the north should also benefit. The overall situation in the eurozone nevertheless

remains very problematic. The wide gap in labour market performance between the south

and north is enough reason to think that the euro project suffers from serious design flaws

For Central and Eastern Europe, the global outlook is of course very important. In Russia,

with its heavy dependence on oil and other commodities, there is a particularly close link. In

the EU countries, the link may be more indirect, mainly through the connection to Germany.

Within the region, we have seen diverging economic trends during the course of this year. In

almost all countries, growth for the year as a whole looks to be lower than in 2012. However,

while Russian growth fell yet again to a new low in Q3, Polish growth bounced back and

surprised on the upside. It is tempting to interpret this as a sign that external conditions have

turned less favourable to energy-based Russia and more favourable to Poland and other

countries that focus on labour-intensive manufacturing. The recent slide in commodity prices

is certainly consistent with this interpretation. However, even within Central Europe, we have

seen significant differences in economic performance. The Czech Republic reported Q3

data that fell short of expectations, while Hungarian growth turned out higher than expected.

If indeed the changing nature of global growth implies that commodity markets will remain in

a holding pattern, Russia would clearly benefit less than Central Europe from the recovery in

the next couple of years. Russia is increasingly running out of easy solutions. While exports

have levelled off, the tight labour market means that stimulating domestic demand is unlikely

to yield good results. The authorities may try, but that would only produce inflation. Growth is

expected to pick up a notch, but still fall far short of the country’s potential. Higher ambitions

Positive signals from

the US and China

Germany a source of

strength in Europe

Eastern Europe

closely linked to

global growth

Russia is running out

of easy solutions


30

are only realistic if Russia is able to pursue reforms that would help it evolve into a much

more attractive location to investors outside the commodity sphere. As we have argued in

the past, nothing suggests that the elite would be able to embrace such drastic changes.

The low output growth and corresponding sluggish gains in living standards will sooner or

later probably result in more widespread political discontent. However, genuine progress will

not happen quickly. We think Russia is stuck on a low-growth path that only allows a very

slow climb up the global income and productivity ladder.

There are reasons to be somewhat more optimistic about the EU countries. Higher activity

among German exporting firms will likely have a knock-on effect on their subcontractors in

Central Europe. Similarly, the Baltic countries may benefit from stronger growth in Finland,

Sweden and Russia. There are also domestic drivers. While eurozone members benefit

from actions taken by the ECB, central banks in countries outside the currency union have

also eased monetary policy substantially. The Czech National Bank even orchestrated a

devaluation of the koruna, as it already had exhausted the room for rate cuts. There is also a

tendency to go slower on fiscal consolidation. Hungary and Poland have both introduced

changes to their pension systems that effectively provide more fiscal leeway. The move

back to a pay-as-you-go approach is problematic from a structural point of view, but it will

allow for more stimulus in the short term. Finally, there will be another (and perhaps final)

round of infrastructure spending financed partly by the EU. The effects will start to kick in

during 2015, in time for the next Polish election.

All this means that growth not only is preconditioned on the global picture. Some countries,

particularly the Baltic States and Poland, which have favourable domestic fundamentals,

should be able to maintain growth even if the global recovery disappoints. However, as in

the case of Russia, the convergence story in northeast Europe is starting to look a lot less

convincing. Few observers now seem to believe that the region has the necessary structural

credentials to substantially outperform the most dynamic economies in the west over the

longer haul. There has obviously been significant rotation within the EU in favour of the north

and east and to the disadvantage of the south and west, but there seems to be little reason

for Central and Eastern Europe to significantly catch up with the richest countries in the

north. The whole region is in danger of getting stuck in the “middle income trap”. Whether

that prospect will help usher in a wave of structural reforms is unclear at this point. While

Central Europe certainly has a much more attractive political landscape than Russia, we

have yet to see the need for bold reforms make a distinct imprint on the political agenda.


Real GDP in selected countries (percentage changes)

2011 2012 2013f 2014f 2015f

Estonia 9.6 3.9 1.5 3.4 3.8

Latvia 5.3 5.0 4.1 4.3 4.0

Lithuania 6.0 3.7 3.4 3.8 4.1

Czech Republic 1.8 -1.0 -1.2 1.7 2.3

Hungary 1.6 -1.7 0.7 1.6 2.1

Poland 4.5 1.9 1.3 2.9 3.4

Slovak Republic 3.0 1.8 1.1 2.0 2.8

Russia 4.3 3.4 1.6 2.5 2.9

Turkey 8.8 2.2 3.6 3.8 4.2

Sources: Official statistics and Handelsbanken forecasts

Cyclical upswing in

eastern EU

Falling into “middle

income trap” a real

risk


31

Sweden

Let it grow, let it grow, let it grow...

The Swedish macro environment is generally developing in line with our scenario. Weak GDP growth is set to

pick up and a recovery in manufacturing and exporting sectors finally seems to be in the offing. Rather than

short-term demand uncertainty, structural issues in manufacturing and the labour market stand out as focal

points to us. Still, we expect only a limited upturn in the labour market next year while inflation should

remain low. While macroprudential regulation brings a new landscape for the Riksbank, we retain our

outlook for monetary policy: easing foreign policies will ultimately challenge domestic reasons to tighten.

Growth acceleration now in the offing

A few things have stood out in the Swedish economy in the past few years. One is how un-

expected strength in service sectors has compensated for downward trends in exports, in-

vestment and manufacturing output. Another is the increase in total jobs, driven especially

by services sectors. Given weak GDP growth, the strength in employment weighs on pro-

ductivity. Without support from foreign markets, domestic resilience should draw to an end

sooner or later. Luckily, both macro and survey data suggest that our forecast for a growth

recovery in H2 will materialise, which we have had in our outlook for over a year. However,

growth is still muted. The recent reading for Q3 shows GDP increasing by only 0.1/0.3 per-

cent q-o-q/y-o-y, but final domestic demand is not looking as weak. Furthermore, fiscal pol-

icy stimulation next year should add fuel for a domestic acceleration.

Our forecast for 2014 GDP growth lands at quite a high figure (3.2 percent). Recent surveys

support our outlook of a revival in manufacturing and exports. However, we still believe in a

rather slow recovery in those areas in 2014, which is why the pick-up in forecast GDP

growth leans more on domestic demand. As weakness in foreign markets and global macro

risks will most likely remain, we do not expect a significant GDP contribution from net ex-

ports. Yet, the bottoming-out of exports and manufacturing industry should be essential to

overall confidence and to the prospects for investments ahead.

Manufacturing: looming challenges underneath recovery prospects

At this point, investment and exports are still some distance from their previous peaks. Thus,

there is a lot of lost ground to regain. At the heart of the matter is manufacturing, where out-

put is down by a total of 9 percent since the peak in Q1 2011. The flattish productivity seen

in the past two years, characterised by weak export demand and a historically-strong SEK,

raises questions about potential productivity for manufacturing and the growth potential for

Sweden. Hence, the real question regarding an industrial recovery is how much of the re-

cent weakness is due to temporarily weak demand and a short-term loss in competitiveness

due to SEK strength, and to what extent does the adversity relate to structural issues?

GDP growth is still

slow, but accelera-

tion is finally around

the corner

Annual GDP growth

next year to land

high, but strong pull

from export markets

is still lacking

Weak demand trends

and SEK strength

cloud underlying

productivity trends


32

Broadly speaking, Sweden ranks high in comparison to peer markets when looking at key

aggregates for gauging competitiveness: labour productivity, unit labour costs and real effec-

tive exchange rates. Yet Sweden has lost ground to US productivity, although that is also

the case with most other mature economies. However, data show that Sweden, on the

macro level, has managed to keep up with the US more successfully than many others.

What is striking is the weak productivity trend that began before the Lehman recession.

In retrospect, the strong productivity trend that followed the Swedish domestic crises in the

early 1990s perhaps raised hopes too high. The subsequent dynamic performance, which

meant a period of catching up for Sweden, was helped by several factors. Initially, there

should have been a set table of easy productivity gains following economic stagnation in the

1970s and 1980s. Additionally, substantial reforms and strong foreign demand for Swedish

core industries promoted progress. A weak currency also helped industries, especially so at

times of fierce market adversity, when a hefty SEK depreciation cushioned exports.

However, macro analysis tends to overlook vital aspects of underlying trends, as aggregate

data miss details on the growth dynamics. The point is that structures do not remain constant;

the economy transforms perpetually. Productivity on the macro level is boosted by significant

compositional effects: totally, within sectors and within firms. Holding sub-sector value-added

shares constant over time and calculating hypothetical trends for productivity is one illustration

of the impact from compositional effects. One conclusion is that the rising share of service out-

put seems to have had only a minor net effect on total private sector productivity. Regardless

of which base year we use (meaning value-added weights for goods and services), the hypo-

thetical productivity trends for the private sector all land close to the actual historical path.

Here, two main dynamics are at work when services have grown faster than goods production.

Higher productivity (and wages) in services signifies a boost to average productivity at the ag-

gregate level. At the same time, slower growth in services sectors works the other way around.

Tentatively, those two seem to have basically cancelled out, it seems. But as there has been a

catching up for goods sectors, in level terms, potential effects from the first type of dynamic

should have narrowed, which should have some bearing on the outlook for macro productivity.

This could suggest lower trend growth ahead.

Turning instead to goods production only, a compositional boost (looking at five sub-sectors)

really seems to have lifted aggregate productivity, especially in the 1990s. Later on, the posi-

tive compositional impact seems to have abated, especially over the past ten years. Then,

productivity in goods sectors seems quite independent of which weights we use (the actual

ones or fixed ones of 1993, 2003 or 2013). Thus, the overall trend seems to be more driven by

the inter-sector productivity during the later period. Unfortunately, the presented calculation is

marred by shortcomings, the main caveat being that findings are highly dependent on which

data are used (aggregation levels and sub-sector division). Yet, the exercise is illuminative.

Looking ahead, we think that total productivity in years to come will likely be slower than in

the1990s and early 2000s, especially so without significant structural reforms or a boost to

At the macro level,

Sweden’s perform-

ance remains quite

strong versus others

Exceptionally helpful

setting after the

Swedish crises in the

early 1990s boosted

manufacturing pro-

ductivity

A substantial portion

of productivity

growth stems from

compositional

change

For goods produc-

tion, the boost from

compositional

change seem to have

faded


33

investment in real and human capital. It may well be that manufacturing, and Sweden, will

have a hard time repeating the successes of the past. However, as we forecast an imminent

acceleration in demand growth, a recuperation in productivity is what we expect first.

Key macroeconomic indicators

Sources: Handelsbanken Capital Markets and Macrobond

Structural issues in the labour market despite recent strength

Evidence does not decisively show severe structural damage since the Lehman recession.

Yet, an increase in equilibrium unemployment seems likely, despite unexpected strength

during the course of the past few years: high employment and a strong trend for the labour

force. The high participation rate should be the response to lowered effective income taxes

and policy tightening in social security schemes. Hence, any decay in the functioning of the

labour market should primarily deal with groups within the labour force (rather than ‘outsiders’).

Looking at the relationship between unemployment and vacancy rates, or the Beveridge

Curve, some impairment to the matching process on the macro level appears. However, given

possible shifts in recruitment behaviour and reporting, we would like to downplay the indicated

worsening in matching efficiency. Moreover, we cannot rule out shifts in the demand for labour,

with potentially sustained low demand for low-skill workers. But also other perspectives on the

labour market indicate challenges. Although effective labour tax wedges have been lowered in

Sweden, ‘outsiders’ – based on education, experience and background – face relatively lower

Percentage change

2011 2012 2013f 2014f 2015f

Household consumption 1.7 1.7 1.8 2.3 2.4

Government consumption 1.0 0.8 1.2 1.2 1.4

Fixed investment 8.3 3.8 -0.7 5.3 4.2

Final domestic demand * 2.6 1.7 1.1 2.4 2.3

Inventories * 0.4 -1.1 -0.2 0.4 0.0

Exports 6.5 1.1 -1.4 3.4 4.0

Imports 7.2 -0.1 -2.1 3.0 4.5

Net exports * 0.0 0.6 0.2 0.4 0.1

GDP, calender adjusted 3.0 1.3 1.0 3.2 2.4

GDP, actual 3.7 0.7 1.0 3.1 2.6

Unemployment ** 7.8 8.0 8.0 7.9 7.7

Employment 2.3 0.6 1.1 0.8 1.0

Hours worked 2.0 0.6 0.4 0.7 1.1

Wages *** 2.4 3.1 2.6 2.8 2.9

Real Disposable Income 3.6 3.0 2.5 2.7 2.0

Savings ratio **** 3.7 5.1 5.6 6.0 5.4

CPI 3.0 0.9 0.0 1.0 2.0

CPIF 1.4 1.0 0.9 1.0 1.5

Net lending, General Government ***** 0.0 -0.5 -1.4 -1.2 -0.7

Current Account ***** 7.3 6.7 6.2 5.7 5.4

* Contribution to GDP growth *** Wage and salary statistics ***** Percent of GDP

** LFS, percent of labour force **** Savings excl. pensions

Economic reform a

likely driver for the

strong trend for la-

bour supply...

...but has achieved

less to improve skills

among workers


34

employment chances. So, significant differences with respect to education or ethnicity remain.

Fairly positive is that long-term unemployment has moved roughly sideways over the past

year, although it is higher than before the recession. Despite high GDP growth forecast in com-

ing years, we expect a fairly limited job boost. And given our forecast of continued high partici-

pation, we do not expect a marked decrease in unemployment. We believe that high unem-

ployment will likely haunt policymakers for some time.

New landscape for monetary policy, but not a new world

Currently, CPIF inflation is well below its historical average. And no plunge in unemployment

is in sight, which could push for accelerating wage growth later on. On top, a low-inflation

environment abroad seems most likely. Also, we forecast the SEK to trend stronger. Thus,

the potential upside to inflation appears limited at this point. Comparison to 2004-08 is illus-

trative, we think. Then, after an extended period of low CPIF inflation, accelerating CPIF

inflation was preceded by a significant trend decrease in the unemployment rate (about 1.5

percentage points) and an increase in wage growth. Certainly, there is no easy rule of thumb

to describe the interaction between unemployment and inflation. And admittedly, energy

prices also added to the acceleration in the CPIF that time. But the real trigger then, in our

view, was domestic wage growth. In our forecast, wage growth remains moderate.

As long as the Riksbank forecasts accelerating GDP and a recovery in the labour market in

coming years, there are certainly reasons against rate cuts, especially given the long period

of a low repo rate and the concerns over credit growth and dwelling prices. But indeed, the

probability of a lower repo rate path has increased, opening up the possibility of a rate cut.

However, our main scenario is a flat rate at 1 percent until the second half of 2014. Although

rate cuts cannot be ruled out, we expect the Riksbank to land at signalling ‘lower for longer’.

And instead of a short-term lowering of the repo path, we think there are two factors against

the sharp hike that the Riksbank keeps signalling for 2015-16. First, new macroprudential

policies should eventually alter the basis for monetary policy. Once details about the policies

are disclosed, the repo rate path will likely be affected (likely during 2014). But until the spe-

cifics of policies are presented, the Riksbank will take that into account only sluggishly.

However, in an outlook with a range of unknowns, including general forecast uncertainty, the

macroprudential impact should not be overstated at this stage. The second factor holding

downside risk is the Riksbank’s outlook for relative policy rates and the SEK, in our view.

With the Riksbank forecasts on policy rates, we think the SEK could reasonably appreciate

more than that indicated by the Riksbank’s KIX forecast. Also, we expect lower foreign pol-

icy rates than the Riksbank does. Should our forecasts prove to be right, the signalled repo

rate hikes in 2015 and 2016 do not look feasible, as the consequential high interest rate dif-

ferentials would then imply unprecedented SEK strength.

Anders Brunstedt, +46 701 54 32, [email protected]

Structural issues

likely to emerge as

we expect high un-

employment to per-

sist

Every angle on con-

sumer prices points

to lasting low infla-

tion pressures

Rate cuts below 1

percent not incon-

ceivable...

...but apparent

downside risk to

repo path of 2015-16

appears more likely

to us



35

Sweden

Norway - a warning bell for Sweden?

Developments on home prices and household debts in Norway and Sweden illustrate the dangers of pursuing

an inflation target without having a macro-prudential framework in place to prevent a housing bubble. We

are not forecasting a collapse of house prices but Norway is further into the danger zone than Sweden and

policy makers are already starting to worry about recent prices declines. Norway could be seen as a warning

bell for Sweden that it is really important to cool down the housing market before it becomes too late.

It is very difficult for a central bank in a small open economy to pursue an independent rate

policy. The exchange rate is too important for economic activity and inflation. If rates rise

relative to those of the country’s main trading partners, the currency will appreciate and bur-

den net exports, company profits and inflation. That restriction has been especially important

in the aftermath of the financial crisis. Monetary policies in the eurozone, US and UK have

been geared towards mitigating the impact of burst housing bubbles and debt deleveraging.

It has resulted in ultra-low policy rates and unconventional monetary policies, putting down-

ward pressure on currencies, especially the dollar and pound sterling.

In that environment, policy rates risk becoming too low for economies that do not suffer from

private sector debt problems or falling house prices. In recent years low interest rates helped

boost house prices in a number of countries, especially in Asia, where there was a swift re-

turn to full employment after the 2008 collapse, but also in Norway and Sweden, where

economies recovered rapidly.

It has been especially acute for Norway, where output only dropped marginally in 2008 and

2009, and where unemployment has been running at very low rates in recent years. Wages

have risen rapidly relative to trading partners; nevertheless, consumer price inflation has been

muted, partly as a result of a gradually rising exchange rate. The Bank of Norway’s pursuit of

an inflation target has been an important motive for keeping the policy rate low. The combina-

tion of strong nominal GDP growth and low interest rates has led to vigorous credit expansion

and rapidly rising house prices. Household debt has risen to close to 200 percent relative to

disposable incomes and house price growth has continued to exceed income growth.

As the Bank of Norway has not been able to lift rates to cool the housing market and credit

growth, the burden has fallen on the government and Norway’s Financial Services Authority

(FSA) to take appropriate measures to hold down demand for credit and house purchases

and to create incentives for banks to restrict the supply of loans. Norway’s election in Sep-

tember this year complicated the political decision-making process. Anything that is negative

for the housing market is bound to be unpopular among voters. The FSA earlier put in place

Norway’s robust

GDP growth and low

interest rates fuel

rocketing household

debt, housing prices


36

an 85 percent loan-to-value ceiling for mortgages. This summer there was also a decision to

raise bank risk weights on mortgages this summer, but it was watered down from the origi-

nal proposals.

But those measures may have been put in place a little too late. The housing market started

to cool in the third quarter and house prices fell almost two percent. The price declines seem

to have continued in the fourth quarter and there are rising concerns that Norway is in for a

sharp drop in house prices. The government is now looking into raising the loan-to-value

ratio for mortgage loans from 85 to 90 percent.

Recent house price trends may prove to be a temporary correction. We do not forecast a

major drop as there are important fundamental drivers for the rapidly rising house prices. But

there is a clear correlation between house price growth and private consumption growth so

we are expecting the housing market to turn from pull to drag for the economy (see our

Macro Forecast Norway, published October 25). But we cannot exclude the possibility of a

housing bubble. If there is a sharper downward turn in prices, things may not look so rosy

any more. Households are highly geared, so the outlook for private consumption is likely to

worsen. Residential construction is relatively high, at around 6 percent of GDP, so that sec-

tor is also likely to take a hit if the housing market worsens.

An outright housing market collapse could turn into a nightmare scenario for the Bank of

Norway. The problem in recent years has been that consumer price inflation has been on

the low side relative to the inflation target. The central bank currently forecasts that the infla-

tion target will not be reached within the three-year horizon. However, that could change

abruptly if domestic demand takes a turn for the worse. In such a scenario, the currency

might decline, putting upward pressure on inflation. If future inflation risks turn out to be to

the upside, the central bank would of course be expected to lift rates. But this would not be

an appropriate response to a cooling housing market.

But perhaps the FSA and the government could reverse the measures taken recently to cool

the housing market, leaving the central bank free to pursue the inflation target by raising

rates? Well, it might turn out to be more difficult to stimulate supply and demand for credit

than to do the opposite. After all, banks cannot be forced to lend or households to borrow. In

a falling housing market, banks might actually choose to be even more conservative, for

instance by requiring higher cash down-payments (i.e. voluntarily lowering loan-to-value

ratios) or being more selective in whom they lend to. Households are also likely to be much

more cautious when house prices fall than when they rise.

It means that so-called macroprudential measures might face the same dilemma as conven-

tional monetary policy. We know that cutting rates when demand is falling might not work.

The economy would then be in a so-called liquidity trap. As a famous economist put it, “You

can lead a horse to water but you can’t make it drink”. Trying to stimulate supply and de-

A fall in Norway’s

house prices could

be looming...

...which could hit

household consump-

tion and residential

construction

You can lead home-

owners to a bank,

but you can’t make

them borrow

http://research.handelsbanken.se/Attachments/20201/Norwegian%20Macro%20Forecast%2025%20october%202013.pdf

http://research.handelsbanken.se/Attachments/20201/Norwegian%20Macro%20Forecast%2025%20october%202013.pdf


37

mand for credit by means of easing up on capital requirements or loan-to-value restrictions

might prove just as impotent as cutting rates.

Faced with the dilemma of falling house prices and rising inflation, it seems likely that many

central banks would prefer to fight house price declines than inflation. Failing to do so might

put the economy in a situation that carries much bigger downside risks. This was the course

of action chosen by the Bank of England.

The lesson is that if you do not fight the battle against house prices before the housing mar-

ket collapses, you might end up losing the fight against inflation. That threat is more acute to

very small, open economies such as those in Norway and Sweden, where exchange rates

matter much more for inflation than they do for the UK. It is still too early to say what will

happen in Norway. Recent house price declines may be just a blip. But if it turns into some-

thing much worse, there is an important lesson to be learnt for Sweden: Do not leave it too

late before addressing a looming house price bubble!

Trends in Swedish residential prices and household debt ratios are still not at such an ad-

vanced stage as in Norway, which is clearly already in the danger zone. While the Norwegian

household debt-to-income ratio has reached almost 200 percent, the current Swedish ratio is

‘only’ at around 170 percent. Relative to incomes, house prices in Norway are up 80 percent in

the past two decades, about the same rise as the UK and Denmark experienced before prices

collapsed, while house prices in Sweden are up around 50 percent. On both counts, Sweden

presently seems to be farther from the danger zone than Norway. But house prices have ac-

celerated this year in Sweden and are now rising much faster than incomes. Household credit

growth has also picked up pace, so the debt-to-income ratio keeps on rising.

It is not too late for Sweden to act to prevent a bubble, but there is no time to wait. The

Riksbank will find it difficult to raise rates until maybe late next year. The FSA has proposed

that risk weights for mortgages be raised from 15 to 25 percent, but implementation would

not take place until next summer. There is no evidence at present that banks are prepared

to lift mortgage rates in anticipation of higher risk weights. One of the banks, Swedbank,

raised mortgage rates by 25 basis points directly after the FSA announcement on November

15 but cut rates the following Monday because other banks did not follow. Given the political

constraints imposed by the Swedish election in September next year, there is no scope to

force households to amortise their debts more rapidly or to make the tax deductibility of in-

terest rate payments less generous. One thing that could be done, that has a low political

cost and would probably be quite effective in holding back house price increases, is to cut

loan-to-value ratios from 85 to 80 or 75 percent. If nothing is done soon, risks will keep on

rising and the Swedish Riksbank might find itself in the precarious situation of wanting to

fight rising inflationary pressures but instead having to fight a deflating house price bubble.

Jan Häggström, +46 8 7011097, [email protected]

Many central banks

would prefer to fight

house price declines

than inflation

Sweden so far lag-

ging Norway’s rise in

housing prices,

household debt

ratios

With an election in

2014, political head-

winds could hinder

much-needed action


38

Norway

Possible interest rate cut in March

Inflation has been considerably lower than expected since September and price pressure ahead seems to be

lower than Norges Bank currently expects. Growth has been broadly in line, but soft data hint at growth

considerably lower than Norges Bank’s forecast. Notwithstanding a weaker NOK, the result should be a

markedly lower interest rate path, with a possible interest rate cut in March next year.

The Monetary Policy Report 3/13, published in September, indicates an unchanged key pol-

icy rate until next summer. However, changes in the economic outlook since September

should lead to a substantial lowering of the path for the key policy rate. We expect Norges

Bank to lower the interest rate path by some 60bp in the longer term, opening up the way for

a possible interest rate cut in March next year.

Weaker NOK and lower money market spreads

The NOK exchange rate has been some 3.6 percent weaker than Norges Bank expected so

far in Q4. However, some of this weakness may be explained by the interest rate differential,

as international money market rates have fallen considerably since September, but the Nor-

wegian ones have fallen more. Some of the downward movement in Norwegian money mar-

ket rates has been in expectation of a lowering of the interest rate path from Norges Bank,

especially after the ECB lowered its policy rates. Money market spreads seem to be lower

than Norges Bank expected in September. The weaker krone and lower spreads contribute

to pulling the interest rate path up.

Lower growth prospects but also lower potential growth

Economic growth has been broadly in line with Norges Bank’s expectation since September,

maybe with the exception of goods consumption, which seems to have been lower. How-

ever, we believe Norges Bank’s estimates for growth ahead are too optimistic. Soft data,

including the latest report from Norges Bank’s regional network, point to growth considerably

weaker than Norges Bank forecasts. According to the regional network, growth is expected

to average around 0.35 percent for the next couple of quarters. Norges Bank, however, ex-

pects growth to pick up to 0.60 percent in Q4 and 0.64 percent in Q1, leading to growth of

2¼ percent next year and 3 percent in 2015. The regional network report also indicates a

substantial downward revision of the output gap. However, Norges Bank’s revision of the

output gap will probably be somewhat smaller than the revision of growth estimates. That is

due to potential growth probably also falling, as is suggested by the very weak performance

of productivity.

Weaker NOK and

lower money market

spreads pull the in-

terest rate path up...

...but weaker growth

prospects pull mark-

edly down.


39

Lower cost and price inflation

Inflation has been considerably lower than Norges Bank expected in September and is set

to stay well below Norges Bank’s forecast. According to Norges Bank’s latest expectations

survey, wage growth expectations among the social partners have declined. They cur-

rently expect wage growth of around 3.6 percent next year, while Norges Bank expects 4

percent. Norges Bank’s regional network expects wage growth of 3.4 percent next year.

Lower wage growth should lead to lower cost and price pressure next year than Norges

Bank currently expects.

No effects of counter-cyclical buffer this time

Norges Bank is set to give advice to the Ministry of Finance (MoF) on the size of a counter-

cyclical capital buffer to be held by banks. Given Norges Bank’s analysis from the Septem-

ber report, the advice will most likely be that a buffer should be turned on, but the size will

probably be lower than the 2.5 percent upper threshold. Given the current weakening of

growth prospects and ongoing softening of the housing market, we would look for a buffer of

0.5-1.0 percent. However, that advice will not be incorporated into the forthcoming report, so

neither text nor forecasts will reflect that advice has been given. Rather, the effects of a

buffer will be included in the report in March, well after the MoF has made its decision public.

Downward revision of some 60bp to key policy rate path

All in all, we expect Norges Bank on December 5 to lower the path for the key policy rate by

up to 60bp, opening up the way for a possible rate cut in March next year.

Kari Due-Andresen, +47 2239 7007, [email protected]

Cost and price pres-

sure also lower.

No effects of

counter-cyclical

buffer until March.

Possible rate cut in

March next year.


40

Finland

Recovery despite structural headwinds

As domestic fundamentals remain weak and fiscal austerity continues, the strength of the recovery depends

on external demand. We see encouraging signs, but structural headwinds limit the pace of GDP growth.

The Finnish economy is gradually starting to recover, but from a very low base. Statistics

Finland’s trend indicator of output indicated that the economy continued to expand in the

third quarter of 2013, by 0.4 percent q-o-q, but substantial revisions are possible in early

December when the first official national accounts’ estimates are released for Q3. Be the

possible surprises positive or negative, GDP volume will contract y-o-y in 2013 for the sec-

ond consecutive year. We still see a gradual recovery ahead, but the timing and the strength

of that recovery depends on foreign demand, as domestic fundamentals are too weak to

initiate domestic demand-driven growth.

Structural challenges limit the scope for export led recovery

There have been recent signs of moderately strengthening sentiment and growth in many

important export markets. Measured by the value of goods exported, Finland’s three most-

important export markets are Sweden, Russia and Germany, in that order; we expect growth

to strengthen in those economies during 2014-15. Due to structural supply-side problems in

Russia, its growth is unlikely to provide Finnish exports a lift as sizable as before the finan-

cial crisis. All in all, we expect the export recovery to be modest compared to previous up-

turns due to structural change in Finnish industries.

As the share of manufacturing electronic products and electrical equipment to total manufac-

turing value-added shrank from 25 percent in 2000-08 to less than 8 percent in Q2 2013 and

the global investment cycle remains too modest to support demand for the engineering sec-

tor, paper, pulp and paperboard products have regained their status as the most important

export product group (16 percent share of total goods exported value in January-August

2013). Machinery and equipment’s share has decreased to 13.3 percent, while coke and

petroleum products’ share has increased to 11.7 percent, close to basic metals’ 11.8 percent

share. The trend of lower value-added intermediate goods, crude materials and fuels in-

creasing their export shares while manufacturing and exports of higher value-added goods

struggle is worrying. Although awareness of this challenge is increasing among the political

and economic elite, there are few ways to rapidly restructuring the industrial base. Uncer-

tainty about the export and growth outlook therefore remains a moderating factor to corpo-

rate investment growth in 2014-15.

Finnish GDP volume

will contract y-o-y in

2013 for the second

year running

Uncertainty over the

export and growth

outlook to moderate

corporate investment

growth in 2014-15


41

Households’ sentiment and finances gradually improve towards 2015

Low confidence and stagnating purchasing power (thanks to lower employment and higher

taxes) led households to be wary about spending in 2013. Consumer price inflation deceler-

ated steeply during 2013, but deflation is not a threat, so lower inflation is welcomed to com-

pensate for the moderate two-year wage deal recently agreed. Taxation is set to rise further

in 2014, as taxes on alcohol, tobacco, soft drinks, electricity and fuels are increasing and

many local governments plan to lift tax rates. Further, cuts in public spending will have both

direct and indirect effects on purchasing power and consumption. We expect private con-

sumption growth to remain relatively modest in 2014, but better sentiment, a stronger labour

market and low interest rates should give a boost to private consumption growth in 2015.

The labour market has been weak throughout 2013: employment and the labour force con-

tracted by 1.1 percent and 0.6 percent y-o-y on average between January and October. Busi-

ness surveys now indicate that the worst fall in employment is probably over, but none of the

main employer sectors expect increasing employment. The pace of contraction will instead

likely be more moderate in coming months. Despite the delayed economic recovery, we mar-

ginally lower our 2013 unemployment rate forecast, to 8.1 percent. Leakage from the labour

force has restrained the increase in the unemployment rate more than we had expected. We

expect the unemployment rate to remain unchanged in 2014, at 8.1 percent. In 2015, the

strengthening business cycle should pull the unemployment rate down to 7.8 percent.

Construction of new residential and non-residential buildings remained in the doldrums this

year, but residential activity has been supported by repairs and renovations, which are nec-

essary given the ageing residential building stock. In 2014-15, we expect construction activ-

ity to pick-up moderately. A slowdown in housing loan stock growth following increased risk-

awareness of consumers and lenders, higher loan margins and increased transaction costs

point to a continued moderation in housing demand, but tight supply in growth centres is

likely to anchor house prices from serious downward corrections.

Closing the sustainability gap is a main priority of fiscal policy

The centralised wage deal will slow growth in public expenditure in 2014-15 and the busi-

ness cycle recovery will support the revenue side, leading to a lower deficit and a slower

build of debt. The government’s focus is on closing the sustainability gap of the public sector

by 2017, estimated to be roughly 4.7 percent of GDP, according to the Ministry of Finance.

The common denominator for planned structural reforms is the aim to boost the supply side

of the economy. The political power of the current government will be tested, as there is a

great urge to get several of these reforms implemented during its term, which ends in the

spring of 2015. Despite the fragmentation of the government base, the government seems

united in keeping Finland’s triple-A credit rating.

Tuulia Asplund, +358 10 444 2403, [email protected]


Tax hikes keep pri-

vate consumption

growth relatively

modest in 2014…

…but a boost is felt

in 2015 from low

rates, improved sen-

timent and a

stronger job market

Tight supply in

growth centres likely

to prevent steep

house prices declines

Government seems

united in keeping

Finland’s triple-A

credit rating


42

Denmark

Better, but still not great

There has been a turnaround in sentiment indicators and there are tentative signs of more stable trends in

housing prices and in the labour market. Thus, following two years of stagnation, there is hope for higher

growth moving into 2014. However, we still see the recovery as being weak and fragile, as household debt is

still high and as the global economic environment is too anaemic to support exports as a driver of growth.

The main risks relate to any increase in interest rates and weaker growth in the eurozone.

Since our previous Macro Forecast in August, the economy has shown signs of finally stepping

away from the on/off recessions that have characterised the past couple of years. The strong-

est signal of this comes from the turnaround in sentiment indicators since the summer. Con-

sumer confidence has risen to a five-year high and the business barometers from the industrial

and service sectors have likewise improved. The less-dire economic performance has also

been confirmed in the latest GDP figures, with growth rates of 0.6 percent and 0.4 percent on a

quarterly basis in Q2 and Q3 respectively. The stronger-than-anticipated expansion in Q3

prompts us to lift our growth estimate for 2013 from a slight contraction to slightly positive GDP

growth of 0.25 percent.

Overall, however, we do not make large changes to our outlook for the economy and still expect

a relatively weak and fragile recovery in economic activity. Taking a closer look at the latest GDP

figures reveals a continued weak underlying economic environment, with the brunt of the im-

provement caused by a one-off investment in ships. Stripping that from the GDP figures, fixed

business investments barely rose and economic activity would have contracted in Q3. Still-low

capacity utilisation indicates that investments will most likely not increase markedly.

It was especially disappointing to see private consumption continuing to contract on the back

of the mentioned increase in consumer sentiment. However, one aspect of the improvement in

consumer confidence is that consumers have raised their views for the prospects for the econ-

omy as a whole, but their assessments of their own personal finances have not yet risen in

earnest. That is an abnormal situation, as households have almost always regarded their own

economies as being in a better state than the Danish economy in general. Thus, there are still

no clear signals that the more stable trends on the labour market, the extremely low debt ser-

vicing costs, positive real wage growth and rising home prices in some parts of the country

have led to an actual increase in consumption.

The figure above indicates that an increase in interest rates would have a meaningful impact on

household purchasing power. The dotted line shows an imaginary rise in the long- and short-term

mortgage bond yields to their long-term averages, which based on historical trends would in-

crease household interest rate payments after tax by more than 2.5 p.p. of disposable income.

Sentiment indicators

paint brighter pic-

ture…

…but we still expect

the recovery to be

weak

Still no clear sign of

pick-up in private

consumption…

Rising yields would

hit consumers hard


43

Even though we see these factors lifting the contribution to growth from private consumption

slightly as we move into 2014, we are still not convinced that consumers will begin to open their

wallets in earnest, not least as household debt has not yet been reduced in any meaningful way,

and as the interest rate sensitivity of the household sector is extremely elevated. We do not ex-

pect yields to increase to that extent in the foreseeable future, but it illustrates the risk to the Dan-

ish economy from any unanticipated rise in yields. Furthermore, it highlights that due to the still-

high debt levels in the household sector, Denmark would most likely be a laggard in a more

marked global economic recovery, if that were to be followed by tighter financial conditions. As

such, we believe that households will continue to focus on savings which would help secure the

longer-term stability of the Danish economy but keep private consumption at bay.

Looking ahead, households should also expect less help from the trend in real wages. Wage

growth is set to be relatively weak – albeit positive – over the forecast horizon as work on re-

storing competitiveness goes on. Furthermore, the current low-inflation environment is not ex-

pected to continue, as we feel relatively comfortable that we have not moved into a vicious

deflationary spiral. Undoubtedly, the low inflation has to some degree been of the more worry-

ing, demand-driven kind from declining wage growth and reduced pricing power of companies.

However, the lower inflation has also been driven by cuts in duties and lower gasoline prices,

and we expect the negative effects from this to diminish as we move into 2014. Finally, there

have so far been no signs of the low inflation having an impact on inflation expectations.

Even though the eurozone has shown signs of stabilisation, growth in the common euro cur-

rency area is still expected to be anaemic at best. Additionally, a still-weak competitive posi-

tion enhanced by the recent strengthening of the trade-weighted DKK exports is not seen as

a strong driver of economic activity. In conclusion, we still see the state of the economy as

fragile, with several potential risks that could derail any recovery. We retain our forecast of

continued subdued GDP growth in the years ahead.

Key macroeconomic indicators

Sources: Statistics Denmark and Handelsbanken Capital Market

Jes Roerholt Asmussen, +45 4679 1203, [email protected]


GDP 1.1 -0.4 0.3 0.9 0.8Household consumption -0.7 -0.1 0.5 0.7 0.6Government consumption -1.4 0.4 0.2 0.6 0.6Gross investment 3.3 0.8 0.6 -0.7 1.1Exports 7.0 0.4 0.5 1.6 0.8Imports 5.9 0.9 1.7 0.7 0.6

Unemployment rate 6.0 6.1 5.8 5.6 5.6Consumer prices 2.8 2.4 0.8 1.6 1.7House prices, one family -2.8 -3.2 2.2 1.5 1.0General gov budget balance* -1.9 -4.2 -1.7 -2.1 -2.6

* Percent of GDP

Inflation will rise

and wage growth

remain subdued

Exports not expected

to come to the rescue


44

Key figures Real GDP forecasts


Inflation forecasts


Unemployment forecasts


Sweden 1.3 1.0 0.9 3.2 2.9 2.4 2.5

Norway 3.1 0.3 0.3 1.2 1.7 1.9 2.1

Norway Mainland 3.5 1.8 1.8 1.5 2.0 2.0 2.0

Finland -0.8 -0.2 -0.2 2.0 2.0 2.2 2.2

Denmark -0.4 0.3 -0.1 0.9 0.7 0.8 0.8

EMU -0.7 -0.5 -0.5 1.0 1.0 1.1 1.1

USA 2.8 1.7 1.7 2.7 2.7 2.9 2.9

UK 0.1 1.3 1.3 1.5 1.5 1.7 1.7

Japan 2.0 1.9 1.9 1.5 1.5 1.2 1.2

Brazil 0.9 2.5 2.3 2.5 2.8 3.0 3.3

Russia 3.4 1.6 2.2 2.5 2.8 2.9 3.1

India 5.1 4.7 4.5 5.0 4.7 5.5 5.5

China 7.8 7.6 7.5 7.3 7.3 7.0 7.0

Czech Republic -1.8 -1.2 -0.8 1.7 1.7 2.3 2.3

Hungary -1.7 0.7 0.4 1.6 1.6 2.1 2.1

Poland 1.9 1.3 1.2 2.9 2.6 3.4 3.0

Slovakia 2.0 1.1 0.9 2.0 2.2 2.8 2.8

2012 2013f

(Previous

forecast) 2014f

(Previous

forecast) 2015f

(Previous

forecast)

2012 2013f 2014f 2015f

Sweden 0.9 0.0 0.0 1.0 1.1 2.0 2.0

Norway 0.8 2.3 2.3 2.0 2.0 1.6 1.7

Finland 2.8 1.5 1.8 1.8 2.2 2.4 2.6

Denmark 2.4 0.8 1.2 1.6 1.8 1.7 1.9

EMU 2.5 1.5 1.5 1.6 1.7 1.7 1.7

USA (core) 1.8 1.3 1.3 1.8 1.8 2.1 2.1

UK 2.8 2.7 2.7 2.3 2.3 2.1 2.1

(Previous

forecast)

(Previous

forecast)

(Previous

forecast)

2012 2013f 2014f 2015f

Sweden 8.0 8.0 8.1 7.9 8.1 7.7 7.8

Norway 3.2 3.5 3.6 3.7 3.7 3.9 3.8

Finland 7.7 8.1 8.2 8.1 8.0 7.8 7.7

Denmark 6.1 5.8 6.1 5.6 6.4 5.6 6.4

EMU 11.4 12.3 12.3 12.2 12.2 12.1 12.1

USA 8.1 7.5 7.5 6.8 6.9 6.2 6.3

UK 7.9 7.7 7.8 7.5 7.6 7.3 7.5

(Previous

forecast)

(Previous

forecast)

(Previous

forecast)


45

Currency forecasts


Interest rate forecasts


Dec 3 <6 m <12 m <24 m <36 m

EUR/SEK 8.87 8.40 8.30 8.10 8.00

USD/SEK 6.55 6.72 7.55 8.10 8.00

GBP/SEK 10.71 10.18 10.12 10.13 10.67

NOK/SEK 1.07 1.04 1.03 1.01 1.00

DKK/SEK 1.19 1.13 1.11 1.09 1.07

CHF/SEK 7.22 6.77 6.64 6.38 6.15

JPY/SEK 6.36 6.52 7.19 7.57 7.27

EUR/USD 1.36 1.25 1.10 1.00 1.00

USD/JPY 102.97 103.00 105.00 107.00 110.00

EUR/GBP 0.828 0.825 0.820 0.800 0.750

GBP/USD 1.64 1.52 1.34 1.25 1.33

EUR/CHF 1.23 1.24 1.25 1.27 1.30

EUR/DKK 7.46 7.45 7.45 7.46 7.46

USD/DKK 5.50 5.96 6.77 7.46 7.46

GBP/DKK 9.01 9.03 9.09 9.32 9.94

CHF/DKK 6.07 6.01 5.96 5.87 5.73

JPY/DKK 5.34 5.79 6.45 6.97 6.78

EUR/NOK 8.31 8.10 8.05 8.00 8.00

SEK/NOK 0.94 0.96 0.97 0.99 1.00

USD/NOK 6.13 6.48 7.32 8.00 8.00

GBP/NOK 10.03 9.82 9.82 10.00 10.67

CHF/NOK 6.75 6.53 6.44 6.30 6.15

JPY/NOK 5.95 6.29 6.97 7.48 7.27

USD/BRL 2.36 2.65 3.00 3.35 3.35

USD/RUB 33.18 35.30 38.30 40.90 41.50

USD/INR 62.32 63.00 62.00 60.00 58.00

USD/CNY 6.09 6.07 6.05 6.05 6.05

EUR/PLN 4.20 4.10 4.00 3.90 3.75

Policy rates Dec 3 <6 m <12 m <24 m <36 m

Sweden 1.00 1.00 1.25 1.75 2.00

US 0.125 0.125 0.50 1.50 2.50

Eurozone 0.25 0.25 0.25 0.25 0.25

Norway 1.50 1.50 1.75 2.00 2.50

Denmark 0.20 0.20 0.20 0.25 0.25

UK 0.50 0.50 0.50 0.50 1.50

3m interbank rates Dec 3 <6 m <12 m

Sweden 1.08 1.20 1.45

US 0.24 0.40 0.70

Eurozone 0.24 0.15 0.15

Norway 1.66 1.65 1.65

Denmark 0.24 0.25 0.25


46

Interest rate forecasts continued...


2y govt. yields Dec 3 <6 m <12 m <24 m <36 m

Sweden 0.92 1.20 1.55 1.80 2.10

US 0.23 0.90 1.50 2.10 2.80

Eurozone (Germany) 0.13 0.15 0.15 0.15 0.30

Norway 1.62 1.65 1.95 2.45 2.95

Denmark 0.02 0.15 0.20 0.20 0.40

Finland 0.22 0.20 0.20 0.20 0.35

UK 0.49 0.55 0.70 0.90 1.10


Sweden 1.64 1.80 2.10 2.40 2.50

US 1.29 1.90 2.40 2.80 3.10


Norway 2.11 2.05 2.15 2.65 3.15

Denmark 0.92 0.55 0.65 0.75 0.85

Finland 0.90 1.00 1.10 1.20 1.30

UK 1.76 1.70 1.80 1.90 2.00


Sweden 2.30 2.40 2.60 2.85 3.00

US 2.80 3.00 3.30 3.40 3.50


Norway 2.83 2.90 3.00 3.20 3.40

Denmark 1.79 1.95 2.15 2.30 2.40

Finland 1.95 2.10 2.30 2.35 2.45

UK 2.84 2.80 3.00 3.10 3.20

2y swaps Dec 3 <6 m <12 m

Sweden 1.35 1.55 1.85

US 0.39 1.00 1.60

Eurozone (Germany) 0.44 0.50 0.50

Norway 1.87 2.00 2.10

Denmark 0.62 0.80 0.80

UK 0.85 0.95 1.10


Sweden 2.04 2.20 2.40

US 1.52 2.00 2.50


Norway 2.46 2.70 2.80

Denmark 1.28 1.50 1.50

UK 1.83 1.90 2.05


Sweden 2.69 2.80 3.00

US 2.87 3.10 3.40


Norway 3.18 3.30 3.30

Denmark 2.21 2.45 2.60

UK 2.80 2.80 3.00

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december 5, 2013 macro forecast -...

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