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Nordic Outlook

Economic ResearchImportant your attention is drawn to the statement on the next page of this report which affects your rights.

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November 2003 English edition

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Nordic Outlook - November 2003

2

SEB Economic Research

Important: This statement affects your rights

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Klas Eklund, Chief Economist +46 8 763 [email protected]

Håkan Frisén, Head of Economic Research [email protected]

Bo Enegren, Economist [email protected]

Ann Enshagen Lavebrink, Research Assistant [email protected]

Ingela Georgii-Hemming, EU Coordinator [email protected]

Olle Holmgren, Economist [email protected]

Kerstin Jendhammar, Research Assistent/Secretary [email protected]

Mikael Johansson, Economist [email protected]

Fax no. +46 8 763 9300

Contributions to the sections on Germany and Norway in this report have been made by Thomas Köbel fromSEB Frankfurt/M and Tharald Stray Laastad from Trading Strategy, Merchant Banking.

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

This report was published on November 18, 2003.Cut-off date for calculations and forecasts was November 12, 2003.

SummaryNordic Outlook – November 2003

3

The International Economy▪ The American economy is in the midst of a powerful upswing, which will carry over a bit into

next year. Growth in 2004 will be 3.7 per cent but will cool in the course of the year as thestimulus from tax cuts and mortgage refinancing fades. During 2005, growth will drop to 2.8 percent and fiscal policy consolidation will begin.

▪ Japan’s economy has offered upside surprises this year. The cyclical upswing will also last into2004 but gradually cool. Growth will be 1.9 per cent next year and 1.2 per cent in 2005.

▪ The euro zone is recovering slowly, as consumer optimism returns, exports bounce back andcertain taxes are cut. However, growth will not exceed 1.7 per cent in 2004 and 2.3 per cent in2005. The Stability Pact is increasingly being undermined.

▪ The Fed will wait until autumn 2004 before hiking its funds rate. By year-end, the rate will be1.5 per cent and by late 2005, 3.0 per cent. The ECB will also wait until after summer beforeraising its refi rate. Bond yields will stay below 5 per cent both in the US and the euro zone.

Sweden▪ The Swedish economy is finding it hard to gather steam. Private consumption growth is strong,

due to solid balance sheets in the household sector, but local government financial woes hamperthe economic recovery. GDP will grow by 2.1 per cent in 2004 and 2.3 per cent in 2005.

▪ Underlying inflation will stay below 2 per cent both in 2004 and 2005, but the Riksbank willchoose to employ a core inflation measure that excludes energy prices and will abstain from low-ering its repo rate. The first rate hike will come after the summer of 2004. The repo rate will standat 3.25 per cent in December 2004 and 3.75 per cent a year later.

▪ The krona will appreciate to TCW 120. The manufacturing sector will lose some of its com-petitiveness, but due to good productivity growth the current account surplus will persist.

▪ The government budget is being squeezed. More cutbacks are needed to stay below the expen-diture ceiling next year. Local governments will boost income taxes both in 2004 and 2005.

▪ The ongoing “growth talks” will not lead to revolutionary results. Wealth tax will be lowered,but only in exchange for increases in other taxes. The business sector will avoid financing thethird week of employee sick pay but will have to pay a larger share of overall sickness benefit.

Other Nordic countries▪ In Norway, monetary policy shock therapy is yielding results. Growth will recover to almost

2½ per cent both in 2004 and 2005. Inflation will fall below the 2.5 per cent target in both years,but Norges Bank has stopped slashing interest rates.

▪ The Danish economy will recover slowly to GDP growth of 1.7 and 2.3 per cent in 2004 and2005, respectively. Inflation is in phase with that of the euro zone, and the central bank is shad-owing the ECB. A referendum on the euro may be held during 2005.

▪ The Finnish economy is also recovering and will achieve GDP growth of 2.5 per cent in 2004and 2.9 per cent in 2005. Inflation will drop below 1 per cent next year, partly due to tax cuts.

4

Nordic Outlook - November 2003

Contents

Summary 3

International overview 5

The US 6

Japan 9

The euro zone 10

The United Kingdom 13

Emerging markets 14

Central and Eastern Europe 15

International financial markets 16

Sweden 19

Denmark 29

Norway 30

Finland 32

Nordic key economic data 33

International key economic data 35

Boxes

US: The growth profile and the labour market 6

US: The presidential election and the effects of fiscal policy 7

The euro zone: Stability Pact under threat 12

Slow, controlled revaluation of yuan 14

Delayed enlargement of the euro zone 15

The US current account deficit and the dollar 18

Sweden: Why so little drama in the forecasts? 19

Sweden: Will new CPI measurement methods lead to a new target variable? 24

Sweden: Two per cent norm sensitive to choice of inflation measure 25

Sweden: What is happening to growth policy? 28

Sweden: Local governments raising taxes 27

International overviewNordic Outlook – November 2003

5

An imbalanced recovery▪ Signs of strength dominant

▪ But the US will lose tempo

▪ Tighter fiscal policies ahead

The American economy is currently growing at arapid pace. In Japan, the cyclical upswing has beenunexpectedly strong. China and India are expandingvigorously. The world economy is thus on the roadto recovery after its slump in recent years. Consensusforecasts for 2004 have shifted upward significantly inrecent months; in this Nordic Outlook, we too haveraised our growth figures for the US and Japan.

However, our forecast for the American economy is –once again – more cautious than the consensus. Thisautumn’s rapid growth is partly a result of massiveeconomic policy stimulus. A continued rapid build-upof household debt, galloping budget deficits and largeimbalances in foreign trade indicate that this trend isnot sustainable. We believe that growth will cool asthe effects of the stimulus policy fade in the course of2004 and are followed by fiscal tightening in 2005.Next year, growth in Gross Domestic Product will be3.7 per cent, somewhat above potential level – butpartly as a consequence of a statistical overhang fromthe autumn upswing. In 2005, GDP growth will onceagain drop below potential.

USD bn, annual rateUS: Public finance and current account

Federal surplus/deficit Current account

Source: EcoWin

92 93 94 95 96 97 98 99 00 01 02 03

-600

-500

-400

-300

-200

-100

0

100

200

300

-600

-500

-400

-300

-200

-100

0

100

200

300

The latter part of our forecast period will thus be char-acterised by economic policy consolidation and mod-est growth. This can be described as a final necessaryphase of the adjustment process after the burst bub-ble. Once it is completed, the preconditions exist forhigher, more sustainable growth. The productivityincrease in the American economy has been

maintained at a high level. This is an important plat-form for such expansion. Even if our relatively cau-tious growth scenario is realised, the final judgementwill still be that it has proved possible to limit the realconsequences of the burst bubble in a way that mustbe regarded as an economic policy success.

Owing to the adjustment process in the United States,global growth will be modest both in 2004 and 2005.The Japanese economy will slow towards its potentialgrowth level again, and recovery in Europe will berelatively lethargic. The euro zone, where the StabilityPact is being watered down, will also shift towardstighter fiscal policy.

GDP growthYear-on-year percentage change

2002 2003 2004 2005US 2.4 2.9 3.7 2.8Japan 0.2 2.4 1.9 1.2Euro zone 0.9 0.5 1.7 2.3OECD 1.8 1.9 2.7 2.6World economy 2.5 2.7 3.5 3.4Sources: OECD, SEB

As a result of American imbalances, the dollar willweaken against both the euro and Asian currencies.The Chinese yuan’s fixed dollar exchange rate will bereplaced during our forecast period by a slow, con-trolled appreciation against the dollar.

Looking ahead, stock and bond markets will be char-acterised by tension between the healing process afterthe bubble, on the one hand, and disappointments inrelation to overly optimistic forecasts, on the otherhand. We expect stock markets to move sidewaysduring 2004, while bond more or less stay unchanged.

Central banks will keep their key interest rates atlow levels. Given modest growth, low inflation pres-sure and tighter fiscal policies, economies will needcontinued propping up. Only well into next year will anormalisation of key interest rates begin. In the US,the Federal Reserve will raise its funds rate to 1.5 percent during the autumn. By the end of 2005 it will be3.0 per cent. The European Central Bank will raise itsrefi rate to 2.25 per cent by the end of 2004 and 3.25per cent by the end of 2005.

The USNordic Outlook – November 2003

6

Growth will culminate early▪ Growth already peaking – will slow

▪ Fed key rate on hold until next autumn

▪ Tighter fiscal policy after presidential election

Since this past summer, the American economy hasbeen characterised by mounting optimism. Businessconfidence has climbed and companies seem to beregaining a desire for capital spending. Despite signsof concern about the weak labour market, householdshave used their tax cuts and lower interest rates –which have enabled them to refinance their homemortgages and thereby slash their housing costs – forincreased consumption. In financial markets, a grow-ing risk appetite has been manifested in rising shareprices and narrowing credit spreads, while long-termyields have climbed. The strong GDP figure for thethird quarter of 2003, with annualised growth topping

7 per cent, confirms the picture of significantly accel-erating economic activity.

In light of this, we are revising our US growth fore-cast upward to 2.9 per cent this year and to 3.7 percent in 2004.

Is the US entering a positive spiral?Hopes of an imminent, lasting recovery are relativelywidespread. The crucial question is whether the cur-rent surge in growth can lead the economy into a posi-tive spiral. Such a scenario presupposes that the la-bour market will bounce back clearly during thecoming six months. If so, rising employment can sus-tain household purchasing power, even when stimulifrom tax cuts and widespread mortgage refinancinghave lost their punch. Capital spending will then alsoachieve new vigour, even though capacity utilisationremains low. Continued rapid productivity growth andrising share prices are important elements of such apositive spiral.

The growth profile and the labour marketOur forecast underscores the differences in the waygrowth is measured in Europe and the United States.The customary American way of calculating growth,where every quarterly change (growth between onequarter and the next) is individually recalculated atan annual rate (“annualised”), enlarges GDPchanges compared to the method generally used inEurope. Measured as annualised growth, GDPgrowth has already culminated with the high thirdquarter 2003 figure.If we instead measure growth in the way that is cus-tomary in Europe – “year-on-year” change between aquarter in one year and the corresponding quarter ofthe preceding year – growth will peak during thefirst and second quarters of 2004.It took a long time before employment started to rise.This is partly a consequence of strong productivitygrowth; due to streamlining, companies have beenable to boost production without having to add new

jobs. Since production hikes affect job creation aftera certain time lag, “slower” year-on-year growth(GDP growth measured in the “European” way) is abetter indicator of labour market trends than annual-ised GDP growth.

During the third quarter of 2003, this year-on-yeargrowth amounted to 3.3 per cent. The pace of growthis thus around its long-term potential level. What weare currently seeing is thus growth that should not beexpected to generate rapidly rising employment.Employment will instead be at its most expansivein mid- and late 2004, one or two quarters after thepeak of the year-on-year growth profile. This looksalmost pre-meditated: The sharpest upswing in USjob creation will thus coincide exactly with the periodwhen the presidential election will be decided. During2005, the labour market will again weaken some-what.

200420032002200120001999

8

6

4

2

0

-2

8

6

4

2

0

-2

Sources: EcoWin, SEB

US: Gross domestic productAnnualised change

SEB

Per centPer cent

forecast

200420032002200120001999

8

6

4

2

0

-2

8

6

4

2

0

-2


US: Gross domestic productYear-on-year change

SEB

Per centPer cent

forecast


7

This is quite possible. The dynamic of a recovery isoften characterised by such positive spirals, where“success breeds success” in a way that is not initiallyapparent.

Our main forecast – in spite of this – is that the path tosustainable recovery is not so straight. Today’s rapidgrowth is partly a consequence of an extremely ex-pansive economic policy. During the first half of2003, home mortgage refinancing alone bolstered thepurchasing power of American households. But thisgrowth is occurring at the expense of worse imbal-ances in the financial position of households, as wellas deficits in the country’s current account and publicsector budgets.

The forces of deceleration will therefore graduallymake themselves felt. Today the above-mentionedstimulus to the finances of households is already be-ginning to ebb. Public sector consumption is levellingoff after a rapid increase in recent years. Austeritymeasures will not materialise immediately, however.Not until the second half of 2004 will the FederalReserve gently begin normalising interest rates. Fiscalconsolidation will come only in 2005, when a newterm of office begins after the November 2004 presi-dential election. The result will be a relatively pro-longed period of growth somewhat below potential.In 2005, GDP growth will cool to 2.8 per cent.

Although our forecast is below consensus, our finalassessment is that the real consequences of the burstbubble will be limited. The Fed’s ambition of using

an extremely low funds rate to smooth and postponethe adjustment thus seems likely to succeed. Sustainedproductivity growth in the economy will serve as astable platform for faster future growth, once the ad-justment has made some progress.

Larger public deficits in the short termThe runaway deterioration in public sector finances iscontinuing. Large tax cuts and rising defence expen-ditures have driven up deficits, while the economy hasbeen too weak to provide any cyclical help. In theshort term, deficits will continue to climb. Next year,the overall public sector deficit will be 6-7 per cent ofGDP, almost on par with Japan. This implies thatpublic savings will have deteriorated by nearly 10 percent of GDP in just four years.

However, public sector debt remains relatively low inan international perspective, currently at about 40 percent of GDP. Fortunately, this means that there isroom to carry out the necessary consolidation at arelatively modest pace during the second half of thedecade. States and cities are nevertheless legally re-quired to balance their budgets, which will demandfaster steps. Our forecast is based on the assumptionthat fiscal tightening during 2005 will be in the rangeof ½-1 per cent of GDP.

The US economy would thereby pass through the foursequences that are common after a period of majorover-heating: Crisis, early recovery, economic policyconsolidation and – after some time – a sustainableupturn.

The presidential election and the effectsof fiscal policyPresident George W Bush has a strong position. TheRepublicans enjoy a majority both in the US Senateand House of Representatives. However, due tovarious independent-minded legislators, the presi-dent cannot be certain that White House proposalswill get through Congress untouched. The November2004 election is about both presidential power and alarge proportion of Congress. Various power-sharingcombinations between the president, Senate andHouse are thus conceivable.For a long time, the president’s position seemed in-vulnerable. However, US difficulties in Iraq along withdomestic labour market and budget problems haveenabled various Democratic challengers to gainground in the opinion polls.It is nevertheless more likely that Bush will be re-elected. Our forecast is therefore based on this. We

also assume that the Republicans will largely main-tain their position of strength in Congress and thatfiscal tightening will start in 2005, in order to bring thebudget deficit under control. Most austerity measureswill probably occur on the expenditure side. Suchdecisions, however, normally take time to pushthrough Congress, so the effects in 2005 will not belarge. Should the Democrats win the election, we ex-pect tax hikes, the impact of which will come quicker.Effects of fiscal policyPer cent of GDP2003:1 2003:2 2004:1 2004:2 2005:1 2005:2 0.4 1.2 0.6 -0.3 -0.5 -0.7


8

Changing forces of growthOur forecast implies that the driving forces in theeconomy will shift. In recent years, consumption –both private and public – has been totally dominant. Agradually tighter economic policy will decrease thecontribution of consumption to growth. Public sectorconsumption is already stagnating, while householdconsumption is decelerating to growth of around 2½per cent. In the short term, inventory build-up willprop up growth. Fixed investments will then graduallybecome the dominant engine of the economy, thoughit will still take some time before this expansiongenuinely takes off. Due to a weaker dollar, the con-tributions from foreign trade will accelerate. However,weak demand from other countries and continuedcompetitive problems for American companies willkeep the change small.

0504030201009998

7.0

6.0

5.0

4.0

3.0

3.0

2.5

2.0

1.5

1.0

0.5

0.0


US: Inflation and unemploymentPer cent Per cent

SEB forecast

Unemployment (LHS)Core inflation, year-on-year change (RHS)

Fed will start hiking rates next autumnDespite the rapid growth that we are seeing right now,the Fed will stick to its pledge to keep the funds ratevery low. The likely scenario is that the Fed will nowgradually signal greater confidence about the labourmarket outlook, but will continue to express concernat the risks of undesirably low inflation. Given ourforecast, it will not be difficult for the Fed to keep itskey rate at low levels. The output gap will remainlarge and inflationary pressure will be low. Unem-ployment will fall somewhat next year, but after that itwill again show an upward trend.

During the winter and spring, the Fed will begin pre-paring the market for a normalisation of interest rates.But its cautious interest-raising cycle will not beginuntil autumn, by which time a 0.5 per cent hike willoccur. In December 2005 the federal funds rate willstand at 3.0 per cent.

The market is currently pricing in a first Fed hike asearly as before summer. The reason for us predicitinga later raise is our weaker-than-consensus growthforecast. The Fed will still hike rates during next yeareven in our conservative forecast. The reason is thatthe Fed’s risk picture will gradually shift. House-hold debts will continue rising at a rapid pace. Thefurther this process continues, the more sensitive theeconomy will be to interest rate hikes once they in-evitably must come.

At present, the Fed has no alternative to continuing itsstimulation of borrowing, since demand is too weak inother parts of the economy. As the corporate sectorstrengthens its balance sheets and capacity utilisationrises, capital spending will climb. With the Americaneconomy beginning to stand on more solid ground, itis likely that the Fed will prefer to accept a certaincooling of growth, instead of continuing to inflate thedebt bubble in the household sector.

USD bn, quarterly data, annualisedUS: Lending to households

Source: EcoWin

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02030

100

200

300

400

500

600

700

800

900

1000

1100

0

100

200

300

400

500

600

700

800

900

1000

1100

JapanNordic Outlook – November 2003

9

Heating up▪ Strong cyclical upswing

▪ Deflationary pressure easing

▪ Reform mandate for Koizumi

The Japanese recovery that began late in 2002 hasbecome stronger than expected. There is consequentlyreason to raise our growth forecast for this yearonce again, this time to 2.4 per cent.

The upturn is occurring on a broad front. Exports haverecovered strongly. Capital spending has reboundedand confidence has climbed in industry – for the firsttime in over three years, today more companies areoptimistic about the future than foresee a downturn.Bond yields have moved up from previously de-pressed levels, resulting in a significant steepening ofthe yield curve. The Tokyo Stock Exchange climbedsharply during the first three quarters of 2003. Finan-cial markets are thus indicating a continued cyclicalupturn and diminishing deflationary expectations. Lastbut not least, rising optimism among households hascontributed to a decline in the savings ratio and con-sumption has risen faster than expected.

We anticipate that the price level will fall by 0.2 percent in 2003, but that next year there will be inflationof 0.1 per cent. Deflation is slowly relaxing its grip.

Growth in 2004 will not be as strong as this year. Tosome extent, the cyclical upswing will lose its vigour.A stronger yen and tighter fiscal policy will also con-tribute to slower growth. GDP will rise by 1.9 percent in 2004.

Since our last forecast, the yen has strengthened morethan expected. This is due to greater strength in theJapanese economy as well as American pressures for amore market-based determination of the value of thedollar against Asian currencies.

Our forecast assumes a marginal strengthening of theyen against the dollar during the coming year. We donot expect the movement of the yen to have majoreffects, however. The Japanese economy is not espe-cially sensitive to exchange rate fluctuations (mer-chandise exports comprise only 10 per cent of GDP),and the export sector is accustomed to external pres-sure for change due to a strong currency.

The domestic economy is being sustained by an ex-pansive monetary policy; the stronger the yen, thelonger the Bank of Japan will keep its key rate at to-day’s extremely low level. We anticipate that the zero

interest rate policy will last until late 2004. Sincethe deflationary danger will gradually ease and theeconomy will regain its footing, during the comingyear the BoJ must prepare the markets for a higherfuture key interest rate.

Second wind for reform policyWhat we are now seeing is mainly a cyclical upswing.The crucial question is whether Japan can now end thelong-term stagnation that has characterised its econ-omy since the big bubble burst 13 years ago.

There are hopeful signs. Over the past six months, co-operation between the BoJ and the Finance Ministry –previously characterised by turf wars and conflictingstrategies – has clearly improved. The new BoJ lead-ership has proved more inclined to satisfy the gov-ernment’s desire for expansion, including the use of“unconventional” methods.

Prime Minister Junichiro Koizumi has strengthenedhis position by being re-elected Chairman of the rul-ing LDP and by winning the recent parliamentaryelection. The LDP’s position did weaken a bit, but theparty has become more dependent on Mr Koizumi asa vote-catcher. As a result, the old “traditionalists”within the LDP have been losing strength. Our per-ception is that the Prime Minister wants to speed thepace of reform efforts. We anticipate that new stepswill be taken in plans to privatise portions of thepostal bank and that there will be increased pressureon the banking sector to restructure.

However, it will take time before reform efforts yieldlasting results. Demography – an old and ageingpopulation – is another obstacle to growth. In ourjudgement, GDP will climb by 1.2 per cent in 2005(close to potential) and inflation will be 0.2 percent.

0504030201009998979695

4

3

2

1

0

-1

-2

-3

4

3

2

1

0

-1

-2

-3


Japan: GDP and inflationYear-on-year changePer cent Per cent

GDP

CPI

SEB forecast

The euro zoneNordic Outlook – November 2003

10

Slow recovery has begun▪ Mounting optimism, but modest growth

▪ Stronger euro delaying interest rate hike

▪ Continued watering-down of Stability Pact

Hopes for an economic recovery in the euro zone nextyear rest mainly on expectations in various surveys. Inthe second quarter of 2003, GDP fell in the three larg-est euro zone economies: Germany, France and Italy.The performance of the French economy in particularwas a disappointment.

We believe the business cycle bottomed out in thesecond quarter and that a slow recovery began in thethird. According to Eurostat’s indicator GDP in-creased by 0.4 per cent compared to the second quar-ter. Inventory build-up is continuing. Private and pub-lic sector consumption are contributing decently togrowth, but capital spending and especially foreigntrade are having a strongly negative effect on GDPgrowth, which will be only 0.5 per cent this year.

Euro zone: Industrial production

Year-on-year percentage change Expectations according to EU business survey, net balance

Source: EcoWin

90 91 92 93 94 95 96 97 98 99 00 01 02 03

-20

-15

-10

-5

0

5

10

15

20

25

-20

-15

-10

-5

0

5

10

15

20

25

Grounds for optimismHowever, there are grounds for optimism about 2004.The stock market upturn since last spring, combinedwith more upbeat economic signals from Asia and theUS, is good news for Europe. Consumption has put upa decent resistance. Reform steps, especially in Ger-many, inspire hope. Recent business confidence sur-veys, reflecting greater optimism in Germany, Bel-gium and elsewhere, also indicate that companiesbelieve they can deal with a stronger euro.

Looking ahead, we expect household consumption togradually strengthen. Savings are at a relatively highlevel, and the wealth position of the household sectoris good. Next year, household income growth willaccelerate, due among other things to lower inflation.

The question marks surrounding the corporate sectorare larger. Much of the adjustment after the excessesof the late 1990s still remains. Owing to euro appre-ciation, the restoration of good earnings will be de-layed. In Germany, the construction sector continuesto hamper investment growth. So capital spending willnot begin to rise in the euro zone until well into 2004.

Overall, we anticipate gradually accelerating GDPgrowth of 1.7 per cent in 2004 and 2.3 per cent in2005. Although this is historically an unexceptionalcyclical upturn, we see a certain downside risk. Ourforecast of a deceleration in American growth andcontinued euro appreciation could have more of aretardant effect than this assessment implies.

Lower core inflation aheadIn recent months, inflation has stubbornly remainedstuck at around 2 per cent, primarily due to rising foodand energy prices. In the course of next year, how-ever, the inflation rate will slow. One reason is baseeffects from lower energy prices, which will causeCPI inflation to drop towards 1.5 per cent. Coreinflation (adjusted for food, alcoholic beverages, to-bacco and energy) will also sink slowly towards 1½per cent. One reason for this will be low importedinflation, especially as a consequence of the strongereuro. We also anticipate that an upturn in productivity,combined with modest pay hikes and low capacityutilisation, will dampen the price trend.

050403020100999897

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

Sources: Eurostat, SEB

Euro zone: InflationYear-on-year percentage change

SEB forecast

CPICPI excl food, alcoholic beverages, tobacco, energy

Inflation in Germany is clearly below the euro zoneaverage, yet fears of deflation have calmed. Next year,inflation will climb slightly in Germany, due to hikesin indirect taxes and fees. The trend towards widerinflation differentials between euro zone countries thathas been evident since the common currency’s incep-tion in 1999 now appears ready to reverse. Differen-tials in pay increases are narrowing, while the pace of


11

GDP growth is tending to converge. This will makelife easier for the European Central Bank.

Since last summer, the ECB has exuded cautious op-timism about the economic cycle and a “wait-and-see”attitude. International economic signals have beenencouraging in recent months, while inflation hasproved somewhat higher than expected. The ECB hasalso expressed concern about high liquidity, althoughin its official strategy it has toned down the role of itsmoney supply target. These factors indicate that fur-ther interest rate cuts are unlikely.

On the other hand, rate hikes may take time to materi-alise. The economic situation remains fragile in theeuro zone, and the strengthening of the currency posesa threat to sustained recovery. If euro appreciationshould also turn out larger than we have estimated, thepath to further interest rate cuts will still be open.However, our forecast is that the ECB will maintainits current refi rate until after the summer of 2004and that its subsequent path towards normalisationwill begin at a slow pace. By the end of 2004, theECB’s key rate will be at 2.25 per cent.

Continued fiscal weakeningThe weak economic growth of recent years is diggingever deeper holes in public finances. We anticipatethat the aggregate public sector deficit in the eurozone during 2003 will be nearly 3 per cent of GDP.This average conceals major differences betweenindividual countries. The problems are most severe inthe big countries. We expect both France and Ger-many to incur deficits just above 4 per cent of GDP,while Italy – thanks to various one-off measures – willonly just succeed in staying below the 3 per cent limitthis year.

Public sector deficitsPercentage of GDP

2002 2003 2004 2005Germany -3.5 -4.2 -3.8 -3.2France -3.1 -4.2 -3.8 -3.4Italy -2.3 -2.7 -2.8 -2.8Total -2.2 -2.9 -2.7 -2.4Source: European Commisson, SEB

Looking at the euro zone as a whole, the deteriorationin public finances has been a consequence of cyclicalweakness. Hardly any active counter-cyclical policyhas been pursued, but automatic stabilisers have beenallowed to operate. In Germany and France, structural

deficits nevertheless rose during the period 2000-2002. As for 2004 budgets, there are still some un-clear points concerning the planned income tax cuts inGermany, for instance, especially regarding their fi-nancing. We assume, however, that the tax reformwill be implemented according to the government’sintentions. France has unveiled a draft budget inwhich structural deficits are improved by more thanhalf a percentage point of GDP, but the EuropeanCommission has viewed this as insufficient. Overall,we do not anticipate any major decrease in publicsector deficits in 2004. A slight improvement shouldoccur in 2005, but the EU’s target of balanced publicfinances appears distant.

Focus on structural policyDuring the late 1990s, very few structural reformswere enacted. Weak exchange rates and a robust in-ternational economy eased the pressures for change.Recently, increased crisis consciousness and narrowerscope for stabilisation policy have again thrown thespotlight on structural issues.

▪ Germany took a key step in October when thegovernment pushed through its “Agenda 2010” inthe Bundestag. The package includes reforms ofthe labour market and the social insurance system.In addition a proposal of income tax cuts is beingput forward. Some of these proposals must still gothrough the Bundesrat (upper house of Parlia-ment), where the opposition holds a majority. Sofar the CDU/CSU has blocked a decision in theBundesrat but we expect a compromise to bereached and the main features of the reform pack-age to be approved.

▪ In Italy the coalition government, after majorinternal tensions and extensive protests, hasreached agreement on a reform proposal to haltthe cost increases in the pension system. This in-cludes a higher retirement age.

▪ In France, the sustainability of the pension sys-tem was strengthened last summer by raising thenumber of working years in the public sector toqualify for a full pension. However, the govern-ment had to back down from its plans to trim thenumber of public sector employees. A lively de-bate is also currently under way in France con-cerning the 35-hour work week. It is unlikely thatthis shortened work week will be scrapped, butovertime rules will probably be reviewed and thenumber of paid holidays reduced.


12

Stability Pact under threatThe Stability Pact is under severe strain. When thePact was written in 1997, it was a compromise be-tween two approaches to fiscal policy:

� According to one approach, each member countryin the currency union should pursue an independ-ent fiscal policy. Since euro zone monetary policycan only be pursued at union level, it is necessaryfor individual countries to be able to stabilise theireconomies via fiscal policy if they are hit by a na-tional disruption.

� Offsetting this is the risk that the policies of a sin-gle country may have an impact at union level. Anexpansive policy in a large country may drive upinflation in the entire union – forcing the ECB toraise interest rates for all member countries.

The rules…The Pact stipulated that fiscal policy as a whole re-mained the business of individual countries, butwould meanwhile be limited by a common set ofrules. The treaty text contains rules about balancingbudgets over a business cycle and states that overallpublic sector deficits may not exceed 3 per cent ofGDP. The treaty was supplemented by more opera-tive resolutions about time limits for excessive defi-cits and under what circumstances the deficit ceilingmay be breached: according to the rules, this mayonly occur during a deep recession.If the European Commission is of the opinion that amember country risks breaking these rules, it beginsan “excessive deficit procedure”. The Commissionwrites an opinion, after which the European Councildecides whether there is an excessive deficit and is-sues recommendations to the country in question. Ifinsufficient steps are taken, sanctions shall be im-posed. They consist of a deposit in a non-interest-bearing account. If the deficit still persists after twoyears, the deposit shall be transformed into a fine.

…and the realityWe believe that the Pact has contributed to betterbudget discipline during the recent cyclical slowdownthan would have existed without the Pact. But thisperiod of weak growth has also subjected the Pact tostrains. To date, the Commission has initiated its ex-cessive deficit procedure against three countries:Portugal (for its 2001 deficit) as well as Germanyand France (2002 deficits). Portugal was subjectedto tough discipline by the Council – but the ruleswere bent for the two larger countries.Although Germany is violating the Pact several yearsin a row, the Council has shown great tolerance.

Finance ministers have had qualms about imposingtough belt-tightening requirements on the union’slargest country.France, however, has triggered opposition by openlydeclaring that its domestic goals enjoy precedenceover the rules of the Pact. The Commission arguesthat France has not taken sufficient steps to remedythe deficits, but has still accepted a gentle interpreta-tion of the rule system. The Commission has calledfor an improvement in the structural deficit of 1.0 percent of GDP in 2004, but France has been cool eventowards this comparatively mild action.

Even more compromisesAt present, the Council is deadlocked and a decisionconcerning France has been postponed until No-vember 25. At the same meeting, the Commissionalso wants to reopen the case against Germany. Weanticipate, however, that the two big countries willgather enough votes to prevent any serious sanc-tions procedure from being set in motion. Some kindof compromises will likely be reached: France andGermany will receive a verbal warning, but theCouncil will again extend the timetable for restoringbudgetary order.The medium-term effects of such compromises arenot big. Given the forecasts we have made in this is-sue of Nordic Outlook, the deficits will graduallyshrink in the next few years. Besides, financial mar-ket confidence in the Pact is already low; anothercompromise is not likely to seem especially dramatic.However, every new round of horse-trading under-scores that the Pact is under threat. In practice, bothGermany and France are violating the existing rulesystem – and Council has de facto accepted this. Ifthe Pact is to survive unscathed, the EU must dealwith the troublesome gap between rules and real-ity.This is probably exactly what will happen. No totalrenegotiation of the Pact seems imminent; the EUdraft constitution contains no change in the Pact. It islikely, however, that the resolutions that make thetreaty operational will be modified to fit better with themilder interpretation that has evolved in practice.This concerns the circumstances under which thedeficit ceiling may be exceeded and the time limitwithin which excessive budget deficits are to be rem-edied. This will allow the EU to save face by arguingthat it is adhering to the Treaty but has neverthelessmade the Pact more flexible. In practice, however, itmeans that the Pact itself is increasingly becoming adocument written in sand.

The United KingdomNordic Outlook – November 2003

13

Modest interest rate hike▪ Unexpected economic strength

▪ Buying pressure will slowly cool

▪ Lingering risk of home price decline

The British economy began a gradual recovery duringthe summer, earlier than expected. Stronger interna-tional demand is stimulating exports and capitalspending. Meanwhile the inflation risk has increased,since already lofty home prices have continuedclimbing. In early November, the Bank of Englandthus carried out its first key interest rate hike for fouryears: from 3.50 to 3.75 per cent.

The national accounts were revised during theautumn. Growth in recent years has been somewhatstronger and more balanced than assumed earlier.Private consumption has not been quite as dominantas previously reported.

The revised figures show stronger growth during thefirst half of 2003; second-quarter GDP growth wasdoubled from 0.3 to 0.6 per cent, on a quarterly basis.This trend continued in the third quarter, when privateservices were a driving force. In light of this andpositive global economic signals, we are revising ourGDP forecasts slightly upward, to 1.9 per cent thisyear, then 2.4 and 2.6 per cent, respectively, in thenext two years.

The housing market shows no signs of cooling. Thepace of year-on-year price increases remains at around20 per cent. This is one important reason why house-holds have resumed their buying spree. Lending tohouseholds is also climbing at a high, stable year-on-year pace of 10-15 per cent. This continued build-upof debt risks escalating to unsustainable levels.

BoE cools the housing marketIn our view, these are the most important reasons whythe BoE recently raised its repo rate. The central bankhad previously hoped for an autonomous cooling indomestic demand and the housing market. But this didnot happen. This is why the BoE wants to dampenpartly credit-driven UK domestic demand and thehousing market.

The BoE will be relatively cautious about further ratehikes. Low inflation also provides room for such astrategy. The central bank will raise its key rate by0.25 percentage points in the first quarter of 2004,then by a total of 0.50 points in the second half of theyear.

This will be sufficient to slow the pace of growth inprivate consumption to just above 2 per cent annuallyin 2004-2005. Real income growth will decelerate andunemployment will climb somewhat. We also predicta certain downturn in home prices. The householdsavings ratio will rise to a historically high 10-11 percent in 2005.

Monetary policy is likely to switch to a new guidingprinciple soon. The BoE is abandoning its inflationtarget based on the retail price index (RPIX) in favourof the EU’s harmonised index of consumer prices(HICP). However, this will have no major impact oninterest rate decisions. Granted that the HICP is at alow 1.4 per cent today, well below the new 2 per centtarget. But looking ahead two years, inflation willclimb to 2 per cent as a consequence of increasedeconomic activity as well as a weakening of thepound.

In effective terms, the currency has depreciated by 7per cent in the past year. The pound will strengthensomewhat in the short term, since the BoE is the firstcentral bank to begin the rate hike cycle. But viewedover a two-year period, there will again be someweakening, partly due to growing government budgetand current account deficits.

UK: Repo rate and house prices

BoE repo rate, per cent (LHS) House prices (Halifax), index 1983 = 100 (RHS)

Source: EcoWin

95 96 97 98 99 00 01 02 03

175

200

225

250

275

300

325

350

375

400

425

450

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

Fiscal policy is expansive. Public sector consumptionwill grow by 3 per cent next year. Health care andeducational investments, combined with lower taxrevenues than expected, will lead to budget strains. In2005, the UK public sector deficit will exceed theMaastricht limit of 3 per cent of GDP.

Chancellor Gordon Brown has a reputation as aguardian of good budgetary discipline, but this is nowunder threat. There is a major risk that for the firsttime in six years, the Labour government will violateits “golden rule” that the central government shouldnot borrow more than it invests over a business cycle.

Emerging marketsNordic Outlook – November 2003

14

Chinese dragon growingfaster and faster▪ Increasing stability in Latin America

▪ Vigorous expansion in China

▪ Controlled revaluation of the yuan

The improving international outlook also applies tothe world’s emerging markets. Low interest rates andshrinking credit spreads are benefiting developingeconomies. Exports are being stimulated by the recov-ery in the US and Japan and in a number of cases alsoby the falling US dollar, since many currencies arepegged to the dollar.

The major economies in Latin America are showingsigns of stabilisation:

▪ In Argentina, the economy has begun to climbout of its depression. The peso has strengthenedby some 25 per cent in the past year, and acutecredit problems have been bridged over by meansof a large IMF loan.

▪ In Brazil, too, the currency has strengthened andinterest rates have fallen. The confidence of inter-national financial markets in the Brazilian leader-ship has increased significantly. Even thoughPresident Lula’s programme for trimming pensionexpenditures for public sector employees is en-countering strong resistance, we expect that it willpass. We do not expect any dramatic new crises inthe next few years.

In Asia, the picture is mainly bright. The big excep-tion is Hong Kong, which is still suffering from theburst real estate bubble. The dollar decline and lowAmerican interest rates have nevertheless providedsome support via the currency board system.In India, large-scale outsourcing of service activitiesby the West is generating new jobs and boosting tech-nical skills. Meanwhile, step-by-step reforms areslowly making the economy more flexible. The proc-ess has achieved such a dynamic that it will also yieldgood growth over the next few years.

China is demonstrating unparalleled growth. Thereare many indications that this year’s GDP increasewill exceed 10 per cent. This would imply 20 per centor more in the rapidly growing coastal regions.Growth is driven by a massive influx of direct invest-ments, an almost inexhaustible supply of cheap la-bour, high investment ratios and a rapid rise in pur-chasing power. China’s accession to the WTO hasopened a growing number of markets, and we antici-pate an increase in the pace of privatisation of state-owned companies.

This expansion is not without problems, however.Inflation is climbing, though still at a low level. Therisk of overheating that will have to be cooled bytough austerity is not imminent right now but maycreep up gradually. We expect that a credit tighten-ing will cool off growth somewhat during nextyear. Longer term, the new leadership of the centralgovernment and the ruling party face the challenge ofcreating a new social insurance system. The bankingsystem is fragile, and restoring it to health will take anumber of years.

Slow, controlled revaluation of yuanChina’s renminbi (“people’s currency”) and its basicunit, the yuan, are pegged to the dollar at a fixed ex-change rate of CNY 8.28. Loud American demandsfor a future Chinese currency revaluation are basedon the fact that China has large trade surpluses withthe US, and that a large influx of capital is contribut-ing to the build-up of rapidly growing Chinese foreigncurrency reserves.It is difficult to calculate an equilibrium exchange ratefor the yuan, since it is not convertible. It is probablyundervalued, but estimates of how much vary. Amodest Chinese currency appreciation would benefitthe world economy; it would make growth easier inthe US and Europe, while cooling down the rapidlygrowing Chinese economy somewhat. China is nev-ertheless unlikely to implement a large one-off re-valuation, among other things because it does notwish to stat a series of currency discuptions in Asia.China’s negotiating position is also relatively

strong, since it is sitting on large holdings of Ameri-can government securities, and since different tradeand barter agreements also may be part of a deal.Nor will any transition to a floating exchange ratetake place as long as the banking system is vulner-able.The likely compromise is that during our forecastperiod – at the earliest during H2 2004 – China willbroaden the yuan’s fluctuation band against the dol-lar and let its currency strenghten within that band. Aprobable pace of appreciation is 3-5 per cent an-nually. We foresee no difficulties for the Chinesecentral bank to steer the yuan in the desired direc-tion, since the currency will not become entirely con-vertible for many years to come. The appreciationwill not be large enough to have any measurable ef-fects on trade.

Central and Eastern EuropeNordic Outlook – November 2003

15

More balanced growth▪ Exports recovering

▪ EU accession will drive capital spending

▪ Budget deficits causing concern

Weak demand in the West has only had a marginalimpact on the relatively strong economic performanceof Central and Eastern Europe. In large economiessuch as Russia and Poland, as well as in the CzechRepublic, Latvia and Lithuania, GDP growth is ac-celerating this year. Russia has benefited from highoil prices, while Poland and other countries are expe-riencing export-driven recovery, despite weaknessesin the EU. The competitiveness of the Polish exportsector has strengthened, thanks to streamlining, lowpay increases and a sharp weakening of the currencyexchange rate.

Except for Poland, strong domestic demand hasfuelled growth in most of the region’s countries.Growing private consumption is a central drivingforce. The background is high real pay increases and,in many places, major cuts in real interest rates. Thelatter is partly a consequence of convergence tradingin the run-up to EU membership on May 1, 2004.

Consumption will continue to stimulate growth nextyear, except in Slovakia and Hungary, where eco-nomic policy is being tightened. Meanwhile, the in-crease in exports and capital spending is strengthen-ing. This will mean broader, more vigorous economicgrowth over the next couple of years.

The Baltic countries and Russia are leading the way inannual GDP increases 2004-2005, with Estonia, Lat-via and Lithuania showing growth in the 5.5-7.0 percent range and Russia about 5 per cent.

In Russia, President Vladimir Putin is in a strongposition in the run-up to the Duma election in Decem-ber and the presidential election in March 2004. TheYukos affair − including the arrest of the oil com-pany’s former head, Mikhail Khodorkovsky − isprimarily politically motivated. In spite of Moody´srevision of Russia´s credit rating to investment grade,the affair underlines sustained legal and political risksin Russia. The short-term effect of the Yukos affairwill be a slowing of foreign capital flows to Russia.However, after the elections we expect the situation tostabilise and the economic reform policies to continue.

An upswing for exports is especially welcome in theCzech Republic, Hungary and Estonia, which areshowing sizeable current account deficits – in Esto-nia’s case at an alarming level, this year more than 15per cent of GDP. We anticipate that the Estonian defi-cit will shrink to about 10 per cent in 2005. This isnevertheless well above the 6-7 per cent of GDP thatis a sustainable level. Despite the need for belt-tightening, fiscal policy will remain expansive, amongother things due to an income tax cut. This increasesthe risk of interest rate unrest in Estonia.

What may jeopardise a continued favourable eco-nomic scenario in Central and Eastern Europe is theabove-mentioned external imbalances, as well as sub-stantial budget deficits in several countries

.

Delayed enlargement of the euro zoneThe new EU countries transition to the euro will bedelayed. The reason is that several countries willhave problems meeting budget and inflation criteria.This applies especially to Poland, the Czech Repub-lic, Hungary and Slovakia, although the first two arein better shape in terms of inflation.This year, these four countries will report budgetdeficits of between 5.0 and 8.0 per cent of GDP,which is well above the Maastricht limit of 3 per cent.

� In our judgement, over the next few years thegovernments of Slovakia, the Czech Republicand Hungary will implement the necessarybudget austerity measures to reduce their eco-nomic imbalances, while maintaining levels ofconfidence in the market.

� Poland’s fragile minority government is continu-ing to pursue an expansive fiscal policy, however.This risks leading the country into a budget crisis,with threatened downgrading of its

credit rating. We nevertheless anticipate certainbudget cutbacks in 2005, but even after thesethe budget will show minus 6 per cent.

Our conclusion is that economic imbalances will de-crease in these four countries, but that their transitionto the euro will be delayed by a year or more com-pared to their original optimistic timetable.The signals from the EU side are also that there is nohurry to enlarge the euro zone eastward. We antici-pate a strict interpretation of the Maastricht criteria. Anarrow exchange rate fluctuation band would createunrest during the candidate countries’ period in theERM2.Our forecast is that the Baltic countries plus Slo-venia will make up the first wave that switches tothe euro in 2008. Next in line, in 2008-2009, will beSlovakia and Hungary. Poland and the Czech Re-public appear likely to have to wait until 2009-2010.For a detailed analysis, see Baltic Outlook, Oct 2003.

International financial marketsNordic Outlook – November 2003

16

Continued low interest rates▪ Warning against stock market overoptimism

▪ Continued steep yield curves

▪ The dollar will weaken further

During the summer and early autumn, internationalshare prices as well as bond yields climbed sharply.The main reason was that last spring’s deflation wor-ries disappeared. During the autumn, stock exchangeswere also cheered by both second and third quarterearnings reports that exceeded expectations. Mean-while, macroeconomic signals have been strong. Theconsequence has been increased risk appetite.

This financial optimism will not continue into 2004.In our scenario, stock exchanges will eventually face acalmer period and bond yields in both the US andEurope will move sideways.

Stock market upturn will slowStronger economic signals and positive companyreports, especially in the US, have driven broad stockmarket indexes upward during the summer andautumn. Cyclically sensitive industries, such as engi-neering and consumer capital goods, have climbedappreciably.

This is typical of a recovery after a cyclical downturn.It is often characterised at first by a steeper yieldcurve and by sharply climbing confidence indicators.This leads to rising risk appetite, where the first up-swing results in a strong upturn in indexes led bycyclical shares. This year, technology and growthshares have also recovered sharply.

We are now on the way into a calmer phase, whereeconomic indicators will level off and the yield curvewill no longer become steeper. After the powerfulGDP rebound of recent months in the US, sentimentindicators will gradually flatten and turn downward.This will lead to a considerably calmer stock mar-ket. For this reason, we do not anticipate that thesemovements will have any major macroeconomic ef-fect during the next year.

Bond yields will peakDuring the summer and autumn, bond yields climbedsharply, especially in the US. Their levels thus re-verted to those prevailing at the beginning of the year.American yields also pulled European ones with them.

Market interest rates will remain low. During the firsthalf of 2004, the interest rate upturn in the US willcease and bond yields will stay put. After that, therewill be a marginal upturn, bringing 10-year Treasuryyields to 5.0 per cent at the end of 2005.

We thus believe that interest levels will be lower thanreflected in market expectations. The main reason isthat our 2004 US growth forecast is below consensusand we anticipate growth below long-term potentialduring 2005. The output gap will thus remain sizeable,and inflation will be low. The tightening of fiscalpolicy that begins in 2005 will also help to hold downinterest levels.

Weekly average, per cent10-year government bond yields

US Germany


99 00 01 02 03 04 05

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

SEB forecast

European bond yields are following the same pattern,but at a somewhat lower level. Slow growth and lowinflation will hold down yields.

Unchanged central bank ratesThe Fed will keep its key interest rate at a very lowlevel to prevent households from cutting back theirconsumption too quickly. However, the Fed willgradually prepare the market for future rate hikes. Thefirst step toward a normalisation of the key rate levelwill be taken during the second half of 2004, whenthe federal funds rate is increased to 1.5 per cent. Itwill reach 3.0 per cent at the end of 2005 − somewhatbelow our previous forecast.

Due to low inflation and an appreciating euro, theECB will also hold off on interest rate hikes. The firstECB rate hike will come in the autumn of 2004. Atthe end of 2004, the bank’s refi rate will be 2.25 percent and at the end of 2005 it will be 3.25 per cent.


17

Per centKey rates

US: Fed funds Euro zone: Refi rate (Germany until 1999)

Sources EcoWin, SEB

97 98 99 00 01 02 03 04 050

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7SEBforecast

Credit spreads – the gap between corporate or emerg-ing market bonds and “safe” government bonds inlarge countries – narrowed sharply during the lowinterest period last spring. During the autumn, theyhave continued to shrink. This reflects an increasedrisk appetite and diminshed bankruptcy risks. Thespreads have squeezed together so much that we doubtthat this movement will continue. Nor do we foresee awidening of credit spreads.

Continued weakening of the dollarIn our last Nordic Outlook, the forecast was that nextyear, the American dollar would weaken to USD 1.20.However, the dollar weakened considerably fasterthan we had expected. One factor that helped triggerthis development was the G7 statement in Septemberabout the need for more “flexible” exchange rates.

The flows generated by direct investments and port-folio reallocations are now contributing to downwardpressure on the dollar. From a fundamental analyticperspective, too − based on the current account deficit− the dollar should weaken from today’s level. Weestimate that the long-term equilibrium exchange rateis USD 1.10-1.15 per EUR.

In order to significantly reduce the big US currentaccount deficit, the dollar needs to be weaker than thisfor some years ahead. We anticipate that the dollarwill reach USD 1.22 per euro during the spring,then remain in the USD 1.20-1.25 range.

The US trade deficit with China has been in the spot-light recently. As indicated above, we anticipate anappreciation of the yuan by 3-5 per cent in 2005.This is not enough to affect trade flows to any greatextent.

The Japanese yen has been traded in a managedmarket, where Japan’s Ministry of Finance has inter-vened continuously to slow any yen appreciation.However, the Ministry seems to have shifted its sightsand is now accepting a somewhat stronger yen thanpreviously. We anticipate that during the comingyear the yen will trade at around 105 per dollar.

There is an obvious risk here that the dollar may fallmore sharply, since the corrections that have occurredto date have not affected trade flows to any great ex-tent. If this occurs, though, a new kind of PlazaAgreement between the major countries is likely to beworked out, in order to counteract excessively sharpcurrency movements.

Weekly averageExchange rates EUR/USD and USD/JPY

USD/JPY (RHS) EUR/USD (LHS)


99 00 01 02 03 04

100

105

110

115

120

125

130

1350.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1.25

1.30

SEBforecast


18

The US current account deficit and the dollarThe American current account deficit is more than 5per cent of GDP. Deficits normally shrink whengrowth slows, since lower growth usually results inlower imports. In the case of the United States, thishas not occurred; today the deficit is twice as largeas it was when economic growth peaked in 1999.For a long time, it could be argued that the Americandeficit was not a problem, since it was matched by alarge capital account surplus: Other countries werewilling to buy American securities on a large scale –so large that the dollar continued to climb despite thegrowing US current account deficit.Today, however, the deficit appears more worrisome.It has reached such a high level that the US has be-come by far the world’s largest borrower. Due togrowing interest costs, the continued swelling of thedeficit is becoming harder and harder to stop. Norare private, business-driven capital flows coveringthe deficit any longer. Instead it is primarily strategicdollar purchases by Asian central banks.

An unstable situationAll this makes today’s situation unstable. IMFeconomists have emphasised that no country inmodern history has been able to maintain such largecurrent account deficits for as long a period as theUS has today; such deficits have always resulted in asizeable weakening of the currency – often by 25-30per cent – or a sharp economic deceleration (orboth), after which a gradual reduction in the deficitcould take place.Granted that the US is no ordinary country. Its cur-rency is the world’s reserve currency, which gives itsubstantial resilience. Nevertheless, the market’s in-terest in the dynamic of the current account deficithas been awakened. The G7 statement in Dubai thisautumn about the need for more “flexible” exchangerates must also be interpreted as a wish that thedollar will fall, at least against major Asian curren-cies.

Our forecast projects a decline in the dollar to USD1.22 per euro this spring and a strengthening of theyen to 105 per dollar. This is not enough to bringabout a rapid decrease in the deficit, however. Cal-culations by the IMF and others indicate that thedollar would need to fall by 35 per cent for the deficitto shrink significantly.One common view is that the economies of Japanand Europe would suffer serious damage from afurther sizeable weakening of the dollar. This risk isoften exaggerated. Movements between leading cur-rencies have previously been very large, especiallyin the 1980s, without significant consequences in thereal economy.It is also possible to identify arguments as to why aweakening of the dollar might have a positive net ef-fect on global growth:� The reaction of central banks will be asymmetri-

cal in a way that will lead to overall easing ofmonetary policy. The Fed will not be con-cerned about the weakening, while the ECB andBoJ will pursue a looser policy if their currenciesstrengthen.

� Stock markets will react positively. In the past1-2 years, a weaker dollar has been correlatedwith a stock market upturn. This trend may con-ceivably continue; an upturn in US stock ex-changes will have contagious effects, whilestock exchanges will generally react positively toa better long-term balance situation in the worldeconomy.

On the other hand, a development in which the Asiancentral banks stop their supportive purchases ofAmerican Treasury securities will lead to generalupward pressure on long-term bond yields.Our overall conclusion is that the world economycan cope with a weaker dollar – provided that ithappens in an “orderly” fashion rather than in large,destabilising jumps.

SwedenNordic Outlook – November 2003

19

Limping recovery▪ Robust productivity offsets krona appreciation

▪ Households can handle tighter policy

▪ Weak local government finances will slow re-covery

▪ Low inflation – but how to measure it?

A stronger krona and tighter fiscal policy will helpmake the Swedish recovery sluggish. GDP will riseby 2.1 per cent in 2004 and 2.3 per cent in 2005, inparity with its potential level. Growth will be drivenby household consumption and exports, while therecovery in capital spending will be delayed. Thecyclical upswing will be too weak to achieve a turn-around in the labour market. Unemployment will stayat nearly 5 per cent until 2005.

Inflation will be low in 2004, due to the strongerkrona and lower energy prices. The wage round willproceed smoothly. In 2005 too, underlying inflationwill end up below the Riksbank’s target. However, thecentral bank will abstain from interest rate cuts, sinceit will be continuing to focus on an inflation measureadjusted for energy prices and because the cyclicalupswing will be underway and lending to householdswill still be rising. The first Riksbank interest ratehike will not occur until next autumn.

The official target of a public sector budget surplustotalling 2 per cent of GDP appears increasingly dis-tant. Public sector savings will fall below 1 per cent of

GDP in both 2004 and 2005. The central governmentbudget seems likely to stay below its expenditureceiling this year, but will again end up under pressurenext year. It will be hard for Prime Minister GöranPersson to win solid support for the ambitious growthpolicy signalled in his mid-September Statement ofGovernment Policy, both among his ruling SDP andits parliamentary allies, the Left Party and GreenParty. We foresee compromises, resulting only inminor changes in the tax system during our forecastperiod.

Local governments are being squeezed by slowergrowth and small increases in central governmentgrants. Meanwhile, demand for health care and socialservice expenditures is continuing to grow. Both in2004 and 2005, local governments will boost incometaxes and fees while holding back on consumption.This will slow Sweden’s economic recovery.

Industry can tolerate stronger kronaThe krona will appreciate significantly in trade-weighted terms (see also the final section of thischapter). The Riksbank’s Total CompetitivenessWeighted or TCW index will fall to 120, a level notreached since 1998.

Most economists are arguing the krona is underval-ued. Traditional macro indicators also show that Swe-den can handle a stronger krona. The current accountsurplus is large and the competitiveness of manufac-turing industry, measured as relative unit labour cost(RULC), looks strong.

Why so little drama in the forecasts?Today’s macro forecasts for the Swedish economyare unusually tightly clustered around a gradual re-covery to GDP growth that is close to the long-termtrend. Our own forecast is slightly below consensus,mainly due to our somewhat weaker internationalscenario. But in our forecast, major risks or possibili-ties for the Swedish economy in the near future donot play any prominent role either. Why does thepicture look so undramatic?� One reason is that right now the output gap is

small. It is thus difficult to foresee any largeswings in growth − either strong cyclical re-covery or some form of collapse due to over-heating.

� Inflation is under control and the outlook for apeaceful wage round is good. No sharp realign-ment of monetary policy is likely.

� Government finances are in decent shape. Nei-ther the public sector nor households are bur-dened by imbalances that can form the startingpoint for a dramatic economic scenario.

The risks of serious contagious effects from thestock market slide on home prices have faded.

� On the other hand, there are few signs of break-through in official growth and structural policythat could initiate a period of more robustgrowth.

Obviously we can never rule out a different economiccourse of events. The international scenario includesboth upside and downside risks. Domestic factorsthat might trigger stronger growth are a more vigor-ous resurgence in the information and communica-tions technology (ICT) sector or a clearer break-through in growth policy than we expect. On thedownside is the risk that the weakening trend of pub-lic finances is more severe than in our forecast andthat austerity measures aimed at households willthus be larger.Yet our overall assessment is that various risk sce-narios both have less amplitude and are less likelythan normally.


20

The earnings situation of the manufacturing sectormay, however, raise some doubts about the ability ofindustry to handle a stronger krona. Statistics Swe-den’s figures from companies show a clear downturn,and statistics from the Association of Swedish Engi-neering Industries indicate that the earnings situationis very depressed.

05040302010099989796959493

110

105

100

95

90

85

80

75

110

105

100

95

90

85

80

75

Sources: SCB, SEB

Sweden: Relative unit labour cost and terms of tradeIndex 1993 = 100

SEB forecast

RULCTerms of trade

The cost situation and earnings situation thus providedivergent indications of how strong a krona the manu-facturing sector can tolerate. This is explained by twotrends that have been typical of Swedish industry inthe past decade.

▪ Competitiveness measured as relative unit labourcost has improved, thanks to strong productivityimprovement. Work productivity in manufactur-ing has increased by an impressive 6-7 per centannually over the past decade.

▪ Meanwhile the relative price of Swedish goodshas gradually deteriorated in the past decade.Terms of trade, i.e. export prices relative to im-port prices, have fallen steeply.

These trends are related to the structure of Swedishmanufacturing. High technology sectors, with tele-coms as their flagship, weigh heavily in the exportmix. These are characterised precisely by high pro-ductivity growth and falling product prices. RULCcalculations that take into account only one side ofthis coin – productivity but not prices – thus show anexcessively positive picture of competitiveness.

Weighing together these various factors, our conclu-sion is that the strengthening of the krona will have acertain cooling effect on Swedish exports and manu-facturing output. Once international demand graduallytakes off, good productivity growth will neverthelessmake it possible for exports to grow by around 5 percent both in 2004 and 2005. Thus Sweden’s largecurrent account surplus will persist during our fore-cast period.

Delay in capital spending upturnSo far there are no signs that capital spending is on theway towards turning around. Such indicators as theNational Institute of Economic Research (NIER)Business Tendency Survey show continued weakness.

Yet the upturn is not likely to be too far away. Fixedinvestments in the business sector (excluding resi-dential investments) have fallen by 6-7 per cent sincethe downturn began and are at a relatively low level inrelation to value-added. Capacity utilisation is alsohigh, compared to previous cyclical troughs.

Capital spendingYear-on-year percentage change

2002 2003 2004 2005Manufacturing -5.2 -4.0 3.0 6.3Service sectors -8.1 -1.7 3.6 5.8Homes 10.4 -4.0 2.0 7.0Public sector 9.5 2.0 2.5 2.5Total -2.5 -2.0 3.0 5.5Sources: Statistics Sweden, SEB

Residential construction will fall this year; in 2004 aweak upturn will begin. The level will, however, re-main historically low during the foreseeable future.Due to the financial squeeze for central and local gov-ernments, public sector fixed investments will leveloff.

Overall, we anticipate that capital spending will con-tinue to fall slightly this year. A modest recovery willbegin during 2004 and strengthen in 2005.

Households still optimisticIncome growth will slow sharply this year. This ismainly due to the belt-tightening effect of fiscal pol-icy. Rule changes in the taxation and benefit systemscontributed 2.5 per cent to income increases in 2002.In 2003-2005, the effect will instead be slightly nega-tive, primarily due to rising local income taxes. Lowerpay hikes will also contribute to the deceleration ofincome growth, while lower inflation will have theopposite effect.

Despite more subdued income growth, householdswill continue to increase their consumption at a decentpace, and at present there are no signs that this trend isabout to stop. The household confidence indicator hasrisen, and home prices have again begun climbingmore rapidly after a temporary slowdown during2002. Meanwhile credit expansion is continuing.

Behind this strong trend are a solid balance sheet anda historically low interest burden for households. Thelarge income increases of 2001 and 2002 were largelyutilised to bolster savings. For this reason, households


21

can maintain consumption growth today by drawingdown their savings buffer. We thus believe that con-sumption growth will gradually accelerate from 1.3per cent in 2002 to 2½ per cent in 2005.

0302010099989796

14

12

10

8

6

4

2

0

-2

14

12

10

8

6

4

2

0

-2

Sources: Statistics Sweden, The Riksbank

Sweden: Property prices and lendingYear-on-year change

Lending to householdsProperty price index, permanent one-family homes

Economic situation of householdsYear-on-year percentage change

2002 2003 2004 2005Disposable income 4.7 1.6 1.5 1.6Consumption 1.3 2.0 2.3 2.5Household savings 8.2 7.4 6.5 5.8ratio, % of disposable incomeSources: Statistics Sweden, SEB

One downside risk in our forecast is that the weaklabour market may dampen household optimism.Poorer public sector finances may also lead to a fiscalpolicy that squeezes households to a greater degreethan we have assumed.

Labour market will remain weakUnemployment has climbed by nearly 1 percentagepoint in the course of 2003. Part of this upturn is dueto a decline in the number of people in government-financed employment training or temporary jobs (“la-bour market programmes”). Meanwhile, strong pro-ductivity growth indicates that companies areresponding to increased cost pressures with effi-ciency-raising measures, which in the short termlower the demand for labour.

In recent years, continued job creation in the publicsector has lowered unemployment. This trend is nowabout to end. Due to increasingly tight public financ-es, the number of jobs in the public sector will leveloff.

Labour marketYear-on-year change

2002 2003 2004 2005Hours worked -1.2 -1.1 0.0 0.3Labour productiv-ity

3.1 2.5 2.1 2.0

Unemployment, %of labour force

4.0 4.8 5.0 4.9

Employment, % ofworking-agepopulation

78.1 77.8 77.3 77.0

Sources: Statistics Sweden, SEB

03020100999897969594

6

4

2

0

-2

-4

-6

-8

-10

6

4

2

0

-2

-4

-6

-8

-10

Source: SCB

Sweden: EmploymentYear-on-year change, rolling 6-month average

ManufacturingPublic sector

There are many indications that the higher unem-ployment we have seen will persist during our fore-cast period. The labour market normally reacts tochanges in output after a time lag, so the effects ofrecent years of economic slowdown have not yetworked their way through. The GDP growth we an-ticipate in the near future will not be sufficient toimprove the labour market situation either.

Smooth wage roundThe 2004 wage round has now begun, but the firstnegotiating proposals do not usually provide muchguidance as to how the final collective agreementswill look. These agreements will probably be con-cluded during the first quarter of 2004.

▪ We do not believe that employer organisationsand unions will have a particularly hard timereaching a settlement on average pay hike levels,since nowadays the Riksbank’s inflation target issuch an established point of departure for the ne-gotiations.


22

▪ The potential deal-breakers are found elsewhere.The Trade Union Confederation’s demands forhigher percentage increases for low-paid em-ployees will be difficult for the employer side toaccept. The question of how to allocate the costsof sick pay will also be difficult to solve; thecentral government’s intention to shift more sickpay costs to employers is a hot potato.

▪ We believe that the 1990s pattern in which mostcollective agreements are for two or threeyears will be repeated.

Overall, the wage round should not be more compli-cated than the previous two. We believe that theweaker labour market will have a certain restrainingeffect. Wage and salary agreements are thus likely toend up at a somewhat lower level than during thelatest three-year period, when contractual pay rose byan average of 2.4 per cent.

Agreed pay increases and wage driftPercentage change

2002 2003 2004 2005Businesssector

3.9 3.6 3.5 3.8

Agreements 2.4 2.3 2.3 2.1Wage drift 1.4 1.2 1.1 1.7Public sector 4.4 3.9 3.6 3.9Agreements 2.1 2.4 2.2 2.3Wage drift 2.3 1.5 1.4 1.6Total 4.1 3.7 3.5 3.9Agreements 2.3 2.3 2.2 2.2Wage drift 1.7 1.3 1.2 1.7Sources: NIER, SEB

Pay hikes beyond those specified in collective agree-ments are becoming increasingly difficult to forecast,among other things because a larger proportion of thelabour market is concluding agreements without stat-ing any binding level for pay increases. White-collaremployees in both the public and the private sectorhave received large salary hikes without this havingbeen specified in any agreement. Now the weakerlabour market will slow the pace of salary increasesfor these groups. In the public sector, a tight budgetsituation will have a further restraining effect. Overall,we anticipate pay increases of between 3½ and 4 percent annually in 2004 and 2005.

Wages/salaries and other labour costs inthe business sectorYear-on-year percentage change

2002 2003 2004 2005Hourly pay 3.9 3.6 3.5 3.8Other payrollcosts1

-0.2 1.0 0.3 0.2

Labour cost 4.1 4.6 3.7 4.01Contribution to total labour costs.Sources: Statistics Sweden, SEB

Favourable inflation outlookThe inflation outlook for next year appears favour-able. A stronger krona, a declining rate of pay in-creases and rising productivity will ease underlyinginflationary pressure, while the contribution fromenergy prices will fall sharply during 2004. Risinglocal government user fees and rent increases willhave the opposite effect.

A number of leading indicators show that inflation ison its way down. Import and producer prices arefalling, while the Business Tendency Survey pointstowards low planned price increases as well as lowinflationary expectations. We anticipate averageUND1X inflation of 1.2 per cent in 2004 and 1.5per cent in 2005. Due to increasing home mortgageinterest expenses, CPI will rise somewhat more thanUND1X, especially during 2005.

0504030201009998

4.0

3.0

2.0

1.0

0.0

4.0

3.0

2.0

1.0

0.0

Sources: Statistics Sweden, SEB:

Sweden: UND1XYear-on-year change

SEB forecast

UND1XUND1X excl energy

UND1X excluding energy – the measure that theRiksbank is focusing on right now (see box) – hasfallen continuously, from 3½ per cent early in 2002 tobelow 1.5 per cent at present. This measure of under-lying inflation will fall short of 2 per cent for anotheryear, then stand at around 2 per cent during 2005.


23

Some areas of our inflation analysis may be worthdiscussing in a little more detail:

▪ Indirect taxes will contribute 0.2 percentagepoints to CPI inflation in 2004 and 0.1 points in2005. Higher energy taxes will contribute 0.2points in 2005Meanwhile Sweden will begin cau-tiously lowering its alcoholic beverage taxes, dueto tax cuts in neighbouring countries and moregenerous personal importation rules. We have as-sumed a first stage in 2005, equivalent to a CPIcontribution of -0.1 percentage points. A com-plete adjustment to the Danish level would lowerCPI by 0.8 percentage points.

▪ Collective negotiations on rents in municipallyowned housing will set the tone for the entireresidential rental market. Municipal housingcompanies are calling for increases of about 4.5per cent, among other things citing higher heatingand electricity costs. Such demands have been

presented previously without leading to especiallylarge final rent hikes. Our estimate is that rentswill rise by about 3 per cent in 2004, or somewhatmore than in 2003.

0504030201009998

4

3

2

1

0

-1

4

3

2

1

0

-1


Sweden: CPI and HICPYear-on-year percentage change

SEB forecast

CPIHICP

Will new CPI measurement methods leadto a new target variable?In January 2005, the methods for measuring Swe-den’s Consumer Price Index will be changed in away that may put the Riksbank in a quandary. Theproposals in question were tabled by the govern-ment’s CPI Commission in 1999.� A new method for weighing together the var-

ious sub-components of the CPI will be intro-duced, for the purpose of eliminating a slightdownside bias in the formula for the long-termindex. This bias has averaged 0.04 per cent an-nually during the past 20 years. All else beingequal, the CPI index level will thus rise 0.04 percent a year more than previously.

� A larger issue concerns computation of the in-flation rate. No decision has been made yet,but the Commission’s proposal is that inflationshould be computed directly as the ratio be-tween actual index figures. This implies that theadjustment for weigh changes carried out overthe past year will no longer be made. This wouldlower the annual change in prices by about 0.2percentage points per year.

In that case, the new index would average 0.15 per-centage points lower overall than today. There isthus a clear possibility that the Riksbank’s target var-iable will be changed in a way that it will show lowerinflation beginning in 2005. This will have conse-quences for monetary policy. The Riksbank maytherefore wish to persuade Statistics Sweden not tochange the method for computing the inflation rate;in its official comment on the Commission’s report,

the central bank says that the issue should be stud-ied further. However, Statistics Sweden will make thedecision. If the change is actually implemented, wecan discern alternative ways in which the Riksbankcan act.� The Riksbank may decide that UND1X, the

measure of underlying inflation for which theBank itself is responsible for methodology, willbe computed with an adjustment for weightchanges and may then switch its official targetvariable from the CPI to UND1X.

� The Riksbank, like the Bank of England, mayswitch its target variable to the EU’s harmonisedindex of consumer prices (HICP). The HICP willnot be affected by the new index formula for theCPI.

� The Riksbank may stick with the CPI and eitherlower its inflation target to 1.8-1.9 per cent...

� … or stick with 2 per cent (and thereby raise itsactual inflation target by 0.15 percentagepoints).

We believe that the Riksbank will choose the last-mentioned alternative. The central bank is alreadyengaged in a debate on its monetary policy targetvariable (see next box). In order not to complicatethis further, it is likely that the Bank will want to avoida formal change in its inflation target. De facto,retaining the CPI while changing the measurementmethod will mean a marginally looser monetarypolicy.


24

▪ Energy prices will make large negative contribu-tions to inflation. This forecast is based on exist-ing forward contracts for electricity prices, whichimply a significant upturn from today’s levels.Due to large base effects, their annual contribu-tion to CPI will still fall from 0.9 percentagepoints in October to -0.1 points in February. Oiland petrol prices will also lower the inflation rateby another 0.2-0.3 points. However, electricityprices have recently been extremely volatile and,due to low levels in reservoirs, large fluctuationsare possible both upward and downward.

▪ The forecast includes relatively large hikes inlocal government fees (heating, rubbish collec-tion, local public transport etc.). Unlike changesin indirect taxes, these affect all measures of un-derlying inflation.

Riksbank will hold off on rate hikeIn the immediate future, monetary policy will be pur-sued in an environment of very low inflation and witha bright outlook in the medium term as well. TheRiksbank’s Inflation Reports share this assessment.Several members of the Executive Board consideredfurther interest rate cuts. Due to low inflation, astronger krona and a continued weak labour market,there is a certain likelihood of one further rate cut thiswinter. However, such action presupposes a period ofslipping confidence indicators.

Our main forecast implies that there will be no morerate cuts; the Swedish economy will continue torecover, while the Riksbank chooses to employ un-derlying inflation adjusted for energy prices as itstarget variable. The fact that households are continu-ing to borrow and that home prices are moving up-ward will gradually play a large role in the Riksbank’sanalysis. For this reason, no further interest rate cutswill be forthcoming.

The next interest rate hike is nevertheless quite dis-tant, given our low inflation forecast. We anticipatethat the Riksbank will begin raising its key rate onlyduring the second half of 2004, somewhat earlierthan the European Central Bank. Our forecast for theSwedish central bank’s repo rate is 3.25 per cent in

December 2004 and 4.0 per cent in December 2005.The margin against the ECB’s refi rate will be 0.75percentage points throughout 2004, and will narrowsomewhat in 2005.

05040302010099989796

9

8

7

6

5

4

3

2

1

9

8

7

6

5

4

3

2

1


Key rates

SEB

Per cent Per cent

forecast

Euro zone: Refi rate (Germany until 1999)Sweden: Repo rate

Further weakening in public financesThe picture of Swedish public finances has becomegloomier, despite the fact that growth and unemploy-ment forecasts are largely the same as in our previousforecast in September. The reason is lower tax reve-nues than expected, especially corporate taxes. Thebudget surplus target seems increasingly remote;we anticipate that public sector savings in both 2004and 2005 will again end up below 1 per cent of GDP,despite the cyclical recovery. This situation is, never-theless, better than in most of the euro zone.

Public sector financesPercentage of GDP

2002 2003 2004 2005Revenues 56.8 56.4 56.5 56.6Expenditures 55.8 56.3 56.3 55.9Financial savings 1.1 0.0 0.1 0.7Consolidated debt 52.4 53.2 53.5 53.0Central govt. debt 47.9 49.1 49.7 49.4Central govt. bor-row. requirem.,SEK billion

-1 43 60 33



25

Two per cent norm sensitive to choice ofinflation measureIn recent years, with few exceptions Swedish mone-tary policy has obeyed the following main rule: If in-flation, measured as UND1X, is estimated to fall be-low 2 per cent in a two-year perspective, the reporate should be lowered; if the forecast indicates infla-tion above 2 per cent, the interest rate should beraised. This rule of action has been easy for the mar-ket to interpret and has also gained great credibility.In its last two Inflation Reports, however, the Riks-bank has shifted the focus of its inflation assessmentto UND1X excluding energy, since the Bank haswished to exclude volatile electricity prices from itsinflation analysis. At the same time, the Bank hasemphasised that its inflation target the CPI.It is not strange that the Riksbank has sometimeswished to ignore certain price effects or is choosingto focus on developments beyond the customaryforecast horizon. On some points, however, we be-lieve that the Riksbank has chosen an unfortunatepath.� The first concerns the lack of analysis of differ-

ent trends in different inflation measures.There is no guarantee that the trend of the CPI,UND1X or UND1X excluding energy will be ex-actly the same. For example, since 1980 the CPIhas risen by an average of 0.25 percentagepoints more than UND1X per year, and there willbe a differential also in the future. All eliminationof product categories from the inflation basketcreates similarly divergent trends, which must bethoroughly analysed. The Riksbank thus cannot,in a meaningful and easily interpreted way, jumpbetween different inflation measures as its targetvariable and at the same time keep its target atexactly 2.0 per cent regardless of which meas-ure is used.

� Our second objection concerns the Riksbank’s“devaluation” of the UND1X measure and re-born emphasis on the CPI as its real target.During the late 1990s, there was a debate onthe shortcomings of the CPI measure. The ab-sence of any established, well-defined measureof underlying inflation was cited for many yearsas a reason for continuing to emphasise theCPI. As the drawbacks of the CPI − especiallythat it was affected by changes in interest rates

− became too large, UND1X was developed asan official measure of underlying inflation. It wasalmost self-evident that in practice, monetarypolicy would shift towards being controlled bythis measure. It is therefore difficult to see anyreasons to now once again focus on the CPI asa target variable. One argument would be thatthe need for a measure of underlying inflationwas at its greatest during the 1990s when thelow-inflation policy was established and thedownturn in interest rates was especially large.However, this argument weighs lightly; evennormal cyclical interest rate movements aresufficient to deform the CPI and make it unus-able as a guiding principle for monetary policy.

The Riksbank’s new strategy – to focus once againon the CPI as a target and at the same time wishingto be able to operationalise this both as UND1X andadjusted for supply side shocks – is creating difficultyin predicting the actions of the Riksbank. We see twopossible ways for the Riksbank to escape from thisdilemma.� One possibility would be to interpret the infla-

tion target in looser terms: Monetary policywould then be guided by more general analysesof inflationary pressure during the next twoyears. The 2 per cent inflation target would thenstill comprise the basis, but the Bank wouldmove away from its finely-tuned signals aboutdeviations of one tenth of a percentage point. Sofar, however, we cannot trace any inclination totone down the role of “tenths” in the Riksbank’sanalysis.

� If the Riksbank wishes to continue working onthe basis of an exact inflation measure – whichall signs indicate – we believe that UND1X isnormally a better measurement variable thanthe CPI. We thus see the value of confirming theunderlying measure, UND1X. This does notcontradict the need for the Riksbank, in case ofmajor supply side disruptions – for example, inenergy prices – to supplement this underlyingmeasure with adjusted measures of “core” infla-tion. At present, however, we see no signs thatthe Riksbank would like to enthrone UND1X asits formal target variable.


26

What is happening to growth policy?The government has invited the social partners to“growth talks” intended to create new openings ineconomic policy. At the top of the agenda are taxa-tion policy and the battle to curb absenteeism due toillness.The internal debate in the ruling SDP will be crucial.Many things will be decided at the extra party con-gress in April 2004, whose theme is “EconomicGrowth”. Some fresh thinking is evident in the back-ground material for the congress now being dis-cussed, which deals with the conflict between highredistributive ambitions on the one hand and rapideconomic growth on the other. Nevertheless, wedoubt that the congress will lead to any decisive shiftin strategy. Redistribution issues are close to thehearts of many Social Democrats. A number of themore far-reaching proposals would also force abreak with the SPD’s current parliamentary allies, theLeft Party and Greens. As a result, the final packagewill be filled with compromises.� In concrete terms, we anticipate that the wealth

tax rate will be lowered (for example, via higherthresholds as well as lighter real estate taxa-tion). However, the Government claims that thismust be “compensated” through other tax hikes.One alternative is increasing the effectivecorporate tax (through restrictions of reserva-tions of profits). Another option is taxation of re-tirement savings – in keeping with the propos-als presented earlier by the special investigationon mobile tax bases headed by

Per-Olof Edin, former chief economist of theSwedish Trade Union Confederation (LO).

� However, there will be no changes in the”breakpoint” at which individuals begin payingcentral government income tax, or in centralgovernment tax rates. Nor will the governmentimplement the fourth and final stage in itsplanned rollback of employee payroll fees im-posed in the mid-1990s.

� Infrastructure and educational spending willlook attractive and will undoubtedly tempt theSPD into lofty rhetoric, but there is no room inthe budget for any major programmes.

� As for sickness benefit, it is likely that compa-nies will avoid the cost of an employee’s thirdsick pay week. Instead they will have to takeover a percentage of the total cost of absentee-ism due to illness – in exchange for lower payrollfees. This may have some positive long-termeffects, but we doubt that these will be visibleduring our forecast period.

� The Prime Minister has pronounced the need fora major overhaul of social insurance with low-er guaranteed benefit levels and higher individ-ual fees. Such a change will take a long time toimplement, however. Thus, we are not countingon any change in benefit levels in the sick pay orunemployment insurance systems during ourforecast period.

The central government is now operating at a deficit.We have adjusted our forecast of its borrowingrequirement upward by about SEK 5 billion peryear. The Kingdom of Sweden will have to borrowmore than SEK 60 billion – nearly 2.5 per cent ofGDP – during 2004.

In recent years, central government expenditures havethreatened to exceed the established ceilings; specialsteps have been required to keep the ceilings intact.Some of these have been of a cosmetic nature, forexample payment flows have been moved betweencalendar years and in one instance, higher expendi-tures were re-defined as lower revenues. Real belt-tightening has also been implemented; for example,planned hikes in benefit levels for sick pay and par-ental insurance were postponed this year. This showsthat the ceilings still partly fulfil their purpose of im-proving discipline in budget expenditure policy.

Our calculations indicate that pressure on the expen-diture ceilings will continue. This year, the steps thatthe government has taken admittedly appear to havebeen sufficient, but during 2004, new cutbacks ofSEK 5-10 billion will be needed.

Lower yield spread against GermanyAlthough Sweden has voted No to the euro, Swedishbond yields will largely continue to follow Germanyields. One factor that may lead to a wider spreadover the next few months is Sweden’s somewhat fast-er economic growth, which increases the risk that theRiksbank will raise its key interest rate before theECB. Meanwhile, we believe that the krona willstrengthen, thereby benefiting Swedish interest rates.Our short-term scenario is that these effects willlargely offset each other and that the 10-year yieldspread will remain at about 60 basis points.

Further ahead – in the course of 2004 – several factorsindicate that the yield margin may shrink.

▪ Sweden’s borrowing requirement is smallerthan that of the euro zone countries, whose overallannual budget deficits will approach 3 per cent ofGDP during the 2003-2005 period.

▪ We also believe that Sweden has a chance to im-prove its creditworthiness.


27

Local governments raising taxesThe local government sector is being squeezed bydecelerating growth in tax bases and higher than av-erage pay increases. In addition, central governmentgrants to local governments are not rising at thesame pace as before. Meanwhile there is heavy de-mand for health care, social services and schools,which has led to strong growth in local governmentconsumption in recent years. The result has beenthat a large proportion of Sweden’s municipalitiesand county councils are running budget deficits.Due to the statutory balanced budget requirement inthe local government sector, action must be taken.There are three possibilities for coming to grips withthe deficits:� Tax increases� Higher user fees for households and companies� Lower consumption and employmentWe anticipate that all three methods will be usedover the next few years.1. During 2003, the average local government taxwas raised by SEK 0.65 per SEK 100 of taxable in-come. This was the highest increase in 25 years.Planned tax hikes during 2004 are about SEK0.30 and we anticipate that the local income tax willbe boosted in 2005 as well, by SEK 0.20.As the following chart indicates, local government taxhas trended upward for the past three decades andthe increase has accelerated in recent years. Thetrend towards increased tax rates has only been in-terrupted during periods when Parliament has im-posed a freeze on local income tax hikes.

The pressure for continued tax hikes is likely to per-sist. Demand for local government services will con-tinue to increase, among other things due to rapid ad-vances in medical technology and an ageing popula-tion. Local politicians will be pressed by the demandsof their citizenry, which are often sustained by rhetoricand rule systems from the government and Parlia-ment.

This puts a spotlight on the separate roles of localpoliticians on the one hand, and Parliament and thegovernment on the other. An individual municipalityhas little incentive to take into account the negativeconsequences that may result from an excessivelyhigh total tax burden. That responsibility instead lieswith Parliament and government, which rarely pro-vide local politicians with assistance in the form ofsystemic changes that ease the pressures on localgovernment services.2. Increases in local government user fees arealso being utilised. This trend is likely to continue andeven accelerate during our forecast years, contribut-ing to a continued rapid pace of increases in theprice of services as part of the CPI.

3. There are many indications that local govern-ment consumption will also be affected. Manylarge municipalities and county councils are present-ing austerity programmes. During 2004, consumptionwill rise. However, this is partly a statistical effect ofthe local government workers’ strike, which reducedconsumption for several few weeks in spring 2003.This effect explains nearly 0.5 percentage points ofthe projected 2004 consumption increase; underlyinggrowth is thus lower. In 2005 we foresee very weakconsumption growth, while the number of employeeswill largely be unchanged.Weak local government finances will thus contributein various ways to the sluggishness of the Swed-ish economic recovery. Local government con-sumption will decelerate, while household purchasingpower will be lowered via higher taxes and user fees.High increases in user fees may also affect monetarypolicy in a longer perspective.In this context, it is also worth mentioning the localgovernment revenue equalisation system, which bothleads to growing goal conflicts between regional andnational levels and hampers the finances of rapidlygrowing regions, especially Stockholm.

0302010099989796

6

5

4

3

2

1

0

-1

6

5

4

3

2

1

0

-1

Source: Statistics Sweden

Sweden: Local government user fees in the CPUYear-on-year percentage change

05009590858075

34

32

30

28

26

24

22

2.0

1.5

1.0

0.5

0.0

-0.5


Sweden: Tax rate in local government

Level (LHS)

Change (RHS)

Per cent Percentage points

forecastSEB


28

▪ Finally, amended rules on the requirements formatching commitments and assets in the port-folios of life insurance companies may result in astructural shift towards a heavier demand forSwedish bonds.

We thus anticipate that the bond yield spreadagainst Germany will shrink to 40 basis points bythe end of next year.

One uncertain factor is economic policy, especiallythe ongoing talks about national growth and structuralpolicy. If these should result in tangible actions, thespread may shrink more than we are anticipating.

Fundamentals supporta stronger kronaSince the euro issue has disappeared from the marketfocus, analysis is concentrating more on fundamen-tals. Sweden’s large current account surplus and rela-tively healthy central government finances point to-wards a stronger krona. Sweden’s fundamental eco-nomic strengths also appear especially robust in asituation where the US current account deficit and theeuro zone’s Stability Pact headaches are so conspicu-ous.

During the immediate future – before the end of 2003– we anticipate that foreign investors may want totake profits after the krona appreciation of the past sixmonths and the upswing in the shares of Ericsson andother companies. However, early in 2004 the desire toassume Swedish risks will return. We expect thekrona to climb to SEK 8.60 per euro in the summer;this means SEK 7.05 per US dollar. Measured by

the trade-weighted TCW index, the krona willstrengthen to 120 – its strongest level since 1998.

It will probably be many years before any new Swed-ish referendum on the euro; the market focus on thekrona’s potential accession rate against the euro willthus fade away. Instead, we anticipate that the kronawill be priced on its own merits compared to the euro.This means both a more volatile krona-euro exchangerate and increased influence for the dollar. The weakdollar may, thus, cause the krona to dip below itslong-term equilibrium level vs. the euro.

We thus foresee a slight weakening of the kronaagainst the euro during 2005 to levels just above thelong-term equilibrium exchange rate (which we esti-mate at SEK 8.60-8.70 per euro).

05040302010099989796

145

140

135

130

125

120

115

110

10.0

9.5

9.0

8.5

8.0


Sweden: Exchange rateMonthly average

SEB forecast

TCW index (LHS) EUR/SEK (RHS)

DenmarkNordic Outlook – November 2003

29

Gradual recovery▪ Strong fundamentals

▪ Temporary lull in consumption

▪ Unemployment will slow upturn

Denmark has weathered the global economic slow-down relatively well. One important explanation isthat its economic fundamentals are in good shape;both foreign trade and public finances are in surplusand inflation is in check. Exports have shown resil-ience. However, owing to an unexpectedly largeslowdown in private consumption growth, this year’sincrease in GDP will be limited to 0.8 per cent, theweakest in a decade. Now consumption is beingnewly stimulated by tax cuts. But this windfall tohouseholds will not have as big an effect as the con-sensus view maintains. The reason is the weakeningof the labour market. The upturn in unemploymentwill not culminate until next spring, reaching 6.5per cent.

Looking ahead, private consumption and capitalspending will drive economic growth. GDP will rise0.8 per cent this year and by 1.7 per cent and 2.3per cent, respectively, in 2004 and 2005.

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Denmark: GDP and inflationYear-on-year changePer cent Per cent

GDPHICP SEB forecast

The lean 0.3 per cent growth rate during the first halfof 2003 was a disappointment and was due to fallingcapital spending and weakened private consumption.Rapidly growing unemployment made consumersnervous. However, a cyclical recovery began thisautumn. The brightening global outlook and stockmarket rally have had a contagious effect on compa-nies and households; their optimism has strengthened.

Increased productivityExport growth has slowed, from a 6 per cent rate lastyear to 2 per cent this year. This has occurred amidst

tough conditions, with weak international demand andan appreciating krone. The Danish export sector’srelative resilience can be explained in part by its com-position, which includes a large share of industriesthat are not so cyclically sensitive. In addition, pro-ductivity growth has accelerated in recent years,from 2-3 per cent to 3-4 per cent annually, helpingoffset the effects of a stronger krone. Export growthwill speed up when the world economy strengthens.However, the appreciation of the Danish currency, inthe wake of a strengthening euro, will hamper growth.

Domestic demand will gradually gain strength. Con-sumption growth will rebound to an average ofmore than 2 per cent annually in 2004-2005. Tax cutswill boost household disposable income. In October,Denmark cut taxes on alcoholic beverages and to-bacco. In January, taxes on soft drinks and incometaxes will be trimmed; the latter corresponds to DKK5.7 billion, or 0.9 per cent of disposable income. Lowinflation and low interest rates are other positive fac-tors for consumption. Considering the uncertain la-bour market, however, we have assumed that a portionof the tax cut will go towards increased saving.

Inflation is under control. Measured as HICP, it willcool from 2.1 per cent this year to 1.5 per cent in 2004and 2.1 per cent in 2005. This is in phase with theeuro zone. Lower energy prices, subdued labour costsand the stronger krone are restraining factors. Inflationwill also slow over the next year due to the tax cuts onalcoholic beverages, tobacco and soft drinks; thesecuts are equivalent to 0.6 percentage points of infla-tion.

EU and euro zone referendumsOn the euro issue, for the past year the Yes side hashad a stable lead. No shift in public opinion seems tohave occurred after Sweden voted no to the euro inSeptember. Late in 2004 the Danes will vote on a newEU constitution. It is possible that this referendumwill also include the four Danish opt-outs from theMaastricht Treaty, among them the euro. An alterna-tive would be to vote on EMU in 2005.

Central bank shadows ECB key rate. In recentyears, with large current account surpluses and astrong krone, the spread in bond yields against theeuro zone has shrunk to 0.15 percentage points. Weforesee a slight widening to 0.20 points. Denmark’scurrent account surpluses will remain large, but adegree of capital outflow can be expected via pur-chases of foreign equities. To balance the krone, thisjustifies a somewhat higher yield spread against theeuro zone.

NorwayNordic Outlook – November 2003

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Interest rate-driven recovery▪ Weaker krone gives industry breathing space

▪ Unemployment will culminate this winter

▪ Low inflation for a long period ahead

Due to falling interest rates, a significant weakeningof the krone and the beginnings of an internationalcyclical upturn, the outlook for the Norwegian econ-omy has brightened considerably in the past year.Norges Bank aggressively cut its key interest rate by4.5 percentage points in less than one year. This hascaused consumption to take off. Meanwhile the weak-ening of the krone has eased some of the pressure onthe beleaguered manufacturing sector. We anticipatethat the deterioration in the labour market will losemomentum and that unemployment will culminatethis winter. GDP growth will rise from 0.5 per centthis year to about 2½ per cent during both 2004and 2005. Private consumption and oil sector invest-ments will be the main driving forces for economicgrowth.

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Manufacturing gets a respiteThe situation of the manufacturing sector remainstroublesome. High pay increases in recent years havegreatly undermined the competitiveness of Norwegianindustry. However, this year’s weakening of the kronemeans that the appreciation of the currency during2002 has largely been rolled back. This, combinedwith some deceleration in the pace of wage and salaryincreases, is easing the problems of manufacturerssomewhat, although their competitiveness remainsunsatisfactory. We thus anticipate continued losses inmarket share ahead.

Due to their unfavourable competitive situation andlow capacity utilisation, manufacturers are continuingto focus on efficiency-raising and cost-cutting meas-ures, while their capital spending will remain rela-

tively weak. It will also take time before the construc-tion sector picks up speed. The market for commercialspace is still plagued by considerable overcapacity.Residential construction will climb during the nextcouple of years but the increase will be modest, in linewith the restrained price trend for housing.

The most important contributions to capital spendingin the next couple of years will instead come from theoil sector. Due to the on-going expansion of severallarge offshore oil fields, investments will increasesubstantially in this sector. Given current high oilprices, we also anticipate that oil sector investmentswill remain at a high level during 2005 as well.

Robust consumptionDuring the summer months, consumption strength-ened. The increased optimism of recent months alsopoint towards higher consumption growth in the nearfuture. Due to high pay increases and relatively highsavings, the economic situation of households can beregarded as solid. A stabilisation of the labour marketas well as low interest rates will thus provide goodincentives for households to boost their consumption.However, owing to continued high unemployment andsome gradual increases in interest rates, consumptiongrowth will not continue to accelerate. Our forecast isthat it will establish itself at a relatively high annualrate of around 3 per cent.

Unemployment has continued climbing and is now atits highest level since 1996. The number of job vacan-cies remains low. It is hardly surprising that the sharpdeterioration in manufacturing competitiveness hasled to rising unemployment. However, a new trend isthat high pay increases have also begun to leave theirmark on public sector employment, where the focuson cost-cutting and efficiency-raising measures isbecoming increasingly apparent. Thus no sharp rise inpublic sector jobs can be expected.

As a result of on-going recovery in the economy, thedeterioration of the labour market will slow. We esti-mate that unemployment will culminate some timeduring the winter and then stay at just below 5 percent, which is a relatively high level in Norwegianterms.

Fiscal policy is expansive. The budget agreementrecently submitted will signify that for the third con-secutive year, withdrawals from Norway’s PetroleumFund will exceed the target in the “fiscal activityrule”, which states that 4 per cent of the Fund’s valuemay be spent each year. In reality, about 6½ per centof Fund assets will be used this year, and the govern-ment plans an almost equally large withdrawal in2004. Nonetheless, the mere fact that a deal was

NorwayNordic Outlook – November 2003

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struck between the non-socialist minority governmentand the labour party will diminish the risk for an evenmore expansive fiscal policy in the future.

Norges Bank misses inflation targetThe underlying inflation rate (CPI-ATE, a consumerprice index that excludes changes in energy prices andindirect taxes) amounted to 0.8 per cent in October.The pace of price increases is thus far below the offi-cial target of 2.5 per cent, as well as below the per-mitted lower inflation threshold. This is a majorproblem for the Norwegian central bank, since thecredibility of its inflation target will tend to be under-mined the longer this deviation lasts.

Norway’s low inflation is primarily due to fallingimport prices, which in turn are a consequence of lowinternational prices and the appreciation of the kroneuntil early 2003. The weakening of the krone sincethen will contribute to the disappearance during 2004of deflationary pressure from imports and goods thatcompete with imports. However, low internationalprices will limit the upturn in imported inflation,while a deceleration in domestically generated infla-tion will occur as a result of the weak labour marketsituation. Taken together, this means that inflationwill remain below target during the next two yearsand that not until autumn 2004 is an initial interestrate hike possible. After that, successive hikes in theNorges Bank deposit rate will occur, reaching the 4per cent level by the end of 2005.

Now that the key rate has bottomed out, this meansthat depreciation pressure on the krone will disap-pear. We anticipate a slight short-term strengtheningof the krone towards NOK 8.10 per euro. After that, arenewed weakening will occur in line with lower oilprices and growing risk appetite. The currency willstand at around NOK 8.50 per euro and NOK 7 perdollar at the end of 2005.

Norway: Key rate and NOK index

Deposit rate, per cent (RHS) NOK index (LHS)Source: EcoWin

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Lasting downturn in pay increases?One result of overheating during the late 1990s wasthat wages and salaries in Norway rose substantiallyfaster than in other countries. As recently as 2002, payincreases were as high as 5¾ per cent. However, thisyear’s wage settlements indicate that the employersand the unions have taken rising unemployment intoaccount. Despite sizeable overhangs and pay hikesdecided last year but taking effect this year, we antici-pate that wages and salaries will increase by nomore than 4½ per cent in 2003. Due to the lowoverhang extending into 2004, combined with contin-ued high unemployment and low inflation, we antici-pate an additional slowdown in the rate of pay hikes in2004 and 2005.

One central issue, however, is whether pay modera-tion can be expected to continue in the medium term.History is not encouraging in this respect, and consid-ering the fiscal policy framework and the influx of oilrevenues, there is a major risk that the Norwegianeconomy will revert to a spiral of high pay hikes, anappreciating currency and further corporate casualtiesin the manufacturing sector.

Wage per employee in business, per centPay hikes in Norway and the euro zone

The euro zone NorwaySource: EcoWin

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FinlandNordic Outlook – November 2003

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Modest upswing▪ Strong income growth in household sector

▪ Bordering on deflation

▪ Additional tax cuts

Despite significant deceleration in growth during thepast few years, the Finnish economy has resisted theeconomic downturn better than most other euro zonecountries. The main reason is that private consump-tion has been robust, among other things due to anexpansive fiscal policy and a relatively resilient labourmarket. This year, consumption will be essentially theonly driving force in the economy. GDP growth willthus not exceed 1.3 per cent. Over the next two years,demand will broaden. Exports in particular, butgradually also capital spending, will strengthen as aninternational cyclical upswing occurs. GDP growthwill accelerate to 2.5 and 2.9 per cent, respectively.

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Exports have performed weakly since the summer of2002. Despite some recovery in the second quarter of2003, they are no higher than a year ago. Industrialoutput, too, has moved sideways in the past year.Expectations in the manufacturing sector remain sub-dued, although the international economic improve-ment of recent months has led to a somewhat moreoptimistic tone. No sharp upswing can be expected,though. The international cyclical upturn will be mod-est and we do not anticipate significant market sharegains. The competitiveness of Finnish manufacturershas been undermined somewhat by euro appreciationand relatively large labour cost increases. Nor can weexpect any repetition of the telecom sector’s unparal-leled success in the 1990s.

Capital spending remains weak. In the second quarter,it fell 5 per cent year-on-year. Today capital spendingis more than 10 per cent lower than when the econ-

omy peaked. Few signs of an imminent upturn infixed investments are evident in the business sector.Capacity utilisation is low, and surveys indicate verylittle willingness among companies to invest. A turn-around in investments will not occur until well into2004, when the international cyclical upturn is wellestablished.

Household consumption is continuing to surge.Retail sales have risen about 4 per cent so far thisyear, while car sales have soared nearly 25 per cent.We see no reasons for a significant slowdown in con-sumption growth over the next couple of years.Households have remained unremittingly upbeatabout their own economic outlook, despite some in-creased concern about the labour market situation.Real income is continuing to rise at a good clip. In-come tax cuts both this year and next will add pur-chasing power, while interest rates remain relativelow. Households are also in a good financial position,with low debt ratios.

Inflation is well below the EU average and will beless than 1½ per cent this year as a whole. Next year,inflation will decline further. Capacity utilisation willremain low in the Finnish economy, while continuedeuro appreciation will help keep import prices down.Alcoholic beverage taxes will also be cut by one third,resulting in a pace of inflation that will probably benegative for a few months.

The labour market has weakened in the past year,especially in manufacturing. The total number of jobswill fall this year, and 2004 will be another weak yearin the labour market. The fragile financial situation oflocal governments will make it harder for them tocontinue adding jobs. Meanwhile it will take timebefore the upturn in production leads to higher de-mand for labour in the business sector. The fact thatcompanies have been reluctant to lay off employees inrecent years also indicates that there will be a time lagbefore they begin recruiting new ones.

The large surpluses of recent years in Finnish publicfinances have left room for fiscal policy to stimulateeconomic activity during the cyclical slowdown,mainly via tax cuts. Next year, income taxes will belowered further and in 2005 the corporate tax rate isto be lowered from 29 per cent to 26 per cent. In2000-2004, the tax burden will fall by more than 2½per cent of GDP. In the same period, public savingswill fall from 7 per cent of GDP to less than 2 percent. This year the central government must beginborrowing again after several years of surpluses.Overall public sector savings will nevertheless end upin positive territory, due to surpluses in the pensionsystem.

Nordic key economic dataNordic Outlook – November 2003

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DENMARKYearly change in per cent

2002 2003 2004 2005Gross domestic product 2.1 0.8 1.7 2.3Private consumption 1.9 1.0 2.2 2.3Public consumption 2.1 0.7 0.6 0.7Gross fixed investment 0.3 -2.8 1.5 3.2Stockbuilding -0.3 0.0 0.1 0.0(change as % of GDP) Exports 5.8 2.0 3.5 4.3Imports 4.2 1.6 4.0 4.0

Unemployment (%) 5.2 5.9 5.9 5.4Consumer prices, (%), average 2.4 2.1 1.5 2.1Wage cost 3.9 3.8 3.6 3.9Household savings ratio (%) 4.8 5.3 5.5 5.2Current account, % of GDP 2.8 3.0 2.6 2.8Public sector financial balance, % of GDP 1.9 1.2 1.4 1.8Public sector debt, % of GDP 45 43 41 39

FINANCIAL FORECASTS Nov 12 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05Deposit rate 2.15 2.15 2.15 2.40 2.95 3.4510-year bond yield 4.66 4.58 4.48 4.70 4.80 4.9510-year spread to Germany, bp 17 18 18 20 20 20USD/DKK 6.42 6.36 6.10 6.10 6.10 6.10EUR/DKK 7.43 7.44 7.44 7.44 7.44 7.44

NORWAYYearly change in per cent

2002 2003 2004 2005Gross domestic product 1.0 0.4 2.4 2.4Gross domestic product (Mainland Norway) 1.3 0.5 2.8 2.5Private consumption 3.6 3.3 3.5 3.0Public consumption 3.2 1.0 2.5 1.5Gross fixed investment -3.6 1.0 2.1 2.8Stockbuilding 0.2 -0.4 0.2 0.0(change as % of GDP) Exports -0.5 -1.2 1.3 4.0Imports 1.7 2.0 2.9 5.2

Unemployment (%) 3.9 4.5 4.8 4.8Consumer prices, (%), average 0.8 2.6 1.0 2.0CPI-ATE 2.3 1.2 1.7 2.0Wage cost 5.3 4.5 3.8 4.0Household savings ratio (%) 7.2 5.1 5.6 5.6Current account, % of GDP 10.8 11.6 10.2 9.7Public sector financial balance, % of GDP 10.0 8.7 8.0 8.0Public sector debt, % of GDP 26 26 26 26

FINANCIAL FORECASTS Nov 12 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05Deposit rate 2.50 2.50 2.50 3.00 3.5 4.0010-year bond yield 5.08 4.90 4.80 5.25 5.35 5.5010-year spread to Germany, bp 59 50 50 75 75 75USD/NOK 7.08 6.92 6.72 6.89 6.93 6.97EUR/NOK 8.20 8.10 8.20 8.40 8.45 8.50

Nordic key economic dataNordic Outlook – November 2003

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SWEDENYearly change in per cent

2002 2003 2004 2005Gross domestic product 1.9 1.4 2.1 2.3Private consumption 1.3 2.0 2.3 2.5Public consumption 2.1 0.6 0.6 0.2Gross fixed investment -2.5 -2.0 3.0 5.5Stockbuilding -0.1 0.4 0.2 0.0(change as % of GDP) Exports 0.4 4.6 5.0 5.4Imports -2.7 4.3 5.7 6.0

Unemployment (%) 4.0 4.8 5.0 4.9Employment 0.1 -0.2 -0.2 0.3Industrial production 2.3 1.5 5.0 5.5Consumer prices 2.4 2.1 1.4 2.1UND1X 2.5 2.3 1.2 1.5Wage cost 4.1 3.7 3.5 3.9Household savings ratio (%) 8.2 7.4 6.5 5.8Real disposable income 4.7 1.6 1.5 1.6Trade balance, % of GDP 6.4 6.4 6.4 6.4Current account, % of GDP 4.2 4.2 4.2 4.1Central government borrowing, SEK bn -1 43 60 33Public sector financial balance, % of GDP 1.1 0.0 0.1 0.7Public sector debt, % of GDP 52 53 54 53

FINANCIAL FORECASTS Nov 12 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05Repo rate 2.75 2.75 2.75 3.25 3.50 3.753-month interest rate, STIBOR 2.95 2.95 3.15 3.65 3.90 4.1510-year bond yield 5.07 4.95 4.80 4.90 5.00 5.1510-year spread to Germany, bp 58 55 50 40 40 40USD/SEK 7.76 7.61 7.05 7.13 7.17 7.21EUR/SEK 8.98 8.90 8.60 8.70 8.75 8.80TCW 125.3 124.7 120.0 120.8 120.9 121.0

FINLANDYearly change in per cent

2002 2003 2004 2005Gross domestic product 2.2 1.3 2.5 2.9Private consumption 1.5 3.0 2.7 2.5Public consumption 4.0 1.5 1.7 1.7Gross fixed investment -4.0 -3.0 1.0 4.0Stockbuilding -0.2 -0.1 0.0 0.0(change as % of GDP) Exports 4.9 1.7 5.1 6.2Imports 1.3 1.8 4.8 6.4

Unemployment (%) 9.1 9.3 9.3 9.0Consumer prices, (%), average 2.0 1.4 0.9 1.6Wage cost 3.2 3.8 3.5 3.5Households savings ratio (%) 3.0 3.1 2.8 2.8Current account, % of GDP 7.1 6.3 6.1 6.1Public sector financial balance, % of GDP 4.2 2.5 1.9 2.0Public sector debt, % of GDP 43 45 45 44

International key economic dataNordic Outlook – November 2003

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EURO ZONEYearly change in per cent

2002 2003 2004 2005Gross domestic product 0.9 0.5 1.7 2.3Private consumption 0.5 1.4 2.0 2.1Public consumption 2.9 1.7 1.2 1.2Gross fixed investment -2.6 -1.3 1.9 4.3Stockbuilding 0.0 0.2 0.2 0.0(change as % of GDP) Exports 1.7 0.2 3.6 5.7Imports 0.1 2.0 4.4 6.1

Unemployment (%) 8.4 8.9 8.9 8.7Consumer prices, (%), average 2.3 2.1 1.7 1.6Household savings ratio (%) 10.0 10.0 9.8 9.8

USYearly change in per cent

2002 2003 2004 2005Gross domestic product 2.4 2.9 3.7 2.8Private consumption 3.1 3.1 3.0 2.0Public consumption 4.4 3.2 1.2 -1.0Gross fixed investment -3.1 4.0 6.3 7.0Stockbuilding 0.7 -0.2 0.5 0.3(change as % of GDP)Export -1.6 1.2 6.8 7.5Import 3.7 3.4 5.3 4.0

Unemployment,(%) 5.8 6.0 5.9 6.1Consumer prices, (%), average 1.6 2.2 1.4 1.5Household savings ratio (%) 3.7 3.7 4.6 5.5

LARGE INDUSTRIAL COUNTRIES

2002 2003 2004 2005GDP, yearly change in per centUnited Kingdom 1.7 1.9 2.4 2.6Japan 0.2 2.4 1.9 1.2Germany 0.3 0.0 1.6 2.0France 1.2 0.2 1.5 2.3Italy 0.4 0.4 1.4 2.3

Inflation, yearly change in per centUnited Kingdom, RPIX 2.2 2.8 2.4 2.5United Kingdom, HICP 1.3 1.4 1.5 2.0Japan -0.9 -0.2 0.1 0.2Germany 1.3 1.1 1.3 1.3France 1.9 2.1 1.6 1.5Italy 2.6 2.8 2.0 1.7

Unemployment, (%)United Kingdom 5.2 5.1 5.3 5.2Japan 5.4 5.5 5.3 5.3Germany 9.8 10.7 10.7 10.5France 9.0 9.5 9.6 9.5Italy 9.0 8.9 8.9 8.8

International key economic dataNordic Outlook – November 2003

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CENTRAL AND EASTERN EUROPE

2002 2003 2004 2005GDP, yearly change in per centEstonia 5.8 4.4 5.4 5.9Latvia 6.1 6.9 6.7 6.5Lithuania 6.8 7.5 6.7 7.0Poland 1.4 3.4 4.4 4.2Russia 4.3 6.2 5.0 4.5Slovakia 4.4 4.0 4.5 5.0Czech Republic 2.0 2.5 3.3 3.8Hungary 3.3 2.8 3.2 4.2

Inflation, yearly change in per centEstonia 3.6 1.4 3.0 3.5Latvia 1.9 2.9 3.7 3.5Lithuania 0.3 -1.2 1.5 2.5Poland 1.9 0.9 2.1 2.8Russia 15.8 13.8 11.7 10.8Slovakia 3.3 8.8 7.7 5.0Czech Republic 1.8 0.3 2.5 3.0Hungary 5.3 4.6 5.8 4.3

FINANCIAL FORECASTS

Nov 12 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05Official interest ratesUS Fed funds 1.00 1.00 1.00 1.50 2.00 3.00Japan Call money rate 0.00 0.00 0.00 0.15 0.25 0.50Euro Zone Refi rate 2.00 2.00 2.00 2.25 2.75 3.25United Kingdom Repo rate 3.75 3.75 4.00 4.50 4.75 4.75

Bond yieldsUS 10 years 4.46 4.50 4.50 4.70 4.85 5.00Japan 10 years 1.36 1.50 1.50 1.75 2.00 2.25Germany 10 years 4.50 4.40 4.30 4.50 4.60 4.75United Kingdom 10 years 5.10 4.90 4.80 5.00 5.10 5.25

Exchange ratesUSD/JPY 109 110 105 105 105 105EUR/USD 1.16 1.17 1.22 1.22 1.22 1.22EUR/JPY 126 129 138 128 128 128GBP/USD 1.67 1.77 1.88 1.82 1.74 1.67EUR/GBP 0.69 0.66 0.65 0.67 0.70 0.73

GLOBAL KEY INDICATORSYearly change in per cent

2002 2003 2004 2005GDP OECD 1.8 1.9 2.7 2.6GDP world 2.5 2.7 3.5 3.4CPI OECD 2.3 2.7 2.0 2.0Export market OECD* 2.9 5.5 8.1 7.8Export market world* 3.5 5.9 8.3 8.0Oil price, Brent (USD/barrel) 25.0 28.7 26.1 24.0* Manufactured goods

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