Nordic Outlook November 2010

Nordic Outlook Somewhat brighter growth outlook
Economic Research – November 2010 — but mounting policy challenges

Contents

International overview 5

Theme 16

The United States 18

Japan 25

Asia 26

The euro zone 29

The United Kingdom 35

Eastern Europe 36

The Baltics 37

Sweden 39

Denmark 48

Norway 49

Finland 53

Economic data 54

Boxes

Ireland the focus of new debt worries 8
Calmer commodity price trend 10
Basel III update 15
Unusually weak recovery 19
Economy vulnerable to energy price shock 20
Long-term unemployment on the way down 20
QE will push up growth a bit 21
The market is worried about inflation 22
A plan to get the deficit under control 24
A 20 per cent probability of recession 30
Watered-down sanctions when EU Stability and
Growth Pact is revised 32
Does the krona risk becoming too strong? 44

Nordic Outlook – November 2010 | 3

Economic Research

This report was published on November 24, 2010.

Cut-off date for calculations and forecasts was November 18, 2010.

Robert Bergqvist Håkan Frisén
Chief Economist Head of Economic Research
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Daniel Bergvall Mattias Bruér
Economist Economist
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Ann Enshagen Lavebrink Mikael Johansson
Editorial Assistant Economist
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Andreas Johnson Tomas Lindström
Economist Economist
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Gunilla Nyström Ingela Hemming
Global Head of Personal Finance Research Global Head of Small Business Research
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Susanne Eliasson Johanna Wahlsten
Personal Finance Analyst Small Business Analyst
+ 46 8 763 65 88 + 46 8 763 80 72

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

Contributions to this report have been made by Thomas Köbel, Klaus Schrüfer, SEB Frankfurt/M and
Olle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible for the Norwe-
gian analysis. Financial analyses are done in collaboration with Trading Strategy and SEB Enskilda Equi-
ties.

4 | Nordic Outlook – November 2010

International overview

Brighter growth outlook, but
mounting policy challenges

ƒ Fed’s stimulus programme will help During the next couple of years, we foresee no major
inflation risks in the 33 countries of the Organisation
ƒ Low inflation despite challenges for Economic Cooperation and Development (OECD),
ƒ Continued debt worries in the euro zone despite the ultra-loose monetary policies now being
pursued. Rising commodity prices and the effects of
ƒ Dilemma for Nordic central banks weaker currencies will lead to slightly higher inflation,
but deflationary forces will continue to predominate.

In recent months the world economic outlook has This means there is room for central banks in major
become somewhat brighter. Expectations of quantita- OECD countries to hold off on hiking their key inter-
tive easing (QE) by the US Federal Reserve contributed est rates for at least another year or so. In addition,
to stronger optimism, reflected among other things in the effects of quantitative easing by the Fed and other
rising share prices. Meanwhile underlying economic central banks will also help keep longer-term market
signals in the United States have been more reas- interest rates down and stimulate asset prices. Over the
suring, after major disappointments during the sum- next couple of years, fiscal policies in OECD countries
mer. Emerging economies have continued to perform will not be as contractive as we previously expected,
strongly, and worries about a hard landing in China and but ongoing debt retirement − mainly in the private
elsewhere have diminished. In Europe, too, economic sector − and lingering weaknesses in the financial sys-
signals have been positive, for example in Germany, the tem will help blunt the effects of monetary policy.
United Kingdom and various Nordic countries. At the
same time, though, uncertainty about the government On the whole, we regard a somewhat higher growth
financial crisis in southern Europe and Ireland has once forecast than previously as justified. We have raised
again increased alarmingly. both our 2010 and 2011 GDP forecast by 0.3 percent-
age points, both for the OECD and emerging markets.
Our upward revision for 2012 is somewhat smaller.
Global GDP growth
Year-on-year percentage change A low-interest environment, growth slightly above trend
in the OECD countries and continued strong growth in
2009 2010 2011 2012
developing economies will mean a relatively favourable
United States -2.6 2.7 2.2 3.4 environment for the stock market.
Japan -5.3 3.1 1.6 1.5
GDP, OECD countries
Germany -4.7 3.6 2.5 1.8 Index 2000 = 100
130.0 130.0
China 8.7 10.2 9.0 8.0
127.5 127.5
United Kingdom -5.0 1.7 2.1 2.1 20%
125.0 125.0
Euro zone -4.0 1.6 1.7 1.5 122.5 122.5

Nordic countries -4.5 2.7 2.8 2.4 120.0 120.0
117.5 25% 117.5
Baltic countries -15.6 0.9 4.0 4.5
115.0 115.0
OECD -3.3 2.5 2.3 2.5 112.5 SEB forecast 112.5
Emerging markets 2.5 7.1 6.3 6.5 110.0 110.0
107.5 107.5
World, PPP* -0.6 4.7 4.1 4.5
04 05 06 07 08 09 10 11 12
World, nominal -1.3 4.0 3.4 3.8
New crisis wave SEB's main scenario
* Purchasing power parities Rapid recovery
Source: OECD, SEB

Source: OECD, SEB
In our August report, we made the assessment that
the downside risks to our main economic scenario



outweighted the upside risks. This time, we foresee ing process in the financial system and household debt
somewhat more symmetrical risks. The probability of retirement is under way. In the US, a clear improve-
stronger economic performance has increased from 15 ment in the labour and housing markets will not occur
to 20 per cent, mainly due to changes in the US risk until well into next year. Only then can consumption
picture. provide genuine support to the economic recov-
ery. German consumers remain cautious and need the
Capital spending growth will be crucial encouragement of slightly higher pay increases ahead,
In the OECD countries, the slowing trend in the re- while tough austerity programmes will limit the poten-
covery that we foresee in late 2010 and early 2011 is tial for an upturn in British consumption.
partly connected to the waning strength of the inven-
tory cycle. In the US, this is reinforced by the fading Economic policy challenges at many
of federal fiscal stimulus measures. Debt retirement in levels
the household sector after the bursting of the housing While the economic outlook for the next couple of
bubble will hamper consumption during the next couple years seems a bit brighter, international economic
of years. An upswing in capital spending is therefore policy collaboration faces a variety of challenges and
vital in order to ensure a continued recovery. conflicts. Despite lofty ambitions − for example in the
Group of Twenty (G20) countries − when it comes to
In some respects, the situation looks rather hopeful.
coordinating economic policies in response to global
Capital spending has taken off in many countries during
imbalances, this autumn has been full of disappoint-
2010. Although upturn figures have been high because
ments. Progress at the recent G20 summit in Seoul,
fixed investment was deeply depressed in 2009, there
South Korea, was limited. In currency policy, for
are factors that point towards a sustained recovery:
example, tensions have escalated. The task of rebuild-
ƒ Non-residential fixed investment is deeply de- ing euro zone institutions is also characterised by major
pressed, even in a longer time perspective. Unlike conflicts. Meanwhile efforts are under way to reform
normal economic expansions, the capital spending the infrastructure of the financial system. International
level in the OECD countries remained rather low bodies are examining the potential for developing new
during the 2006-2007 boom. instruments to make the credit market more stable and
less pro-cyclical. Several boxes and our Theme article
ƒ Balance sheets, especially in large American corpo- discuss these issues later in this report.
rations, are much stronger than normal. This will
make larger self-financing of capital investments Current accounts
possible, facilitating the upturn while the financial Per cent of GDP
12.5 12.5
system remains relatively fragile.
10.0 10.0
ƒ Historical associations signal that capital spend-
7.5 7.5
ing growth is more dependent on the change in
5.0 5.0
capacity utilisation than on its actual level. This
2.5 2.5
indicates that a recovery in fixed investments may
0.0 0.0
begin at an earlier stage.
-2.5 -2.5
US: Non-residential fixed investments
-5.0 -5.0
As a percentage of GDP, current prices
-7.5 -7.5
14.5 14.5
99 00 01 02 03 04 05 06 07 08 09
14.0 14.0
13.5 13.5 China Euro zone Sweden
13.0 13.0 US Japan
Source: IMF
12.5 12.5
12.0 12.0
Fundamentally, the challenges are all about getting to
11.5 11.5
grips with the imbalances and systemic deficiencies
11.0 11.0
10.5 10.5
that triggered the crisis, but also easing the impact
10.0 10.0 of the somewhat uncoordinated stimulus policies
9.5 9.5 now being implemented, which themselves create new
9.0 9.0 problems.
70 75 80 85 90 95 00 05 10
Many countries face a two-dimensional challenge when
Source: US Department of Commerce
it comes to contributing to a rebalancing of the world
Although US small businesses are still suffering from economy. It is a matter of formulating fiscal, monetary
fairly restrictive credit conditions, we thus foresee and structural policies in ways that contribute to better
good capital spending growth as an important driving balance, both short- and long-term and in a national
force for economic expansion during a period when the and international perspective.
inventory cycle is losing momentum. Meanwhile a heal-



Internal rebalancing is a matter of phasing out pub- economy: overly aggressive stimulus policies in low in-
lic stimulus and aid policies as soon as more private terest rate countries or an excessively cautious commit-
investments and consumption can take over as growth ment to domestic driving forces in surplus economies.
engines. External rebalancing, for some countries, is
a matter of such steps as reducing their dependence Some of the drawbacks associated with extreme stimu-
on consumption-driven growth and increasing their lus measures have thus appeared earlier than expected.
dependence on exports. For others, such as China, it is These effects, in the form of a weaker US dollar and
the opposite: reducing dependence on exports in favour rising commodity and asset prices, do not primarily af-
of domestic demand. fect the countries that implement such measures, but
affect other parts of the world via global transmission
Mounting currency-related tensions mechanisms.
The world economic situation, with rapid growth in
The main targets of criticism are excessively cautious
many emerging economies as well as continued dif-
Chinese currency policy, on the one hand, and overly
ficult financial problems and a fragile recovery in large
aggressive stimulus programmes in the US, on the other.
portions of the OECD countries, requires a wide variety
At the G20 summit in Seoul, the US tried to launch a
of suitable political medicines. The forces driving
proposal to restrict how large a country’s current ac-
currency movements have been dominated by these
count surplus or deficit could be. A proposal to establish
cyclical differences. Currencies have appreciated in
such a restriction equivalent to 4 per cent of GDP was
countries with strong government finances and where
voted down, but the IMF will continue examining similar
the central bank has been able to withdraw part of its
ideas and will report back to the next G20 summit. It is
monetary stimulus. In many cases, these are countries
obvious, however, that international political coopera-
with large commodity exports that have benefited from
tion is not strong enough at present to resolve all the
high prices. Fundamentally, this is a trend that often
disagreements that have arisen.
contributes to better global balance, since many prob-
lem countries receive a little extra help from exports,
Emerging economies will remain the
whereas currency appreciation cools off rapidly-growing
economies.
engine
Emerging economies, especially in Asia, will continue
In recent months, however, this trend has led to more to serve as the largest engine in the world economy.
troublesome consequences, resulting in currency policy During the next couple of years GDP will increase by
tensions − sometimes described as “currency war”. One 6-7 per cent in emerging economies, compared to OECD
basic reason for this is the ultra-loose monetary policy growth close to the trend level: about 2½ per cent. As
being pursued in the US, the euro zone, Japan and a share of global GDP, Asian emerging economies have
the UK, culminating in the Fed’s quantitative easing. now climbed to just below one fourth. The proportion
Because of the “search for returns”, surplus liquidity of global exports destined for these economies has risen
migrates to countries with higher potential returns. from less than 5 per cent in 1980 to nearly 15 per cent.
This increases currency appreciation pressures in
export-dependent countries, especially in Asia. These Asian emerging economies
countries have responded by resorting to currency As a percentage of the global economy
interventions. In recent months, various countries have
also used financial regulation, tariffs and taxes to stem 1980 1990 2000 2009
the inflow of foreign capital. GDP 7.9 11.0 15.1 22.6
Exports 4.7 5.5 9.5 15.9
In the OECD, there is a milder version of the same
dilemma for countries that are now on the way towards Imports 4.6 5.7 8.3 14.5
slowly tightening their monetary policies. In the pre- Accumulated
vailing low-inflation environment, currency apprecia- direct investments 4.4 4.9 6.0 8.3
tion has helped squeeze inflation to levels perceived as NOTE: South Korea, Hong Kong, Singapore and Taiwan are
uncomfortable. Central banks are thus abstaining from classified as developed and are not included here.
normalising interest rates to the extent that domestic Sources: IMF, UNCTAD, SEB
factors would justify. This also applies to Norway and
Sweden, for example. Among the 10 largest economies, Asian emerging economies largely managed to avoid
Australia is now the only one that has not cited cur- the downturn that affected the OECD countries during
rency rate trends as a reason to slow the pace of its key the crisis years, then began a rapid recovery. This is
interest rate hikes. due to several factors. The role of intra-regional trade
has increased. Meanwhile improved macro policies and
Disunity on policy conclusions greater flexibility have made these economies more
One reason why international cooperation has seized up resilient in the face of global downturns. From a growth
this autumn is differences of opinion about what is the standpoint, the potential for “decoupling” − with dif-
fundamental reason behind the imbalances in the world ferent growth paths for emerging economies and OECD
countries − has increased.



Ireland the focus of new debt worries
Market worries about European sovereign debt Yet the underlying situation in Ireland and Portugal
problems have intensified again. Rising risk premi- is not as serious as in Greece. The two countries
ums for Ireland and Portugal have pushed up their have lower government debt and better underlying
government bond yields to levels well above those credibility. They consequently have a good chance of
prevailing before the bail-out package for Greece and avoiding defaults or debt write-downs. IMF studies
the European Financial Stability Facility (EFSF) were show that markets often overreact in crises and that
launched last spring. the upturn in yields is not due to bad fundamentals
alone. International aid also provides political leaders
Renewed market worries
Yield spread vs Germany, 10-year government bonds
with a form of backing that enables them to imple-
10 10 ment unpopular belt-tightening measures.
9 9
8 8 Ireland and Portugal are also such small economies
7 7 that the financial aid mechanisms now in place will
6 6 be able to deal with their problems. Instead, devel-
5 5 opments in Spain will determine whether the Euro-
4 4
pean debt crisis will again dominate global financial
3 3
2 2
markets. The sovereign debt problem is smaller in
1 1 Spain than in the other PIIGS countries (Portugal,
0 0 Ireland, Italy and Greece). On the other hand, Spain
Oct Jan Apr Jul Oct Jan Apr Jul Oct has a larger external debt burden if the private sector
08 09 10
France Ireland Portugal is also included. Signals of renewed economic weak-
Greece Italy Spain ness are also especially serious in a situation where
Source: Reuters EcoWin
unemployment is around 20 per cent.
The banking crisis has made the situation acute in
Ireland. Costs related to saving the banking sector Although our main scenario is that Spain will manage
will push up the Irish government budget deficit to without international help, there will be continued
more than 30 per cent of GDP this year: money that uncertainty ahead. Wider yield spreads between euro
has not yet been borrowed in the market. Excluding zone countries will probably also persist during the
bank support, the deficit is more than 10 per cent of foreseeable future. The market has learned the les-
GDP. The uncertainty surrounding Ireland’s banking son that even in the euro zone, risks must be priced
system showed to be too large for general govern- on the basis of the conditions in each respective
ment austerity programmes to calm the markets. country. European institutions also seem to need a
Ireland, EU and the IMF have now agreed on a sup- certain level of pressure from market forces in order
port package. The details are not yet known, but will to muster the strength to reform the Stability Pact
temporarily calm down market worries. Thereafter and establish a credible rule system.
though, the focus will probably shift to Portugal.

But at the same time as emerging economies have of the yuan by 4 per cent against the USD during the
shown increasing resilience, world economic integration coming year, but this is unlikely to do much to mollify
has continued to increase. This applies both to the real critics who accuse China of pursuing an excessively rigid
economy via trade flows and direct investments and to currency policy.
the financial sphere via short-term capital flows and in-
tegrated capital markets. Financial integration has been Nordic fundamentals are paying off
an important prerequisite for the rapid growth trend of The Nordic countries are continuing to benefit from
the past decade. During 2010, however, its drawbacks strong economic fundamentals, especially their low
in the form of capital flows that lead to sharply ap- sovereign debt levels. Their export structure, both in
preciating currencies and bubble tendencies in asset terms of sectors and countries, also puts them in a good
markets have become apparent. position to take advantage of the global recovery. In our
assessment, these countries will also cope well with the
In the short term, Asian countries are trying to soften appreciation of their currencies this autumn.
the impact of these phenomena by using both domestic
tightening measures and capital controls. In the long We are revising our Nordic growth forecasts upward.
term, the best medicine is to increase the role of do- In Sweden, GDP will increase by 5 per cent this year,
mestic demand in growth, thereby making these econo- significantly faster than in other EU countries. During
mies less dependent on exports and currencies. Looking the next couple of years, too, we expect GDP growth to
ahead, we expect Chinese currency policy to play some be above trend. In the other Nordic countries, growth
part in this. The pace of yuan appreciation will remain will be more subdued. Strong exports will enable the
cautious, however. We expect China to boost the value Danish economy to continue growing by more than 2



per cent a year, despite fiscal tightening. In Finland, Our assessment is that Latvia and Lithuania will join the
the economic recovery has gained strength in recent euro zone in 2014, in keeping with their ambitions.
months. We now see prospects for GDP growth of 3 per
cent in 2011. As in Sweden, this growth will be broad- More symmetrical inflation risks
based. The Norwegian economy will grow by more Rising commodity prices and the Fed’s quantitative
than 2 per cent a year, but high resource utilisation easing programme have contributed to growing uncer-
is already beginning to limit supply-side potential in tainty regarding inflation trends in the OECD countries.
Norway. Inflation expectations, measured as break-even inflation
in the index-linked bond market, have also risen − espe-
cially in the US.
GDP growth, Nordic and Baltic countries
Year-on-year percentage change A mechanistic calculation indicates that a commod-
2009 2010 2011 2012 ity price upturn might push up inflation as much as 2
percentage points, but in recent decades the impact
Sweden -5.1 5.0 3.5 2.5
of commodity prices at the consumer level has been
Norway -1.4 0.5 2.3 2.2 rather small. Low resource utilisation is one reason why
Denmark -4.7 2.2 2.2 2.1 the impact of commodity prices is unlikely to be larger
this time around. Taken together, we have adjusted CPI
Finland -8.1 2.7 3.0 2.8
inflation upward by 3-4 tenths of a percentage point
Nordics -4.5 2.7 2.8 2.4 in the US and the euro zone as a consequence of the
Estonia -13.9 2.5 4.0 4.0 commodity price increase, especially via the impact of
Latvia -18.0 -0.3 4.0 5.0 higher oil and food prices.

Lithuania -14.7 1.0 4.0 4.5 Core inflation will remain low
Year-on-year percentage change
Baltics -15.6 0.9 4.0 4.5
3.0 3.0

Source: OECD, SEB 2.5 SEB 2.5
forecast

Gradual recovery in the Baltic countries 2.0 2.0
After their extreme economic downturn in 2009, all
1.5 1.5
three Baltic countries showed positive year-on-year
GDP growth during the past two quarters. We continue 1.0 1.0
to predict a gradual export-led recovery. Meanwhile
domestic demand is beginning to thaw. The Baltics 0.5 0.5

have restored their competitiveness after success- 0.0 0.0
fully applying an internal devaluation policy, but the 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
growth of private consumption and capital spending will
Euro zone US
be sluggish due to public sector pay freezes in 2011, Source: Eurostat, BLS, SEB

high unemployment including structural problems and
continued private debt retirement. The Fed’s expansion of its balance sheet has provided
new fuel for discussion about the risk of triggering
US: The credit channel has stabilised inflation by printing money and boosting the money
Ratio, year-on-year percentage change
supply. Broad money supply aggregates have again
12 12 begun to grow, but still at a very slow pace. The credit
multiplier also seems to have started rising again but is
10 10
not far from its lows. Our conclusion is that monetary
8 8 measures are signalling lower deflation risk but that
6 6
there is still plenty of time for the Fed to withdraw li-
quidity if a real-term upturn should take off in earnest.
4 4
We have revised our overall inflation forecast slightly
2 2
upward and consider the risk picture more symmetrical
0 0 than before. But most indications are still that infla-
86 88 90 92 94 96 98 00 02 04 06 08 10
tion will remain low during the next couple of years.
M2 money supply Resource utilisation remains low in the OECD, leading to
Credit multiplier (M2/monetary base)
Source: Federal Reserve historically low pay hikes. Unit labour cost is also being
pushed down by cyclical recovery in productivity.
Overall, we expect decent annual GDP growth of
4-5 per cent in the Baltics during the next couple of Central bank stimulus nearing its end
years. Estonia is adopting the euro on January 1, 2011. In the US, the euro zone, Japan and the UK, monetary
stimulus measures remain the most important instru-



ment for safeguarding economic recovery. Low underly- from zero. The challenge for the central banks will be
ing inflation pressure and stable inflation expectations to achieve maximum impact from their stimulus meas-
will enable central banks to continue their zero inter- ures, on the one hand, while preserving their long-term
est rate policies well into 2012. credibility, on the other. Their strategy for accomplish-
ing this is to emphasise their readiness to resume
Another option is unconventional monetary policy stimulus measures using the relevant tools, but mean-
aimed at keeping the entire yield curve − in nominal while to carefully avoid spelling out their timetable
and real terms − at the lowest possible level as well as for this exit strategy.
keeping inflation expectations at a suitable distance

Calmer commodity price trend the relationship between supply and demand will not
Since the summer, commodity prices have gained new be as strained as in 2006-2008. This indicates that
upward momentum after a brief slump last spring. Saudi Arabia, with its large production reserves, will
Metals and agricultural commodities have climbed continue to have a major influence on prices. Saudi
to new record levels, measured in US dollars. The Arabia’s aim is to keep the price of Brent oil in the
fact that commodity prices, especially oil prices, are USD 70-90/barrel range. We believe that the price
rising so early in the OECD countries’ economic cycle of Brent will end up in the upper part of this range −
may pose a danger to their relatively fragile economic slightly above today’s level.
upturn. What is driving commodity prices?
Index, thousands
We see four main reasons for the rapid price move- 900 12
ments of recent months: 1) Less uncertainty about
the world economic trend. 2) Poor grain harvests 800 10
due to weather effects. 3) An increased element of 700 8
speculative trading (especially evident from grain
contracts). 4) The decline in the USD, which creates 600 6
upward pressure on prices, since commodities are 500 4
priced mainly in dollars and producers want compen-
400
sation for USD depreciation. The latter two factors 2

have been closely linked to the Fed’s QE2 measures. 300 0
Jan May Sep Jan May Sep Jan May Sep
High commodity prices 08 09 10
Index, monthly data, USD S&P GSCI Commodity index (LHS)
500 500 Baltic Dry (RHS)
Source: S&P, Baltic Exchange
450 450
400 400
Agricultural prices will be weather-driven for
350 350 another while. Most agriculturally related commod-
300 300 ity prices have soared rapidly this autumn, especially
250 250 cotton, but wheat prices have levelled off after their
200 200 sharp upturn in July-August due to extreme weather
150 150 in two major producer countries, Russia and Ukraine.
100 100 In the short term, there is a risk that the La Niña
50 50 weather phenomenon will affect agricultural produc-
00 01 02 03 04 05 06 07 08 09 10 tion into early next year, thereby pushing prices up
Agriculture Energy
further. But in a more long-term perspective, under-
Industrial metals lying supply and demand conditions point towards a
Source: HWWI
calmer price trend.

This autumn’s commodity rally, which has re- Gold will continue to glitter. Gold prices reached
cently lost some steam, is thus only partially due to new nominal record highs this autumn. Here, too,
fundamental factors. We thus continue to expect a the Fed’s announcement of a new quantitative eas-
more moderate price upturn ahead, with levelling- ing round contributed to a sharp price increase, but
off tendencies later in our forecast period. Another adjusted for inflation, gold prices are nearly 30 per
indication is that this autumn, the Baltic Dry freight cent below their peak levels in the 1980s. We expect
index has shown a downward trend, ending its strong gold prices to remain high due to long-term uncer-
correlation with commodity prices in recent years. tainty about inflation or deflation, the solvency of
countries and the future currency system. World Bank
Oil is climbing towards USD 90. In their latest representatives have indicated that they are open to
monthly reports, the International Energy Agency allowing gold to regain some kind of role in a re-
(IEA) and the Organisation of Petroleum Exporting formed global currency system, and this may push up
Countries (OPEC) both adjusted their 2011 global oil gold prices further.
demand forecast slightly upward. In spite of this,



− for example by way of higher commodity prices and
Unit labour costs
wages. The low-return environment in the West is also
Year-on-year percentage change
9 9
triggering unwanted capital inflows that lead to unde-
8 8 sirably strong currencies and increase the risks of as-
7 7 set bubbles. The room for continued interest rate hikes
6 6
is limited by appreciation pressure. In some countries,
5 5
4 4 capital controls − now an acceptable policy tool − are
3 3 one way of protecting their currency.
2 2
1
0
1
0
Slower pace of Nordic key rate hikes
-1 -1
The differences in monetary policy conditions between
-2 -2 the major OECD countries and Sweden and Norway are
-3 -3 also becoming increasingly clear. Developments in these
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 two Nordic countries show a number of similarities with
Europe (OECD countries) US certain Asian countries. Rapid domestic credit growth
Source: OECD
and a risk of housing market bubbles justify higher inte-
rest rates. But wider key rate spreads against the major
OECD countries imply currency appreciation, among
Looking ahead, central banks will emphasise that other things resulting in slower inflation. The central
expanding their balance sheets is still part of the banks in Sweden and Norway may thus indirectly be
monetary policy arsenal. Japan is closest to expanding forced to adjust their interest rates to those in other
quantitative easing, while the probability of new QE countries in order to avoid an excessively strong cur-
rounds from the Fed or Bank of England is far smaller. rency.
We expect the European Central Bank (ECB) to limit
itself to offering liquidity and accepting government Financial conditions less expansive in Sweden
securities as collateral for borrowing from the ECB. Rebase 100 = 2003:3
103 103
Tighter conditions
Key interest rates 102 102
Per cent 101 101
7 7 100 100
99 99
6 SEB 6 98 98
forecast
97 97
5 5
96 96
4 4 95 Easier conditions 95
94 94
3 3 93 93
2 2 92 92
03 04 05 06 07 08 09 10
1 1
US Sweden Euro zone
0 0 Source: SEB
00 02 04 06 08 10 12
For a long time, the situation of Norges Bank in Norway
Euro zone US
Source: ECB, Fed, SEB
has been characterised by this dilemma. In a gentler
form, it is also beginning to be true of Sweden’s Riks-
Our assessment is that the QE programmes now in bank. In its latest Monetary Policy Report, the Riksbank
place will be carried out but that unconventional adjusted its key interest rate path downward, stating
monetary policy will then be nearing its end. New more explicit references than previously to internation-
purchases of government securities will be increasingly al uncertainty and the consequences of interest rate
controversial. Because many countries regard QE as a hikes for the krona. Looking ahead, we expect the
substitute for currency intervention, new programmes Riksbank to deliver rate hikes largely in accordance
may jeopardise G20 collaboration and coordination, with the path it has now announced. This means that
thereby escalating currency policy tensions. Meanwhile we are not significantly changing our forecast from the
the justification for new monetary stimulus is dimin- last Nordic Outlook.
ishing, since market lending conditions have actually
improved, though not normalised. Growth and inflation We expect the Riksbank to hike its key rate in Decem-
risks have become more symmetrical, which points in ber and February, thus reaching a rate of 1.50 per cent.
the same direction. After that, hikes will be less frequent, mainly due to
the risks of an excessively strong krona. By the end of
Central banks in emerging economies often face a dia- 2011, the repo rate will stand at 2.25 per cent and by
metrically opposite set of problems, compared to those the end of 2012 at 3.0 per cent. Our forecast is thus
of major OECD countries. There is a risk that domestic higher than today’s prevailing market pricing.
bottlenecks will spread, boosting inflation pressures



Because of low inflation in Norway, we expect Norges Funding requirements, PIIGS countries, 2011
Bank to hold off until next summer before resuming EUR billion
rate hikes. Towards the end of 2011 the deposit rate Maturing Net Total
will reach 2.50 per cent. We expect Norway’s output loans lending (% of GDP)
gap to be closed by early 2012; for this reason we Greece 38.5 20.0 25.1
expect a slightly faster pace in the bank’s rate hikes. By Ireland 4.4 22.6 16.7
late 2012 the deposit rate will stand at 3.75 per cent. Italy 279.4 75.2 22.2
Key interest rates Portugal 26.2 13.1 22.7
Per cent
Spain 124.5 90.4 20.2
7 7
Source: Bloomberg, SEB
6 SEB 6
forecast
5 5 In the short term, the recommendations of the EU, IMF
and other bodies are also cautious − reflecting a desire
4 4
not to interrupt the fragile recovery with excessively
3 3 synchronised austerity policies. This means that coun-
2 2 tries in a position to do so are being asked to postpone
belt-tightening or even stimulate the economy.
1 1

0 0 Overall, fiscal policies appear likely to be mildly con-
00 02 04 06 08 10 12 tractive during the next couple of years. In some of the
PIIGS countries the dose of austerity is very large, and
Euro zone Norway Sweden
Source: ECB, Norges Bank, Riksbank, SEB it is also likely that further measures will be necessary.
Among major countries, only the UK has decided to
Because the two central banks will carry out relatively
implement a large austerity package. In countries like
cautious rate hikes due to the risks of strong currencies
Germany and France, very modest austerity measures
and low inflation, home prices will continue upward
are being implemented. In the US, we expect an agree-
in Norway and Sweden. This will increase the risk of
ment to extend the Bush administration’s tax cuts to be
painful corrections ahead. Certain other steps are being
reached at the last minute. In spite of this, federal fis-
taken to slow the price trend, for example the recently
cal policy will have a tightening effect equivalent to
enacted loan-to-value ceiling on mortgages in Sweden.
about 1 per cent of GDP. In Japan, the government has
Given Sweden’s strong central government finances, a announced new stimulus measures this autumn despite
policy mix that includes faster key interest rate hikes huge government debt.
and a more expansionary fiscal policy would be an
alternative, but at present the Riksbank and the gov- Net lending
ernment do not seem prepared to change their division Per cent of GDP
of responsibility in Sweden’s stabilisation policy. This 2010 2011 2012
is despite the fact that such an arrangement would be
United States -11.1 -9.7 -6.9
well in line with international discussions concerning
today’s imbalances, but also with lessons about the Japan -9.8 -9.1 -8.5
importance of not allowing lending and home prices to United Kingdom -11.4 -9.4 -7.6
expand for too long. Euro zone -6.2 -5.5 -5.0

Different fiscal strategies OECD -7.8 -6.7 -5.5
The global financial and credit crisis pushed public sec- Source: OECD, IMF, SEB
tor deficits and debts to unsustainable levels in many
countries. In the long term, major belt-tightening will Major countries are apparently not being pressured by
thus be necessary. For example, IMF calculations indi- financial markets to speed up their austerity measures.
cate that current deficits combined with demographic Interest rates have remained depressed, despite the
strains will require austerity measures in the range large supply of government securities. This will enable
of 6-9 per cent of GDP in order to stabilise govern- these countries to prop up their economies to a fairly
ment debt in the G20 countries. The severe crisis in the high degree during the next couple of years and
PIIGS countries also show that immediate measures are thereby postpone their adjustment burdens.
needed to ease acute financial mistrust.
Long-term yields sideways next six
months
Globally, government bond yields fell sharply during
the first eight months of 2010. During the spring, the
accelerating crisis in the PIIGS countries drove down



long-term yields in major OECD countries. After that, a their German equivalent at 3.40 per cent.
gloomier economic outlook in the US provided new mo-
mentum for this trend. By the end of August, the yield We expect Nordic government bond yields to climb
on 10-year German government bonds bottomed out at somewhat faster. Partly because of continued key rate
around 2.10 per cent, well below prevailing yields when hikes, the spread between Swedish 10-year bonds and
the financial crisis culminated late in 2008. German ones will widen from today’s 25 to 50 basis
points by the end of 2012. The equivalent Norwegian
With a certain time lag, American bond yields have also spread will rise from around 65 to 90 points in Decem-
fallen: from 4 per cent in April 2010 to 2.4 per cent ber 2012.
in early October. Increasingly clear signals that the
Fed was preparing new QE measures initially helped Fundamentals still controlling
give yields an extra downward push. Once the size of currencies
the stimulus programme was announced, bond yields In the past year, fundamentals have been the main driv-
bounced back upward by 40-50 basis points in both ing force in the foreign exchange market. Currencies
the US and Germany. More stable economic signals have appreciated in countries with strong govern-
in the US, combined with a normalisation of inflation ment finances and where the central bank has been
expectations, also contributed to the yield upturn. able to withdraw part of its monetary stimulus. In
The phase-out of the ECB’s liquidity measures has also many cases, these are countries with large commod-
driven yields in Germany. This has been especially true ity exports that have benefited from high prices. In
of yields on short-term bonds, but long-term yields have recent months this more or less natural trend has led to
also been affected to some extent. troublesome consequences, resulting in currency policy
tensions − sometimes described as “currency war”.
10-year government bond yield
Per cent
Looking ahead, we believe that exchange rates will
7.0 7.0
continue to be driven by growth and interest rate
6.5 6.5
SEB differentials. In this environment, the G3 currencies
6.0 forecast 6.0
(USD, EUR and JPY) and the British pound will be losers
5.5 5.5
in the immediate future. Of this group, we expect the
5.0 5.0
4.5 4.5
USD to continue to be pulled down by the Fed’s poli-
4.0 4.0
cies for another while, but we do not anticipate any
3.5 3.5
surprises. The USD is thus relatively close to bottom-
3.0 3.0 ing out. We expect the EUR/USD exchange rate to be
2.5 2.5 back above 1.40 early next year. After that, strong US
2.0 2.0 economic growth combined with lingering debt prob-
99 00 01 02 03 04 05 06 07 08 09 10 11 12 lems in the PIIGS countries will cause the EUR/USD rate
to fall again towards 1.25 or 1.30. The pound will also
US Germany
Source: Reuters EcoWin, SEB see a similar trend against the euro: further short-term
weakening, then a return to more fundamentally justi-
We do not expect bond yields to revert to their late-
fied levels of around GBP 0.80 per euro.
summer lows. Worries about a new US and global reces-
sion will gradually fade in 2011, while the upturn in Exchange rates
commodity prices will help dispel risks of deflation. Index 100 = July 2007
160 160
Yet there are reasons to expect continued low bond 150 150
yields ahead. Central banks will be pursuing very 140 140
expansionary monetary policies, and a normalisation of 130 130
key interest rates is far away in time. The Fed’s bond 120 120
110 110
purchases will also help hold down bond yields in the
100 100
US, and the Fed will also continue to be prepared to 90 90
act if an upturn in long-term yields should threaten 80 80
the economic recovery. Our forecast of a continued 70 70
decline in core inflation during much of 2011 also points 60 60
towards continued low yields. Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov
07 08 09 10
EUR SEK USD
Our conclusion is that bond yields both in the US and GBP NOK JPY
Germany will remain at today’s levels until the second Source: Reuters EcoWin

half of 2011. Only when the time for central banks to
As for the USD/JPY exchange rate, the trend towards a
hike interest rates begins to move closer will long-term
stronger yen is probably close to ending. We expect the
yields climb cautiously. By the end of 2012, 10-year
USD/JPY rate to remain in the vicinity of 80 for another
US Treasury yields will stand at 3.60 per cent and



while and then gradually move towards 100 as American
Stock markets still below 2007 peaks
long-term yields slowly creep upward. Rebase 100 = 2007:7
120 120
The Riksbank’s lowering of its key interest rate path
110 110
in October contributed to a temporary reversal in
100 100
the Swedish krona appreciation trend, but we expect
90 90
this appreciation to regain its strength as the Riks-
80 80
bank delivers further key rate hikes in December and
70 70
February. We believe that because of continued good
60 60
export growth and a favourable valuation, the EUR/SEK 50 50
exchange rate will reach 9.00 during the first half of 40 40
2011 and then continue to 8.75 by the end of 2011. 30 30
Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct
The Norwegian krone has lost ground recently, since 07 08 09 10
both monetary policy and the flow outlook have wors- US Emerging markets
ened. Norges Bank has underscored its displeasure while Euro zone Sweden
Source: Reuters EcoWin, SEB
carrying out large sales of NOK on behalf of the Govern-
We see potential for a continued stock market upturn.
ment Pension Fund of Norway. In the next few months,
Low interest rates have helped boost the valuations of
the flow outlook in particular will improve. We foresee
nearly all other asset classes (commodities, bonds etc.),
a move towards an EUR/NOK rate of 8.00 by the end
but so far equities have only followed profits, without
of 2010. After that, the EUR/NOK rate will continue
any extra multiplier effect. Nordic companies also have
to 7.75 by late 2011 and 7.50 by late 2012.
relatively low valuations. Share prices of Nordic listed
Equities benefiting from low interest companies divided by carrying amount (book value) are
15 per cent below their 10-year average, according to
rates SEB Enskilda’s forecast. It is reasonable to believe that
Low interest rate policies around the world and
next year, share prices will move in such a way as to
strong balance sheets, together with decent world
bring valuations closer to the 10-year average. It should
economic growth − driven by expansive developing
be added that profits are expected to increase at a
economies − have sustained strong stock markets during
healthy pace; in 2012 an increase of about 10 per
the past year. The Fed’s QE announcement in August
cent is expected. Nordic export companies will be able
helped stock exchanges worldwide regain their upward
to continue taking advantage of increased exposure to
momentum. American share price indices have climbed
emerging markets.
more than 10 per cent since late August, but the formal
decision to launch QE2 provided no further stimulus for At the same time, there are reasons to bear in mind
the stock market; the decision was expected. various risks, included flare-ups of financial worries
in Europe. The risk of a global trade war has not been
Macroeconomic strength, combined with an advanta-
entirely averted. Another risk is that the profit growth
geous sectoral and market exposure, contributed to
expected by companies may turn out to be too high,
favourable performance on Nordic stock exchanges. In
but this is offset by a significant upside risk for company
recent weeks, share prices have moved sideways. Be-
sales growth estimates. Overall, most indications are
cause of high expectations, company earnings reports
that Nordic stock exchanges will perform strongly in
for the third quarter were not able to boost share
2011.
prices in general, despite higher profits and a surpris-
ingly strong volume trend. The appreciation of Nordic
currencies also contributed to a more subdued stock
market trend.



Basel III update
In November 2010, the G20 heads of state and gov- in order to avoid regulatory restrictions on their
ernment who met in Seoul gave the green light to operations. In addition, depending on economic and
the implementation of Basel III, based on a proposal financial circumstances, the authorities may imple-
by the Basel Committee on Banking Supervision. ment a counter-cyclical capital buffer, which may
This decision will mean a gradual phase-in of tighter vary between 0 and 2.5 per cent. If all these capital
capital adequacy rules (starting in January 2013) and adequacy requirements are fully implemented, this
new global minimum liquidity rules (starting in 2015) means that the level of core Tier 1 capital will be
by 2018. The purpose of Basel III is to strengthen the raised from 2 to a maximum of 9.5 per cent and for
resilience of the banking sector, prevent excessive Tier 1 capital from 4 to 11 per cent. The situation will
risk-taking and leveraging and reduce the pro-cyclical also include a stricter definition of what should be
effect of the financial system on the real economy. regarded as capital.

In the long term, these changes will create greater The liquidity rules are based on two measures: The
stability both in the financial system and in the real liquidity coverage ratio and the net stable fund-
economy. Because there will be increased competi- ing ratio. The first measure requires a bank to hold
tion for capital, however, it will lead to higher inter- enough liquid assets to survive 30 days of major
est rates, lower capital supply and resulting costs funding problems. The second measure is aimed at
to the real economy during the transitional period achieving a better balance between the maturities of
2012-2018. There are strong differences of opinion a bank’s assets and liabilities, that is, to ensure that
as to the magnitude of these effects, but the exten- available stable funding will be larger than the need
sion of this transition period compared to the original for such funding. In addition to these measures, a
December 2009 proposal will reduce such adverse leverage ratio will be tested, specifying that capital
effects. must exceed 3 per cent of the bank’s exposures.

In brief, Basel III will mean that the minimum require- For Nordic banks, the most significant features of
ment for the core Tier 1 capital ratio will be raised Basel III are the changes in liquidity rules. More
from 2 to 4.5 per cent of a bank’s risk-weighted as- long-term, stable borrowing via an amended borrow-
sets. The requirement for Tier 1 capital will be raised ing structure and longer maturities will increase the
from 4 to 6 per cent. In addition, banks must hold a expenses of banks. This will affect interest rates for
capital conservation buffer of 2.5 per cent of risk- borrowers as well as the profitability of the banking
weighted assets. This means that banks must have sector.
total common equity of at least 7 per cent


Theme

Greater need for new monetary system
ƒ Meagre Seoul summit but progress in 2010 The contours of a new monetary system
The world has gone without a formal international mon-
ƒ New global monetary system on agenda
etary system for nearly 40 years. The Bretton Woods
(BW) system was ended in 1971 after having been
operating since 1945. BW was a global fixed exchange
This autumn the climate of cooperation among the rate system anchored by the US dollar, and indirect by
Group of 20 countries has deteriorated. There are gold. This system also resulted in the establishment of
several reasons for this worrisome disunity. The need the International Monetary Fund. The IMF was assigned
for private and public debt retirement is hampering the the task of focusing on balance of payments problems,
domestic growth dynamic in many countries, increasing currency policy and free trade in order to promote eco-
their dependence on exports and thus tempting them to nomic growth and trade, generate income and jobs and
weaken their currencies in various ways. There is also stop competitive devaluations.
genuine disagreement among G20 countries about the
actual causes of their shared imbalances and systemic For four decades, the US dollar has remained the de
problems. Many countries have weak governments, also facto anchor in the “non-system” that followed BW.
making it harder to implement politically demanding But this question has been raised: Does the world need
belt-tightening and structural reforms. a new multilateral monetary system in order to reduce
economic imbalances and return to high and stable eco-
But on some points, the G20 summit confirmed progress nomic growth? The G20 has entrusted the IMF − during
made in recent international discussions, for example, France’s G20 chairmanship in 2011 − to present propos-
the decision to introduce new capital adequacy and als on the mechanisms for a new system.
liquidity requirements for banks (Basel III). In addition,
power relationships in the International Monetary World trade volume
Fund (IMF) have been modernised to give emerging
economies a greater say. The G20 also decided that World Trade Monitor,
concrete country-specific economic policy action plans index 100 = 2000, seasonally adjusted
should be established. This will strengthen the Mutual 250 250
Assessment Process (MAP), which will continuously World trade total
Emergning economies
evaluate countries to establish whether they are pursu- 200 Advanced economies
200
ing policies that adversely impact other countries.
150 150
G20’s 2011 focus under French leadership
Looking ahead, the G20 has identified a number of is-
100 100
sues that will dominate its work until the next summit
in Cannes late in 2011. Some of the key issues are:
50 50

1. The IMF, Bank for International Settlements (BIS) and
Financial Stability Board (FSB) will propose new tools to 0 0
91 93 95 97 99 01 03 05 07 09
reduce financial sector risk levels, based on a systemic
perspective, to be reported to G20 finance ministers Source: Netherlands Bureau for Economic Policy Analysis
and central bank governors at their next meeting.
We see four main reasons why the issue of a global
2. The IMF will examine and propose guidelines on how monetary system has been raised again:
to identify when a country is showing excessively large
current account surpluses or deficits. The American 1. A decade of rapid globalisation has made countries
proposal for quantitative restrictions on acceptable cur- highly economically and financially interdependent.
rent account surpluses or deficits (which was admittedly There is a great need for cooperation in many areas to
rejected in Seoul) is an example of the kinds of issues avoid disruptions and reduce the risk of protectionism.
the IMF will further consider.
2. Large differences in the cyclical position of coun-
3. The IMF will examine the need and possible mecha- tries and related financial and monetary policy issues
nisms for a new international monetary system. create international tensions. A new system may not
solve imbalance problems but can help ensure that


Nordic Outlook November 2010

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Nordic Outlook November 2010