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Macro Research
December 5, 2013
Macro Forecast
Central banks on divergent tracks
US: Unemployment to hit Fed’s threshold in H2 2014
Eurozone: Heading for deflation?
China: Growth stabilising, reforms on the way
Sweden: Let it grow, let it grow, let it grow...
Norway - a warning bell for Sweden?
Contents Introduction Central banks on divergent tracks 4
FX markets Policy shifts bode for a USD rally 8
US Unemployment to hit Fed’s threshold in H2 2014 10
Eurozone Heading for deflation? 14
United Kingdom Turning the corner 18
Japan Fastest growing economy – so far 20
China Growth stabilising, reforms on the way 22
India RBI to liberalise India’s financial system 24
South East Asia Cyclical pick-up ahead, yet long-term challenges 25
Brazil Persistent pressures 27
Central and Eastern Europe Future convergence at risk 29
Sweden Let it grow, let it grow, let it grow... 31
Sweden Norway - a warning bell for Sweden? 35
Norway Possible interest rate cut in March 38
Finland Recovery despite structural headwinds 40
Denmark Better, but still not great 42
Key figures 44
Disclaimer 47
Contact information
Jan Häggström, +46 8 701 1097, [email protected]
Petter Lundvik, +46 8 701 3397, [email protected]
Gunnar Tersman, +46 8 701 2053, [email protected]
Helena Trygg, +46 8 701 1284, [email protected]
Anders Brunstedt, +46 701 54 32, [email protected]
Eva Dorenius, +46 701 50 54, evdo01@ handelsbanken.se
Knut Anton Mork, +47-2239-7181, [email protected]
Kari Due-Andresen, +47 223-97007, [email protected]
Marius Nyborg Hov, +47-223 97 340, [email protected]
Jes Roerholt Asmussen, +45 4679 1203, [email protected]
Tiina Helenius, +358 10 444 2404, [email protected]
Tuulia Asplund, +358 10 444 2403, [email protected]
http://www.handelsbanken.se/research
Macro Forecast, December 5, 2013
4
Introduction
Central banks on divergent tracks
The global monetary policy landscape has seen diverging tendencies this year, with rate hikes in several
emerging economies while the ECB has cut rates and the Bank of Japan and the US Federal Reserve have
pursued aggressive quantitative easing. Next year, policies in developed countries will be on diverging tracks,
with the Fed starting to move towards less accommodative policies, while the ECB will be on the opposite
tack. Sweden and Norway are more likely to follow the Fed than the ECB.
One of the themes of recent Macro Forecasts has been the divergence of economic out-
looks. The implication has been that monetary policies face very different challenges across
the globe. Rising inflationary pressure has already produced monetary policy responses in
many emerging economies and has also been a factor in the reluctance of the People’s
Bank of China to add stimulus this year and the willingness to accept a stronger renminbi.
That has held back the strength of recoveries in emerging economies.
The challenges facing the central banks in Western Europe, the US and Japan have been
rather similar up until now, but that is gradually changing. The US is leaving many problems
behind, supporting a shift in Fed policy, which we think is imminent. If monetary policy is left
in place for too long in a recovering economy, there is a risk that new bubbles start to form.
The UK has surprised favourably this year, leading markets to price in rate hikes in the not
too distant future. In Japan, the aggressive monetary policy put in place a year ago has
helped push inflation upwards, but the Bank of Japan has to keep buying government bonds
to prevent interest rates from rising. The ECB is years behind and needs to focus on pre-
venting deflationary tendencies and help mend the dysfunctional eurozone credit market.
In the Nordic countries, Denmark is probably still happy to keep very low interest rates to
help household finances and real estate markets recover. Finland is still in a weak recovery
and credit growth is trending down, so the country will likely not find it problematic for some
time that the ECB keeps rates close to zero. Norway and Sweden are different. Recoveries
from the great recessions were relatively strong; low interest rates have contributed to
booming housing markets and rising household debt. Inflation is still well below targets in
both countries, but both central banks forecast rate hikes within a year.
We argued in our August Macro Forecast that rate hikes in Sweden next year are very
unlikely unless the Fed starts to signal hikes and help the dollar appreciate versus the euro
and the Swedish krona. Unilateral rate hikes in Sweden would probably strengthen the cur-
rency too much and wreak havoc on the Riksbank’s forecast of inflation returning to target. If
Emerging economies
fighting inflation and
currency appreciation
A three-way fork in
the road
Two camps in the
Nordics
Sweden waiting for
US action
Macro Forecast, December 5, 2013
5
we are right about the Fed next year, we will likely also see the Riksbank diverge from ECB
and Bank of England policies.
Will the Fed spoil the party again for emerging markets?
As the US labour market continues to improve, conditions will soon be in place for the Fed to
start scaling down its monthly purchases of treasuries and mortgage bonds. We look for that to
happen within the coming months. Towards the end of the year, the US economy will most
likely not need ultra-low rates either. That shift will probably be signalled well in advance, fol-
lowing the communications policy adopted by the Fed under Chairman Ben Bernanke.
When Bernanke started to talk in late May about the likelihood that the Fed would start ta-
pering asset purchases within the next couple of FOMC meetings, it came as a big surprise
to most market participants. Readers of our Macro Forecast should not have been surprised,
as we wrote a year ago that such a signal from the Fed was likely to come before the sum-
mer of 2013. Bernanke’s comments in May were not a slip of the tongue, we think, but were
probably intended both as a guide on where Fed policy was heading and as a trial balloon to
see the impact of the policy change signal on financial markets.
The Fed’s view on the impact of bond purchases has been that the effect comes as the pro-
gramme is announced rather than at the time when it is executed. The market reaction to Ber-
nanke’s talk about the end of tapering seemed to confirm that view, as bond yields rose
sharply in the following weeks. The negative term premium, as we estimate it (see our Global
Macro Forecast from August 2013 for details), switched to positive and approached the aver-
age level seen during the five years preceding the start of the Fed’s QE programmes.
The FOMC’s decision on September 18 came as a surprise and bond yields fell back again,
but not by as much as they had risen since May. That would seem to be a logical response,
as the Fed only postponed the start of tapering. Consequently, we do not expect a new ma-
jor leap upwards for bond yields once the Fed actually starts to reduce purchases. Rather,
we see a gradual rise in yields as markets start to prepare for the next shift in Fed policy,
which will be rate hikes.
But what about emerging markets? Those experienced a dramatic reaction in May after
Bernanke started to talk about tapering: currencies fell in tandem with stock markets. At the
Kansas Federal Reserve conference in Jackson Hole, central bankers and leading politi-
cians from emerging economies voiced concern that the Fed did not pay attention to the
impact outside the US of changes in monetary policy. Will we see a repeat of all of that once
the Fed actually starts to move? Will money once again rush out of emerging markets?
We are not so certain. First of all, causality is not so clear. If Bernanke’s tapering talk was
the real reason for emerging market currencies and stock markets falling, why did they re-
cover again in late summer yet developed world bond markets did not? Some would say that
Tapering likely to
start in the coming
months - really
Impact of bond pur-
chases comes on an-
nouncement
Emerging markets
hit by investor exo-
dus at first tapering
announcement…
…but this is unlikely
to happen again
Macro Forecast, December 5, 2013
6
is because the FOMC chose not to start tapering on September 18. But the problem with
that line of reasoning is emerging market currencies and stocks turned around almost one
month prior to the Fed meeting. Were they more forward-looking than the US bond market,
which was taken by surprise on September 18? That is hardly likely.
One plausible explanation is that there were other factors at work, provoking first a decline
and then a recovery for emerging markets. For instance, China started to deliver data that
were worse than expected in May. That would be important for many emerging economies,
especially those selling commodities to China, such as Brazil and Indonesia. In August, Chi-
nese economic data started to turn better than expected. That happened to coincide with
recoveries in emerging market currencies and stock markets. So there are factors other than
the Fed that might explain why emerging markets started to underperform in May and also
why they started to perform better again in August, well before we knew that the Fed would
not start tapering in September.
There is also a second reason why we are not so sure that emerging markets will be so
sensitive once the Fed’s policy shift occurs. The emerging market turmoil in May and June
served to highlight underlying problems with inflationary pressures and lack of reform. Cen-
tral banks in many cases responded by tightening monetary policy to hold back inflation,
helping bring investors back to those markets and boosted their currencies. So credibility for
monetary policy in emerging markets seems to have returned.
However, discussions about the need for structural reforms have also intensified. We cannot
be so sure about the results. Two of the big emerging economies in Asia, India and Indone-
sia, also have elections before the summer, making the outlook for structural reforms still
uncertain. Opinion polls indicate that more reform-oriented politicians are advancing. It
would seem that the market unrest in early summer, for whatever reason it came, was a
warning bell to politicians in emerging economies and one can only hope that it leads to an
increased focus on necessary reforms.
A shift in Fed policies would help the eurozone avoid deflation
There are several reasons why there are deflationary risks in the eurozone. Historically-high
unemployment, especially in the south, is a major factor pushing down wages and prices. It
will take a long time to bring unemployment down to levels where those downward pres-
sures disappear. We do not think that rising inflation in Germany and possibly a few smaller
economies in the eurozone will be enough to offset deflationary tendencies elsewhere.
The ECB is trying to speed up the eurozone recovery but rate cuts do not always help when
households, firms and governments are all trying to consolidate their finances. The weak-
ness of banks, especially in the south, is another reason why low policy rates are not stimu-
lating credit growth. Making banks stronger must be part of the recipe for keeping deflation-
ary risks at bay, but it might take another year before there is any action on this front.
Weak Chinese data
likely hurt in May
Emerging market
monetary policy
credibility is back
Structural reforms a
hot topic
Weak banks…
Macro Forecast, December 5, 2013
7
Inflation in the eurozone has also been held back by the appreciation of the euro. The gen-
eral price level in the eurozone relative to the US and other trading partners has risen this
year. If the euro rises further, deflationary pressures are likely to intensify, so a weaker euro
would be a welcome contribution to reduce risks for deflation.
Short-term interest rates in the eurozone and the US moved in tandem during 2013, but,
even so, the dollar has weakened versus the euro. One of the reasons might be the simulta-
neous expansion of the Fed’s balance sheet and the contraction of ECB’s. An end to QE in
the US and some kind of move towards expanding the ECB’s balance sheet might thus help
reverse euro strength. Signals from the Fed of a change in rate policy would probably
strengthen the dollar versus the euro. We forecast a large decline in the euro next year (see
separate article) for this very reason, so the ECB should not have reason to complain if the
Fed shifts towards less accommodative policies. The longer the Fed delays tapering or the
start of rate hikes, the bigger is the risk of deflation in the eurozone.
Jan Häggström, +46 8 701 1097, [email protected]
…and strong EUR,
slow recovery
No complaints from
the EU if the Fed
gets accommodative
Macro Forecast, December 5, 2013
8
FX markets
Policy shifts bode for a USD rally
Monetary policy has not reflected fundamental economic conditions in the US or the eurozone, in our view.
However, that seems to be about to change in a direction that supports the USD versus the EUR. We have
built an econometric error-correction model that indicates the USD will appreciate by more than 15 percent
versus the EUR in the next 12 months.
We expect differences in economic conditions and policy between the US and the eurozone
to sharply strengthen the USD versus the EUR. Our forecast is that the EUR/USD rate will
hit 1.10 within twelve months and parity within twenty-four months. At present, US GDP is 6
percent higher than its pre-financial-crisis level, while the average q-o-q growth rate for the
first three quarters of 2013 is 2.2 percent in annualised terms. The corresponding numbers
for the eurozone are much worse. The level of GDP is 2.4 percent lower than before the
crisis, while the average annualised growth rate for 2013 is 0.2 percent. The unemployment
rate is 7.2 percent and declining in the US versus 12.2 percent and likely still not at its peak
in the eurozone. Moreover, deflation risks are much higher in the eurozone.
Credit to non-financial businesses, a fundamental factor for economic growth, is currently
expanding in the US and contracting in the eurozone. In the past 12 months, the debt-to-
GDP ratio for those businesses increased steadily in the US but declined in the eurozone.
The difference in credit demand of course is an important reason, but structural factors are
also important. In general, US banks are in good shape, while banks in the eurozone are
undercapitalised. Moreover, monetary policy in the US is still much more expansive than in
the eurozone. The real policy rate is lower, but in addition, the policy rate relative to nominal
GDP growth is also lower.
In the middle of 2009, household debt was elevated relative to GDP. Since then, it normalised
sharply in the US but declined only modestly in the eurozone. Consequently, in the eurozone,
deleveraging will likely continue to weigh on growth, while in the US, residential construction is
already an economic driver, as households are leaving debt problems behind.
For at least the past 6-12 months, monetary policy has not reflected fundamental economic
conditions in the US or the eurozone, in our view. However, that seems to be about to
change in a direction that supports our EUR/USD forecast. The interest rate cut by the
European Central Bank (ECB) on November 7, to a record-low of 0.25 percent, is likely a
starting point for a new, more accommodative policy in the eurozone. At the press confer-
ence after the meeting, ECB President Mario Draghi restated the ECB’s commitment to
keep interest rates at or below current levels for “an extended period” and emphasised that
the bias of monetary policy remains on the downside.
USD to strengthen
sharply vs. the EUR
on differences…
…in economic condi-
tions…
…in financial condi-
tions for businesses
…and in household
debt
Monetary policy is
shifting in the euro-
zone…
Macro Forecast, December 5, 2013
9
On the other hand, the Fed will likely start tapering asset purchases over coming months.
Although such a step will probably be combined with an extension of forward guidance to
maintain the prevailing policy accommodation and prevent longer-term bond yields from ris-
ing, financial markets are likely to interpret such a policy shift as a tightening.
An error-correction regression supports our EUR/USD forecast
We have built a parsimonious econometric error-correction (EC) model that fits data well
and has predictive power outside the estimation sample. The EC model consists of a long-
run equilibrium relation between the EUR/USD rate, the difference in the unemployment rate
between the US and the eurozone and the slope of the German government yield curve (10-
year minus 2-year bonds), where the latter two variables are exogenous. Thus, in our model,
the long-run equilibrium EUR/USD rate is a linear function of the two exogenous variables1.
The short-term dynamics are designed so that part of the gap between the actual and the
long-run equilibrium EUR/USD rate is closed in the following period. Specifically, in the re-
gression, the percentage change y-o-y in the EUR/USD rate is the dependent variable, while
the gap mentioned above, lagged by 12 months, is the explanatory. The actual regression is
of course made in one step to increase efficiency.
If the actual EUR/USD rate is equal to the long-run equilibrium rate, the expected EUR/USD
rate 12 months ahead will not change. If the actual rate is higher than the long-run equilib-
rium rate, the expected EUR/USD rate 12 months ahead will decline (the USD strengthens
versus the EUR). The model accounts for 74 percent of the actual variation during the sam-
ple period (2004-13); the rest is due to a stochastic error term. The predictive power outside
the estimation sample is shown in the left-hand graph above. The out-of-sample forecast for
2011-13 when the estimation sample is shortened to 2004-10 is roughly as good as for the
within-sample forecast.
Our EC model indicates that the USD will appreciate by 16 percent versus the EUR in the
next 12 months. That would correspond to a change from the current EUR/USD rate of 1.35
to 1.13 in 12 months, which is relatively close to our forecast of 1.10.
Only minor changes to our EUR/USD and EUR/SEK forecasts
We make only minor changes to our forecasts, as we foresaw the ECB easing on November 7
that surprised financial markets. Consequently, we maintain our EUR/USD and EUR/SEK fore-
casts. Although Swedish economic prospects are reminiscent of the US in many respects, we do
not expect the SEK to strengthen by as much versus the EUR as the USD. In the future, once the
SEK stabilises, we expect the EUR/SEK rate to fluctuate in a band between 7.75 and 8.25.
Petter Lundvik, +46 8 701 3397, [email protected]
1 Long-run equilibr. EUR/USD = 1.571 + 0.0471*difference in unemployment rate – 0.0993*German yield curve
…as well as in the US
An EC model of the
EUR/USD rate
Equilibrium gaps
shape short-term
dynamics
Predictive power
outside the sample
Model forecast close
to our EUR/USD
forecast
EUR/SEK in a band
between 7.75 and
8.25
Macro Forecast, December 5, 2013
10
US
Unemployment to hit Fed’s threshold in H2 2014
The past three recessions have been caused by financial exuberance. To put a damper on risk-taking, the Fed
will likely start tapering in coming months to weaken the idea in financial markets of a Fed put. We think the
unemployment rate will continue to decline faster than the FOMC is expecting, hitting the Fed’s threshold to
start hiking rates in the second half of 2014 and putting the first Fed hike on the cards for late next year.
GDP growth seems to be back on track after a soft patch in the fourth quarter of last year,
when it almost stalled. Though the fear of falling off the fiscal cliff did not fully materialise at
the end of 2012, tax hikes and automatic sequestration spending cuts created headwinds
that weighed on growth over the first half of 2013. However, those measures also helped get
federal finances in order. The headwinds abated: growth hit 2.8 percent in the third quarter
and will likely remain at rates slightly below 3 percent in the coming years.
Data-dependent Fed to taper in coming months
The FOMC has frequently stated that monetary policy is data-dependent and that forward
guidance, including thresholds to start hiking rates, is not a binding commitment. Thus, at
every meeting the Committee is free to make the appropriate policy decision regardless of
previous guidelines and market expectations. Moreover, the Committee is well aware that
the past three recessions have been caused by financial exuberance and that the seeds of
the next recession are likely already planted in financial markets. At the moment, hardly
anyone believes that the next recession will be prompted by high inflation and the Fed’s
tightening policy to cool the economy. Consequently, searching for information about exces-
sive risk taking or any other form of exuberance is probably a top priority at the Fed.
The costs of the current asset purchasing programme are likely rising as the Fed’s asset
holdings increase. In our view, the Fed should stop all further asset purchases as soon as
possible. Financial markets tend to see them as a Fed put – the idea that the Fed will arrest
increases in bond yields2 by raising the pace of its asset purchases or postponing rate hikes.
That implicit Fed guarantee is lowering the compensation for risk and encouraging exces-
sive risk-taking. At present, complacent investors are focusing more on how much longer the
current monetary policy regime will last and what mix of policy tools the Fed will use in the
future than on the real economy. However, belief in a Fed put is likely an illusion, especially
on a longer horizon. Investors will eventually have to face the real risks of their investments,
which could lead to sharp selloffs of risky assets and a substantial rise in the level of com-
2 The Fed has explicitly stated its ambition to press down longer-term bond yields, on residential mortgages in
particular, while no corresponding assurances have been made for equity markets.
GDP growth back on
track
Past three recessions
due to financial exu-
berance
Investors focusing
more on Fed than on
the real economy
Macro Forecast, December 5, 2013
11
pensation for risk. That is a scary scenario that has the potential to rock the economy.
Moreover, a Fed put could result in a serious misallocation of capital, as it implies that the
pricing of risk does not reflect true risks or even perceived risks. Too much capital could be
allocated to risky financial investment, crowding out productive real-economy investment.
We expect the FOMC to start tapering in the next three meetings. The unemployment rate,
which is likely to continue declining faster than the Committee expects, will probably hit the
Fed’ threshold to start hiking rates in the second half of 2014. A first Fed hike will likely come
late next year. The fact that super dove Janet Yellen is expected to become the next Fed
Chairman after Ben Bernanke is of minor importance. A Fed Chairman has to do whatever it
takes. The present Chairman was nominated by a republican president and hardly anyone
expected him to become a super dove. Under other economic conditions, he might have
been characterised as a hawk. In our view, it is impossible to guess which label Janet Yellen
will get in the future. She might even be characterised as a chameleon.
Sub-par US recovery
The Fed’s aggressive policy response to the financial crisis of 2007-08 likely prevented a
really deep economic contraction. Bernanke has often stated the importance of massive
monetary accommodation to arrest feedback-driven downward sloping spirals that could end
in a 1930s-like depression. The longer a large output gap persists, the more permanent
damage is done to the supply side of the economy and to the working-skills of long-term
unemployed people in particular. According to him, the implication is straightforward. Eco-
nomic policy should be as aggressive as possible in order to minimise the loss of potential
output in the long run. However, Bernanke has driven that perspective to an extreme. In an
unprecedented experiment to fight unemployment, an exceptionally expansive monetary
stimulus has been maintained much longer than ever before.
Fed officials claim that the prevailing monetary policy is working, as, according to them, the
output gap is primarily due to weak aggregate demand. However, we have for some time ar-
gued that the decidedly weak recovery and persistent high unemployment are partly due to
structural factors and not only to cyclical ones. Consequently, boosting aggregate demand by
only monetary measures is not optimal. Our view is definitely not unique. All economists would
welcome structural reforms as a complement to loose monetary policy. Unfortunately, such
reforms have no chance of passing Congress. President Obama has not even tried. Bernanke
has on several occasions appealed to Congress to do its share to speed up recovery, but
overall pressure on Congress has been weak. A major reason is likely the strong focus on
monetary policy and the Fed. Appropriate structural measures could take the form of retraining
programmes for the unemployed and improvements in the education system, including access
to higher education for children from low-income homes and investment in new infrastructure
(for instance, broadening access to high-speed internet).
A Fed Chair has to
do whatever it takes
As aggressive policy
as possible, accord-
ing to Ben Bernanke
Bernanke in favour
of structural reforms
Macro Forecast, December 5, 2013
12
To widen our perspective, we compare the US situation with the Swedish economic crisis in
the early 1990s, which had a very different policy response. In Sweden, a dysfunctional la-
bour market led to high wage increases and inflation, which, combined with a fixed ex-
change rate, eroded global competitiveness. Export-dependent businesses closed down and
unemployment skyrocketed. Public finances, the banking system and the housing market
were hit hard. Eventually, the fixed exchange rate was abandoned and a series of structural
reforms were launched. Ultimately, that led to low and stable inflation, sustainable public
finances, financial stability and high productivity growth. Real bond yields were high during
most of both the economic decline and the recovery, but after the introduction of a floating
exchange rate, the SEK weakened sharply, boosting exports and curbing imports.
In the US, aggressive monetary policy and capital support to the banking system via the
TARP programme fixed the financial system and prevented a really deep contraction, but
the measures did not kick-start business investment and employment. Structural reforms
(i.e. fixing fundamental economic problems) seem necessary to create the conditions for a
strong recovery. The Swedish focus on structural reforms in the early 1990s likely deepened
the economic contraction and made it more protracted, but it did kick-start the recovery.
Expect bond yields to rise but remain historically low
To prevent bond yields from rising sharply, the Fed will likely combine the tapering of its asset
purchases with a change in its forward guidance to maintain the prevailing accommodative pol-
icy. One possibility is to lower the unemployment threshold for starting to hike rates to 6 percent,
from the current 6.5 percent, which would expand the period of low policy rates. However, finan-
cial markets would likely still interpret tapering as the start of a tightening cycle. In May-June of
this year, when the Fed signalled that tapering was imminent, financial markets interpreted that
as a signal of more rapid rate hikes too and long bond yields rose significantly.
When the conditions that affect asset prices change, the price adjustments often take place
in two steps. First, prices adjust partly on the expectation of a change. Then, as the change
is realised, the rest of the price adjustment occurs. The stronger the expectations, the larger
the share of the price adjustment that takes place before the change is actually realised. At
present, financial markets are not pricing in any Fed hikes at all in the coming two years.
The two-year government bond yield (a rough estimate of average short interest rates over
the next two years) is 0.22 percent. If the credit market were to fully price in our Fed forecast
(0.50 percent within twelve months and 1.50 percent within twenty-four months), the two-
year government bond yield would rise to 0.6-0.8 percent. However, it is unlikely that finan-
cial markets would fully price in expectations. In the summer of this year, when financial
markets expected the Fed to taper in October, the two-year government bond yield peaked
at 0.5 percent. Moreover, the 10-year government bond yield topped out at 3 percent.
The longer the Fed waits to taper and hike interest rates, the higher the likelihood that ag-
gressive hikes will be part of an appropriate policy in the future. On the one hand, financial
The US crisis vs. Swe-
den’s in the 1990s
Structural reforms to
kick start recovery
Tapering will be seen
as the start of a
tightening cycle
Moderate rise in
yields if Fed tapers in
coming months…
Bumpy ride if Fed
waits
Macro Forecast, December 5, 2013
13
markets seem to be almost addicted to the Fed put and low interest rates. On the other
hand, they seem to fear sharp selloffs of longer-term bonds and risky assets, which indi-
cates support for a timely start of the tightening cycle. Awareness is growing that interest
rates cannot remain low forever and that the exit from the current monetary regime will likely
become more turbulent the longer the Fed waits to start the long, difficult journey to more
normal and sustainable monetary conditions.
When will the unemployment rate hit 6.5 percent?
The unemployment rate, which peaked in late 2009 at 10 percent, declined faster than the Fed
expected and hit 7.3 percent in October of this year. If the decline were to continue at the
same pace, the unemployment rate would hit 6.5 percent, the Fed’s threshold for starting rate
hikes, in 12 months. In other words, a simple linear extrapolation of the unemployment rate
decline points to a first Fed hike in late 2014, which is exactly in line with our Fed forecast. Be
that as it may, the Fed has emphasised that an unemployment rate of 6.5 percent is not a trig-
ger for hiking rates. If appropriate, policy rates could stay unchanged at their present low levels
long after the unemployment rate has dropped below 6.5 percent.
There is a good chance of the unemployment rate hitting the threshold rate of 6.5 percent
sooner than in 12 months; in other words, in the second half of 2014. The monthly increase
in non-farm payrolls needed to keep the unemployment rate unchanged (the break-even
pace) has declined in recent years. In 2009, the break-even pace was roughly 100,000, but
it has now declined to 50,000. A major reason is slower growth in the labour force due both
to demographic factors and to an increasing number of distressed workers leaving. We es-
timate that dropouts at present amount to 1-2 percent of the labour force.
Key macro indicators
Sources: Macrobond and Handelsbanken Capital Markets
Petter Lundvik, +46 8 701 3397, [email protected]
Percentage change 2011 2012 2013f 2014f 2015f
GDP 1.8 2.8 1.7 2.7 2.9
Public spending -1.0 -1.0 -1.9 1.3 2.0
Household spending 2.5 2.2 1.9 2.0 2.3
Residential investment 0.5 12.9 14.2 12.9 12.6
Non-residential investment 7.6 7.3 2.2 3.8 4.1
Inventory investment -0.2 0.2 0.1 0.1 0.0
Net exports* 0.1 0.1 0.1 0.1 0.0
Unemployment** 8.9 8.1 7.5 6.8 6.2
Core inflation (PCE) 1.4 1.8 1.3 1.8 2.1
*Contribution to GDP growth **Percent of the labour force
Unemployment de-
clined faster than the
Fed expected
Unemployment rate
to hit 6.5 percent in
H2 2014
Macro Forecast, December 5, 2013
14
Eurozone
Heading for deflation?
A surprise drop in October inflation forced the ECB’s hand. Risks of deflation must be taken very seriously
when the policy rate is close to zero. The eurozone is now in a similar bind as Japan has been in for many
years. The price level relative to main competitors is too high but the currency refuses to weaken, so the
domestic price level has to adjust downwards instead. Unlike Japan, unemployment is very high,
contributing to deflationary tendencies. Consequently, we expect the ECB to ease monetary policy further
while the Fed moves in the opposite direction, so a substantial decline in the euro will help prevent deflation.
The eurozone economy bottomed out before the summer, but growth did not accelerate ma-
terially in the third quarter. Sentiment indicators have disappointed a little in recent months,
suggesting that the recovery will remain sluggish. We look for around 1 percent GDP growth
in 2014, implying that growth rates continue around 0.2-0.3 percent per quarter. The upside
is limited by several factors. Weakness in the banking sector is holding back the supply of
credit and the need to reduce debt burdens the private sector, holding back demand. The
ECB’s rate cuts will not do much to stimulate either credit supply or demand, except in
economies that are not saddled with bank or debt problems.
The need for fiscal consolidation is also a factor for weak recoveries in many countries. Fol-
lowing the recommendations from the IMF last autumn, European leaders agreed to hold off
from budget cuts while economies were in recession. As a result, there have been very lim-
ited budget improvements. That will come back to haunt governments now that economies
are recovering.
The budget problems are most acute in Spain, where the central government deficit so far in
2013 is actually larger than in the previous year, despite the implementation of budget cuts and
tax hikes in the second half of 2012. For the Spanish regions and local communities, we only
have data for the first half of 2013, but that is not a pretty picture either. The European Com-
mission now forecasts that the general government deficit in Spain will remain around 6-7 per-
cent of GDP in 2014-16, even though it expects an economic recovery. One of the reasons is
that some of the tax hikes implemented in recent years were temporary and will expire.
That puts the Spanish government in a very awkward position in the run-up to the general
elections in the autumn of 2015. But the alternative, to let deficits keep on running, risks put-
ting Spain in a similar position as Italy, which has a government-debt-to-GDP ratio well
above 100 percent. That would necessitate even tougher budget cuts later on in order to
reach higher primary surpluses. Otherwise, the budget situation would spin out of control.
We look for around 1
percent GDP growth
in 2014
European leaders
agreed to hold off on
budget cuts
Budget problems
most acute in
Spain...
Macro Forecast, December 5, 2013
15
The need for budget cuts also looms large in many other eurozone economies. Even if fiscal
austerity is deferred, the general public knows that they will eventually be hit, which is con-
tributing to holding back consumer spending. It also makes for a situation where political
support for governments remains weak. In France, President Hollande is plumbing new
depths in opinion polls. His policy proposals are met with protests from left and right, farmers
and entrepreneurs. Whether that is a factor behind the recent declines in economic senti-
ment indicators is hard to tell, but government policies certainly do not seem to be helping
the recovery.
The upcoming EU parliamentary elections in May will present an ideal opportunity for voters
to show their discontent with current policies. That overlaps with a period when important
decisions need to be taken about a banking union. As a consequence, there could be re-
newed market tensions. The current calm in bond markets is partly the result of the ECB’s
policies and commitments, but it also reflects no real disturbances to the political process
aiming at a banking union. The big hurdles on that front still lie ahead.
How big are the deflationary risks?
Surprisingly-low inflation numbers in October were one of the factors triggering the ECB rate
cut. Several eurozone countries are already in negative territory, most notably Greece,
where inflation is currently -1.9 percent. Spain just dipped below the zero line on core infla-
tion, but the underlying deflationary tendencies were masked by the VAT hike last year tem-
porarily lifting consumer prices. Both countries have massive unemployment, so downward
pressures on wages is likely to persist for a long time, contributing to falling unit labour
costs, weak income growth and weak domestic demand.
...but budget cuts
also needed in many
other eurozone
economies
New flare-up of mar-
ket tensions?
Greece in deflation,
Spain also dipped
below zero
Macro Forecast, December 5, 2013
16
Germany faces the opposite situation. Unemployment may decline to below 5 percent in
coming quarters, which is certain to put upward pressure on wage costs and prices. The
recently-agreed minimum wage will also contribute to rising inflationary pressures. The
pockets of upward pressures on wage costs and prices are probably too small presently to
offset the downward pressures elsewhere. The ECB did the right thing by cutting the policy
rate, but more needs to be done in order to reduce the risk that the eurozone aggregate
ends up in deflation. There is not much room left to lower policy rates, but there is a lot of
room to push down borrowing rates for households and firms, especially in the weaker
economies. Gaps between bank lending rates and the ECB policy rate have widened in
many countries due to the weakness of their banks.
There is not that much the ECB can do about the financial fragmentation of the eurozone
other than to support efforts to create a functioning banking union. Low funding costs for
banks will certainly help banks’ profits. But an important offsetting factor is that returns on
bank assets will continue to be depressed by write-downs for bad debt. When and how a
banking union will be implemented is still uncertain, so it is unlikely to have much of an im-
pact in the short term on financing conditions in the countries facing deflationary tendencies.
Consequently, the negative impact from bank weakness on employment and domestic de-
mand is likely to persist.
However, the ECB can still make an impact on the general deflationary tendencies for the
eurozone. The exchange rate is an important factor influencing the relative price level be-
tween the eurozone and the rest of the world. The lesson from the UK since 2009 and Japan
during the past year is that quantitative easing can have a dramatic impact on the currency.
For the UK and Japan, a falling exchange rate led to rising import prices and an upward
push for consumer prices. The immediate impact on inflation from currency depreciation is
much larger than the impact from a monetary policy expansion on inflation via higher aggre-
gate demand.
We have argued in previous macro research reports that persistent deflationary tendencies
in Japan were a reflection of the fact that the currency, and consequently the relative price
level, got stuck at too high a level. If relative price level depreciation cannot take place via
the exchange rate, it has to come about via a lower relative rate of inflation. With very low
rates of inflation in the US and Europe, inflation in Japan had to turn negative. Please note
that throughout the long period of deflation, Japan did not really have big slack in the labour
market: the rate of unemployment has been relatively low.
The situation in the eurozone is now similar to Japan’s situation in the years before the big
monetary policy shift started to push down the yen a year ago. That analogy is relevant for
the eurozone relative to other economies and for individual countries within the eurozone.
The euro has remained strong and the price level is too high. Unless the currency drops
sharply, inflation has to be pushed down relative to other countries and the eurozone as a
The ECB did the
right thing by cutting
policy rate, but more
needs to be done
Still uncertain when
and how banking
union will be imple-
mented
Lesson from the UK
and Japan: QE can
have a dramatic im-
pact on the currency
Eurozone now in a
similar situation to
where Japan was...
Macro Forecast, December 5, 2013
17
whole might thus end up in deflation. But between countries in a monetary union, exchange
rate adjustments are by definition impossible, which explains why wages and prices have to
fall in the countries that need to restore their competitiveness – unless they rise in Germany,
of course.
Unlike Japan, the eurozone has large slack in the labour market. Stripping out Germany,
where unemployment may soon lead to higher wage inflation, the unemployment rate in the
eurozone is close to 15 percent, a record-high by a wide margin. Including Germany, unem-
ployment is just over 12 percent, which is also a record. In 2014 and 2015, we do not think
that unemployment will fall by very much, so the deflationary force will remain. The IMF, in
its October economic outlook, actually forecast that the eurozone will not fall below 10 per-
cent in 2018, so downward pressure on wages and prices will be in place for a very long
period unless the ECB acts aggressively.
If the ECB were to undertake some kind of QE and/or the Fed winds down QE and starts
hiking rates, the euro is likely to drop against the US dollar and other major currencies. That
is actually our forecast (see separate article). Moreover, once markets begin to expect Fed
hikes, rates will also move in favour of the dollar versus the euro. Therefore, it is not our
main scenario that the eurozone will find itself in a long period of deflation. But our assump-
tions for the ECB and the Fed, or the exchange rate impact of a shift in relative monetary
policies, could turn out to be wrong, so deflation risks remain. In our view, the ECB is al-
ready paying close attention to those risks and will adjust policies accordingly. We will wit-
ness an extended period of low ECB rates, possibly into 2018, and the ECB is also likely to
adopt measures to expand its balance sheet. That will reduce deflationary risks for the euro-
zone as a whole, but downward pressure on prices and wages in the countries riddled with
mass unemployment are likely to persist.
Jan Häggström, +46 8 701 1097, [email protected]
...but eurozone also
has high unemploy-
ment, so downward
pressure on wages
and prices set to per-
sist unless ECB acts
aggressively
We forecast that
EUR will drop vs.
USD and other cur-
rencies
Macro Forecast, December 5, 2013
18
United Kingdom
Turning the corner
A broad-based recovery within all sectors is now a fact. GDP is driven by private consumption, but the
outlook for investments has improved as financial conditions have eased. Productivity growth has been
absent, but we expect productivity to rebound sharply. Reaching the forward guidance threshold will not
necessarily trigger rate hikes by the Bank of England.
National account statistics for the third quarter showed robust economic growth. GDP was
reported at 0.8/1.5 q-o-q/y-o-y. So far, the recovery has been driven by household consump-
tion and investments, but exports cut a staggering 0.9 percentage points off Q3 GDP. De-
spite the gloomy external sector, barometers and economic indicators are more positive,
inflation expectations are at a record-low and all industrial sectors are growing. So where
does the economy go from here?
Comparing economic growth this year with 2010 (mainly because the household sector did
some rebalancing during that period) shows that the household sector’s debt-to-income ratio
decreased from approximately 140 percent in 2010 to 132 percent last year. During the
same period, the savings ratio decreased from just above 7 percent to 6 percent, meaning
that the consumption-driven economy has so far not increased the debt burden of house-
holds. The housing market recovery seen so far has caused concerns about a housing price
bubble. But as long as the debt burden has not increased, the number of mortgage approv-
als is far below the long-term average and lending secured on dwellings remains at fair lev-
els, pointing to no worries about increasing house prices. The recent joint statement by
Governor Carney and Chancellor Osborne regarding the Funding for Lending scheme,
which will be refocused towards only businesses, will silence worries about a housing price
bubble. It seems as though first-time buyers are the ones entering the property ladder
sooner due to the Help to Buy programme.
Employment expectations are on a downward trend. That supports our view of muted em-
ployment growth ahead. At the same time, output expectations are heading upwards, imply-
ing that productivity will increase. Optimism is also increasing in the industrial sector within
both domestic and export manufacturing. Low productivity has been an issue for quite some
time and unit labour costs for the whole economy have increased by 15 percent since Q1
2008, while GDP has fallen by 2.5 percent. Productivity measured as output per hour in the
whole economy has fallen by more than 5 percent during the same period. As said before,
we do not expect a fast and strong rebound due to falling real wages and the fact that em-
ployment has risen faster than economic growth. That in turn would imply that productivity
should increase at least to some extent while employment growth will be muted during our
The recovery has
been driven by do-
mestic demand
Lower savings ratio
and slightly better-
balanced households
Productivity growth
as output per hour in
the whole economy
has fallen
Macro Forecast, December 5, 2013
19
forecast period. If corporations use higher productivity to raise wages instead of increasing
their own margins, consumption could get an extra boost. However, our forecast is that in-
creased productivity will instead result in increased profits.
Despite the household sector doing quite well, it has been difficult for companies to increase
investments. Investment intentions are more optimistic in both the services sector and the
manufacturing sector, according to the Bank of England survey. “Agents’ summary of business
conditions” and growth within the construction sector should boost investments in other areas
too. The external sector of the economy has made small contributions to overall growth in the
past couple of years. The outlook for exports looks brighter, as major export destinations in the
eurozone are recovering and exporters should get an extra boost from the pound sterling. But
the current account deficit has widened and the deficit will likely remain, as the economy has
sizeable net assets abroad and as exports deteriorated in Q3.
Consumer prices have been above the two percent target for three years. The rise in tuition
fees, planned fuel duty and duties on alcohol and beverages are pushing inflation higher
while the pound sterling’s appreciation has the opposite effect. The fact that fewer firms are
expected to not raise prices ahead makes the pressure on inflation look even smaller. We
expect inflation to approach the target during our forecast period. The forward guidance
adopted by the Bank of England stated that the MPC will keep the policy rate low as long as
unemployment is above 7 percent. Governor Carney highlighted at the Inflation Report press
conference that if the unemployment threshold were to be reached sooner than the MPC
forecast, rates will not be hiked if the MPC finds it inappropriate at that time: “The 7 percent
is a threshold, not a trigger for rate increases”.
The British economy is growing fast but still faces some problems. Real earnings growth is
not positive due to high inflation and some household rebalancing is yet to be done. The
fiscal squeeze has caused 100,000 more jobs to be lost in the public sector and the debt
crises in the eurozone are not yet solved. And for British growth to be better balanced, the
external side must improve in line with domestic demand. But for now, domestic demand
has lifted UK growth to one of the better-performing G7 countries.
Key indicators
Source: Handelsbanken Capital Markets
Helena Trygg, +46 8 701 1284, [email protected]
Percentage change 2011 2012 2013f 2014f 2015f
GDP 1.1 0.1 1.3 1.5 1.7Household consumption -0.5 1.2 2.0 2.1 1.8Gross investment -2.4 0.9 -2.6 5.0 4.1Unemployment rate* 8.0 7.9 7.7 7.5 7.3Consumer prices 4.5 2.8 2.7 2.3 2.1
* ILO measure
Investments inten-
tions are more opti-
mistic
Fewer firms expected
to not raise prices
“7 percent is a
threshold, not a trig-
ger for rate in-
creases”
Better-balanced
economy needs ex-
ternal demand
Macro Forecast, December 5, 2013
20
Japan
Fastest growing economy – so far
As one of the fastest-growing economies among the G7 countries, Japanese GDP has finally reached the same
level as at the peak in Q1 2008. So far, growth has been driven by private consumption due to stimulative
fiscal policy. Monetary policy will remain accommodative until consumer prices reach the 2 percent target.
The third arrow of Abenomics, the process of implementing structural reforms, is hopefully on its way.
Third quarter GDP confirmed the economic performance so far this year, despite slower
growth in the third quarter compared to the first two quarters due to weaker consumption. As
the fastest-growing economy among G7 – at least for now – Japan finally managed to reach
the same GDP level as at the peak in Q1 2008. So far, growth has been driven mainly by
private consumption, but business spending has also contributed to overall growth. Since
March 2011, the trade balance surplus has turned into a deficit, as imports growth is
stronger than exports. Exports to China have increased by more than 20 percent since Q1
2011 and imports are growing by more than exports due to higher domestic consumption.
However, as the JPY has weakened against most currencies, we expect exports to grow
slightly stronger ahead.
With more than 15 years of deflation, the Bank of Japan has been very clear that the central
bank has the tools to escape falling prices and that inflation will reach the target of 2 percent
within two years. Since the implementation of the inflation target, consumer prices have in-
creased due to improvements in aggregate supply and demand balance, increasing inflation
expectations and the effect of currency movements. However, as deflation has been going on
for so long, there is a high degree of uncertainty as to whether inflation will remain on an up-
ward trend (i.e. if prices will respond in the right way to aggregate demand and supply bal-
ance). Finally, developments in domestic inflation expectations should be watched carefully.
For more than two decades, investments as a share of GDP have been significantly higher
in Japan than in other developed countries. Will this pattern continue and, if so, how will ex-
pected inflation affect investment plans? So far, machinery orders, which are a good indica-
tor of investments, have improved and domestic orders are improving by even more than
foreign orders. The Tankan barometer also shows that the financial situation for companies
has recovered for all sizes of industries, both in terms of financial conditions and actual prof-
its. So, overall sentiment looks good for investments ahead. The economic situation has
changed, as inflation is finally turning positive: headline CPI has reached 1 percent while
core inflation is still hovering around zero. And as inflation is increasing, real rates are de-
clining, making it even more convenient for companies to invest.
Japanese GDP finally
managed to reach
the Q1 2008 peak
Consumer prices
have increased…
…but high degree of
uncertainty remains
Domestic orders im-
proving even more
than foreign orders
Macro Forecast, December 5, 2013
21
Abenomics contributes to better conditions for business investments, as the purposed corpora-
tion tax cut will ease investments even further. Public investments will likely continue to make a
high contribution to growth due to an additional boost from economic measures. However, re-
cent data show a trend within investments that policymakers probably did not count on: Japa-
nese exporters are increasing their capital spending. For example, carmakers Mazda and
Honda chose not to build new factories in Japan but instead turned to Thailand. Japanese di-
rect investment in South East Asia in the first half of this year nearly tripled and Japanese
banks have lent a record amount into the region, beginning last year. So in a sense, Abenom-
ics is working abroad, but if increasing profits are to boost economic domestic growth, there
must be an improvement in domestic investments and increasing wages at home.
However, it could take many years before we see if Abenomics has boosted investments.
The decisions by the carmakers were actually made long before Abenomics even existed.
Still, it is important to monitor these developments carefully. Exports and industrial produc-
tion are expected to increase moderately as overseas economies pick up, which will most
likely boost business fixed investments and profits. Hopefully, increasing profits will boost
wages and investments at home, supporting economic growth ahead. Looking ahead, we do
not expect strong growth to continue. As economic growth so far has been driven by private
consumption, that pattern is unlikely to continue as we enter 2014 and the tax increase in
April will most likely dampen household spending. If Abenomics succeeds, it is time to im-
plement purposed reforms, such as the reduction of taxes on business fixed investments (to
stimulate private investment to encourage firms’ efforts to raise wages) and the overhaul of
the social security and taxation system.
The Bank of Japan’s efforts to double the monetary base is starting to show results. In Oc-
tober, the monetary base increased by 45 percent compared to October last year and the
increasing amount of money being fed into the system lifted consumer prices somewhat.
However, will prices respond in the right way to the aggregate demand and supply balance?
Developments in domestic inflation expectations should be watched carefully. As Governor
Kuroda at the Bank of Japan has said more than once that the central bank is willing to ad-
just monetary easing policy to handle downside and upside risks to the 2 percent target,
monetary policy will continue to be accommodative during our forecast period.
Key indicators
Source: Handelsbanken Capital Markets
Helena Trygg, +46 8 701 1284, [email protected]
Percentage change 2011 2012 2013f 2014f 2015f
GDP -0.6 1.9 1.9 1.5 1.2Household consumption 0.5 2.4 1.6 0.8 0.8Business investment* 3.3 1.8 -1.5 1.9 1.4
*Non-residential investment
Japanese exporters
are increasing their
capital spending
Exports and indus-
trial production are
expected to increase
moderately
Will prices respond
in the right way to
aggregate demand
and supply balance?
Macro Forecast, December 5, 2013
22
China
Growth stabilising, reforms on the way
Although growth stabilised and achieved a better balance during the autumn, challenges remain in terms of
consumer inflation, house prices and credit growth, which has made the People’s Bank of China tighten
liquidity. More important, however, is the big slate of reforms announced after the Third Plenary Session of
the CCP Central Committee. The success of those reforms depends on implementation. Even if Chairman Xi’s
plans are crowned with success, the reforms are likely to slow growth in the short run.
After some fluctuations over the summer and early autumn, growth now seems to have sta-
bilised. Compared to last summer’s surge led by the SOE-dominated heavy industries, it is
also better balanced. The slowdown in construction activity, especially housing, reinforces
that impression. We thus revise our 2013 growth forecast from 7.5 percent to 7.6 percent.
Challenges remain
Yet all is not well. CPI inflation continues to accelerate. House prices continue to rise and
credit expansion remains a serious concern, as do non-performing loans, especially loans to
local government funding vehicles. Those issues are related, as local governments continue
to rely on land sales for much of their revenues. The People’s Bank appears to have re-
sponded by tightening liquidity. Monetary policy is difficult to monitor in China because of the
absence of a key policy rate or some other central policy instrument. After the liberalisation
of bank lending rates, we can no longer read anything from the benchmarks decided by the
State Council. Reserve requirement ratios are also no longer used as high-frequency policy
instruments. The remaining possibility is to look at short-term money-market rates. Although
those tend to move with the calendar, with typically end-of month peaks, persistent trend
changes signal policy changes. Such an upward trend has been clearly discernible for the
seven-day repo and the one-month SHIBOR rates. Although their recent peaks have been
lower than the one in June, that is not the case for the 12-month Treasury bill rate, which lies
at its highest rate since the beginning of 2006.
Third Plenum
For the leadership, it was no doubt important to have the economy in reasonable order be-
fore the Third Plenary Session of the 18th
Meeting of the CCP Central Committee. For
longer-term growth sustainability, however, the reforms announced in the wake of that ses-
sion will be way more important, even though they may slow growth in the short run. First
and foremost, the liberalisation of a number of rules and regulations will encourage private
entrepreneurship in competition with the large SOEs, even in sectors where the SOEs are
now completely dominant. Although SOE privatisation is not on the agenda, market forces
Growth forecast re-
vised slightly upward
Upward pressure on
house prices and CPI
inflation has been
met with liquidity
tightening
Market liberalisation
and SOE reform
Macro Forecast, December 5, 2013
23
are now expected to play a “decisive” role in resource allocation, upgraded from the former
“basic” role. Furthermore, the SOEs will themselves undergo major reforms in terms of gov-
ernance and management, to encourage profit-making rather than expansion and the accu-
mulation of physical assets. SOEs will also be asked to pay higher dividends.
Financial reform has been well on its way for some time, so the Plenum provided few new
initiatives. It is important, however, that the establishment of private financial institutions is
being encouraged and that the FX system is moving towards convertibility on the capital
account, albeit slowly. The managed appreciation of the renminbi (RMB) against the USD
seems to have slowed, probably due to a belief that the rate is now close to equilibrium. We
thus predict no big changes from here, as we believe movements in either direction are be-
coming more or less equally probable.
Shadow banking is a sticky point for Chinese policy. On the one hand, the government sees
the need for innovation in the financial system, but on the other hand it fears systemic insta-
bility. The People’s Bank is now seeking to allay these fears by introducing important meas-
ures of macroprudential regulation. Banks’ maturity and currency mismatches are to be
monitored, as are short-term capital flows. A plan for deposit insurance will be worked out
and a resolution mechanism will be put in place for failing banks.
Social and political reforms
The two most important social reforms announced after the Third Plenum include a liberali-
sation of the hukou residential registration system for third- and fourth-tier cities. As a result,
urbanisation is expected to turn towards these smaller cities, of which there are more than
4,000 with a total population exceeding 300 million. The other is the relaxation of the one-
child policy for parents who are themselves only children. Both of those reforms will add to
labour supply, although the relaxation of the one-child policy will naturally need time to work.
The most spectacular political reform is the abolition of the system of detention without due
process, called “reform through re-education”. On a different front, the fiscal system is to be
improved and expanded, hopefully making local governments less dependent on land sales.
A third important change will come in the assessment system for government leaders, which
will add a number of soft criteria in addition to regional or local GDP growth rates.
Finally, Chairman Xi reinforced his own power by putting the oversight of the reform process
in the reins of a small group that he chairs. Although the success of the reform plans re-
mains uncertain, he has, at least, put his own personal prestige at stake.
Knut Anton Mork, +47 2239 7181, [email protected]
Financial reform
continues
Gradual hukou re-
form, relaxation of
the one-child policy
Macro Forecast, December 5, 2013
24
India
RBI to liberalise India’s financial system
The agenda of new central bank Governor Raghuram Rajan is to boost competition and challenge vested
interests in India’s financial sector. Although the RBI mandate allows him to liberalise the financial system,
he cannot take on the real economy and deficient infrastructure. Those are up to lawmakers to address, but
until supply-side problems are resolved, the road to recovery will likely remain slow and bumpy.
Indian GDP growth seems to be bottoming out. It accelerated to 4.8 percent y-o-y in Q3 of
this year from a four-year record-low of 4.4 percent in Q2. To restore growth, the govern-
ment has to address bureaucratic bottlenecks, deficient infrastructure and fading investor
confidence. However, we do not expect any structural reforms involving lawmakers before
the next general election (in May 2014). In our view, government policy could only change in
a more populist direction as the election approaches. To secure victory, the ruling Congress
Party will likely increase subsidies to rural India, further damaging fiscal finances.
Still, we have become more optimistic. New central bank Governor Raghuram Rajan has so
far done an excellent job. Since he took over leadership, the Reserve Bank of India (RBI)
has relaxed some capital restrictions, reintroduced the repo rate as the main policy instru-
ment to restore transparency and promised to deregulate financial markets in India, but he
has also raised the repo rate to fight stubbornly high inflation. The measures ended an on-
going exchange rate crisis and stabilised the Indian currency at around 63 INR per USD.
That is an impressive record, but perhaps his most important achievement is to have in-
jected hope into the economy through his agenda to boost competition and challenge vested
interests in India’s financial sector, which is a complete break with his cautious and risk-
adverse predecessors. His goal is a “dramatic remaking” of the banking system over the
next few years to free it from the morass of state controls introduced after Indira Gandhi na-
tionalised many private banks when she was Prime Minister in the late 1960s.
The RBI plans to grant new banking licences and allow foreign institutions to take a broader
role. Moreover, it also plans to overhaul rules relating to state-backed banks, which control
roughly three-quarters of lenders’ assets, partly by encouraging swifter recognition of bad
loans, which have hampered the financial system during India’s economic slowdown.
Even though the RBI mandate allows Raghuram Rajan to liberalise the financial system, he
cannot take on the real economy and deficient infrastructure. Those are up to lawmakers to
address, but until supply-side problems are resolved, the road to recovery will likely remain
slow and bumpy.
Petter Lundvik, +46 8 701 3397, [email protected]
Economy still in a
slump
RBI not only fighting
inflation…
…but also challeng-
ing vested interests…
…by freeing the fi-
nancial system
Supply-side prob-
lems persist
Macro Forecast, December 5, 2013
25
South East Asia
Cyclical pick-up ahead, yet long-term challenges
As growth in developed markets picks up, exports from emerging asia should strengthen in 2014. The firming of
Chinese growth and weakening of exchange rates in most of the region further supports a moderate export-led
recovery. However, GDP growth is unlikely to return to levels seen before the recent financial crisis.
Asian trade responding to global pick-up
World GDP growth accelerated in the third quarter of this year on the back of a rebound in
China and faster growth in the US, UK and Japan. Asian exports and industrial production
clearly responded to this acceleration, with the three-month moving average in y-o-y growth
of Asian exports excluding Japan picking up from 3.3 percent in July to 6.6 percent in Sep-
tember. The outlook for growth in the developed world looks fairly positive, as the fiscal drag
in the US should diminish, the UK economy has reached a sustainable recovery and the
eurozone rises from recession to modest growth. Despite a modest slowdown, Japan should
also contribute positively to global demand next year.
The improvement in developed world growth conditions will benefit the export-driven Asian
economies the most, the very same ones that have suffered from weak external demand
during the past couple of years. The recent increase in US IT sector activity is a positive sign
for Asian producers of electronics, including South Korea, Thailand, Malaysia and Taiwan.
Due to somewhat stronger global economic growth in 2014e, we expect the coming year to
be better for South East Asia and the export-driven economies in particular.
GDP growth not likely to return to pre-crisis pace
An important explanation for the global growth slowdown in 2011-13 has been the simulta-
neous deceleration of GDP growth in the BRIC countries (Brazil, Russia, India and China).
The IMF, in its latest World Economic Outlook of October 2013, describes that slowdown as
partly cyclical and partly structural. The cooling down of cyclical factors partly explains the
slowdown in BRICs, but for China and India, about half of the slowdown is structural in na-
ture. The cyclical part of the slowdown follows from the unwinding of post-crisis stimulus,
notably in China but also in other parts of the world, and from changes in commodity prices,
which rose after the stimulus efforts but started to fall around 2011. Lower commodity prices
had an asymmetrical and disproportional effect on various Asian economies. In the recovery
phase, when commodity prices rose, Asian commodity importers suffered from declining
purchasing power and corporate profitability; later on, when the business cycle started to
deteriorate and commodities fell, the Asian commodity exporters’ economies were naturally
hit by a negative commodity shock.
Asian exports picked
up in the third quar-
ter
The export-driven
Asian economies
benefit the most
from global accelera-
tion
Half of the growth
slowdown since 2011
is structural in China
and India
Macro Forecast, December 5, 2013
26
The structural slowdown that has explained a large part of the deceleration in China and
India can be traced to various structural impediments, such as regulatory framework in key
sectors of production, permits and project approvals, and overstretched corporate balance
sheets, all of which are bottlenecks to growth in India, according to the IMF. In China, the
IMF expects structural issues to permanently lower growth, as China can no longer rely on
its current capital-intensive growth model, which needs vast migration from the countryside
to urban industrial production. Accordingly, the IMF forecasts China’s GDP growth at only 7
percent in the coming five years (2014-18), a marked slowdown from the 1998-2013 aver-
age growth of 9.6 percent.
Weaker growth in India and China, especially permanently weaker growth in the case of
China, has major implications for Asia as a region. The linkages to the rest of Asia material-
ise through inter-regional trade and financial markets, but also through indirect channels via
developed world growth that affect Asia as a whole. Those long-term effects are likely to be
larger for Asian economies with strong trade ties to China, in particular Malaysia, Singapore,
South Korea, Thailand, Hong Kong and Taiwan. For those economies, the value-added from
exports to China amount to around 4.0-5.5 percent of GDP.
As China is a major market for almost all other Asian economies and as it also has such a
large weight in the global economy, its weaker growth potential will be reflected in other
parts of Asia. Nevertheless, the long-term trends in China will not derail the cyclical out-
bursts and drops that are present in all market economies.
Key risks to the cyclical outlook of South East Asia in 2014
Developments over the past few years have made it clear what the key risks are to stable
economic conditions in South East Asia. The importance of Chinese growth is obvious, as
already stated; hence, a hard landing remains at the top of the risk list.
The economic performances of this past summer clearly showed that South East Asia is
vulnerable to sudden rises in interest rates in the developed world. Since then, investors
have focused more on the fundamentals of individual emerging market countries. Econo-
mies with larger current account deficits and external financing needs have faced the largest
falls in capital flows and currency values, and in equity and bond prices. Of the emerging
Asian economies, India and Indonesia belong to that category, as does Thailand, as its cur-
rent account has fallen to a deficit of 5 percent of GDP in Q2 2013 from a surplus of 1.2 per-
cent in the previous quarter.
The interest rate shock led to a series of mini-crises in the balance of payments for a few
countries, notably in India and Indonesia. In a typical balance of payment crisis, capital in-
flows fall and current account deficits can no longer be financed. That causes a noticeable
weakening of the currency, which reduces residents’ purchasing power through higher im-
port prices. It is exactly that process that, after a time, restores the current account back to
balance as domestic demand and imports adjust. In the short term, the loss of purchasing
power dominates and economic activity suffers, but in the medium term, improvements in
competitiveness are likely to stimulate exports and overall growth. As capital inflows deterio-
rate, lending conditions tighten considerably in the most-affected economies. To break the
vicious cycle of depreciating currency and accelerating inflation and to reduce the outflow of
foreign capital, the Indonesian central bank hiked policy rates between June and September
five times by a total of 175 basis points. That tightening of monetary and fiscal policy implies
slower growth for Indonesia in 2014.
Lately, portfolio flows have recovered in the region as a whole, but the more fragile global
emerging market economies – South Africa, Brazil, India, Turkey and Indonesia – still face
headwinds and their currencies continue to be weaker than at the beginning of the year. In
comparison, the Korean won hardly weakened during the summer turbulence. The coming
year will most likely show that the South East Asian economies are not a homogenous bunch.
Tiina Helenius, +358 10 444 2404, [email protected]
In China, the IMF
expects structural
issues to perma-
nently lower
growth…
…and effects are
likely to fall on those
Asian economies
with strong trade ties
to China
The key risks to
Asian region are
Chinese growth
slowdown…
…and an interest rate
shock from higher
rates in developed
world
Fundamentals
among the region’s
economies differ:
some are more vul-
nerable than others
Macro Forecast, December 5, 2013
27
Brazil
Persistent pressures
Like many other economies, economic activity in Brazil is in for a modest recovery. However, against the
backdrop of Brazil’s still-low average income and productivity levels, the prospects for the near future are
disappointing. Growth is being held back by a combination of labour shortages and weak investment activity,
and, given the elections next year, Brazil’s underlying problems are unlikely to be addressed in the near term.
Meanwhile, inflationary pressures will likely force further monetary tightening.
Like other emerging economies, Brazil has been recovering gradually from the slowdown
that started in mid-2011. However, the recovery is weak and uneven, while inflation remains
elevated. The poor growth performance, coupled with a tight labour market, squares well
with the hypothesis that the economy is being held back by a lack of production capacity.
The supply-side constraints are not easily overcome. The overall picture is consistent with
the notion of a fall in the underlying growth rate of potential output. For a country in Brazil’s
circumstances, investment and savings would seem quite low. The current level of capital
accumulation is clearly not consistent with substantially higher growth. Given the very limited
slack in the economy, it falls on the central bank to focus its attention on controlling inflation.
To some extent, Brazil’s trouble is a reflection of changing global trends. Activity is picking
up in overseas markets. In the US, the economy seems to have performed better than many
have expected, in line with our view. The deep political infighting in Washington was clearly
not enough to derail the recovery. Against that background, there is renewed talk about
when the Fed will start tapering its bond purchases. In China, growth seems stable and also
somewhat stronger than previously thought. The early analysis from the just concluded ple-
nary meeting of the Communist Party suggest that initiatives are underway to address some
of the issues that may weigh on the economy’s performance going forward. Even the euro-
zone seems to be in for a muted recovery.
Despite these positive developments, one would think that commodity markets would also
be seeing a turnaround. Not so. While stock markets are testing new highs, commodity
prices have been soft, a clear negative for countries like Brazil. The country’s exports have
increased lately, in dollar terms, partly as a reflection of a significant downward slide in the
country’s real effective exchange rate. However, exports are still lower than before the start
of the most recent slowdown. Like Russia, another big commodity exporter, Brazil is facing
global market conditions that are less fertile now than before. The evolving nature of growth
in China, global rebalancing and the threat of Fed tapering are likely some of the negatives
when Brazil’s commodity exporters consider adding to existing capacity.
Brazil’s recovery
weak and uneven
Changing global
trends part of the
picture
Commodity markets
have remained soft
Macro Forecast, December 5, 2013
28
Under these circumstances, even if the weaker exchange rate for the real helps making the
manufacturing sector more competitive, the case for investment-driven growth seems quite
limited. Consumption, by contrast, has held up rather well. Domestic demand has outpaced
GDP, which means that the current account has moved from surplus to a sizeable deficit.
The deficit is not large enough to cause significant concern, but it is indicative of the state of
overheating that Brazil finds itself in. The unemployment rate has, according to the official
statistics, sunk to an all-time low. Clearly, a general lack of productive capacity is limiting the
supply response to continued buoyant consumption, and, as a result, inflation has failed to
come down.
The Brazilian authorities are facing a policy dilemma that looks very similar to what their
counterparts in Russia are dealing with. Fiscal and monetary stimulus is not working. If more
expansionary policies are adopted, the likely result is further overheating and, in the end,
inflationary pressures. The Brazilian authorities are aware of this and the central bank, quite
appropriately, is taking steps to tighten its monetary policy stance. What is lacking, however,
like in Russia, is the political will to move ahead with a more ambitious structural agenda
aiming at encouraging investment, particularly in parts of the tradable goods sector other
than commodities.
There may be reason to believe that such a strategy has greater chances of success in Brazil
than in Russia. The economy is less one-sided and Brazil’s brand of politics is perhaps not as
destructive. However, one should not underestimate the challenges, especially in the near
term. Elections are scheduled for next October, both for the office of president and for the Na-
tional Congress. In the current political landscape, no bold moves can be expected before
then. Widespread protests during the past summer signalled strong discontent with various
aspects of public policy, including with regard to the level of administratively set prices, the
quality of public services provided, and the lack of progress on the corruption front.
Beyond the election, things may change; however, in the near term, markets will likely focus on
short-term problems such as inflation. Last week, the key SELIC interest rate was raised to
10.00 percent. More may come if Fed tapering triggers renewed weakness in the BRL. Expec-
tations for real GDP suggest growth of 2.5 percent for both 2013 and 2014, followed by 3.0
percent in 2015. Underscoring the fairly negative view on potential output growth, we believe
that unemployment will rise only slightly, while CPI inflation is set to fall gradually, from slightly
over 6 percent in 2013 to 5.5 percent in 2015. Markets will thus remain focused on the over-
heating problem. The deterioration in public finances presents yet another worry and this trend
may not be reversed until 2015, after the elections. While that may be viewed as a temporary
phenomenon, serious underperformance could trigger volatility at some point.
Gunnar Tersman, +46 8 701 2053, [email protected]
Brazilian economy
clearly overheated
The authorities face
a policy dilemma
Elections next year
likely to deter any
structural reforms
Slow growth and
high interest rates on
the cards
Macro Forecast, December 5, 2013
29
Central and Eastern Europe
Future convergence at risk
In most of the economies in Central and Eastern Europe, economic conditions seem to be improving,
mirroring developments elsewhere. While the better global economy plays a major role in this, domestic
factors are also at work. Nevertheless, growth is likely to be quite modest, capped by various structural
impediments. Future convergence is clearly at risk. So far, however, policymakers have either not realised
this or wanted to take sufficient steps to reinvigorate the development process.
Financial markets, sentiment indicators and hard data all suggest that the global economy is
indeed poised to pick up. In the US, we have seen a stream of positive signals, despite the
civil war mentality that seems to characterise the politicians in Washington. While growth
remains low in a historical context, especially considering the slack in the labour market, the
US still looks set to outperform Western Europe. In China, data has also surprised on the
upside, dispelling fears about a possible hard landing. The early analysis of the Communist
Party’s recently-concluded plenary meeting also suggests some positive conclusions that
point in the same direction. The situation among other major emerging economies is more
mixed. While capacity constraints and structural problems are holding back growth in some
places, growth remains buoyant in others. Nevertheless, as a group, emerging economies
may play a more limited role in supporting global growth than we have been used to during
recent years.
Even in the eurozone, things are slowly looking better. Economic activity and employment
have at least stabilised in the troubled south. In the north, we are likely to see a quicker and
more tangible improvement. Germany is a leveraged play on global trade and there is also a
potential for greater spending at home. Clearly, the backdrop of record-low unemployment,
real wage gains, robust company profits and extremely low interest rates, as well as solid
public finances, provides fertile soil for significant growth in domestic demand. So far, the
attitudes among firms and households have been rather cautious, but that could change.
There is already a buzz about how activity has picked up in Germany’s traditionally sleepy
housing market. And given the economic weight of Germany among its neighbours, other
countries in the north should also benefit. The overall situation in the eurozone nevertheless
remains very problematic. The wide gap in labour market performance between the south
and north is enough reason to think that the euro project suffers from serious design flaws
For Central and Eastern Europe, the global outlook is of course very important. In Russia,
with its heavy dependence on oil and other commodities, there is a particularly close link. In
the EU countries, the link may be more indirect, mainly through the connection to Germany.
Within the region, we have seen diverging economic trends during the course of this year. In
almost all countries, growth for the year as a whole looks to be lower than in 2012. However,
while Russian growth fell yet again to a new low in Q3, Polish growth bounced back and
surprised on the upside. It is tempting to interpret this as a sign that external conditions have
turned less favourable to energy-based Russia and more favourable to Poland and other
countries that focus on labour-intensive manufacturing. The recent slide in commodity prices
is certainly consistent with this interpretation. However, even within Central Europe, we have
seen significant differences in economic performance. The Czech Republic reported Q3
data that fell short of expectations, while Hungarian growth turned out higher than expected.
If indeed the changing nature of global growth implies that commodity markets will remain in
a holding pattern, Russia would clearly benefit less than Central Europe from the recovery in
the next couple of years. Russia is increasingly running out of easy solutions. While exports
have levelled off, the tight labour market means that stimulating domestic demand is unlikely
to yield good results. The authorities may try, but that would only produce inflation. Growth is
expected to pick up a notch, but still fall far short of the country’s potential. Higher ambitions
Positive signals from
the US and China
Germany a source of
strength in Europe
Eastern Europe
closely linked to
global growth
Russia is running out
of easy solutions
Macro Forecast, December 5, 2013
30
are only realistic if Russia is able to pursue reforms that would help it evolve into a much
more attractive location to investors outside the commodity sphere. As we have argued in
the past, nothing suggests that the elite would be able to embrace such drastic changes.
The low output growth and corresponding sluggish gains in living standards will sooner or
later probably result in more widespread political discontent. However, genuine progress will
not happen quickly. We think Russia is stuck on a low-growth path that only allows a very
slow climb up the global income and productivity ladder.
There are reasons to be somewhat more optimistic about the EU countries. Higher activity
among German exporting firms will likely have a knock-on effect on their subcontractors in
Central Europe. Similarly, the Baltic countries may benefit from stronger growth in Finland,
Sweden and Russia. There are also domestic drivers. While eurozone members benefit
from actions taken by the ECB, central banks in countries outside the currency union have
also eased monetary policy substantially. The Czech National Bank even orchestrated a
devaluation of the koruna, as it already had exhausted the room for rate cuts. There is also a
tendency to go slower on fiscal consolidation. Hungary and Poland have both introduced
changes to their pension systems that effectively provide more fiscal leeway. The move
back to a pay-as-you-go approach is problematic from a structural point of view, but it will
allow for more stimulus in the short term. Finally, there will be another (and perhaps final)
round of infrastructure spending financed partly by the EU. The effects will start to kick in
during 2015, in time for the next Polish election.
All this means that growth not only is preconditioned on the global picture. Some countries,
particularly the Baltic States and Poland, which have favourable domestic fundamentals,
should be able to maintain growth even if the global recovery disappoints. However, as in
the case of Russia, the convergence story in northeast Europe is starting to look a lot less
convincing. Few observers now seem to believe that the region has the necessary structural
credentials to substantially outperform the most dynamic economies in the west over the
longer haul. There has obviously been significant rotation within the EU in favour of the north
and east and to the disadvantage of the south and west, but there seems to be little reason
for Central and Eastern Europe to significantly catch up with the richest countries in the
north. The whole region is in danger of getting stuck in the “middle income trap”. Whether
that prospect will help usher in a wave of structural reforms is unclear at this point. While
Central Europe certainly has a much more attractive political landscape than Russia, we
have yet to see the need for bold reforms make a distinct imprint on the political agenda.
Gunnar Tersman, +46 8 701 2053, [email protected]
Real GDP in selected countries (percentage changes)
2011 2012 2013f 2014f 2015f
Estonia 9.6 3.9 1.5 3.4 3.8
Latvia 5.3 5.0 4.1 4.3 4.0
Lithuania 6.0 3.7 3.4 3.8 4.1
Czech Republic 1.8 -1.0 -1.2 1.7 2.3
Hungary 1.6 -1.7 0.7 1.6 2.1
Poland 4.5 1.9 1.3 2.9 3.4
Slovak Republic 3.0 1.8 1.1 2.0 2.8
Russia 4.3 3.4 1.6 2.5 2.9
Turkey 8.8 2.2 3.6 3.8 4.2
Sources: Official statistics and Handelsbanken forecasts
Cyclical upswing in
eastern EU
Falling into “middle
income trap” a real
risk
Macro Forecast, December 5, 2013
31
Sweden
Let it grow, let it grow, let it grow...
The Swedish macro environment is generally developing in line with our scenario. Weak GDP growth is set to
pick up and a recovery in manufacturing and exporting sectors finally seems to be in the offing. Rather than
short-term demand uncertainty, structural issues in manufacturing and the labour market stand out as focal
points to us. Still, we expect only a limited upturn in the labour market next year while inflation should
remain low. While macroprudential regulation brings a new landscape for the Riksbank, we retain our
outlook for monetary policy: easing foreign policies will ultimately challenge domestic reasons to tighten.
Growth acceleration now in the offing
A few things have stood out in the Swedish economy in the past few years. One is how un-
expected strength in service sectors has compensated for downward trends in exports, in-
vestment and manufacturing output. Another is the increase in total jobs, driven especially
by services sectors. Given weak GDP growth, the strength in employment weighs on pro-
ductivity. Without support from foreign markets, domestic resilience should draw to an end
sooner or later. Luckily, both macro and survey data suggest that our forecast for a growth
recovery in H2 will materialise, which we have had in our outlook for over a year. However,
growth is still muted. The recent reading for Q3 shows GDP increasing by only 0.1/0.3 per-
cent q-o-q/y-o-y, but final domestic demand is not looking as weak. Furthermore, fiscal pol-
icy stimulation next year should add fuel for a domestic acceleration.
Our forecast for 2014 GDP growth lands at quite a high figure (3.2 percent). Recent surveys
support our outlook of a revival in manufacturing and exports. However, we still believe in a
rather slow recovery in those areas in 2014, which is why the pick-up in forecast GDP
growth leans more on domestic demand. As weakness in foreign markets and global macro
risks will most likely remain, we do not expect a significant GDP contribution from net ex-
ports. Yet, the bottoming-out of exports and manufacturing industry should be essential to
overall confidence and to the prospects for investments ahead.
Manufacturing: looming challenges underneath recovery prospects
At this point, investment and exports are still some distance from their previous peaks. Thus,
there is a lot of lost ground to regain. At the heart of the matter is manufacturing, where out-
put is down by a total of 9 percent since the peak in Q1 2011. The flattish productivity seen
in the past two years, characterised by weak export demand and a historically-strong SEK,
raises questions about potential productivity for manufacturing and the growth potential for
Sweden. Hence, the real question regarding an industrial recovery is how much of the re-
cent weakness is due to temporarily weak demand and a short-term loss in competitiveness
due to SEK strength, and to what extent does the adversity relate to structural issues?
GDP growth is still
slow, but accelera-
tion is finally around
the corner
Annual GDP growth
next year to land
high, but strong pull
from export markets
is still lacking
Weak demand trends
and SEK strength
cloud underlying
productivity trends
Macro Forecast, December 5, 2013
32
Broadly speaking, Sweden ranks high in comparison to peer markets when looking at key
aggregates for gauging competitiveness: labour productivity, unit labour costs and real effec-
tive exchange rates. Yet Sweden has lost ground to US productivity, although that is also
the case with most other mature economies. However, data show that Sweden, on the
macro level, has managed to keep up with the US more successfully than many others.
What is striking is the weak productivity trend that began before the Lehman recession.
In retrospect, the strong productivity trend that followed the Swedish domestic crises in the
early 1990s perhaps raised hopes too high. The subsequent dynamic performance, which
meant a period of catching up for Sweden, was helped by several factors. Initially, there
should have been a set table of easy productivity gains following economic stagnation in the
1970s and 1980s. Additionally, substantial reforms and strong foreign demand for Swedish
core industries promoted progress. A weak currency also helped industries, especially so at
times of fierce market adversity, when a hefty SEK depreciation cushioned exports.
However, macro analysis tends to overlook vital aspects of underlying trends, as aggregate
data miss details on the growth dynamics. The point is that structures do not remain constant;
the economy transforms perpetually. Productivity on the macro level is boosted by significant
compositional effects: totally, within sectors and within firms. Holding sub-sector value-added
shares constant over time and calculating hypothetical trends for productivity is one illustration
of the impact from compositional effects. One conclusion is that the rising share of service out-
put seems to have had only a minor net effect on total private sector productivity. Regardless
of which base year we use (meaning value-added weights for goods and services), the hypo-
thetical productivity trends for the private sector all land close to the actual historical path.
Here, two main dynamics are at work when services have grown faster than goods production.
Higher productivity (and wages) in services signifies a boost to average productivity at the ag-
gregate level. At the same time, slower growth in services sectors works the other way around.
Tentatively, those two seem to have basically cancelled out, it seems. But as there has been a
catching up for goods sectors, in level terms, potential effects from the first type of dynamic
should have narrowed, which should have some bearing on the outlook for macro productivity.
This could suggest lower trend growth ahead.
Turning instead to goods production only, a compositional boost (looking at five sub-sectors)
really seems to have lifted aggregate productivity, especially in the 1990s. Later on, the posi-
tive compositional impact seems to have abated, especially over the past ten years. Then,
productivity in goods sectors seems quite independent of which weights we use (the actual
ones or fixed ones of 1993, 2003 or 2013). Thus, the overall trend seems to be more driven by
the inter-sector productivity during the later period. Unfortunately, the presented calculation is
marred by shortcomings, the main caveat being that findings are highly dependent on which
data are used (aggregation levels and sub-sector division). Yet, the exercise is illuminative.
Looking ahead, we think that total productivity in years to come will likely be slower than in
the1990s and early 2000s, especially so without significant structural reforms or a boost to
At the macro level,
Sweden’s perform-
ance remains quite
strong versus others
Exceptionally helpful
setting after the
Swedish crises in the
early 1990s boosted
manufacturing pro-
ductivity
A substantial portion
of productivity
growth stems from
compositional
change
For goods produc-
tion, the boost from
compositional
change seem to have
faded
Macro Forecast, December 5, 2013
33
investment in real and human capital. It may well be that manufacturing, and Sweden, will
have a hard time repeating the successes of the past. However, as we forecast an imminent
acceleration in demand growth, a recuperation in productivity is what we expect first.
Key macroeconomic indicators
Sources: Handelsbanken Capital Markets and Macrobond
Structural issues in the labour market despite recent strength
Evidence does not decisively show severe structural damage since the Lehman recession.
Yet, an increase in equilibrium unemployment seems likely, despite unexpected strength
during the course of the past few years: high employment and a strong trend for the labour
force. The high participation rate should be the response to lowered effective income taxes
and policy tightening in social security schemes. Hence, any decay in the functioning of the
labour market should primarily deal with groups within the labour force (rather than ‘outsiders’).
Looking at the relationship between unemployment and vacancy rates, or the Beveridge
Curve, some impairment to the matching process on the macro level appears. However, given
possible shifts in recruitment behaviour and reporting, we would like to downplay the indicated
worsening in matching efficiency. Moreover, we cannot rule out shifts in the demand for labour,
with potentially sustained low demand for low-skill workers. But also other perspectives on the
labour market indicate challenges. Although effective labour tax wedges have been lowered in
Sweden, ‘outsiders’ – based on education, experience and background – face relatively lower
Percentage change
2011 2012 2013f 2014f 2015f
Household consumption 1.7 1.7 1.8 2.3 2.4
Government consumption 1.0 0.8 1.2 1.2 1.4
Fixed investment 8.3 3.8 -0.7 5.3 4.2
Final domestic demand * 2.6 1.7 1.1 2.4 2.3
Inventories * 0.4 -1.1 -0.2 0.4 0.0
Exports 6.5 1.1 -1.4 3.4 4.0
Imports 7.2 -0.1 -2.1 3.0 4.5
Net exports * 0.0 0.6 0.2 0.4 0.1
GDP, calender adjusted 3.0 1.3 1.0 3.2 2.4
GDP, actual 3.7 0.7 1.0 3.1 2.6
Unemployment ** 7.8 8.0 8.0 7.9 7.7
Employment 2.3 0.6 1.1 0.8 1.0
Hours worked 2.0 0.6 0.4 0.7 1.1
Wages *** 2.4 3.1 2.6 2.8 2.9
Real Disposable Income 3.6 3.0 2.5 2.7 2.0
Savings ratio **** 3.7 5.1 5.6 6.0 5.4
CPI 3.0 0.9 0.0 1.0 2.0
CPIF 1.4 1.0 0.9 1.0 1.5
Net lending, General Government ***** 0.0 -0.5 -1.4 -1.2 -0.7
Current Account ***** 7.3 6.7 6.2 5.7 5.4
* Contribution to GDP growth *** Wage and salary statistics ***** Percent of GDP
** LFS, percent of labour force **** Savings excl. pensions
Economic reform a
likely driver for the
strong trend for la-
bour supply...
...but has achieved
less to improve skills
among workers
Macro Forecast, December 5, 2013
34
employment chances. So, significant differences with respect to education or ethnicity remain.
Fairly positive is that long-term unemployment has moved roughly sideways over the past
year, although it is higher than before the recession. Despite high GDP growth forecast in com-
ing years, we expect a fairly limited job boost. And given our forecast of continued high partici-
pation, we do not expect a marked decrease in unemployment. We believe that high unem-
ployment will likely haunt policymakers for some time.
New landscape for monetary policy, but not a new world
Currently, CPIF inflation is well below its historical average. And no plunge in unemployment
is in sight, which could push for accelerating wage growth later on. On top, a low-inflation
environment abroad seems most likely. Also, we forecast the SEK to trend stronger. Thus,
the potential upside to inflation appears limited at this point. Comparison to 2004-08 is illus-
trative, we think. Then, after an extended period of low CPIF inflation, accelerating CPIF
inflation was preceded by a significant trend decrease in the unemployment rate (about 1.5
percentage points) and an increase in wage growth. Certainly, there is no easy rule of thumb
to describe the interaction between unemployment and inflation. And admittedly, energy
prices also added to the acceleration in the CPIF that time. But the real trigger then, in our
view, was domestic wage growth. In our forecast, wage growth remains moderate.
As long as the Riksbank forecasts accelerating GDP and a recovery in the labour market in
coming years, there are certainly reasons against rate cuts, especially given the long period
of a low repo rate and the concerns over credit growth and dwelling prices. But indeed, the
probability of a lower repo rate path has increased, opening up the possibility of a rate cut.
However, our main scenario is a flat rate at 1 percent until the second half of 2014. Although
rate cuts cannot be ruled out, we expect the Riksbank to land at signalling ‘lower for longer’.
And instead of a short-term lowering of the repo path, we think there are two factors against
the sharp hike that the Riksbank keeps signalling for 2015-16. First, new macroprudential
policies should eventually alter the basis for monetary policy. Once details about the policies
are disclosed, the repo rate path will likely be affected (likely during 2014). But until the spe-
cifics of policies are presented, the Riksbank will take that into account only sluggishly.
However, in an outlook with a range of unknowns, including general forecast uncertainty, the
macroprudential impact should not be overstated at this stage. The second factor holding
downside risk is the Riksbank’s outlook for relative policy rates and the SEK, in our view.
With the Riksbank forecasts on policy rates, we think the SEK could reasonably appreciate
more than that indicated by the Riksbank’s KIX forecast. Also, we expect lower foreign pol-
icy rates than the Riksbank does. Should our forecasts prove to be right, the signalled repo
rate hikes in 2015 and 2016 do not look feasible, as the consequential high interest rate dif-
ferentials would then imply unprecedented SEK strength.
Anders Brunstedt, +46 701 54 32, [email protected]
Structural issues
likely to emerge as
we expect high un-
employment to per-
sist
Every angle on con-
sumer prices points
to lasting low infla-
tion pressures
Rate cuts below 1
percent not incon-
ceivable...
...but apparent
downside risk to
repo path of 2015-16
appears more likely
to us
Macro Forecast, December 5, 2013
35
Sweden
Norway - a warning bell for Sweden?
Developments on home prices and household debts in Norway and Sweden illustrate the dangers of pursuing
an inflation target without having a macro-prudential framework in place to prevent a housing bubble. We
are not forecasting a collapse of house prices but Norway is further into the danger zone than Sweden and
policy makers are already starting to worry about recent prices declines. Norway could be seen as a warning
bell for Sweden that it is really important to cool down the housing market before it becomes too late.
It is very difficult for a central bank in a small open economy to pursue an independent rate
policy. The exchange rate is too important for economic activity and inflation. If rates rise
relative to those of the country’s main trading partners, the currency will appreciate and bur-
den net exports, company profits and inflation. That restriction has been especially important
in the aftermath of the financial crisis. Monetary policies in the eurozone, US and UK have
been geared towards mitigating the impact of burst housing bubbles and debt deleveraging.
It has resulted in ultra-low policy rates and unconventional monetary policies, putting down-
ward pressure on currencies, especially the dollar and pound sterling.
In that environment, policy rates risk becoming too low for economies that do not suffer from
private sector debt problems or falling house prices. In recent years low interest rates helped
boost house prices in a number of countries, especially in Asia, where there was a swift re-
turn to full employment after the 2008 collapse, but also in Norway and Sweden, where
economies recovered rapidly.
It has been especially acute for Norway, where output only dropped marginally in 2008 and
2009, and where unemployment has been running at very low rates in recent years. Wages
have risen rapidly relative to trading partners; nevertheless, consumer price inflation has been
muted, partly as a result of a gradually rising exchange rate. The Bank of Norway’s pursuit of
an inflation target has been an important motive for keeping the policy rate low. The combina-
tion of strong nominal GDP growth and low interest rates has led to vigorous credit expansion
and rapidly rising house prices. Household debt has risen to close to 200 percent relative to
disposable incomes and house price growth has continued to exceed income growth.
As the Bank of Norway has not been able to lift rates to cool the housing market and credit
growth, the burden has fallen on the government and Norway’s Financial Services Authority
(FSA) to take appropriate measures to hold down demand for credit and house purchases
and to create incentives for banks to restrict the supply of loans. Norway’s election in Sep-
tember this year complicated the political decision-making process. Anything that is negative
for the housing market is bound to be unpopular among voters. The FSA earlier put in place
Norway’s robust
GDP growth and low
interest rates fuel
rocketing household
debt, housing prices
Macro Forecast, December 5, 2013
36
an 85 percent loan-to-value ceiling for mortgages. This summer there was also a decision to
raise bank risk weights on mortgages this summer, but it was watered down from the origi-
nal proposals.
But those measures may have been put in place a little too late. The housing market started
to cool in the third quarter and house prices fell almost two percent. The price declines seem
to have continued in the fourth quarter and there are rising concerns that Norway is in for a
sharp drop in house prices. The government is now looking into raising the loan-to-value
ratio for mortgage loans from 85 to 90 percent.
Recent house price trends may prove to be a temporary correction. We do not forecast a
major drop as there are important fundamental drivers for the rapidly rising house prices. But
there is a clear correlation between house price growth and private consumption growth so
we are expecting the housing market to turn from pull to drag for the economy (see our
Macro Forecast Norway, published October 25). But we cannot exclude the possibility of a
housing bubble. If there is a sharper downward turn in prices, things may not look so rosy
any more. Households are highly geared, so the outlook for private consumption is likely to
worsen. Residential construction is relatively high, at around 6 percent of GDP, so that sec-
tor is also likely to take a hit if the housing market worsens.
An outright housing market collapse could turn into a nightmare scenario for the Bank of
Norway. The problem in recent years has been that consumer price inflation has been on
the low side relative to the inflation target. The central bank currently forecasts that the infla-
tion target will not be reached within the three-year horizon. However, that could change
abruptly if domestic demand takes a turn for the worse. In such a scenario, the currency
might decline, putting upward pressure on inflation. If future inflation risks turn out to be to
the upside, the central bank would of course be expected to lift rates. But this would not be
an appropriate response to a cooling housing market.
But perhaps the FSA and the government could reverse the measures taken recently to cool
the housing market, leaving the central bank free to pursue the inflation target by raising
rates? Well, it might turn out to be more difficult to stimulate supply and demand for credit
than to do the opposite. After all, banks cannot be forced to lend or households to borrow. In
a falling housing market, banks might actually choose to be even more conservative, for
instance by requiring higher cash down-payments (i.e. voluntarily lowering loan-to-value
ratios) or being more selective in whom they lend to. Households are also likely to be much
more cautious when house prices fall than when they rise.
It means that so-called macroprudential measures might face the same dilemma as conven-
tional monetary policy. We know that cutting rates when demand is falling might not work.
The economy would then be in a so-called liquidity trap. As a famous economist put it, “You
can lead a horse to water but you can’t make it drink”. Trying to stimulate supply and de-
A fall in Norway’s
house prices could
be looming...
...which could hit
household consump-
tion and residential
construction
You can lead home-
owners to a bank,
but you can’t make
them borrow
Macro Forecast, December 5, 2013
37
mand for credit by means of easing up on capital requirements or loan-to-value restrictions
might prove just as impotent as cutting rates.
Faced with the dilemma of falling house prices and rising inflation, it seems likely that many
central banks would prefer to fight house price declines than inflation. Failing to do so might
put the economy in a situation that carries much bigger downside risks. This was the course
of action chosen by the Bank of England.
The lesson is that if you do not fight the battle against house prices before the housing mar-
ket collapses, you might end up losing the fight against inflation. That threat is more acute to
very small, open economies such as those in Norway and Sweden, where exchange rates
matter much more for inflation than they do for the UK. It is still too early to say what will
happen in Norway. Recent house price declines may be just a blip. But if it turns into some-
thing much worse, there is an important lesson to be learnt for Sweden: Do not leave it too
late before addressing a looming house price bubble!
Trends in Swedish residential prices and household debt ratios are still not at such an ad-
vanced stage as in Norway, which is clearly already in the danger zone. While the Norwegian
household debt-to-income ratio has reached almost 200 percent, the current Swedish ratio is
‘only’ at around 170 percent. Relative to incomes, house prices in Norway are up 80 percent in
the past two decades, about the same rise as the UK and Denmark experienced before prices
collapsed, while house prices in Sweden are up around 50 percent. On both counts, Sweden
presently seems to be farther from the danger zone than Norway. But house prices have ac-
celerated this year in Sweden and are now rising much faster than incomes. Household credit
growth has also picked up pace, so the debt-to-income ratio keeps on rising.
It is not too late for Sweden to act to prevent a bubble, but there is no time to wait. The
Riksbank will find it difficult to raise rates until maybe late next year. The FSA has proposed
that risk weights for mortgages be raised from 15 to 25 percent, but implementation would
not take place until next summer. There is no evidence at present that banks are prepared
to lift mortgage rates in anticipation of higher risk weights. One of the banks, Swedbank,
raised mortgage rates by 25 basis points directly after the FSA announcement on November
15 but cut rates the following Monday because other banks did not follow. Given the political
constraints imposed by the Swedish election in September next year, there is no scope to
force households to amortise their debts more rapidly or to make the tax deductibility of in-
terest rate payments less generous. One thing that could be done, that has a low political
cost and would probably be quite effective in holding back house price increases, is to cut
loan-to-value ratios from 85 to 80 or 75 percent. If nothing is done soon, risks will keep on
rising and the Swedish Riksbank might find itself in the precarious situation of wanting to
fight rising inflationary pressures but instead having to fight a deflating house price bubble.
Jan Häggström, +46 8 7011097, [email protected]
Many central banks
would prefer to fight
house price declines
than inflation
Sweden so far lag-
ging Norway’s rise in
housing prices,
household debt
ratios
With an election in
2014, political head-
winds could hinder
much-needed action
Macro Forecast, December 5, 2013
38
Norway
Possible interest rate cut in March
Inflation has been considerably lower than expected since September and price pressure ahead seems to be
lower than Norges Bank currently expects. Growth has been broadly in line, but soft data hint at growth
considerably lower than Norges Bank’s forecast. Notwithstanding a weaker NOK, the result should be a
markedly lower interest rate path, with a possible interest rate cut in March next year.
The Monetary Policy Report 3/13, published in September, indicates an unchanged key pol-
icy rate until next summer. However, changes in the economic outlook since September
should lead to a substantial lowering of the path for the key policy rate. We expect Norges
Bank to lower the interest rate path by some 60bp in the longer term, opening up the way for
a possible interest rate cut in March next year.
Weaker NOK and lower money market spreads
The NOK exchange rate has been some 3.6 percent weaker than Norges Bank expected so
far in Q4. However, some of this weakness may be explained by the interest rate differential,
as international money market rates have fallen considerably since September, but the Nor-
wegian ones have fallen more. Some of the downward movement in Norwegian money mar-
ket rates has been in expectation of a lowering of the interest rate path from Norges Bank,
especially after the ECB lowered its policy rates. Money market spreads seem to be lower
than Norges Bank expected in September. The weaker krone and lower spreads contribute
to pulling the interest rate path up.
Lower growth prospects but also lower potential growth
Economic growth has been broadly in line with Norges Bank’s expectation since September,
maybe with the exception of goods consumption, which seems to have been lower. How-
ever, we believe Norges Bank’s estimates for growth ahead are too optimistic. Soft data,
including the latest report from Norges Bank’s regional network, point to growth considerably
weaker than Norges Bank forecasts. According to the regional network, growth is expected
to average around 0.35 percent for the next couple of quarters. Norges Bank, however, ex-
pects growth to pick up to 0.60 percent in Q4 and 0.64 percent in Q1, leading to growth of
2¼ percent next year and 3 percent in 2015. The regional network report also indicates a
substantial downward revision of the output gap. However, Norges Bank’s revision of the
output gap will probably be somewhat smaller than the revision of growth estimates. That is
due to potential growth probably also falling, as is suggested by the very weak performance
of productivity.
Weaker NOK and
lower money market
spreads pull the in-
terest rate path up...
...but weaker growth
prospects pull mark-
edly down.
Macro Forecast, December 5, 2013
39
Lower cost and price inflation
Inflation has been considerably lower than Norges Bank expected in September and is set
to stay well below Norges Bank’s forecast. According to Norges Bank’s latest expectations
survey, wage growth expectations among the social partners have declined. They cur-
rently expect wage growth of around 3.6 percent next year, while Norges Bank expects 4
percent. Norges Bank’s regional network expects wage growth of 3.4 percent next year.
Lower wage growth should lead to lower cost and price pressure next year than Norges
Bank currently expects.
No effects of counter-cyclical buffer this time
Norges Bank is set to give advice to the Ministry of Finance (MoF) on the size of a counter-
cyclical capital buffer to be held by banks. Given Norges Bank’s analysis from the Septem-
ber report, the advice will most likely be that a buffer should be turned on, but the size will
probably be lower than the 2.5 percent upper threshold. Given the current weakening of
growth prospects and ongoing softening of the housing market, we would look for a buffer of
0.5-1.0 percent. However, that advice will not be incorporated into the forthcoming report, so
neither text nor forecasts will reflect that advice has been given. Rather, the effects of a
buffer will be included in the report in March, well after the MoF has made its decision public.
Downward revision of some 60bp to key policy rate path
All in all, we expect Norges Bank on December 5 to lower the path for the key policy rate by
up to 60bp, opening up the way for a possible rate cut in March next year.
Kari Due-Andresen, +47 2239 7007, [email protected]
Cost and price pres-
sure also lower.
No effects of
counter-cyclical
buffer until March.
Possible rate cut in
March next year.
Macro Forecast, December 5, 2013
40
Finland
Recovery despite structural headwinds
As domestic fundamentals remain weak and fiscal austerity continues, the strength of the recovery depends
on external demand. We see encouraging signs, but structural headwinds limit the pace of GDP growth.
The Finnish economy is gradually starting to recover, but from a very low base. Statistics
Finland’s trend indicator of output indicated that the economy continued to expand in the
third quarter of 2013, by 0.4 percent q-o-q, but substantial revisions are possible in early
December when the first official national accounts’ estimates are released for Q3. Be the
possible surprises positive or negative, GDP volume will contract y-o-y in 2013 for the sec-
ond consecutive year. We still see a gradual recovery ahead, but the timing and the strength
of that recovery depends on foreign demand, as domestic fundamentals are too weak to
initiate domestic demand-driven growth.
Structural challenges limit the scope for export led recovery
There have been recent signs of moderately strengthening sentiment and growth in many
important export markets. Measured by the value of goods exported, Finland’s three most-
important export markets are Sweden, Russia and Germany, in that order; we expect growth
to strengthen in those economies during 2014-15. Due to structural supply-side problems in
Russia, its growth is unlikely to provide Finnish exports a lift as sizable as before the finan-
cial crisis. All in all, we expect the export recovery to be modest compared to previous up-
turns due to structural change in Finnish industries.
As the share of manufacturing electronic products and electrical equipment to total manufac-
turing value-added shrank from 25 percent in 2000-08 to less than 8 percent in Q2 2013 and
the global investment cycle remains too modest to support demand for the engineering sec-
tor, paper, pulp and paperboard products have regained their status as the most important
export product group (16 percent share of total goods exported value in January-August
2013). Machinery and equipment’s share has decreased to 13.3 percent, while coke and
petroleum products’ share has increased to 11.7 percent, close to basic metals’ 11.8 percent
share. The trend of lower value-added intermediate goods, crude materials and fuels in-
creasing their export shares while manufacturing and exports of higher value-added goods
struggle is worrying. Although awareness of this challenge is increasing among the political
and economic elite, there are few ways to rapidly restructuring the industrial base. Uncer-
tainty about the export and growth outlook therefore remains a moderating factor to corpo-
rate investment growth in 2014-15.
Finnish GDP volume
will contract y-o-y in
2013 for the second
year running
Uncertainty over the
export and growth
outlook to moderate
corporate investment
growth in 2014-15
Macro Forecast, December 5, 2013
41
Households’ sentiment and finances gradually improve towards 2015
Low confidence and stagnating purchasing power (thanks to lower employment and higher
taxes) led households to be wary about spending in 2013. Consumer price inflation deceler-
ated steeply during 2013, but deflation is not a threat, so lower inflation is welcomed to com-
pensate for the moderate two-year wage deal recently agreed. Taxation is set to rise further
in 2014, as taxes on alcohol, tobacco, soft drinks, electricity and fuels are increasing and
many local governments plan to lift tax rates. Further, cuts in public spending will have both
direct and indirect effects on purchasing power and consumption. We expect private con-
sumption growth to remain relatively modest in 2014, but better sentiment, a stronger labour
market and low interest rates should give a boost to private consumption growth in 2015.
The labour market has been weak throughout 2013: employment and the labour force con-
tracted by 1.1 percent and 0.6 percent y-o-y on average between January and October. Busi-
ness surveys now indicate that the worst fall in employment is probably over, but none of the
main employer sectors expect increasing employment. The pace of contraction will instead
likely be more moderate in coming months. Despite the delayed economic recovery, we mar-
ginally lower our 2013 unemployment rate forecast, to 8.1 percent. Leakage from the labour
force has restrained the increase in the unemployment rate more than we had expected. We
expect the unemployment rate to remain unchanged in 2014, at 8.1 percent. In 2015, the
strengthening business cycle should pull the unemployment rate down to 7.8 percent.
Construction of new residential and non-residential buildings remained in the doldrums this
year, but residential activity has been supported by repairs and renovations, which are nec-
essary given the ageing residential building stock. In 2014-15, we expect construction activ-
ity to pick-up moderately. A slowdown in housing loan stock growth following increased risk-
awareness of consumers and lenders, higher loan margins and increased transaction costs
point to a continued moderation in housing demand, but tight supply in growth centres is
likely to anchor house prices from serious downward corrections.
Closing the sustainability gap is a main priority of fiscal policy
The centralised wage deal will slow growth in public expenditure in 2014-15 and the busi-
ness cycle recovery will support the revenue side, leading to a lower deficit and a slower
build of debt. The government’s focus is on closing the sustainability gap of the public sector
by 2017, estimated to be roughly 4.7 percent of GDP, according to the Ministry of Finance.
The common denominator for planned structural reforms is the aim to boost the supply side
of the economy. The political power of the current government will be tested, as there is a
great urge to get several of these reforms implemented during its term, which ends in the
spring of 2015. Despite the fragmentation of the government base, the government seems
united in keeping Finland’s triple-A credit rating.
Tuulia Asplund, +358 10 444 2403, [email protected]
Tiina Helenius, +358 10 444 2404, [email protected]
Tax hikes keep pri-
vate consumption
growth relatively
modest in 2014…
…but a boost is felt
in 2015 from low
rates, improved sen-
timent and a
stronger job market
Tight supply in
growth centres likely
to prevent steep
house prices declines
Government seems
united in keeping
Finland’s triple-A
credit rating
Macro Forecast, December 5, 2013
42
Denmark
Better, but still not great
There has been a turnaround in sentiment indicators and there are tentative signs of more stable trends in
housing prices and in the labour market. Thus, following two years of stagnation, there is hope for higher
growth moving into 2014. However, we still see the recovery as being weak and fragile, as household debt is
still high and as the global economic environment is too anaemic to support exports as a driver of growth.
The main risks relate to any increase in interest rates and weaker growth in the eurozone.
Since our previous Macro Forecast in August, the economy has shown signs of finally stepping
away from the on/off recessions that have characterised the past couple of years. The strong-
est signal of this comes from the turnaround in sentiment indicators since the summer. Con-
sumer confidence has risen to a five-year high and the business barometers from the industrial
and service sectors have likewise improved. The less-dire economic performance has also
been confirmed in the latest GDP figures, with growth rates of 0.6 percent and 0.4 percent on a
quarterly basis in Q2 and Q3 respectively. The stronger-than-anticipated expansion in Q3
prompts us to lift our growth estimate for 2013 from a slight contraction to slightly positive GDP
growth of 0.25 percent.
Overall, however, we do not make large changes to our outlook for the economy and still expect
a relatively weak and fragile recovery in economic activity. Taking a closer look at the latest GDP
figures reveals a continued weak underlying economic environment, with the brunt of the im-
provement caused by a one-off investment in ships. Stripping that from the GDP figures, fixed
business investments barely rose and economic activity would have contracted in Q3. Still-low
capacity utilisation indicates that investments will most likely not increase markedly.
It was especially disappointing to see private consumption continuing to contract on the back
of the mentioned increase in consumer sentiment. However, one aspect of the improvement in
consumer confidence is that consumers have raised their views for the prospects for the econ-
omy as a whole, but their assessments of their own personal finances have not yet risen in
earnest. That is an abnormal situation, as households have almost always regarded their own
economies as being in a better state than the Danish economy in general. Thus, there are still
no clear signals that the more stable trends on the labour market, the extremely low debt ser-
vicing costs, positive real wage growth and rising home prices in some parts of the country
have led to an actual increase in consumption.
The figure above indicates that an increase in interest rates would have a meaningful impact on
household purchasing power. The dotted line shows an imaginary rise in the long- and short-term
mortgage bond yields to their long-term averages, which based on historical trends would in-
crease household interest rate payments after tax by more than 2.5 p.p. of disposable income.
Sentiment indicators
paint brighter pic-
ture…
…but we still expect
the recovery to be
weak
Still no clear sign of
pick-up in private
consumption…
Rising yields would
hit consumers hard
Macro Forecast, December 5, 2013
43
Even though we see these factors lifting the contribution to growth from private consumption
slightly as we move into 2014, we are still not convinced that consumers will begin to open their
wallets in earnest, not least as household debt has not yet been reduced in any meaningful way,
and as the interest rate sensitivity of the household sector is extremely elevated. We do not ex-
pect yields to increase to that extent in the foreseeable future, but it illustrates the risk to the Dan-
ish economy from any unanticipated rise in yields. Furthermore, it highlights that due to the still-
high debt levels in the household sector, Denmark would most likely be a laggard in a more
marked global economic recovery, if that were to be followed by tighter financial conditions. As
such, we believe that households will continue to focus on savings which would help secure the
longer-term stability of the Danish economy but keep private consumption at bay.
Looking ahead, households should also expect less help from the trend in real wages. Wage
growth is set to be relatively weak – albeit positive – over the forecast horizon as work on re-
storing competitiveness goes on. Furthermore, the current low-inflation environment is not ex-
pected to continue, as we feel relatively comfortable that we have not moved into a vicious
deflationary spiral. Undoubtedly, the low inflation has to some degree been of the more worry-
ing, demand-driven kind from declining wage growth and reduced pricing power of companies.
However, the lower inflation has also been driven by cuts in duties and lower gasoline prices,
and we expect the negative effects from this to diminish as we move into 2014. Finally, there
have so far been no signs of the low inflation having an impact on inflation expectations.
Even though the eurozone has shown signs of stabilisation, growth in the common euro cur-
rency area is still expected to be anaemic at best. Additionally, a still-weak competitive posi-
tion enhanced by the recent strengthening of the trade-weighted DKK exports is not seen as
a strong driver of economic activity. In conclusion, we still see the state of the economy as
fragile, with several potential risks that could derail any recovery. We retain our forecast of
continued subdued GDP growth in the years ahead.
Key macroeconomic indicators
Sources: Statistics Denmark and Handelsbanken Capital Market
Jes Roerholt Asmussen, +45 4679 1203, [email protected]
Percentage change 2011 2012 2013f 2014f 2015f
GDP 1.1 -0.4 0.3 0.9 0.8Household consumption -0.7 -0.1 0.5 0.7 0.6Government consumption -1.4 0.4 0.2 0.6 0.6Gross investment 3.3 0.8 0.6 -0.7 1.1Exports 7.0 0.4 0.5 1.6 0.8Imports 5.9 0.9 1.7 0.7 0.6
Unemployment rate 6.0 6.1 5.8 5.6 5.6Consumer prices 2.8 2.4 0.8 1.6 1.7House prices, one family -2.8 -3.2 2.2 1.5 1.0General gov budget balance* -1.9 -4.2 -1.7 -2.1 -2.6
* Percent of GDP
Inflation will rise
and wage growth
remain subdued
Exports not expected
to come to the rescue
Macro Forecast, December 5, 2013
44
Key figures Real GDP forecasts
Source: Handelsbanken Capital Markets
Inflation forecasts
Source: Handelsbanken Capital Markets
Unemployment forecasts
Source: Handelsbanken Capital Markets
Sweden 1.3 1.0 0.9 3.2 2.9 2.4 2.5
Norway 3.1 0.3 0.3 1.2 1.7 1.9 2.1
Norway Mainland 3.5 1.8 1.8 1.5 2.0 2.0 2.0
Finland -0.8 -0.2 -0.2 2.0 2.0 2.2 2.2
Denmark -0.4 0.3 -0.1 0.9 0.7 0.8 0.8
EMU -0.7 -0.5 -0.5 1.0 1.0 1.1 1.1
USA 2.8 1.7 1.7 2.7 2.7 2.9 2.9
UK 0.1 1.3 1.3 1.5 1.5 1.7 1.7
Japan 2.0 1.9 1.9 1.5 1.5 1.2 1.2
Brazil 0.9 2.5 2.3 2.5 2.8 3.0 3.3
Russia 3.4 1.6 2.2 2.5 2.8 2.9 3.1
India 5.1 4.7 4.5 5.0 4.7 5.5 5.5
China 7.8 7.6 7.5 7.3 7.3 7.0 7.0
Czech Republic -1.8 -1.2 -0.8 1.7 1.7 2.3 2.3
Hungary -1.7 0.7 0.4 1.6 1.6 2.1 2.1
Poland 1.9 1.3 1.2 2.9 2.6 3.4 3.0
Slovakia 2.0 1.1 0.9 2.0 2.2 2.8 2.8
2012 2013f
(Previous
forecast) 2014f
(Previous
forecast) 2015f
(Previous
forecast)
2012 2013f 2014f 2015f
Sweden 0.9 0.0 0.0 1.0 1.1 2.0 2.0
Norway 0.8 2.3 2.3 2.0 2.0 1.6 1.7
Finland 2.8 1.5 1.8 1.8 2.2 2.4 2.6
Denmark 2.4 0.8 1.2 1.6 1.8 1.7 1.9
EMU 2.5 1.5 1.5 1.6 1.7 1.7 1.7
USA (core) 1.8 1.3 1.3 1.8 1.8 2.1 2.1
UK 2.8 2.7 2.7 2.3 2.3 2.1 2.1
(Previous
forecast)
(Previous
forecast)
(Previous
forecast)
2012 2013f 2014f 2015f
Sweden 8.0 8.0 8.1 7.9 8.1 7.7 7.8
Norway 3.2 3.5 3.6 3.7 3.7 3.9 3.8
Finland 7.7 8.1 8.2 8.1 8.0 7.8 7.7
Denmark 6.1 5.8 6.1 5.6 6.4 5.6 6.4
EMU 11.4 12.3 12.3 12.2 12.2 12.1 12.1
USA 8.1 7.5 7.5 6.8 6.9 6.2 6.3
UK 7.9 7.7 7.8 7.5 7.6 7.3 7.5
(Previous
forecast)
(Previous
forecast)
(Previous
forecast)
Macro Forecast, December 5, 2013
45
Currency forecasts
Source: Handelsbanken Capital Markets
Interest rate forecasts
Source: Handelsbanken Capital Markets
Dec 3 <6 m <12 m <24 m <36 m
EUR/SEK 8.87 8.40 8.30 8.10 8.00
USD/SEK 6.55 6.72 7.55 8.10 8.00
GBP/SEK 10.71 10.18 10.12 10.13 10.67
NOK/SEK 1.07 1.04 1.03 1.01 1.00
DKK/SEK 1.19 1.13 1.11 1.09 1.07
CHF/SEK 7.22 6.77 6.64 6.38 6.15
JPY/SEK 6.36 6.52 7.19 7.57 7.27
EUR/USD 1.36 1.25 1.10 1.00 1.00
USD/JPY 102.97 103.00 105.00 107.00 110.00
EUR/GBP 0.828 0.825 0.820 0.800 0.750
GBP/USD 1.64 1.52 1.34 1.25 1.33
EUR/CHF 1.23 1.24 1.25 1.27 1.30
EUR/DKK 7.46 7.45 7.45 7.46 7.46
USD/DKK 5.50 5.96 6.77 7.46 7.46
GBP/DKK 9.01 9.03 9.09 9.32 9.94
CHF/DKK 6.07 6.01 5.96 5.87 5.73
JPY/DKK 5.34 5.79 6.45 6.97 6.78
EUR/NOK 8.31 8.10 8.05 8.00 8.00
SEK/NOK 0.94 0.96 0.97 0.99 1.00
USD/NOK 6.13 6.48 7.32 8.00 8.00
GBP/NOK 10.03 9.82 9.82 10.00 10.67
CHF/NOK 6.75 6.53 6.44 6.30 6.15
JPY/NOK 5.95 6.29 6.97 7.48 7.27
USD/BRL 2.36 2.65 3.00 3.35 3.35
USD/RUB 33.18 35.30 38.30 40.90 41.50
USD/INR 62.32 63.00 62.00 60.00 58.00
USD/CNY 6.09 6.07 6.05 6.05 6.05
EUR/PLN 4.20 4.10 4.00 3.90 3.75
Policy rates Dec 3 <6 m <12 m <24 m <36 m
Sweden 1.00 1.00 1.25 1.75 2.00
US 0.125 0.125 0.50 1.50 2.50
Eurozone 0.25 0.25 0.25 0.25 0.25
Norway 1.50 1.50 1.75 2.00 2.50
Denmark 0.20 0.20 0.20 0.25 0.25
UK 0.50 0.50 0.50 0.50 1.50
3m interbank rates Dec 3 <6 m <12 m
Sweden 1.08 1.20 1.45
US 0.24 0.40 0.70
Eurozone 0.24 0.15 0.15
Norway 1.66 1.65 1.65
Denmark 0.24 0.25 0.25
Macro Forecast, December 5, 2013
46
Interest rate forecasts continued...
Source: Handelsbanken Capital Markets
2y govt. yields Dec 3 <6 m <12 m <24 m <36 m
Sweden 0.92 1.20 1.55 1.80 2.10
US 0.23 0.90 1.50 2.10 2.80
Eurozone (Germany) 0.13 0.15 0.15 0.15 0.30
Norway 1.62 1.65 1.95 2.45 2.95
Denmark 0.02 0.15 0.20 0.20 0.40
Finland 0.22 0.20 0.20 0.20 0.35
UK 0.49 0.55 0.70 0.90 1.10
5y govt. yields Dec 3 <6 m <12 m <24 m <36 m
Sweden 1.64 1.80 2.10 2.40 2.50
US 1.29 1.90 2.40 2.80 3.10
Eurozone (Germany) 0.69 0.70 0.80 0.90 1.00
Norway 2.11 2.05 2.15 2.65 3.15
Denmark 0.92 0.55 0.65 0.75 0.85
Finland 0.90 1.00 1.10 1.20 1.30
UK 1.76 1.70 1.80 1.90 2.00
10y govt. yields Dec 3 <6 m <12 m <24 m <36 m
Sweden 2.30 2.40 2.60 2.85 3.00
US 2.80 3.00 3.30 3.40 3.50
Eurozone (Germany) 1.74 1.80 2.00 2.10 2.20
Norway 2.83 2.90 3.00 3.20 3.40
Denmark 1.79 1.95 2.15 2.30 2.40
Finland 1.95 2.10 2.30 2.35 2.45
UK 2.84 2.80 3.00 3.10 3.20
2y swaps Dec 3 <6 m <12 m
Sweden 1.35 1.55 1.85
US 0.39 1.00 1.60
Eurozone (Germany) 0.44 0.50 0.50
Norway 1.87 2.00 2.10
Denmark 0.62 0.80 0.80
UK 0.85 0.95 1.10
5y swaps Dec 3 <6 m <12 m
Sweden 2.04 2.20 2.40
US 1.52 2.00 2.50
Eurozone (Germany) 1.08 1.10 1.20
Norway 2.46 2.70 2.80
Denmark 1.28 1.50 1.50
UK 1.83 1.90 2.05
10y swaps Dec 3 <6 m <12 m
Sweden 2.69 2.80 3.00
US 2.87 3.10 3.40
Eurozone (Germany) 2.01 2.10 2.30
Norway 3.18 3.30 3.30
Denmark 2.21 2.45 2.60
UK 2.80 2.80 3.00
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