NO nov 2005 Eng omsl · 2008. 11. 21. · based upon it. Opinions contained in this research report...

ECONOMIC RESEARCH · ENGLISH EDITION

Nordic Outlook

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Global economy continuing to resist American decelerationSweden: ketchup effect for jobs means higher key interest rate

NOVEMBER 2006

Nordic Outlook - November 2006

2

SEB Economic Research

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Håkan Frisén, Head of Economic Research [email protected]

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Ann Enshagen Lavebrink, Research Assistant [email protected]

Olle Holmgren, Economist [email protected]

Mikael Johansson, Economist [email protected]

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Contributions to the section on Germany in this report have been made by Thomas Köbel and Klaus Schrüfer fromSEB Frankfurt/M. C

SEB, Economic Research, KA3, SE-106 40 STOCKHOLM

This report was published on November 21, 2006.Cut-off date for calculations and forecasts was November 16, 2006.

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Summary

The international economyThe American deceleration will continue. GDP growth in 2007 will be 2.1 per cent — norecession, but clearly below trend. Due to lingering inflationary threats and a tight labour market, theFederal Reserve will wait until the middle of next year before cutting its key interest rate.

The world economy has good immunity to a US deceleration. Domestic demand is strong inEurope as well as in China and Japan.

Unemployment in many countries is falling towards levels it has not reached for decades, butthe forces of globalisation are helping to hold down inflation.

Despite low inflation, many central banks are raising their key rates as insurance against thethreat that liquidity growth and falling unemployment will together trigger a surge of inflation. TheEuropean Central Bank will hike its refi rate to 4 per cent and the Bank of Japan will continue itscautious rate hikes.

Solid confidence in continued low inflation will keep bond yields down, resulting in very flat yieldcurves around the world in the next couple of years. Since central banks are acting a little tougher,however, in the short term bond yields will rise somewhat from today’s depressed levels.

The dollar will weaken as the interest rate gap between the US and other parts of the globaleconomy narrows. China will revalue the yuan by 5 per cent against the USD next year.

SwedenGDP will grow clearly above trend – 4½ per cent this year and 3½ per cent in 2007. Householdpurchasing power will surge due to higher real wages and lower taxes, fuelling a consumptionboom.

Strong growth will lead to a sharp improvement in the labour market situation. Employmentwill rise by 80-90,000 people both this year and next. The new government’s job policies will stimu-late labour supply, alleviating bottleneck problems. Registered unemployment will stay flat next yearas National Labour Market Board programmes are discontinued, but total unemployment will drop.Equilibrium unemployment will eventually also fall.

The wage round will result in somewhat faster nominal pay hikes: just above 4 per cent annually in2007 and 2008. Unit labour costs will rise slowly, as will inflation. UND1X inflation will neverthe-less stay well below the Riksbank’s 2 per cent target both in 2007 and 2008.

The labour market will strengthen faster than the Riksbank expects. The bank will thus continueits rate hikes for preventive purposes. Next autumn, the repo rate will stand at 4 per cent. Ashrinking interest rate gap against the ECB and lower wealth tax will help support the krona.

Other Nordic countries and the BalticsIn Norway, mainland GDP will increase by 3.8 per cent this year and 3.3 per cent in 2007. Con-sumption will grow rapidly and unemployment will fall to a very low level. Pay hikes will speed up,and inflation will exceed 2 per cent in 2008. Norges Bank will raise its sight deposit rate forpreventive purposes to 5.0 per cent by the end of 2007.

The Danish economy will continue its vigorous growth. Exports will keep expanding and afavourable earnings climate will lead to higher capital spending. The labour market is getting in-creasingly tight and pay increases are rising. Inflation will climb somewhat above 2 per cent.

In Finland, growth is peaking this year. The export boom will gradually fade and growth willcool to 3.3 per cent in 2007. Unemployment will fall but pay increases will remain low for anotheryear. Inflation will stay below 2 per cent in 2007.

The Baltic countries are showing rapid economic growth. Overheating risks are increasing inEstonia and Latvia. Lithuania’s growth is more balanced. Excessive inflation will delay euro zoneaccession until 2010 at the earliest.

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Contents

Summary 3

International overview 5

The United States 12

Japan 16

China 17

The euro zone 18

The United Kingdom 22

Central and Eastern Europe 23

Sweden 24

Denmark 33

Norway 34

Finland 36

Nordic key economic data 37

International key economic data 39

Boxes

How does the Phillips curve actually look nowadays? 7

The US and China: The two big engines of the worldeconomy — but how big? 10

The congressional election: Little impact on economic policy 15

The euro zone: Difficult challenges for monetary policy 20

Sweden: Lower equilibrium unemployment long-term 27

Money supply as an inflation warning flag 29

Evaluation of the Riksbank’s policies 31

5


International overview

Persistent underlying strength

Mild American deceleration, continued goodglobal growth

Continued low inflation outside the US

Rapid interest rate hikes in Europe, but theFed will hold off cuts until summer

Stable long-term yields

In recent years, the world economy has experiencedits best growth in more than 30 years. The UnitedStates and China have been powerful engines. West-ern Europe and Japan have gradually also built upspeed. Unemployment has fallen in all major econo-mies. Yet inflation has remained low — as haveinterest rates. Financial markets have taken on ever-greater risk and asset prices have risen. Stock mar-kets have rallied, in some cases reaching all-timehighs.

Several factors now indicate that a degree of cyclicaldeceleration is on the way. Interest rate hikes in theUS have led to a major downturn in the housingmarket. Certain contagious effects are likely in othersectors of the American economy and later in otherparts of the world economy. Meanwhile a number ofother central banks have raised their key interest ratesin order to prevent future inflation problems — eventhough inflation is still low right now.

Last spring, financial markets worried about a riskscenario in which US stagflation problems, combinedwith geopolitical uncertainty, might lead to a globaldownturn. Investors quickly took their profits andreduced their risk exposure. Stock markets fell. Sincethen, however, stock markets have turned around andrisen steadily. Meanwhile bond yields have trendeddownward even though central banks have hiked theirkey rates at an unexpectedly rapid pace.

GDP growthYear-on-year percentage change

2005 2006 2007 2008United States 3.2 3.2 2.1 2.5Japan 2.7 2.9 2.3 2.0China 9.9 10.5 9.5 9.0Euro zone 1.5 2.7 2.3 2.0Nordic countries 2.8 3.9 3.3 2.4OECD 2.7 3.2 2.5 2.4World economy 4.9 5.2 4.6 4.5Sources: OECD, SEB

Our analysis of underlying global forces mainlysupports this shift towards greater confidence infinancial markets. Our conclusion is that that theunderlying positive forces that have driven theworld economy in recent years will remain pre-

dominant. Globalisation and keen competition,together with continued supply shocks from Asia, arepowerful structural factors that lead to both rapidgrowth and low inflation. The forces of growth willhelp limit the impact of the American slowdown,while a persistently disinflationary environment willmean that monetary tightening will not have to go sofar that it throttles continued expansion.

This is why the world economy will grow almost asfast during 2007 as this year. During 2008, growthwill slow marginally as other regions outside the USshow some declines. Overall, the global economy willexhibit continued good growth figures during ourforecast period.

Orderly US coolingThe American slowdown has become increasinglyapparent. Annualised GDP growth fell from 5½ percent in the first quarter of this year to 1½ per cent inthe third quarter. To date, the downturn has beenconcentrated in residential construction, but fallinghome price increases will also dampen householdconsumption ahead. An inventory draw-down willalso keep down growth in the next few quartersaccording to the traditional cyclical pattern.

Meanwhile important forces are helping to keep theUS economy moving. Business profits are continuingto rise, which will sustain capital spending activity.Consumer spending is supported by rising shareprices and the decline in oil prices over the past fewmonths. In addition, during 2007 the Fed will gradual-ly ease the effects of stagnating home prices. Ouroverall conclusion is that American GDP growth willdecelerate to slightly above 2 per cent in 2007 andthat in 2008 it will remain a bit below trend. This stillimplies a relatively mild deceleration: far from reces-sion, but instead what is usually described as a mid-cycle correction.

The three other major economic regions – China,Japan and Western Europe – have good potential to

20082007200620052004

80

70

60

50

40

30

20

80

70

60

50

40

30

20

Source: SEB

Oil priceBrent, USD/barrel

SEB forecast

6



resist the American infection rather well. Domesticdemand is being sustained by the fall of the oil price.Contagious effects from the US will be limited, sincethe downturn there primarily affects domesticallyoriented sectors with low import content. We alsopredict that the correlation between American andglobal growth will be lower than historical associa-tions indicate, since the causes of the US decelera-tion are more specifically American than, forexample, the real estate crisis that occurred around1990 or the IT and stock market bubble around theturn of the millennium.

Consequently, our forecast is that global growth willonly slow down to a minor extent next year.China’s rapidly growing share of global output will initself have a positive impact on the rate of worldeconomic expansion; continued vigorous Chinesegrowth is calculated from a base that is becominglarger year by year. On a smaller scale, all the Nordiccountries will also continue to grow strongly and willagain help to sustain growth in 2007.

Low inflation outside the USUnemployment has trended downward in a largemajority of countries during the past decade. In mostplaces this is due to both domestic structural changesand the effects of globalisation. In many countries,unemployment is now lower than it has been forseveral decades, without inflation taking off (see alsothe box on the Phillips curve).

Despite falling unemployment and rising oil prices inrecent years, inflationary pressure remains low.The table below shows how strikingly little theinflation rate has reacted to oil prices, compared to theimpact of the 1973-74 (“OPEC I”) and 1980-81(“OPEC II”) oil crises.

Inflation after oil shocksPercentage change in consumer prices

OPEC I OPEC II Today1973-74 1980-81 2005-06

United States 9 12 3United Kingdom 13 15 2Japan 17 6 0Germany 7 6 2Sweden 8 13 1Sources: OECD, SEB

Overall, core inflation (price increases excludingenergy and food) in major industrialised countries(G7) is parked continuously at 1 per cent, if the US isexcluded. In China, due to keen competition and over-investments, inflation is also fluctuating around 1 percent despite rapid economic growth. In all the Nordiccountries, inflation is low, even though Norway andDenmark are showing extremely low unemployment.

Challenge for monetary policyThe combination of rapid growth and falling unem-ployment, on the one hand, and continued low infla-tion on the other, is not straightforward and easy forthe world’s central banks to handle. Higher employ-ment would normally cause capacity shortages andrising inflation. But when inflation stubbornly remainsextremely low, despite a quadrupling of oil prices andhistorically low unemployment, this complicates lifefor many central banks.

The risks of keeping nominal interest rates very lowover a lengthy period have been increasingly dis-cussed in recent months. This tends to drive up assetprices and increase risk-taking by various marketplayers, which in itself may lead to financial instability.Meanwhile a cautious central bank must assume thatthe combination of rapid liquidity growth and mount-ing capacity restraints will sooner or later lead toinflation. What we do not know is whether theprocess will be gradual or whether it will be in thenature of a ketchup effect, with inflationary forcesbehaving well until they reach a breaking point andtrigger a sudden wave of inflation (see box).

In light of this, it is not a complete surprise that anumber of central banks have become more

0605040302010099989796959493

11

10

9

8

7

6

5

4

11

10

9

8

7

6

5

4

Sources: Eurostat, ONS, SEB

UnemploymentPer cent

Euro zoneThe Nordic countriesUnited Kingdom

06050403020100999897

3.5

3.0

2.5

2.0

1.5

1.0

0.5

3.5

3.0

2.5

2.0

1.5

1.0

0.5

Source: SEB

Core inflationYear-on-year percentage change

OECD excl. US and countries with high inflationUS

7



How does the Phillips curve actually looknowadays?In the traditional neo-classical world picture, aneconomy is often analysed in simplified form viaaggregated supply and demand functions.

In the short term, the supply curve is ordinarilyassumed to have a positive slope (which reflectsdiminishing returns and rising production costs ascapacity utilisation rises). The demand curve has anegative slope, since high inflation undermines realdemand.

In the labour market, this approach is equivalent tothe traditional Phillips curve, which shows the trade-off between lower unemployment and higher inflation.In the short term, it is thus possible to “exchange”lower unemployment for slightly higher inflation, andvice versa.

In the long term, however, the supply curve is as-sumed to be vertical. Potential GDP level — whereresources are fully utilised but not over-extended — isassumed to be independent of inflation. This isattributable to the theory of a “natural” unemploymentlevel (non-accelerating-inflation rate of unemploy-ment, NAIRU) at which inflation is stable, which wasawarded the Nobel Prize this year. In terms of thePhillips curve, this is equivalent to a long-term verticalPhillips curve; unemployment below NAIRU triggersinflation; unemployment above it slows inflation.

In this analytical framework, the short-term differencebetween actual and potential GDP — the output gap— has been an important instrument for centralbanks. If unemployment falls below NAIRU, costsand prices rise since aggregate output is higher thanpotential. A positive output gap thus leads to in-creased inflation due to over-utilisation of resources.Unemployment above the equilibrium level implies anegative output gap and a falling inflation rate.

But today’s reality does not really look like this.Globalisation has resulted in a supply shock. Accord-ing to some estimates, the number of workers inactivities exposed to international competition hasdoubled in recent decades. Meanwhile new technolo-gy and keener competition have lowered costs in anumber of sectors. The result has been that produc-tion can be increased more than previously beforeinflation signals a danger of overheating.

In other words, empirical data indicate that nowadaysthe Phillips curve is flat across a large interval. Theimplication is that it will be possible to sharplyincrease output and reduce unemployment, withouttriggering inflation.

At least for a while. But to careful central banks thequestion is whether this development is sustainable.Can they really count on the supply curve to remainflat even if liquidity and employment continue to riseat a rapid rate? Can they genuinely rely on inflation toremain absent even if unemployment falls to record-low levels? Won’t inflation finally creep upwardgradually, albeit at lower unemployment levels thanbefore? Or — even worse: Will the economy reach apoint where inflation suddenly pours back full force,like ketchup out of a plastic bottle? If the latter is thecase, the flat segment of the Phillips curve is adangerous path that lures central banks into over-heating where the lack of inflation is just a short-termaberration.

Once the economy has sailed into waters where theold navigation charts no longer provide guidance, anumber of problems thus arise for central banks,whose task is to protect price stability and financialstability. The NAIRU concept becomes less useful,since it is a moving target. But detailed analyses oflabour market structures and liquidity growth becomemore important.

Unemployment

Inflation

Traditional Phillips curve

Unemployment

Inflation

Traditional Phillips curve

Unemployment

Inflation

Flatter Phillips curvedue to globalisation

Unemployment

Inflation

Flatter Phillips curvedue to globalisation

Unemployment

Inflation

Phillips curve according to NAIRU theory

NAIRU

Risinginflation

Fallinginflation

Unemployment

Inflation

Phillips curve according to NAIRU theory

NAIRU

Risinginflation

Fallinginflation

8



inclined to gradually raise their key interest rateswithout awaiting clear inflation warnings. This is akind of insurance against future inflation risks, whichrisk-minimising central banks regard as reasonable.These key rate hikes are due to worries about risingasset prices as well as uncertainty about the futureimpact of monetary growth and an increasingly stronglabour market on inflation.

Key interest rate convergenceNo unambiguous pattern is easy to discern, however.The central banks differ in terms of where they are inthe economic cycle, but also in terms of how inflationhas reacted to rising growth and a tighter labourmarket. Also of importance is how various centralbanks have chosen to define their target parameters.The European Central Bank, for example, explicitlyfactors lending and monetary aggregate trends into itsanalytical framework. This makes it easier to justify apreventive tightening policy, whereas countries withstricter inflationary targets have bigger problems ineducating markets about their approach.

The US is clearly ahead of most other countriesin the economic cycle. Inflation has — albeit with acertain time lag — reacted in a rather traditionalway to ever-higher resource utilisation. The FederalReserve is careful to warn of late-cyclical inflationrisks, but due to the deceleration now underway inthe economy, growth will fall clearly below poten-tial next year and unemployment will begin to rise.In that situation, we believe that the Fed’s nextmove will be to lower its key interest rate. Howev-er, this will not happen until the summer of 2007 –and will be less than we anticipated in the lastNordic Outlook. In December 2007, the federalfunds rate will stand at 4.50 per cent.

The ECB will continue to hike its key interestrate. Economic growth in the euro zone is abovetrend and unemployment is falling. Meanwhilelending and money supply growth is clearly abovethe ECB’s preferences. Granted that inflation iscurrently falling due to lower oil prices, forecastsfor the coming year indicate an inflation ratesomewhat above the ECB’s target. We anticipatethat the ECB will raise its key rate one more timethis year and that the refi rate will then peak at4.0 per cent during the first half of 2007. Webelieve that structural factors that are helping tolower NAIRU are of less importance to the cau-tious ECB leadership during the current strongcyclical situation.

The Bank of Japan is also in a rate-hiking phase.However, deflation is only slowly and reluctantlyeasing its grip, while the government’s fiscal policywill also be tightened gradually. The next rate hikewill not come until after the end of 2006. At year-end 2007 the key rate will stand at 1.0 per cent.

Nordic boom leading to higher ratesThe Nordic region is in the midst of sharp economicupturn. This year’s GDP increases will be the strong-est since 2000. Employment is increasing rapidly in allthese countries. In Denmark and Norway, unemploy-ment has fallen to levels that have historically led toaccelerating pay increases. Meanwhile inflationremains low, and in Norway it has even fallen thisyear. The contradictory signals from low inflation onthe one hand and rapid growth and low unemploy-ment on the other are thus especially clear in theNordic countries. Further complicating the situation isthat both Norges Bank and Sweden’s Riksbank havechosen a monetary policy based on explicit inflationtargets.

For Norges Bank, the question of preventiveinterest rate hikes is leading to the clearest goalconflicts. The Norwegian central bank has chosento signal that the risks of a pay and inflation ketch-up effect have increased in the past year. This iswhy the bank has accelerated the pace of interestrate hikes, even though inflation is far below itstarget. We anticipate that the sight deposit ratewill be raised from today’s 3.25 per cent to 5.0per cent at the end of 2007. This is somewhatfaster than the plans announced to date by NorgesBank.

In Sweden, there are still untapped resources in theeconomy. This is because the improvement in thelabour market began late, but also because there issignificant potential for an expanding labour supply,among other things due to the new government’spolicies aimed at attracting more people into thelabour market. In light of rapid job and outputgrowth, as well as continued vigorous creditexpansion, we still believe that the Riksbankprefers to raise its key rate faster than themarket expects. We anticipate that the refi ratewill reach 4 per cent next autumn.

In Denmark, too, the labour market has strength-ened significantly in the past year. One reason is

08070605040302010099

7

6

5

4

3

2

1

0

7

6

5

4

3

2

1

0

Sources: ECB, Fed, SEB

Key ratesPer cent

forecastSEB

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

9



the “flexicurity” policy, but this is now beginning toreach the limits of what it can achieve. However,due to Denmark’s fixed exchange rate policy, theNationalbank must rely on the ECB’s ratehikes.

Flat yield curvesWith the exception of the Bank of Japan, all theabove-mentioned central banks are thus movingtowards key interest rates around 4 per cent, albeit atdifferent speeds and from different directions. Givenlong-term inflation rates at or just below 2 per cent,this forecast implies real short-term interest ratesof around 2-3 per cent, which is close to the levelthat the central banks regard as neutral. Ordinari-ly, key interest rates would be raised well above theneutral level, given today’s strong economic situation.In our opinion, however, the level we are forecastingis sufficient to achieve the appropriate cool-down.The supply-stimulating and efficiency-raising effectsof globalisation and new technology will persist forsome time. The threat of inflation on a global scale isthus low, and central banks do not need to raiseinterest rates so high.

A flattening of yield curves is now graduallyoccurring in Europe and Japan, in the same way asoccurred previously in the US. There are still thosewho argue that flat and especially inverted yieldcurves constitute a recession warning. However, weare sticking to the view we have advanced in recentissues of Nordic Outlook — flat yield curves are aconsequence of the inflation and supply analysispresented above. Low inflation leads to low nomi-nal bond yields while cautious central banks arespeeding up their rate hikes a bit in order toprevent any future inflation and offset excessivemonetary stimulation.

Temporary upturn in bond yieldsWe anticipate somewhat tougher central banks onboth sides of the Atlantic, compared to market expec-tations. Consequently, we are counting on a certainrebound in long-term yields in the immediatefuture.

In the US, the Fed has tried to persuade the mar-kets that a lowering of the federal funds rate is notimminent, with the aim of decelerating the previousrapid downturn in bond yields. This attempt has sofar met only mixed success, but we anticipate that10-year Treasury yields will climb somewhat, to4.80 per cent by year-end. During 2007 the trendwill be downward; as the Fed’s key rate cutapproaches, bond yields will resume their down-turn. By the end of 2007, the ten-year Treasurywill stand at 4.50 per cent.

In recent years, the movement of euro zone bondyields has shadowed that of their US counterparts.The German ten-year government bond has beenparked about 100 basis points below the Americanequivalent. Looking ahead, this spread will shrink.GDP growth in the euro zone will actually bemarginally higher than in the US next year. Thedifference in key interest rates at the end of 2007will be only 50 points, compared to 250 points asrecently as last summer. We anticipate a slightpositive slope in the German yield curve, whichmeans that the 10-year yield will rise to 4.10 percent by mid-year 2007, parking there for the restof the year. The spread against the US 10-yearTreasury will thus shrink to 40 points.

Nordic bond yields will largely follow Germanones. Denmark will continue to shadow these,with a positive spread of about 10 basis points.Swedish bond yields should rise somewhat morethan German ones, since Swedish inflation iscreeping upward and growth is stronger than inGermany; the eventual result will be that the yieldspread against Germany disappears altogether.Norwegian bond yields will rise somewhatfaster and the yield spread will widen to about 70points late in 2007.

Low, stable bond yields will mean that risk appetitewill receive good support. Last spring, uncertaintyabout American economic performance and centralbank strategy led to profit-taking, and stock marketsfell. As confidence resumed and the Fed’s key interestrate approached its peak, stock markets have recov-ered. The assessment of the American economy weare making here — a deceleration, but a gentle one —and our forecast that the Fed’s key rate has peakedand rate cuts will follow — together indicate thatduring the coming year the US stock market willenjoy support from falling interest rates. In Europe,interest rates will admittedly rise, but in the context of

08070605040302010099

7

6

5

4

3

2

1

0

7

6

5

4

3

2

1

0

Sources: Reuters EcoWin, SEB

10-year government bonds

forecastSEBUS

GermanyJapan

10



The US and China: The two big engines ofthe world economy – but how big?There is no doubt that China’s importance to theworld economy has increased. How much, though,depends partly on how we choose to summariseChina and other countries in a global aggregate.

Merely summarising across the board with the helpof current prices in a single currency (usually USD)underestimates China’s importance to global GDP.The reason is that price levels in China are signifi-cantly lower than in the major OECD countries. Thestandard method for correcting this is to adjust theestimate for purchasing power. This means that weadjust the exchange rates of countries for differencesin relative price levels, with the US dollar as a base.The result is a GDP level according to purchasingpower parities (PPP), in which China’s contribution tothe world economy becomes significantly larger,since in China a dollar goes substantially further thanin other countries.

According to the estimates used by the IMF, a PPP-adjusted Chinese yuan had an exchange rate of CNY1.92 per dollar in 2005, compared to the actualexchange rate of CNY 8.18. Compared to the US,China thus has an adjustment factor in the range of1:4. Against the rest of the world, the adjustment isabout 1:3. China consequently has 3 times as muchweight when we estimate GDP growth using PPPthan using nominal exchange rates.

PPP weighting reflects changes in global prosperitybetter, since it takes into account differences inpurchasing power. It also avoids excessively largefluctuations between countries; nominal exchangerates can of course move sharply without changingthe underlying real economy or price levels. When itcomes to different countries’ shares of total globalGDP, this method is thus preferable.

As the tables indicate, PPP weighting makes China’scontribution to world GDP and GDP growth very large.This year and next, China will account for nearly onethird of global growth. Calculated in PPP terms,China’s GDP is already three fourths that of theUnited States.

In other cases, however, the PPP method exagger-ates China’s importance. It is often more relevant touse a nominal weighting system. For example, thisapplies to exporters who must assess global marketprospects; both demand and profitability are deter-mined by actual exchange rates, more than bypurchasing power parities.

In the world of nominal exchange rates, China’scontribution to global growth is significantly smaller,but China remains the world’s third largest exporterafter the US and Germany, and over time it is advanc-ing strongly regardless of measuring method.

In the financial field, current nominal exchange ratesare obviously the best weighting method. Thisenables us to note that China’s stock market isinsignificant in size, representing only 0.5 per cent ofglobal market capitalisation at the end of 2005. IfHong Kong is included, China’s share is just above2½ per cent. However, there are financial muscles inChina’s foreign currency reserve, which make upmore than 20 per cent of the world’s overall currencyreserves.

Contribution to global GDP growthPercentage points

PPP weighted 2006 2007United States 0.6 0.4China 1.6 1.6World economy 5.2 4.6

Nominally weightedUnited States 0.9 0.6China 0.5 0.5World economy 4.0 3.3Sources: IMF, SEB

The area where China plays by far its largest role inworld trade is as an importer of commodities. Chinaaccounts for one third of global demand for steel andin recent years has accounted for more than 50 percent of the increase in steel consumption. In manyother metals, China’s dominance has been evenlarger. China’s share of global oil consumption ismore modest, but due to strong growth the increasein Chinese oil consumption has still accounted for 30per cent of global oil consumption growth in recentyears.

Share of global totals, selected economiesPer cent, 2005

US China Japan GermanyGDP, PPP 20 15 6 4GDP, nominal 28 5 10 6Exports 10 7 5 9Stock market capitalisation 39 0.5 12.5 3.5Oil consumption 25 8 6 3Steel consumption10 32 8 4

Sources: IMF, Iron and Steel Institute, Energy InformationAdministration, Goldman Sachs

11



satisfactory economic performance and growth abovetrend. Macro factors thus point towards a continuedgood stock market situation.

Dollar will slowly weakenThe shrinking interest rate spread between the US andthe euro zone is one indication that the dollar willcontinue to weaken against the euro. We anticipatethat the euro will stand at USD 1.32 at the end of2007. It will weaken somewhat more against theNorwegian krone and the Swedish krona.

The dollar should also weaken against the yen. In thelight of Japanese inflation and foreign trade, the yenappears significantly undervalued. On the other hand,

0807060504030201135

130

125

120

115

110

105

100 1.4

1.3

1.2

1.1

1.0

0.9

0.8

Sources: Reuters EcoWin, SEB

Exchange rates USD/JPY and EUR/USD

SEBforecast

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

continued large capital outflows will prevent a rapidappreciation. At the end of 2007, USD/JPY willreach 110.

Chinese currency policy is of vital importance, bothbecause Chinese trade with the US has increased soquickly and because the yuan exchange rate can beexpected to affect various other Asian countries.China’s trade surplus — like its foreign currencyreserve — is now increasing dramatically. TheDemocratic return to power in the House of Repre-sentatives will probably mean growing American callsfor an acceleration of China’s currency appreciationand a transition to floating exchange rates as well as aconvertible currency.

The introduction of full convertibility is likely to bedelayed for another several years. But it is a fact thatduring the past year, China has both eased its capitalaccount and allowed a wider trading band against thedollar. The pace of yuan appreciation has increasedsomewhat, albeit slowly. China will also graduallydiversify its currency reserve, which will contributeto a marginal weakening of the dollar. We expect theyuan to be revalued by about 5 per cent againstthe dollar during 2007, in small steps.

12


The United States

Soft landing under way

Growth below trend next year

Lingering inflationary impulses

Fed holding off, will cut key rate by summer

The slowdown in the American economy has becomeclearer. Annualised GDP growth fell from 5½ per centin the first quarter to 1½ per cent in the third quarter.Year-on-year GDP growth is now below 3 per centfor the first time since 2003. Our conclusion in thelast Nordic Outlook — that earlier interest rate hikesare now starting to bite — has thus been confirmed.The housing market is cooling off, and the adjustmentin low household saving can begin. Meanwhile thecorporate sector’s dynamism and good profitsindicate that the slowdown will not be especially deep.

Our forecast implies that GDP growth as an annualaverage will fall from 3.2 per cent in 2006 to 2.1per cent next year: no recession but still below theconsensus view.

Despite the slowdown in growth that is under way,the Federal Reserve’s stabilisation policy task is farfrom simple. Resource utilisation is high, and coreinflation has climbed rapidly this year. The corporatesector is in robust shape, with good profitability andample cash reserves. So far, household consumptionhas not diminished especially much, and it is difficultto determine at what point in time a weaker housingmarket will put a damper on consumption.

This is why the Fed’s strategy is largely a matterof playing for time. The central bank does not wantthe financial markets to start pricing in any imminentcuts in the federal funds rate yet. In recent months,the Fed has pointed out that the downturn in thehousing market will not necessarily have any majorrepercussions in the rest of the economy. As long as

the Fed sees little risk of a hard landing, there is noreason to accelerate its interest rate cuts. Instead, topFed officials see a need to warn about existing infla-tionary risks, which might even require interest ratehikes. We thus anticipate that the Fed will wait untilJune before its first interest key rate cut and willthen lower the key rate by another 50 basis points to4.50 per cent by the end of 2007 – i.e. below theprevailing market view.

Recovery will take timeDuring the third quarter, growth was weak. It appearsunlikely that the economy will rebound as early as thebeginning of next year. Most short-term indicators arepointing downward, and various factors will also helprestrain growth in a slightly longer perspective:

Inventory build-up continued at a fairly rapidpace during the third quarter. An inventory adjust-ment is a regular feature of slowdown phases ofthe type the US economy is now experiencing.Having inventory draw-downs still ahead of us willplace restrictions on how fast the recovery canoccur. The weak third quarter GDP growth figurecannot be ascribed at all to inventory reduction,which makes it extra significant as an indicator ofweaker performance.

Residential construction fell by 17 per centduring the third quarter. This represented a negativecontribution equivalent to 1.2 percentage points ofannualised GDP growth. As the chart belowindicates, construction remains historically high.Since there is still plenty of room for furtherdeclines, it is reasonable to count on significantnegative contributions for another year or so. Witha certain lag, there will also be secondary effects inthe form of declining infrastructure investments,lower consumption of interior fitting products andso on.

However, the trend of home prices will be thecrucial factor behind how deep the downturn will

2008200720062005200420032002200120001999

9

8

7

6

5

4

3

2

1

0

-1

-2

9

8

7

6

5

4

3

2

1

0

-1

-2

Sources: BLS, SEB

US: Gross domestic productPer cent

forecastSEBYear-on-year change

Annualised change

USD billion, annualisedUS: Inventory changes

Source: US Department of Commerce

90 92 94 96 98 00 02 04 06

-100

-75

-50

-25

0

25

50

75

100

125

-100

-75

-50

-25

0

25

50

75

100

125

13


The United States

turn out to be; private consumption is broadly affect-ed via this channel. Our perception is that individualmonthly price changes are not crucial; it is the longertrend — discernible year-on-year — that is importantin determining how households will adjust theirconsumption and saving patterns.

No quarterly national statistics after Q2 are availableyet, however. Year-on-year price increases in thatquarter were still as high as 10 per cent, though theincrease between the first and second quarters wasonly 1.2 per cent. Monthly statistics on the change insale prices nevertheless fell below zero in September,both for new and existing homes. This indicates thatthe official quarterly statistics will also show acontinued clear slowdown in home prices during Q3,although these two sources of statistics differ both interms of definitions and information gathering tech-niques. Vacancy levels and the larger number of daysin the market before home sales close are otherindications that the price adjustment is far from over.Our forecast is that year-on-year price increaseswill also fall to zero in the quarterly statistics in2007.

Previously, the wealth effect from rising home priceswas one important reason why consumption has heldup and saving has been squeezed down to negativelevels. Households have been able to borrow againsttheir homes and consume part of the rising assetvalue. When prices stagnate, this effect fades.

A downturn of 10 percentage points in the rate ofhome price increases, all else being equal, would slowhousehold consumption growth by nearly 2 percent-age points. On the other hand, the continued stockmarket upturn will help to sustain consumption. Wethus anticipate that the increase in consumption willslow from just above 3 per cent this year to 2-2½per cent in 2007. Such a trend implies that thehousehold savings ratio will gradually rise from itscurrent negative level to about 1 per cent in 2008.

Hard landing can be avoidedThe above-mentioned forces will contribute to a GDPgrowth next year of only slightly above 2 per cent.This means that growth will be clearly below trend,resulting in gradually declining resource utilisation andeventually an easing of inflationary pressures.

Meanwhile there are offsetting factors that will reducethe risks of a recession.

Capital spending outside the housing sector willcontinue to grow. To date, companies have beenrelatively cautious about new capital spendingcommitments. Given their high profit levels andhigh capacity utilisation, there is thus potential forfurther expansion. Because of ample corporate cashreserves, sensitivity to interest rates is also relative-ly low.

Also sustaining consumption will be the fact thatthe oil bill is no longer increasing as a share ofhousehold budgets. This autumn’s falling oil priceswill stimulate the economy at least in the shortterm. Rising share prices also serve as a counter-weight to slower residential asset growth. Since

Year-on-year percentage changeUS: GDP and employment

GDP EmploymentSources: US Department of Commerce, BLS

80 82 84 86 88 90 92 94 96 98 00 02 04 06

-5-4-3-2-10123456789

-5-4-3-2-10123456789

Per cent of GDPUS: Residential construction

Source: US Department of Commerce

50 55 60 65 70 75 80 85 90 95 00 05

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

Year-on-year percentage changeUS: House prices

Existing homes, NAR OFHEO, total

New homes, NAR

Sources: OFHEO, National Association of Realtors, USDC

01 02 03 04 05 06

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

14


The United States

American households on the whole are richer thanever, this will naturally soften the need for savingsadjustment — although share ownership is farmore concentrated among the richest householdsthan is real estate ownership.

Also affecting the economic recovery process is howlengthy the slowdown in home prices will be. Theexperience of other English-speaking countries is thathome prices bounce back relatively fast onceinterest rate cuts begin. The Fed’s key rate cutsnext year should thus lead to a stabilisation of homeprices.

Taken together, there are thus good reasons why GDPgrowth next year will stay well above zero, therebyavoiding a recession. In 2008, growth will acceler-ate somewhat, but will remain below trend.America’s soft landing may thus be a rather fleetingepisode. The risks in our forecast are instead on theupside. This diverges from our view in the last NordicOutlook, when we viewed a hard landing as the mainrisk.

Strained resource situation for a whileHigh resource utilisation is one important reason whythe Fed wants to hold off on interest rate cuts.Unemployment has again fallen to 4.4 per cent afterclimbing late this past summer. Job growth hasadmittedly faded slowly, but the influx of new partici-pants into the US labour market has meanwhile beenmore sluggish than expected.

Fears that inflexible labour supply may justify down-ward revisions in estimates of potential US growthhave thus gained new fuel. In our view, potential USgrowth has fallen from about 3½ per cent to about 3per cent. This is one reason why the Fed’s rate cutswill take time to materialise and why they will not beaggressive during 2007.

Looking ahead, it is likely that job creation will contin-ue to slow. There is a strong association betweenGDP and employment (see chart). GDP growth ofaround 2 per cent does not provide room for any jobgrowth worth mentioning, if we look at the pattern ofthe past decade. However, productivity growth iscooling down right now, in keeping with the tradition-al pattern at the end of a cyclical expansion, whichwill help somewhat to sustain employment in the shortterm. We thus anticipate that job growth next year willbe around ½ per cent, equivalent to roughly 60,000people per month. This implies that unemploymentwill slowly creep upward.

Stubborn inflationary forcesDue to the oil price decline of recent months, theconsumer price index is now falling sharply. On theother hand, underlying inflationary pressure is show-ing the opposite trend. Core CPI — inflation excludingenergy and food — has climbed quite sharply, al-though it fell back somewhat in October. We identifythree main factors behind this upturn:

Rising unit labour costs as wage and salary costsincrease and productivity growth slows.

Greater opportunities in a mature cyclical phase topass on earlier cost increases for energy andother input items to consumer prices.

The shelter component in inflation has risensharply. This is largely an effect of higher interestrates. With a one year lag, the shelter componentshows a close co-variation with the Fed’s keyinterest rate.

These inflationary forces will gradually weaken.Pressure from costs of input goods will ease relativelysoon, whereas other inflationary forces will continuefor longer. Core inflation is now about to peak but willremain at a high level, around 3 per cent, for the nextsix months or so. Core inflation using the PersonalConsumption Expenditures deflator (core PCE) is a bit

Year-on-year percentage changeUS: Core inflation and unit labour cost

Core CPI (LHS) ULC (RHS)Source: BLS

97 98 99 00 01 02 03 04 05 06

-2

-1

0

1

2

3

4

5

6

1,00

1,25

1,50

1,75

2,00

2,25

2,50

2,75

3,00

06050403020100

2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

7

6

5

4

3

2

1

0

Source: BLS

US: Shelter and fed funds rateShelter, contribution to CPI (LHS)Fed funds rate, per cent (RHS)

15


lower but is well above the Fed’s 1-2 per cent “com-fort zone”.

Fed playing for timeGiven rising inflation and a slowdown in growth thathas been concentrated so far in residential construc-tion, the Fed sees strong reasons not to fuel hopes ofa monetary policy easing. The central bank wants tobe sure that inflation has peaked and is beginning tofall before it switches to prioritising measures aimedat staving off the risk of recession. It also wants to

The United States

The congressional election: Little impacton economic policyAs a result of the November 7 congressional election,the Democrats took control of the US Congress (boththe House of Representatives and the Senate). Thiswill mean divided government, since the Republicanscontrol the White House.

The effect will be that neither side can push throughits own policies. By and large, this is probably goodfor the federal budget. Under George W. Bush, theRepublican majority has been amazingly generouswith the taxpayers’ money; now both sides will keep aclose eye on each other and block the other party’spet projects. The Democrats will be able to stopfurther tax cuts and the White House will not approveDemocratic proposals to enlarge spending. From aneconomic policy standpoint, the two years until the2008 presidential election will probably be almostdevoid of major domestic economic policy decisions.

keep falling bond yields from fuelling the upturn foranother while.

To some degree, the Fed faces a typical late-cyclicaldilemma. But the situation also includes specialcharacteristics that make the risks of policy mistakeslarge in both directions. Additional interest rate hikeswould be risky in a situation where growth and thehousing market are showing such clear downwardsigns after a lengthy upturn. On the other hand, ratecuts would also be a risky undertaking in a situationwhere inflation is too high while the corporate sectoris in such good shape and the household savings ratiois negative.

A rate cut by mid-year 2007 is logical, given that coreinflation will have begun to slow by then, according toour forecast. Even if there are indications that quarter-ly GDP figures are beginning to turn upward by thistime, growth will remain below trend. This means thatunemployment will continue rising; the Fed will thusno longer need to regard the resource situation as anobstacle to a looser monetary policy.

Our conclusion is that the Fed will wait until June2007 before delivering its first interest rate cut. Thiswould mean that the federal funds rate will have stoodat 5.25 per cent for a whole year, an unusually longperiod for such an activist central bank.

The post-election resignation of Donald Rumsfeld asDefence Secretary may signal a faster US exit fromIraq and lower war spending than otherwise, under-scoring our view that the election outcome may provebeneficial to the federal budget.

The election outcome may have a major impact inanother field: trade policy. A Democratic-controlledCongress may prove more protectionist than aRepublican one, and next year President Bush isunlikely to receive renewed fast-track authority fortrade negotiations. The chances of the Doha Roundbeing revived have thus diminished further, and therisk of a confrontation with China has increased.

080706050403020100

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

Sources: BLS, SEB

US: Inflation Year-on-year pecentage change

SEBforecast

Core inflationCPI

16


Japan

Growth is past its peak

Domestic demand driving economic growth

Upturn in inflation from lower level

Undervalued yen will appreciate

In the past six months, Japanese economic trendshave become more mixed, after practically all thecurves had pointed upward in 2005. Consumerconfidence has fallen. Employment and incomegrowth have leveled off. Meanwhile the retail sectorhas performed weakly, raising questions about thestrength of private consumption, but we still expectdomestically driven growth above trend over the nextcouple of years.

Second quarter GDP growth was weak, but recov-ered slightly in the third quarter due to strong exports.The large decline in public sector investments contin-ued. However, private domestic demand was robustand has grown a little more than 3 per cent year-on-year in the last two quarters. Booming investments inthe private sector have offset a certain weakening ofprivate consumption and business confidence remainsat high levels. Because of somewhat weaker interna-tional demand combined with a strengthening of theyen ahead, GDP growth will slow from 2.9 per centthis year to an average of a bit above 2 per centduring 2007 and 2008.

Continued signs of deflationWhile the real economy has shown a more mixedpicture than previously, inflation has been slightlyweaker than expected. In late August new inflationestimates were presented, after the base year for theconsumption basket was changed from 2000 to 2005.An increased weight for products with falling prices,such as home electronics, pulled down the inflationtrajectory by 0.5 percentage points.

This means that core inflation as measured in the USand Western Europe, i.e. excluding energy and food,is still negative. In September it fell from a rate of -0.4per cent to -0.5 per cent. The inflation yardstick thatpreviously served as the Bank of Japan (BoJ) targetvariable — CPI excluding fresh foods — showed aninflation of 0.2 per cent in September. This partiallynew inflation picture, combined with certain growthdisappointments, has led to slightly lower expectationsof interest rate hikes from the BoJ.

Our assessment is that the next interest rate hikewill not come until 2007. At the same time, it shouldbe pointed out that after abandoning its zero interestrate policy last summer, the BoJ is guided less thanbefore by short-term movements in inflation, whichhas also been confirmed by the bank’s recent hawkishcomments. Despite downward revisions, the trend of

CPI inflation is also still upward, with an increasefrom -0.1 per cent early this year to 0.6 per cent inSeptember, i.e. within the interval (0-2 per cent) thatthe bank has defined as compatible with price stability.Monetary policy must also take into account the risksof financial imbalances if interest rates are excessivelylow, as well as the interactions with fiscal policy —with Japan’s gigantic public sector debt creatingspecial conditions.

The new government of Prime Minister Shinzo Abe issticking to the old government’s budget target, i.e. abalanced primary budget by 2011. Abe clearly de-clared that this would occur mainly via expenditurecuts and growth-promotion policies. The recovery inproductivity growth over the past few years wasmainly due to restructuring in the manufacturingsector. Large portions of the domestic economy arestill in great need of reforms, thus providing signifi-cant potential for improvements. Yet it is still worthasking whether tax hikes are also needed in order tomeet the major fiscal challenges ahead. No sales taxincrease is in the cards during the next couple ofyears, however.

Undervalued yenLowered expectations of the BoJ and an increasedappetite for borrowing cheaply in yen and investing inother more high-yielding assets have generated furtherdownward pressure on the Japanese currency. Thereal effective exchange rate, i.e. the nominal exchangerate adjusted for price increases in Japan compared toother countries, is now at its lowest level since theearly 1990s. Given our forecast that the interest rategap with other countries will gradually narrow and thefact that the yen is fundamentally undervalued, weanticipate an appreciation during the course of2007 and 2008. At the end of 2008, the yen will standat JPY 105 per dollar.

Japan: Real effective exchange rate

Source: IMF

90 92 94 96 98 00 02 04 06

70

75

80

85

90

95

100

105

110

115

120

125

70

75

80

85

90

95

100

105

110

115

120

125

17


China

Uncontrollable sheer strength

Continued imbalanced growth

Cautious attempts to cool down the economy

Faster currency revaluation

China’s economy continues to break records. Duringthe first half of 2006, GDP grew at a rate of about 11per cent. Third quarter growth was 10.4 per cent.Fixed investments continue to rise, although the rateof increase cooled somewhat to “only” 23 per cent.Instead, net exports helped keep the pace up; by allindications, the trade surplus will be above USD 170billion for 2006 as a whole. Despite the roaringeconomy, inflation is low — around 1½ per cent. Thereasons are overproduction and stiff competition.

Shift in strategy neededMost other countries would envy China’s macrofigures. But below the surface there are a variety ofproblems with today’s strong investment- andexport-driven growth:

It primarily benefits city dwellers. The urban-ruralincome gap is widening rapidly. These growingdisparities contradict government promises tocreate a more “harmonious” society.

Growth is based on loose lending practices atexcessively low real interest rates. Since local bankmanagers, party officials and industrialists havestrong incentives to support each other’s regionalprojects, serious credit monitoring is often absent.

Investments are thus often of poor quality. Onesymptom of this is that productivity growth hasslowed in recent years. In other words, growth isprimarily due to a massive increase in resourceutilisation — not to a more efficient economy.

Capital-intensive growth is energy-intensive andharmful to the environment; in its “green nationalaccounts”, China’s National Bureau of Statisticsestimates the costs of environmental destruction atabout 3 per cent of GDP per year.

China’s growing trade surplus and undervaluedcurrency generate accusations of mercantilism andcovert protectionism from other countries, particu-larly the United States.

The government wants to deal with these problemsthrough a strategy for more consumer-driven growth.Last March the People’s Congress proclaimed a “newsocialist countryside” as a key objective and promisedimproved benefits for farmers. The GDP growthtarget was set at 7½ per cent. Since then the keyinterest rate has been raised along with bank reserve

requirements. We do not believe these measures aresufficient, but predict continued above-target growth:GDP will rise by 10½ per cent this year and 9½per cent in 2007.

Gradual financial service reformsFinancial service sector reforms are of potentiallymajor importance, since more efficient capital alloca-tion — and higher real interest rates — are necessaryin order to deal with the problem of overinvestmentand bad investments.

The three largest government-owned banks have beenrelieved of a large proportion of their bad loans,placed under new management and floated in thestock market — thereby also gaining foreign share-holders. The Shanghai Stock Exchange is graduallyopening up to trading in more and more shares.Portions of the capital account are also slowlyopening to outflows — it is now easier for Chineseinvestors to invest in foreign currencies. In 2004-05China showed large short-term currency inflows(excluding the trade balance and direct investments).These have been replaced this year by outflows,enabling part of excess liquidity to leak out.

China is also repeating its earlier statements that theyuan will become a floating, fully convertible curren-cy but that this must take the time it will take. Thetrading band against the US dollar has gradually beenstretched, and exchange rate volatility has increasedsomewhat. This indicates that the regime is cautiouslytesting the waters for larger reforms.

To foreign eyes, this process may seem agonisinglyslow. However, the pace of yuan appreciation againstthe USD has accelerated in the past six months and isnow well in line with our forecasts in the AugustNordic Outlook, when we predicted a revaluation of3-5 per cent this year. We expect the yuan toappreciate by 5 per cent against the dollar in 2007.

Index January 2005=100Exchange rate USD/Yuan

Source: Reuters EcoWin

Jan05

Apr Jul Oct Jan06

Apr Jul Oct

95.0

95.5

96.0

96.5

97.0

97.5

98.0

98.5

99.0

99.5

100.0

100.5

95.0

95.5

96.0

96.5

97.0

97.5

98.0

98.5

99.0

99.5

100.0

100.5

18


The euro zone

Continued evidence ofstrength

GDP growth will be above trend in 2007 too

Continued labour market improvement

Inflation around 2 per cent

ECB will hike key rate to 4 per cent in spring

The euro zone continues to exhibit vigorous growth.GDP will rise 2.7 per cent this year, slowing to 2.3per cent in 2007 — modest growth in an internationalperspective but still clearly above trend. Strongereconomic performance, high inflation and rapidmonetary expansion have led the European CentralBank to normalise its key interest rate at a relativelyfast pace. We anticipate continued rate hikes to 4 percent during the spring of 2007. Persistent economicstrength and an ever more robust labour market aresufficient motives, although the ECB will need torevise its 2007 inflation forecast downward.

Signs of strength predominateAccording to most indicators, the strong economicexpansion will continue for another while andgrowth will remain above trend. The EuropeanCommission’s sentiment indicator kept climbingduring the third quarter, and Germany’s IFO businessconfidence index climbed in October. The “currentsituation” component hit its highest level in 15 years,and expectations for the future rose. The Germaneconomic recovery remained powerful. This supportsour forecast that the German economy will maintainits momentum well into next year, despite the Januaryvalue-added tax hike and a weaker internationaloutlook. In Germany we expect GDP growth of 2½per cent this year and nearly 2 per cent next year.

Meanwhile there are signals that the euro zone is pastits growth peak. The purchasing managers’ index has

turned downward both for manufacturing and servicesectors and the volatile ZEW index has fallen steeply,reflecting greater concern among financial investorsabout the effects of a US slowdown. Our overallconclusion is that due to certain contagious effectsfrom the US, Western Europe is close to its cyclicalpeak. An unexpected stagnation in French GDP in thethird quarter may be an early sign of this. Still,domestic resilience is sufficient to enable the eurozone to grow at 2¼-2½ per cent in 2007 too.

Rising consumptionHousehold consumption is gaining strength in the eurozone as a whole. Retail sales increased step by step inJune, July and August, but slowed down somewhat inSeptember. The European Commission’s consumerindicator and a stronger labour market point towardscontinued rising consumption ahead.

The retail sector has mainly picked up speed in Franceand to some extent in Spain, while it is more sluggishin Germany. However, the German VAT hike inJanuary 2007 may lead to marginally higher consump-tion late in 2006 and a corresponding lull early in2007. We do not believe that this effect will be solarge, though. Because the labour market is continuingto improve and household savings are high, it insteadlooks as if household consumption will grow at adecent pace next year. In the euro zone as a whole,private consumption will increase by 2 per cent thisyear and by more than 1.5 per cent in 2007.

Foreign trade will decelerateThe main threat to a continued cyclical upturn isdeteriorating export prospects as the US economyslows. Net trade probably shifted to providing anegative contribution to growth in the third quarter.

ECB President Jean-Claude Trichet recently presentedcalculations whose conclusion was that 1 percentagepoint lower American growth would slow euro zone

IndexEuro zone: Purchasing manager's index

Manufacturing ServicesSource: NTC Economics Ltd

00 01 02 03 04 05 06

42.5

45.0

47.5

50.0

52.5

55.0

57.5

60.0

62.5

42.5

45.0

47.5

50.0

52.5

55.0

57.5

60.0

62.5

Year-on-year percentage change and indexEuro zone: Retail sales and confidence

Retail sales (LHS) Consumer confidence (RHS)

Sources: DG ECFIN, Eurostat

00 01 02 03 04 05 06

-20.0

-17.5

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

19


The euro zone

growth by 0.2 percentage points, including secondaryeffects via other countries. Such a small effect ishardly supported by the historical links betweengrowth in the two regions. Historical experience alsopoints towards a tendency to underestimate sec-ondary effects at the beginning of a slowdownwhen the analysis focuses mainly on trade flows.

Meanwhile other factors indicate that contagiouseffects will be less than during previous Americanslowdowns:

The euro zone’s trade with the rapidly growingeconomies of Eastern Europe and Asia is in-creasingly important. In addition, there is current arapid rise in exports to neighbouring countries inWestern Europe (the UK, Switzerland and theNordic countries excluding Finland), which buymore than one third of euro zone exports. Theeconomic indications are that exports to theseregions will continue to grow.

The American slowdown is largely concentrated indomestic sectors with low import content and withgenerally weak connections to other countries,which reduces contagious effects.

We thus anticipate that euro zone exports will contin-ue to hold up relatively well in the first half of 2007.As an annual average, export growth will slow fromover 8 per cent in 2006 to 6 per cent in 2007.

Unemployment will continue downwardEuro zone unemployment has levelled off at a five-year low of 7.8 per cent for five months in a row.However, there are many indications that the down-ward trend will resume, although there is a slight riskof an upward rebound because extra jobs werecreated by the football World Cup last summer. Therewas also a change in unemployment data-gatheringmethods in Germany, which probably pushed downjobless figures during the summer.

Both employment indicators and our growth forecastindicate that the underlying trend towards a strong-er labour market will continue. We are thussticking to our forecast that unemployment willaverage around 7.5 per cent next year.

The gradual downturn in unemployment has generatedgreater interest in what jobless level is compatible withstable inflation (non-accelerating inflation rate ofunemployment, NAIRU). In line with our predictions,the ECB has now explicitly raised the issue of labourmarket-related inflation risks. In his introductoryaddress at a press conference in October, for the firsttime ECB President Trichet mentioned the downwardtrend of joblessness and the upturn in employmentwhen describing euro zone economic performance.

Our unemployment forecast for 2007 is close to oreven below NAIRU estimates by the OECD and theEuropean Commission, for example (7.5-8 per cent).This implies a rising risk of wage-driven inflation.

On the other hand, many structural changes are underway that will influence how far unemployment candecline without triggering faster inflation. Labourimmigration from new EU countries and price pres-sures due to globalisation will continue to help restrainfuture pay increases. In addition, rule changes in Italy(the “Biagi laws”) have pushed down unemploymentby creating a large number of new part-time jobs. Theso-called Hartz laws in Germany have had an impactin the same direction.

Our conclusion is that NAIRU is somewhat lowerthan conventional estimates indicate and that thequantity of available resources is larger. Continuedlow labour shortage figures point in this direction. Themonetary policy consequences of this supply analysiswill be small in the short term, however. Our esti-mates according to the “Taylor rule” show that theECB is mainly influenced by the change in unemploy-ment. As long as unemployment is trendingdownward, this will give the ECB a motive forfurther interest rate hikes.

Year-on-year percentage change and net balanceEuro zone: Employment

Actual (LHS) Expected according to manufacturing industry (RHS)

Sources: DG ECFIN, ECB

00 01 02 03 04 05 06

-20.0

-17.5

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Per centEuro zone: Resource utilisation

Capacity utilisation in manufacturing sector (LHS) Unemployment (RHS) OECD:s measure of NAIRU (RHS)

Sources: DG ECFIN, Eurostat, OECD

00 01 02 03 04 05 06 07

6.06.57.07.58.08.59.09.5

10.010.511.011.512.0

76

77

78

79

80

81

82

83

84

85

86

20


The euro zone

Difficult challenges for monetary policyOne of the most frequently recurring argumentsagainst a common currency was that WesternEurope is not an optimal currency area. A commonmonetary policy would thus lead to an inappropriatestabilisation policy in some regions and countries.The counter-argument of euro advocates was thatgreater economic integration would lead to increas-ingly synchronised cyclical movements in the eurozone member countries. Over time, a commonmonetary policy would thus suit a growing number ofmember countries nicely.

Reality has been more complex. The synchronisationof short-term cyclical movements has admittedlyincreased – but the long-term differences in growthbetween member countries do not seem to havesmoothed out. This has resulted in new, in somerespects more difficult, challenges to monetary policy.

Previously fast-growing members – such as Irelandand Spain – have continued to grow rapidly, even withthe euro. They have had clearly higher inflationpressure than the euro zone average. But since thecommon key interest rate is set on the basis ofdominant inflation trends in the euro zone as a whole,real interest rates in these fast-growing countrieshave ended up lower than the euro average. Theyhave thus received an extra growth push. Meanwhileslowly growing countries – especially Germany –have reported lower inflation than average. There,real interest rates have been clearly higher than theeuro zone average, slowing growth further. Thisimplies that monetary policy has strengthenedgrowth divergences in the euro zone.

Accumulated GDP and price increases in selectedeuro zone countries1999-2006, per cent

HICP GDP

Ireland 27 50

Spain 25 30

Germany 12 10

Italy 19 10

Source: European Commission

The example of Germany is revealing. Germaneconomic policy aims at regaining competitiveness.Since this has not been possible by means ofnominal depreciation, the only way out has been realdepreciation — i.e. by achieving lower inflation thanother currency union members. When this was

actually achieved, however, the effect — via themechanism described above — has been higher realinterest rates and even slower growth. Commonmonetary policy has thus indirectly penalised what, insome respects, has been a successful nationalpolicy.

Despite all these adversities, Germany has survivedthe challenge reasonably well. The strong Germantradition of aiming at low inflation has worked. But theproblem will become far more difficult ahead.

Italy has thorny growth and budget problems, rootedin the fact that over a period of many years thecountry’s manufacturers have lost competitivenessdue to weak productivity growth and an old-fashionedexport structure. Italy has shown both weak growthand relatively high inflation. The devaluation alterna-tive does not exist. One way out of these problemswould be to try to repeat the German trick of realdepreciation – but this must occur in Italy, which lacksGermany’s attitude towards low inflation, and in asituation where the “reward” will be higher realinterest rates. It will also have to occur in a unionwhere Germany has had low inflation for a long time.Italy must, in other words, push down inflation wellbelow German levels in order to succeed.

In Spain, too, difficult adjustment problems can beexpected when today’s extremely strong constructionmarket cools, pulling down growth instead of fuellingit. In that situation, Spain will also discover that fallinginflation – unexpectedly – leads to higher real interestrates and decelerating growth.

The potential pitfalls are probably more serious thanmost people realise today. The political challengeswill also be larger – as will calls for structural reformsto increase the flexibility of the economy and reducevulnerability when growth cools. Here Spain hasshown much greater willingness to adapt than Italy,where Romano Prodi’s coalition has already seendefections, been forced to accept far-reachingcompromises and seen central government debtdowngraded to a level perilously close to the ECB’sminimum acceptance level.

In our assessment, markets have not yet entirelypriced in all the monetary policy complications thatItaly faces. The risk premium on Italian governmentbonds will thus rise. The spread against Germangovernment bonds will widen.

Low but rising pay increasesWages continue to increase at a rather calm pace.Nominal year-on-year hourly wage costs admittedlyspeeded up from 2.2 to 2.4 per cent in the secondquarter. Nevertheless, this rate of increase will meancontinued weak inflationary pressure from wages;unit labour costs are increasing at around 1 per cent.

On the other hand, there are some indications of risingwage increases. Germany’s largest steel producers(Salzgitter AG and ThyssenKrupp AG) recently agreedto the highest collective pay hikes in ten years. Thisindicates that the labour market improvement willaffect coming wage negotiations. Next year collectiveagreements will be reached for nearly 7 millionGerman employees (about 20 per cent of the labour

21


The euro zone

market). High corporate profits, relatively highinflation, due among other things to the VAT hike, andan ambition to compensate for low wage increases inrecent years, are factors that may contribute to higherwage demands in these negotiations.

Choppy inflation due to oil and VATHICP inflation fell to a 1.7 per cent rate in September,then fell to 1.6 per cent in October, after havingstubbornly remained well above 2 per cent for nearlytwo years. In short order, HICP thus dropped to alevel below the ECB’s target of inflation close to butjust below 2 per cent. The downturn in inflation isexplained entirely by the rapid fall in oil prices.

Base effects from energy will shortly change fromnegative to positive, again driving up inflation. Inaddition, the effect of the German VAT hike in Januarywill be to boost inflation by 0.3 percentage points inthe euro zone as a whole, and by more than 1 point inGermany. HICP inflation will rise to about 2.1 percent early next year. After that, base effects willshow up and the inflation trend will thus be bumpyduring the rest of 2007. On average, HICP inflationnext year will be 2.0 per cent, which is thus marginal-ly higher than the ECB target.

This forecast means that the ECB will have lessclear inflation arguments for continued rate hikesnext year. In the short term, however, ECB manage-ment is likely to be conservative about any downwardrevisions in the inflation forecast. According to theECB’s August forecast, HICP inflation will end upbetween 1.9 and 2.9 per cent in 2007. The middlepoint in this forecast interval will also probably be wellabove the inflation target in the next forecast that theECB unveils early in December.

ECB key rate at 4 per cent this springAll indications are that the ECB will raise its refirate to 3.50 per cent in December – the sixth 25basis point increase during this rate-hiking cycle. Themost interesting result of the bank’s monetary policy

meeting will be its statement about future interest ratestrategy. The real economic trends that the bankpresents will probably emphasise continued stablegrowth and a tighter labour market, thus providingsupport for continued interest rate hikes. The ECBwill probably continue to tone down the contagiouseffects from the American slowdown.

Nor will money supply growth provide support for anend to interest rate hikes. Having declined marginallyin June and July due to slower household mortgageborrowing, M3 growth has again accelerated. InSeptember it stood at 8.5 per cent, exceeding by awide margin the 4.5 per cent benchmark that the ECBconsiders compatible with low, stable inflation.

Lower actual inflation and somewhat lower “break-even” inflationary expectations show that the ECBfaces a dilemma, but our overall assessment is that theECB will still not deviate from its plan to continuehiking interest rates as economic growth signalsbecome stronger. We thus believe that the ECB willraise its key rate to 4 per cent during the firsthalf of 2007. It is unlikely that the ECB will go higherthan this, since the US slowdown and a stronger eurowill decelerate both inflation and growth.

The risk picture for our interest rate scenario issymmetrical. On the one hand, there is a risk that theUS cool-off will have a greater impact than is now inthe cards and that the ECB will be forced to take thisinto account earlier. In addition, the ECB may need tomore clearly revise its inflation forecast downward.

The main upside risk is that the real-term economicupturn in Europe will be even more long-lasting. Ifunemployment keeps falling, sooner or later supplyconstraints will emerge, resulting in broader inflation-ary pressure. In that case, the ECB will hardly stophiking interest rates during the first half of 2007, butinstead will continue upward above a neutral interestrate during the autumn.

Year-on-year percentage changeEuro zone: Credits and money supply

Credits M3 money supplySource: ECB

00 01 02 03 04 05 06

3

4

5

6

7

8

9

10

11

12

13

3

4

5

6

7

8

9

10

11

12

13

2008200720062005

2.6

2.4

2.2

2.0

1.8

1.6

1.4

1.2

1.0

2.6

2.4

2.2

2.0

1.8

1.6

1.4

1.2

1.0

Sources: Eurostat, SEB

Euro zone: InflationYear-on-year percentage change

SEB forecast

HICPCore inflation

22


The United Kingdom

Key interest rate tops out

Export boom will slow in 2007

Modest consumption despite home pricerebound

Calm wage growth due to weak labour market

The British economy is continuing to grow at aboutits trend level of 2½ per cent. There will be a slightcooling in 2007 as export growth becomes morenormal after this year’s jump. Domestic demand willgrow at a modest pace. The labour market will beweak for another year. No further interest rate hikesare needed after the Bank of England (BoE) boostedits repo rate in November.

This autumn’s hard data and sentiment indicatorsconfirm the picture of stable economic perform-ance. GDP growth has stood at 0.7 per cent fourquarters in a row. Manufacturing is in a modestrecovery phase after last year’s recession. Servicesectors are growing at a decent pace. Constructioncompanies are providing early signals that the worst isover.

Exports will rise by about 15 per cent this year —their fastest growth since the 1970s. Exports of oilproducts and better demand from Western Europeare important reasons. A certain global slowdownin 2007 will slow export expansion to 6-7 per cent.The UK is one of the Western countries mostaffected by a US deceleration, with 15 per cent ofexports going there; the impact of an Americanslowdown is usually visible faster than in Continen-tal Europe.

The investment climate will improve somewhat,due to rising capacity utilisation and record corpo-rate profits. The business sector’s capital spendingappetite has risen this year but is still relatively low,given the profit situation; capital spending bybusiness has stayed below 10 per cent of GDP forthe past three years.

Private consumption continues to grow at a bitabove 2 per cent annually. The basic reason for thisrather slow pace is the weaker labour market,reflected this autumn by a continued decline inhousehold optimism. Household income will alsogrow somewhat more slowly next year due to thegovernment’s ambition to restrain public sector payincreases. But there are also supportive forces inthe form of lower energy prices and even higherhome prices.

Home prices up againHome prices climbed 8 per cent during the first threequarters of 2006, measured year-on-year. The impact

on private consumption should not be exaggerated,however. Studies by the BoE indicate that the link hasweakened in recent years. One illustration is thatconsumption responded only mildly when homeprices hit new record levels. The rate of increases inhome prices can be expected to slow towards 3-5per cent in 2007 in the wake of higher interest rates.

Employment will rise by less than 0.5 per cent boththis year and next, halving the rate of increase during2002-2005. Unemployment has climbed rapidly andwill move up further in the next six months; theaverage in 2007 will be 5.5 per cent. The upturn isdue to a sharply rising labour supply, among otherthings because of immigration from the new EUcountries.

Wage and salary growth this autumn has remainedwell below the BoE’s “tolerance level” of 4½ per cent.This is true even including bonus payments. Theimminent wage round will take place in a weak labourmarket situation. Since there is a strong relationshipbetween employment and pay, we foresee total payincreases (contracts plus wage drift) of just above 4per cent annually in 2007 and 2008. This rate ofincrease combined with the downturn in energy pricesduring the past few months strengthens our belief thatinflation pressure will gradually ease and theinflation target of 2 per cent will again beachieved. In the short term, however, the inflationrate will remain close to 2.5 per cent, among otherthings due to certain high price increases in the retailsector and base effects.

In November the BoE followed up its surprisingAugust interest rate hike with another step, increasingthe repo rate from 4.75 to 5.0 per cent. Given ourforecast scenario, the BoE may support the econo-my by easing interest rates at the end of 2007. At4.75 per cent the bank’s key rate will again be neutral,which seems like a reasonable balance in a situationwhere the economy is growing at its potential rate,inflation is on target while certain resources areavailable in the labour market.

Per centUnited Kingdom: Pay and employment

Wages and salaries, excl bonuses (LHS) Wages and salaries, incl bonuses (LHS) Total employment (RHS)

Source: Office for National Statistics, UK

98 99 00 01 02 03 04 05 060.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

23


Central and Eastern Europe

Strong, imbalanced growth

Ever-clearer overheating risks in the Baltics

Political uncertainty and large budget deficitsin Central Europe

Further delays in the euro timetable

Growth in Central and Eastern Europe will culminatethis year at a high level. Fading global growth, com-bined with higher interest rates, will lead to somecooling. In the Baltic countries, clearer supply con-straints will also help decelerate rapid growth. Over-heating symptoms will remain in Estonia and Latvia.

Generally speaking, Central and Eastern Europeangrowth will be broad-based, with both rising exportsand domestic demand contributing. Hungary will bean exception, since its fiscal austerity programme willcreate a deep slump in growth. We expect GDP in theregion (including Russia) to increase by 7.2 per centthis year. This implies an upward adjustment by half apercentage point compared to Nordic Outlook inAugust. Our growth forecasts for 2007 and 2008remain unchanged at roughly 6 per cent annually.

The Baltics are continuing to exhibit the fastesteconomic expansion. Estonia will grow by 11.5 percent this year. Demand remains strong, but GDPgrowth is slowing due to a mounting labour shortage.High pay increases combined with the prevailing pricebubble in the housing market mean there are risks of ahard landing. Latvia is moving towards overheating.The consumption and credit boom are continuing.The current account deficit remains at a level that isunsustainable in the long term. Unemployment isfalling to record-low levels, driving continued highpay increases. In Lithuania, growth is slower than inEstonia and Latvia. The economy is more balanced,with inflation and current account deficits at modestlevels. The real estate boom has waned, partly due todashed expectations about imminent euro zoneaccession. In the long term, however, growingrecruitment problems pose an inflationary risk.

Despite clear signs of overheating in Estonia andLatvia as well as inflationary risks in Lithuania, nofiscal austerity is on the horizon. Meanwhile thecentral banks have a limited arsenal due to thesecountries’ fixed currency exchange systems, althoughLatvia has some latitude to continue hiking its interestrates. Euro zone interest rate increases will marginallycool the strong credit demand in the Baltics.

Russia’s economy is growing at a healthy clip, withprivate consumption as its strongest driving force. Acertain decline in oil prices will not disrupt thisfavourable growth picture. Public sector finances aresolid. The government has built up a sizeable financial

buffer, and the budget could withstand an oil pricedownturn as low as USD 35 per barrel. The centralbank is allowing some appreciation in the roubleexchange rate, partly offsetting high inflation. Invest-ment activity is rising but remains hampered bypolitical uncertainty, for example regarding thegovernment’s ownership role in the business sector.

Ukraine’s recovery following its 2005 crisis iscontinuing. Growth is being driven mainly by privateconsumption, but investments have also gainedmomentum. After several months of deadlock follow-ing the March parliamentary election, last summer agovernment was formed and a broad National UnityPact established guidelines for Ukraine’s foreignpolicy and economic policy, among other things. Thispact was weakened by an unexpected defectionwithin a few months when the pro-Western party OurUkraine left the coalition, but the big picture is thatthe political situation has stabilised, which is benefit-ing investment activity.

Central Europe is plagued by political uncertaintyafter parliamentary elections in several countries overthe past year. In our assessment, the governments inPoland and Hungary will remain in office despiteobvious political tensions. The Czech Republic isleaning towards a broad left-right government afterthe centre-right government lost a confidence vote.Slovakia’s highly diverse government, which includesanti-reform ministers, will probably fall apart duringthe current parliamentary term of office.

Political uncertainty will result in a more expansivefiscal policy in Poland, the Czech Republic andSlovakia. In the short term, this will sustain growth.GDP expansion will level off at around 5 per cent inPoland and 6 per cent in Slovakia, while Czechgrowth will slow somewhat from 6 to 5 per cent.Rising public sector expenditures will, however, makeit harder to come to grips with imbalances in publicfinances. There are risks that economic instability willincrease and that necessary structural reforms will bedelayed. Budget deficits will shrink somewhat in thenext couple of years, but in 2008 all four large CentralEuropean countries will show deficits above 3 percent of GDP (the threshold for joining the euro zone).

Euro zone accession is no longer as high a priori-ty in most euro candidate countries in the region. Ourassessment is that Slovakia and the Czech Republicwill join the euro zone in 2011, Poland in 2012 andHungary in 2014. In Estonia, Latvia and Lithuania,inflation remains an obstacle to accession. The delaysin the euro timetable mean that the Baltics can beginjoining the euro zone in 2010 at the earliest.

24


Sweden

Strong growth, fallingunemployment

Consumption boom with upside risks

Structural policy will expand room for growthwhile lowering equilibrium unemployment

Higher pay increases, slowly rising inflation

Repo rate will peak at 4 per cent next year

The Swedish economy is growing rapidly. This year,GDP growth will reach about 4½ per cent, nextyear 3½ per cent (adjusted for the number of workdays). In 2008, US economic deceleration will slowdown Sweden’s GDP growth rate to its long-termtrend of around 2½ per cent. The risks of evenweaker performance lie mainly in a faster decelerationof global growth. However, strong balance sheetsamong both companies and households indicateupside risks when it comes to domestic demand.

Household income is rapidly increasing, thanks torising real wages and lower taxes. We expect annualconsumption growth of around 3½ per cent in thenext couple of years. Capital spending will keepexpanding, though the rate of increase will slowsomewhat next year. High profit levels and recordcapacity utilisation in manufacturing are underlyingforces driving these investments.

Employment has taken off in earnest. We expectmore than 80,000 new jobs this year and around90,000 next year. Due to the rapid upturn, resourceutilisation is now rising rather fast. Labour shortagesare emerging in a number of sectors.

Because of steps to boost labour supply, the non-accelerating-inflation rate of unemployment(NAIRU) eventually will fall and the potentialemployment rate will rise. In the short term however,matching problems will rise when people with low

employability who were previously in labour marketpolicy programmes enter the labour force.

Despite this, the 2007 wage round will reflect astronger labour market. The wage round may beexacerbated by strong union demands for extraconcessions to benefit low income-earners andpromote greater gender equality. The general wageand salary demands presented to date by the unionsindicate that pay increases over the next couple ofyears will be ½-1 percentage points higher than during2004-2006.

Rising pay increases will accelerate domestic inflation-ary pressure, but inflation will end up below theRiksbank’s target throughout our forecast period.UND1X inflation will increase to only 1.1 per cent in2007 and 1.5 per cent in 2008.

Rapidly rising employment and labour shortages insome sectors will cause the Riksbank to keep raisingits repo rate, despite low inflation. By stretching itsforecast horizon and attaching more importance toresource utilisation and the risk of financial imbalanc-es, the bank has increased its freedom of action. Webelieve that the repo rate will be hiked to 4 per centduring 2007 – above the present market view but stillin the lower range of what the Riksbank itself consid-ers to be a neutral rate.

Fiscal policy will be weakly expansive both this yearand next. The risk is that various austerity measuresmay be delayed, resulting in an even more expansivefiscal policy. Nevertheless, the official budget targetwill be met and central government debt will beamortised at a rapid pace, due among other thingsto coming privatisations of state-owned companies.

Exports will resist US slowdownOptimism is still strong in the export sector, and mostindications are that export growth will remain good.The direct effects of weaker demand from the USare small and will be limited to about ½ per cent ofexports. When the US deceleration eventually spreadsto other regions, the impact on Swedish exports willbecome somewhat more noticeable.

The historical correlation between American GDPgrowth and Swedish exports is far greater than in ourforecast. We are thus relying on the arguments wepresented earlier on increased immunity elsewhere inthe world, plus the fact that the US downturn has anunusually typical domestic character, but the risks inour Swedish export forecast are on the downside.

Capacity utilisation in manufacturing is at recordlevels, according to measurements by StatisticsSweden and the National Institute of EconomicResearch (NIER). If exports are to keep growing,capital spending must continue upward. Good corpo-

060504030201009998979695

8

6

4

2

0

-2

-4

8

6

4

2

0

-2

-4

Source: Statistics Sweden

Sweden: GDP and employmentYear-on-year percentage change

GDPEmployment

25


Sweden

rate profits and optimism in recent business tendencysurveys point in this direction.

Consumption boom will intensifyHouseholds are benefiting from rising employment andlow inflation, which provide good real wage increasesdespite modest nominal figures. The new non-socialistgovernment’s 2007 budget will also lead to extraincome equivalent to about SEK 20 billion. Purchas-ing power will rise a full 4.6 per cent in 2007 and2.5 per cent in 2008. In 2006-2008, consumptionwill rise an average of over 3½ per cent yearly, aconsumption boom that, in modern times, iscomparable only to the years around the turn ofthe millennium. Yet we expect the household sav-ings ratio to rise both this year and next, illustratingthe upside risks in our consumption forecast.

Economic situation of householdsYear-on-year percentage changes

2005 2006 2007 2008

Private consumption 1.8 3.8 3.7 3.2

Disposable income 1.8 3.3 4.6 2.5

Savings ratio, % level 7.8 8.2 9.0 8.5

Sources: Statistics Sweden, SEB

The Riksbank’s rate hikes may help cool off thisbuying spree, for example by dampening the housingmarket. Various indicators also point towards a clearsoftening of home prices. This is true, for example,of real estate agent confidence indicators and house-hold surveys, which have signalled that the upturnmay be about to end. SEB’s own home price indicatoris also pointing towards such a change. In recentmonths, official numbers from Statistics Sweden haveshown various signs of market weakening as well.

But these signals must be weighed against the fact thatyear-on-year home price increases are still relatively

high, according to official statistics. In addition, risingemployment and large income increases will continueto sustain the housing market. Real estate tax cuts willalso help keep home price increases up. In our assess-ment, a broad, lengthy slowdown in the housingmarket is still some time away.

Robust job expansionDemand for labour began to rise unusually late in thiseconomic cycle but has now taken off in earnest. Theyear-on-year increase rate is now around 100,000jobs. The employment upturn is broad and the numberof jobs is rising in most sectors. The accumulatedupturn during 2006, 2007 and 2008 is estimated at230,000. The public sector will account for about40,000 of these. An increase in average work hoursmay perhaps contribute to a somewhat slower upturnin job numbers than we have forecasted.

With a rapid upturn in jobs, labour shortages willbecome increasingly common. The percentage ofcompanies reporting shortages is now risingrapidly, according to the NIER’s Business TendencySurvey, although still a bit short of the levels aroundthe turn of the millennium.

Meanwhile the government is launching a policyaimed at boosting labour supply in various ways. Itis doubly positive that this is occurring in a period ofrising demand: reducing bottleneck risks and boostingthe chances that those entering the labour market willland jobs. For the poor forecaster, though, it is not soeasy to estimate the net impact of strong demandgrowth, on the one hand, and policy-driven supplyside effects on the other. But we believe it helps toseparate the analysis into two time perspectives.

In the short term, developments will be affectedmostly by the changes in labour market policyprogrammes the government is proposing and bythe cyclical upturn in labour force participation.

Year-on-year percentage changeSweden: Home prices

Quarterly survey Single family home index, monthly

Source: Statistics Sweden

95 96 97 98 99 00 01 02 03 04 05 06

-2,5

0,0

2,5

5,0

7,5

10,0

12,5

15,0

-2,5

0,0

2,5

5,0

7,5

10,0

12,5

15,0

0706050403020100999897

4

3

2

1

0

-1

-2

4

3

2

1

0

-1

-2


Sweden: Employment indicatorYear-on-year percentage change

IndicatorEmployment

26


SwedenSweden

In the long term, the impact of changes in benefitrules and the tax system is the important thing.Here the effect is clear: equilibrium unemploymentwill fall, and jobs will increase.

Let us begin with the short-term perspective.

Labour marketYear-on-year percentage change (unless otherwisestated)

2005 2006 2007 2008

Labour force 0.4 1.4 1.8 0.7

Employment 0.4 1.9 2.1 1.3

Registeredunemployment, % 5.9 5.4 5.2 4.5

Total unemployment, % 8.4 8.2 7.2 5.8

In labour market policy programmes, % 2.7 3.1 2.1 1.4

Of which, in temporary jobs, % 1.8 1.9 1.3 1.0

Of which, in training programmes, % 0.9 1.2 0.8 0.4


Uncertain supply side effectThe influx of people into the labour force is nowincreasing in traditional cyclical fashion. Whenthere are more jobs, this strengthens people’s motiva-tion to enter the labour market, for example bycompleting their studies early or holding off onstarting a study programme when the chances oflanding a job improve. Lower absences due to illness(sick leave) and a trend towards higher labour marketparticipation among older people of working age havealso contributed to increased labour supply.

The government’s proposal to reduce the number ofpeople in labour market policy programmes byabout 80,000 (equivalent to more than 1.5 per cent ofthe labour force) in the course of next year must now

be added to this. About half the cutbacks consist ofsubsidised jobs, while the other half consists oftraining programmes whose participants are notstatistically included in the labour force.

According to its budget bill, the government expectsthis policy to lead to higher registered unemploymentnext year (measured as annual averages). Understand-ably, the Finance Ministry is now assuming a cautiousview and expects positive rather than negative surpris-es, but we foresee a significant likelihood that boththe government and the Riksbank are over-estimating the statistical effects of a lower vol-ume of labour market programmes.

Labour market policy programmes often lead todisplacement effects. A large percentage ofsubsidised jobs will remain even when the subsidyis eliminated. The supply-stimulating effect ofcutting training programmes may also be over-estimated. The alternative to attending a trainingprogramme run by the National Labour MarketBoard (AMS) may often be to attend a regulareducational programme or register for sick leave.

In addition to trimming the volume of labourmarket policy programmes, the government isproposing a cut in employer payroll fees for newemployees in so-called new start jobs. In addition,a new and so far unspecified employment guar-antee will be introduced for people who riskexhausting their unemployment benefits. Neither ofthese programmes will be defined as labour marketpolicy programmes, though in many respects theyare similar to them.

Thus our conclusion is that the real effect of thecutbacks will not be so large. Registered unemploy-ment may increase temporarily for a few monthswhile AMS programmes are trimmed, but historicalcomparisons indicate that registered unemploymentnormally falls during an economic expansion even ifAMS programmes are reduced. The cyclical effectseems to mean more for unemployment than thechanges in AMS programmes, as illustrated by

06050403020100999897969594939291

40

30

20

10

0

40

30

20

10

0

Sources: NIER, SEB

Sweden: Companies with labour shortageNet percentage

080706050403020100

9

8

7

6

5

4

9

8

7

6

5

4


Sweden: UnemploymentPer cent of labour force

SEBforecast

Registered unemployment +labour market programmes

Registered unemployment

27


Sweden

developments in 1997-2000. During this period,unemployment fell more than 3.5 percentage points,even though AMS programmes shrank almost asmuch as they appear set to do in 2007 and 2008.

Labour market changes, 1997-2000Thousands of people, year-on-year percentagechange

1997 1998 1999 2000

Employment -43 57 90 90

Job programmes 1 5 -4 -4

AMS programmes -11 -19 -31 -28

Unemployment 0.0 -1.6 -1.0 -1.0


Right now there are available resources in the Swed-ish economy. Output and employment are a bit belowpotential levels, but due to the strength of the econo-my, in 2007 they will rather quickly approach poten-tial. The government’s supply side policy is notenough to change this. Granted, registered unem-ployment will rise somewhat as cutbacks in AMSprogrammes peak, but the annual average willfall slightly from 2006. Total unemployment —including AMS programmes — will drop sharply andshortages will climb.

In the long term, the government’s proposal for lowerunemployment benefits combined with a working taxcredit will lower unemployment while boostingemployment (see box).

To summarise, our conclusions about the interactionbetween cyclical forces and supply side policy arethat registered unemployment will rise somewhatwhen AMS programmes are cut, but only temporarily,and less than stated in the budget bill. Some people

leaving these programmes will presumably find itrelatively difficult to find jobs. In a longer perspective,stronger incentives to work will help boost the em-ployment rate and push down equilibrium unemploy-ment.

Hotter wage roundDuring the 2007 wage round, collective pay agree-ments will be concluded for nearly 3 million employ-ees. For various reasons, this wage round may bemessier than in many years. The labour marketsituation is more heated than it has been during anywage round in the past decade. In addition, uniondemands for special concessions benefiting low-income earners and to promote greater gender equalityare larger than usual. There is also disunity about howthe new pension agreements for members of theSwedish Trade Union Confederation (LO) shouldaffect their room for pay hikes. Union dissatisfactionwith the government’s economic reforms might alsoresult in a greater inclination to use the strike weapon.

The government is implementing various proposalsthat will tend to weaken the trade union move-ment in the long term. Starting on January 1, unionmembership dues will no longer be tax-deductible.Unemployment benefits are also being lowered, whilecharges are being raised and differentiated. This willmake union membership less attractive. If today’ssystem of union-administered benefit societies isreplaced by mandatory central government-operatedunemployment insurance, separated from the unionmovement, the result may be a sizeable loss of unionmembership. The percentage of employees belongingto unions would then decline from today’s high levels.

The trade union movement will oppose governmentpolicies in various ways. During the next couple of

Lower equilibrium unemployment long-termThe budget bill contains a number of proposalsaimed at boosting the labour supply. They are basedon the fact that the ratio between unemploymentbenefit levels and work income influences equilibri-um unemployment (NAIRU) and the employmentrate. The higher the benefit level, the lower theemployment.

The government is proposing both a special taxcredit on income from employment and cuts injobless benefit levels and sick pay. This will very likelyenable unemployment to fall and employment toincrease more than previously without triggeringinflation. It is difficult to say how large this effect willbe. A rough assessment based on internationalestimates of links between taxes and benefit levelsindicates that the employment rate might rise by 1-1.5 per cent age point and NAIRU might fall by at

least half a percentage point as a consequence of thegovernment’s proposal.

This higher employment rate will occur partly becauselabour force participation will increase and partlybecause NAIRU will fall. The NIER’s estimate ofNAIRU is currently 4.5 per cent. Within a few years,equilibrium unemployment might thus fall to 4 percent.

Experience indicates that this type of changes affectsthe equilibrium unemployment rate gradually and witha time lag. In the short term, the effect on the rate ofpay increases and, further ahead, on inflation will belimited. During our current forecast period, until theend of 2008, neither our wage and salary forecast norour estimate of the resource situation will be affectedto any great extent.

28


Sweden

years, tensions between the government and theunions will certainly be a recurring theme. However,we do not believe that these tensions will affect thecoming wage round to an especially great degree. Theunion side has far too much to lose if the spirit ofcooperation built up between labour and managementover the past decade is lost.

Timetable for 2007 wage round

Expiration date of Sector Number ofcurrent agreement employees

March 31 Manufacturing, 1,100,000services,construction

April 30 Manufacturing, 300,000services

May 31 Manufacturing, 100,000services

June 30 Local governments 1,000,000

September 30 Central government 300,000

Total 2,800,000

We thus believe that the risk of serious problems inthe 2007 wage round is rather small. Solidly support-ed inflationary expectations and experience of achiev-ing real wage hikes even with modest nominal in-creases will make high pay demands unlikely.

Initial union demands are ½-1 percentage pointshigher than the corresponding ones before the 2004wage round. This indicates that pay agreements willend up at a level that will accelerate the rate of wageand salary increases. Pay hikes will reach morethan 4 per cent annually during both 2007 and2008, contributing to higher inflation ahead, but theyare no threat to the Riksbank’s inflation target duringthe next two years. Our forecast is that most of thelabour market will sign wage and salary agree-ments for another three-year period.

Low inflationUND1X inflation fell to 1 per cent again in Octoberafter a temporary summer upturn. Short-term move-ments are mainly affected by energy prices, and theautumn downturn was thus due to lower oil prices.Core inflation (UND1X excluding energy) has beenrelatively stable at about ½ per cent for the past sixmonths.

Our forecast implies that UND1X inflation willremain below 2 per cent in the next couple ofyears. The annual averages will be a mere 1.1 percent in 2007 and 1.5 per cent in 2008. Prices ofimported goods will continue to fall for at leastanother year. Price pressure on consumer goods inthe world market is continuing, and the appreciationof the krona will reinforce its effect in Sweden.

Domestic core inflation will gradually move upward,however:

Increasing resource utilisation will graduallylead to higher inflationary pressure, but unitlabour costs (ULC) will be kept down by strongproductivity growth and modest pay increases foranother while. Only towards the end of our fore-cast period will ULC rise at a pace that will causecyclical inflationary pressure to become a factorworth taking into account. The pattern of labourcost changes will be disrupted by a temporary cutin the pension charge during 2006, which will driveup the cost increase in 2007, but experience showsthat this type of temporary variations will notinfluence price behaviour.

Rents increased very weakly in 2006, mainly dueto falling interest rates in 2005. In contrast, risinginterest rates will now help push up rents.Rising energy prices in recent years will alsocontribute to higher rent increases, while cuts inreal estate tax will pull in the opposite direction.

Energy prices will continue upward, though ampleprecipitation over the past month seems likely toresult in a substantially smaller upturn in electricityprices than we had previously anticipated. The pricechanges that have already been announced stillrepresent a certain increase this winter. We alsoanticipate that oil prices will again move upward toUSD 66 per barrel by the end of 2007, in line withpricing in the market.

Looking ahead, the CPI will increase faster thanUND1X. The main reason is that the Riksbank’s keyinterest rate hikes lead to rising home mortgageinterest expenses (which are visible in CPI butexcluded from UND1X). The budget bill also con-tained a number of proposed indirect tax increases. In2007 tobacco tax will be raised, and a new tax onvehicle insurance will be introduced. The governmentgenerally seems prepared to use excise taxes to

2008200720062005

2.0

1.5

1.0

0.5

0.0

2.0

1.5

1.0

0.5

0.0

Källor: SCB, SEB

Sverige: UND1XÅrlig procentuell förändring

UND1X exkl. energi

UND1X

Prognos SEB

29


Sweden

Money supply as an inflation warning flagSome economists maintain that growth in moneysupply is the most important indicator of inflation inthe medium term. Among central banks, the ECB inparticular attaches importance to money supply. Butsuch central banks as the Fed and the Riksbankrarely mention money supply, preferring instead tofocus on growth, unemployment, productivity andwages.

It is notable, however, that the minutes from theRiksbank monetary policy meeting in October revealthat two Board members mentioned the rapidgrowth of money supply (M3 is currently increasingby 19 per cent, year-on-year). Also, the BoE hasrecently paid greater attention to monetary aggre-gates.

There need not be any fundamental conflict betweenthese approaches. When growth accelerates, themoney supply normally also increases. The crucialpractical question is whether rapid monetary expan-sion is a reliable warning flag for coming inflation ornot. Monetarists often maintain that it is, while othersargue that money supply observations are meaning-less unless they are analysed in terms of resourceutilisation and pay.

Both approaches involve potential problems. Moneysupply measures are highly volatile. They may beinfluenced by both structural factors and temporarymovements in financial markets. For small openeconomies, there is also the problem of largecurrency flows. The ECB tries to resolve this byanalysing the underlying components in the variousmoney supply measures, but in many cases, it isclear that rapid monetary expansion has been basedon real-term growth that need not lead to inflation inthe foreseeable future.

Meanwhile it is famously difficult to evaluate stablemodels of resource utilisation, wages and salariesand especially productivity. Our ability to make

forecasts a couple of years into the future is weak,and our picture of resource utilisation is frequentlyrevised. In a special box in the international overview,we describe how NAIRU estimates are becomingmore unreliable, and also in this chapter on Swedenwe show how the equilibrium rate of unemploymentshifts over time. Predictions based on pay andproductivity thus risk being near-sighted.

Our own conclusion is nevertheless that the disad-vantages of using money supply as an inflationindicator are too great, at least in a small economysuch as Sweden. The graph showing the correlationbetween inflation and money supply during the 1990sillustrates these problems. The inflation upturnduring 2001 might admittedly be connected to thestrong increase in money supply during 1999 and2000. But money supply also increased sharplyduring 1993-94 and 1996-97, without this having anyvisible effects on inflation. One explanation for thispattern may be that the increase in money supply isprimarily connected to growth, which need not alwaysresult in inflation.

finance its reforms. We thus expect them to keepcontributing to inflation in 2008. The government’sproposal for higher dental care subsidies has theopposite effect and is expected to result in negativecontributions to both UND1X and the CPI of 0.2percentage points in 2008.

Repo rate heading towards 4 per centThe Riksbank has clearly signalled that a new interestrate hike is coming in December. The repo rate willthus have doubled from 1.5 to 3.0 per cent in thecourse of one year. The latest Inflation Report inOctober assumes a repo rate of 3.25 per cent in June2007 and 3.5 per cent at the end of 2007. Given sucha path, risk-adjusted UND1X inflation will stand at 2.1per cent in mid-2009. In the previously so importanttwo-year horizon, however, inflation ends up below 2per cent. At present, the Riksbank also seems satisfied

with the market’s expectations of a repo rate that willpeak at around 3½ per cent in the course of next year.

However, we are sticking to our forecast that theRiksbank will raise the repo rate to 4 per cent in 2007.The main reason is that the labour market willimprove faster than the Riksbank expects. Labourshortages are increasing rapidly. In such a situation, itappears natural that the Riksbank, like other centralbanks in Western Europe, wants to raise its key rateto a neutral level relatively soon. Because the Riksbankhas a slightly more flexible relationship to its inflationtarget, for example extending its forecast horizon, thisgives it a greater degree of freedom to carry outinterest rate hikes despite low actual inflation. A 4 percent peak is still in the lower portion of the neutralinterval the Riksbank itself has specified (3.5-5per cent), which reflects our belief in continued lowinflationary pressure.

Year-on-year percentage changeSweden: Money supply and inflation

M3 (former definition) M3

UND1X (RHS)

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

30


Sweden

0807060504030201009998979695

9

8

7

6

5

4

3

2

1

9

8

7

6

5

4

3

2

1

Sources: Riksbank, SEB

Key ratesPer cent

forecastSEB

The pace of interest rate hikes is likely to gradu-ally slow a bit. Since June, the Riksbank’s ExecutiveBoard has raised the repo rate at each meeting. Ourforecast implies that the bank will abstain from ratehikes at some meetings in the spring and thus reach arepo rate of 4 per cent in October 2007.

In a longer time perspective, the effects of thegovernment’s supply side stimuli will contribute toa marginally lower key rate, but given the prevailingeconomic situation, its importance is not so large.The Riksbank is sceptical towards NAIRU measure-ments and is unlikely let a possible future fall in theequilibrium unemployment rate affect its interest ratepolicy in the short run.

Signs of slowing home prices might also persuadethe Riksbank to halt its rate hiking earlier, but webelieve it is too early to draw the conclusion that weface a permanent slowdown in the real estate market.The statistics are volatile, and a continuedimprovement in the labour market will help sustainhome prices.

07060504030201009998

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

Source: SEB

Sweden: Interest rate spread vs. Germany10-year government bond

ActualModel estimate

Bond yields in Sweden have remained lower than inGermany. Our forecast means that both the ECB andthe Riksbank will proceed in a slightly tougher waythan the market currently expects. On the margin, thisdifference is greater for Sweden. Together withrelatively vigorous growth in Sweden, in itself thispoints towards a somewhat faster upturn in Swedishlong-term yields.

Meanwhile we expect the supply of Swedish govern-ment bonds to be limited due to strong central govern-ment finances and divestments of state-owned com-panies. This will offset an upturn in bond yields.

Our assessment of the net effect is that the long-term yield spread versus Germany will fall to zeroduring 2007. This means that a 10-year Swedishgovernment bond will climb from today’s level ofaround 3.60 to 4.10 per cent by late next year. Also inSweden, the yield curve will consequently flattensubstantially.

Stronger kronaThe krona has trended upward since the currencyturbulence of last autumn. Since we expect the gap inkey interest rates against the ECB to be eliminated, itis reasonable to predict a further strengthening ofthe krona.

The recent change of government also points towardscontinued krona appreciation. According to a surveyin the recent edition of SEB Merchant Banking’s SEKViews, Sweden’s attractiveness as a location forinvestments has increased. The proposed cut in thewealth tax is one example. The divestments of state-owned companies will, however, hardly generate anynet inflows, since the government has decided tospeed up the National Debt Office’s amortisation of itsforeign currency debt to SEK 40 bn annually in 2007-2009.

0807060504030201

11

10

9

8

7

6

11

10

9

8

7

6

Sources: Eurostat, SEB

Sweden: Exchange ratesMonthly average

USD/SEK

EUR/SEK

SEBforecast

31


Sweden

Evaluation of the Riksbank’s policies

In 1995 the Riksbank formally adopted an inflationtarget for its monetary policy. In 2005, theparliamentary Standing Committee on Financedecided that an independent investigation wouldevaluate how the bank has handled monetary policyunder the inflation target regime of the past decade.The investigators are Professors Frederic Mishkin(recently appointed to the Federal Reserve Board) andFrancesco Giavazzi. Their report will be published latein November. We will permit ourselves here – withoutany inside information – to speculate on what mainmessage the investigators may conceivably present.

We expect the Riksbank will receive high marks forhaving nearly fulfilled its inflation target during theperiod being examined, at the same time as thebank has become more transparent andpredictable.

The report will, however, probably also criticise theRiksbank for having missed its target for manyyears “from below”. This implies that it could havelowered interest rates sooner, for example in orderto stimulate the labour market. This criticism will bemild, however, since no observer — not even SEB —has produced clearly better inflation forecasts.

Some criticism will probably be aimed at how theRiksbank chooses target variables. Officially, thebank says that the CPI should be kept at 2 per cent,but in practice the Riksbank almost always choosesto follow UND1X inflation. It occasionally focuses ona core inflation measure. We believe that the reportwill recommend a clearer focus on underlyinginflation rather than on the CPI.

We believe that the report will recommend “flexibleinflation targeting”. This means paying someattention to both the real economy and to financialstability, and using a more flexible forecast horizon.However, we believe that the report will adviseagainst asset price targeting. To a great extent, thismeans that the Riksbank will receive support for themore flexible interpretation of its inflation target ithas launched during the past year. The report maypossibly propose further clarifications.

We expect the investigators to back the Riksbank’smodified forecasting methodology — its shift fromassuming a constant repo rate to basing its forecaston market expectations about interest rates. Theywill also discuss the advantages and disadvantagesof the Riksbank’s plan to state its own optimalinterest rate path; they may possibly conclude thatthe bank’s Inflation Reports should present aninterest rate path in the form of a fan chart, whichstraddles conceivable paths and has an upper andlower limit.

Nor would we be surprised if the investigators, enpassant, expressed their amazement that theFinance Ministry’s own authority — the NationalInstitute of Economic Research — expresses suchstrongly normative opinions about what theRiksbank should do. This may trigger suspicions ofindirect control by politicians.

To summarise: Fundamentally good marks for theRiksbank, but with a number of technical opinions onhow to improve forecasting methodology andsignalling systems.

We are sticking to our forecast that the krona willstrengthen to SEK 8.80 per euro by the end of2007. The krona will appreciate even more against thedollar. We expect it to reach a level of SEK 6.50 perdollar early in 2008.

Moderately expansive fiscal policyThe government has been clear about its ambition thatall tax cuts must be financed, even in the short term.It will thus not rely on “dynamic effects”, i.e. futureimprovements in the functioning of the economy thathelp boost long-term tax revenue. According to thebudget bill, the government will fall a mere SEK 5billion short of achieving this ambition in 2007.

However, we believe that the expansive impact of thebudget will be larger — about SEK 15 billion. The riskis that this expansion will be even larger. The reason isthat the government’s financing measures will proba-bly be less effective than estimated and that some ofits measures also risk being delayed.

080706050403020100

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0

Sources: NIER, SEB

Sweden: Fiscal policy stancePer cent of GDP

forecastSEB

One example is the increase in tobacco tax. Previousexperience points towards difficulties in actuallycollecting higher tobacco tax revenue, since the taxbase will be eroded via smuggling. It is also likely thatthe government’s cutbacks in labour market policy

32


Sweden

programmes will lead to higher expenses elsewhere,for example through higher absences due to illness.Raising unemployment insurance fees and the newvehicle insurance tax will require both legal andadministrative actions that may take time to complete.

The government will hardly delay its tax cuts becauseof these time lags on the financing side. The resultwill thus be a more expansive fiscal policy thanannounced in the budget bill.

Public financesPercentage of GDP

2005 2006 2007 2008

Revenue 56.3 56.0 53.7 53.0

Expenditures 53.5 52.7 51.2 50.9

Financial savings 2.8 3.3 2.5 2.1

Central govt debt 47.2 43.6 38.9 36.2

Central govtborrowing req, SEK bn -14 -5 -60 -36

Sources: Swedish National Financial Management Authority,SEB

The officially targeted surplus in public finances (2per cent of GDP over the business cycle) is not indanger, however. Our estimates indicate that the 2006budget surplus will be even higher than thegovernment is projecting. Given a continued strongeconomy, there is a high probability of positivesurprises in the budget figures.

Privatisations of state-owned companies will allow aspeed-up in amortisation of central governmentdebt. We expect privatisations equivalent to SEK 50billion per year in 2007 and 2008. These flows do notaffect the budget target estimates, but they will lead toa rapid decline in central government debt.

33


Denmark

Growth will stay above trend

Strong domestic demand will slowly decline

Increasingly stretched labour market

Fiscal tightening may be needed

The Danish economy is steaming along at full speed,fuelled by both domestic demand and exports. Highgrowth will continue well into next year, after which agradual slowdown will occur, since there will befurther interest rate hikes, fiscal stimuli will end andgrowing supply constraints will begin to be felt.

We expect GDP to increase by 3.7 per cent thisyear, and by 2.7 and 2.3 per cent in 2007 and 2008,respectively. We have adjusted our forecasts for 2006and 2007 somewhat upward, partly due to revisednational accounts. Even after this adjustment, therisks are on the upside. GDP growth will remain wellabove trend, which is around 2 per cent. An alreadystrong labour market will thus strengthen further,accentuating resource shortages.

Strong indicators point towards a continued boom.The manufacturers’ purchasing manager index hasclimbed steadily, from just above the “expansionthreshold” of 50 in March to an historically high 63.6in October. The service sector index is also historical-ly high. The construction industry’s sentiment indica-tor has hit an all-time high. Only household confi-dence has dropped slightly from a high level. House-holds are probably somewhat less optimistic due tohigher interest rate and the first signals of a cool-down in the red-hot housing market. For example,home sales declined early in 2006 after several yearsof uninterrupted vigorous expansion. The rapid paceof price increases will slow moderately in 2007-2008.

Exports are partly driven by the German upturn andwill grow by more than 10 per cent this year. Agradual downward shift to 5 per cent growth in 2008will follow in the wake of weakened global demandand some deterioration in competitiveness.

Robust capital spendingBusiness investments took off in 2005-2006 and willremain strong for another year or so; the same is trueof residential construction. High capacity utilisationand profits are driving capital spending by the manu-facturing sector. Despite a strong labour market,private consumption is moving towards a morenormal growth rate after several robust years. Thereasons are higher interest rates and the end of fiscalincentives. Car sales are also shrinking.

Unemployment has fallen continuously from 6.7 percent at the beginning of 2004 to 4.2 per cent inSeptember this year. It will continue downward to 4per cent, which has previously been a trigger point forpay increases. Job growth of nearly 2 per cent, thefastest pace since 1997, will gradually slow.

Mounting labour shortageThe labour shortage that began in construction justover a year ago and spread to manufacturing lastspring intensified in the autumn. Tendencies towards amore general resource shortage are also discernible inthe form of high capacity utilisation in manufacturing.

An initial jump in pay can be noted in construction,but the wage trend is still remarkably calm in retailingand manufacturing. Several major collective agree-ments will be renegotiated in 2007 and wages willclimb. Labour market reforms and globalisationmeanwhile have a restraining effect. Total annual paygrowth will rise from just over 3 per cent thisyear to 4.5 per cent.

HICP inflation fell this autumn due to lower energyprices and will remain below 2 per cent in the shortterm. Underlying inflation continues to rise gradually.Looking ahead, inflation will speed up when higherwages and salaries begin to impact consumer prices.HICP inflation will rise to an average of 2.3 percent in 2008. The risks are on the upside.

We do not expect monetary policy to ease the risk oflabour market overheating more than marginally.Because Denmark pegs its krone against the euro, thecentral bank shadows ECB interest rate hikes.The effect of the 2007 budget will be neutral. Lookingahead, our assessment is that fiscal tightening may benecessary.

Denmark: Manufacturing capacity utilisation

Capacity utilisation, per cent (LHS) Net labour shortage (RHS)

Source: Statistics Denmark

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

-1

0

1

2

3

4

5

6

7

8

9

10

11

76

77

78

79

80

81

82

83

84

85

86

87

88


34

Norway

Hotter and hotter

Another year of vigorous growth

Hot labour market will speed up pay increases

Faster pace of interest rate hikes

Krone will regain strength

The Norwegian economy is showing no signs ofslowdown. Expansive economic policy, good interna-tional demand and favourable terms of trade willcontinue to sustain growth in the short term. Thisyear mainland GDP (excluding offshore oil) will growby 3.8 per cent. The boom has resulted in rapid jobgrowth, currently 3 per cent year-on-year. Unemploy-ment has fallen to historically low levels and thelabour shortage has increased noticeably. The 2006spring wage round led to modest pay hikes, but thereare now signs that the hot labour market will eventual-ly speed the pace of wage increases.

Inflation (excluding energy and taxes) has remained adownside surprise but now seems to have passed itslow point. With increasing inflation risks on thehorizon, Norges Bank has chosen to act preventivelyby signalling faster interest rate hikes ahead. Webelieve that the pace will be even faster thanannounced in the bank’s latest inflation report.However, in the short term this will have little impacton the real economy; growth will remain clearly abovetrend in 2007. There will be a gradual slowing as theinterest rate hikes begin to bite, at the same time asinternational growth is decelerating and domesticsupply constraints multiply. Mainland GDP growthwill consequently fall from 3.3 per cent in 2007 to2.3 per cent in 2008.

Broad-based growthDomestic demand will continue to grow on a broadfront. Retail sales point towards consumption growthof around 4 per cent this year. Continued strongemployment and good real wage increases pointtowards rapid consumption growth in 2007 as well.

To date, the effects of Norges Bank’s interest ratehikes have been small. One reason is that growingcompetition in the Norwegian banking market hashelped to delay increases in lending rates. The ratehikes will gradually make themselves felt, however.Household debt has risen sharply in recent years andnow totals about 190 per cent of disposable income,which is substantially higher than in the late 1980s.According to Norges Bank’s estimates, the householdinterest burden will rise to 6½ per cent of income nextyear: higher than the average during the past decadebut far from the levels prevailing around 1990.

Good profits but worse competitivenessThe situation in the business sector also looks brightin the short term. Pay hikes have been low in recentyears, while price trends in the world market havefavoured Norwegian companies. This has contributedto a surge in profitability which, along with highcapacity utilisation, stimulates capital spending.

Looking ahead, however, manufacturing competi-tiveness will deteriorate due to higher pay hikesthan elsewhere and a strengthening of the krone. Withlabour costs already some 20 per cent higher than incompetitor countries, Norwegian manufacturers arevulnerable if the commodities boom should fade.There are similarities to the situation in the late 1990s,when high labour costs were initially offset by agradual weakening of the currency. When the kronelater turned upward, competitiveness problemsbecame acute.

Poorer competitiveness, somewhat slower marketgrowth and capacity constraints in certain industrieswill significantly erode traditional merchandise exportsin the next couple of years. Oil exports will probablyturn upward next year, however, after a few years offalling volume. With oil prices at around USD 65 perbarrel, we anticipate that the level of oil investmentswill be sustained, for example by increased prospect-ing activity. Several major projects are moving to-wards completion, which will nevertheless mean thatthe level of capital spending will culminate.

Pay increases speeding upThe labour market is now quickly becoming tighter.Labour shortages have increased significantly andunemployment has fallen to its lowest level since thelate 1990s. The question is how fast and to whatextent mounting labour shortages will trigger higherwage and salary increases. Pay hikes have been

08070605040302010099989796959493

6.5

6.0

5.5

5.0

4.5

4.0

3.5

3.0

2.5

6.5

6.0

5.5

5.0

4.5

4.0

3.5

3.0

2.5

Sources: Statistics Norway, SEB

Norway: Wages and unemploymentPer cent

forecastSEBWages

Unemployment

35


Norway

modest to date, partly because many national payagreements were signed early last spring, when thelabour market was not as tight. In many cases, theframework for this autumn’s local negotiations wasalso established last spring. The results of the autumnlocal negotiations will hardly become known untilearly next year, but anecdotal information pointstowards faster pay hikes. For example, data from theregional network of Norges Bank show an upwardrevision in expected pay increases this year from 3.75per cent to 4.5 per cent.

Looking ahead, the labour market will becomeeven tighter. Labour supply has levelled off to someextent in the past six months, which is an indicationthat domestic labour market reserves have begun todry up. Meanwhile the influx of foreign labour willslow as the demand for labour rises in Sweden andvarious Eastern European countries, for example.According to the Labour Force Survey, unemploy-ment will fall to an average of 3 per cent in the nexttwo years, which is lower than in the late 1990s. Payincreases are projected to climb to about 5 per centyearly.

While resource utilisation has become more strained,underlying inflationary pressure according to CPI-ATEhas been weak. The trend has been downward in thecourse of 2006, but data from the past two monthsindicate that this trend may have reversed. Mostindications are that domestic inflation will be drivenupward by high pay increases and by a late-cyclicalslowing of productivity growth.

Norges Bank has clearly shifted its focus of attentionfrom low inflation to ever-higher resource utilisation.In its Inflation Report in early November, the centralbank signalled that the sight deposit rate will be raisedat two of three coming meetings to a 3.75 per centlevel in March. Meanwhile the bank revised its interestrate path upward to 4.75 per cent by the end of 2007,

compared to 4.25 per cent previously. It thus took afurther step away from strict inflation targetingto a more preventive strategy.

Norges Bank is also distancing itself from its inflationtarget by using other inflation measures besides theCPI-ATE. For example, the Inflation Report statedunderlying inflation as 0.75-1.5 per cent, compared tothe September CPI-ATE figure of 0.5 per cent.Meanwhile the report emphasised that the costs ofending up below the inflation target over a long periodare relatively small, when low price increases areattributable to favourable supply side conditions.

According to the central bank’s forecast, by the endof 2007 real interest rates will reach the level that thebank has identified as neutral (2½-3½ per cent). Inlight of Norway’s high resource utilisation, such a realinterest level seems relatively low. We thus believethat the pace of rate hikes may be even faster inthe next six months and will then reach 5.0 percent by the end of 2007. To avoid an excessivelystrong krone, it is unlikely that Norges Bank will gohigher than this, given our forecast that Sweden’sRiksbank and the ECB will peak at 4 per cent. Thelessons of monetary tightening in 2001-2002 and thecriticism then aimed at Norges Bank for havingmoved too harshly may also serve as a restrainingfactor.

We regard the depreciation of the krone during thesummer and autumn as temporary and possibly aneffect of the oil price downturn. Given our forecastthat oil prices will rebound and Norway will raise itskey interest rate faster than other countries, webelieve that the krone will once again strengthento NOK 7.60 per euro and NOK 5.76 per dollar by theend of 2007.

Fiscal activity rule within reachFor the first time since the “fiscal activity rule” wasintroduced in 2001, spending from the nationalPetroleum Fund now seems likely not to exceed the 4per cent ceiling, according to the 2007 budget. Fiscalpolicy nevertheless remains expansive, although it isexpected to stimulate growth somewhat less in 2007than this year. Higher public sector employment willalso mean greater competition for labour.

Given the government’s assumption of an average oilprice of NOK 390 per barrel in 2007 (just above USD60/barrel at today’s exchange rate), there will be roomfor an additional NOK 13 billion in the budget accord-ing to the fiscal activity rule. However, the govern-ment has hinted that it does not intend to utilise all ofthis wiggle room, in light of the strong economicsituation.

08070605040302

3.0

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

Sources: Statistics Norway, SEB

Norway: CPI-ATEYear-on-year percentage change

forecastSEB


36

Finland

Growth peaking at high level

Broad growth, normalisation of exports

Unemployment will continue to fall

Low pay hikes in 2007 – but higher in 2008

Finland’s boom will continue for another year but haspassed its growth peak. Weaker international demandand slower real income increases will slow expansion.Meanwhile the main driving forces of growth areshifting this year from exports to domestic demand.GDP will rise by 5.3 per cent in 2006, by 3.3 percent in 2007 and 2.6 per cent in 2008.

Base effects, statistics push figures upWe have adjusted our 2006 forecast upward by a full1.0 percentage point compared to the last NordicOutlook, but this is almost exclusively due to changesin statistics. New methodology and new information-gathering procedures in the national accounts haveaffected outcomes; for example, services exportshave been revised upward. Base effects from thespring 2005 paper industry strike also affect 2006data, boosting this year’s GDP growth by around onepercentage point.

In the first half, GDP rose by 6.2 per cent, withstrong contributions from most sectors, especiallyexports. The Statistics Finland Monthly Indicator ofTotal Output indicates slower third quarter growth asthe strike effect disappears from year-on-year figures,but this autumn’s business tendency surveys indicatethat underlying growth will remain high into next year.In manufacturing and construction, confidence hasreached record highs. Service sectors have lost someof their swagger, but retailers remain very optimistic.

There is healthy demand for exports, especially insuch major sectors as electronics and chemicals.Total exports will increase by 13 per cent this year

and then grow by a more normal pace of 7 per centnext year.

In recent years, households have enjoyed highlyfavourable conditions for consumption due to taxcuts, very low inflation, low interest rates and grow-ing employment. In addition, home prices have risen;during the third quarter, prices of flats and attachedhomes rose by 8 per cent year-on-year, matching the1989 all-time high in real terms. Looking ahead, theseexpansive conditions will be somewhat constrained.No new tax cuts are in the cards, interest rates areclimbing, Finland’s strong job growth is slowing andinflation will eventually accelerate. The housingmarket is moving towards a gentle cool-down. Ourconclusion is that consumption growth will stay highalso this year (3.6 per cent), but fade to 2.3 per centin 2008.

Strong labour marketIn recent months there have been signs that unem-ployment is about to level off at 7.5-8.0 per cent. Butgiven our economic growth scenario, it is reasonableto assume a continued downturn to an average of 7per cent in 2007 and 2008. Companies in manufactur-ing and distributive trades are also signalling furtherexpansion in their workforces.

Despite strong demand for labour, pay increases arelow; they will be less than 3 per cent both this yearand next, compared to around 4 per cent in recentyears. Long-term collective pay agreements and lowinflation have laid the groundwork for this. However,we anticipate that the negotiating climate will heatup when the next wage round begins in one year.The fundamental reasons will be a tight labour marketcombined with a few years of high business profits,which will drive up pay demands. Wage and salarygrowth will thus rise to about 4 per cent in 2008. Thismeans, in turn, that inflation will get an upwardpush, from 1.5 per cent next year to an average of1.9 per cent in 2008.

080706050403020100

6

5

4

3

2

1

0

-1

6

5

4

3

2

1

0

-1

Sources: Eurostat, Statistics Finland, SEB

Finland: GDP and inflationYear-on-year percentage change

GDP

HICP

SEB forecast

Year-on-year percentage changeFinland: Core inflation and earnings

Earnings in manufacturing (LHS) Core inflation (RHS)

Sources: OECD, Eurostat

95 96 97 98 99 00 01 02 03 04 05 060.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1

2

3

4

5

6

7

8

37


Nordic key economic data

DENMARK

Yearly change in per cent2005 2006 2007 2008

Gross domestic product 3.4 3.7 2.7 2.3Private consumption 4.0 3.8 2.3 2.0Public consumption 1.2 1.0 0.8 0.8Gross fixed investment 9.0 9.5 6.0 3.5Stockbuilding (change as % of GDP) -0.2 0.0 0.0 0.0Exports 9.2 12.0 7.0 5.0Imports 12.1 13.2 7.4 4.8

Unemployment (%) 5.7 4.5 4.0 3.9Consumer prices, harmonised 1.7 1.9 2.1 2.3Wage cost 2.9 3.2 4.4 4.6Current account, % of GDP 3.0 2.5 2.4 2.4Public sector financial balance, % of GDP 4.9 4.3 3.5 3.0Public sector debt, % of GDP 35.9 29.0 24.0 23.0

FINANCIAL FORECASTS Nov 16 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08Deposit rate 3.50 3.75 4.25 4.25 4.25 4.0010-year bond yield 3.81 4.05 4.20 4.20 4.20 4.1010-year spread to Germany, bp 4 5 10 10 10 10USD/DKK 5.83 5.87 5.87 5.64 5.52 5.52EUR/DKK 7.46 7.45 7.45 7.45 7.45 7.45

NORWAY


Gross domestic product 2.3 2.6 3.7 2.2Gross domestic product (Mainland Norway) 3.7 3.8 3.3 2.3Private consumption 3.4 4.0 3.4 2.9Public consumption 1.5 2.8 2.9 2.9Gross fixed investment 10.9 8.4 5.4 1.9Stockbuilding (change as % of GDP) 0.2 0.0 0.0 0.0Exports 0.7 2.5 4.6 2.0Imports 7.4 6.6 4.7 2.9

Unemployment (%) 4.6 3.5 2.9 3.0Consumer prices 1.6 2.4 1.7 2.1CPI-ATE 1.0 0.7 1.3 2.1Wage cost 3.3 4.3 5.0 5.1Current account, % of GDP 16.6 18.5 18.5 17.0Public sector financial balance, % of GDP 16.2 18.0 19.5 17.5

FINANCIAL FORECASTS Nov 16 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08Sight deposit rate 3.25 3.50 4.25 5.00 5.00 5.0010-year bond yield 4.18 4.50 4.70 4.80 4.80 4.7010-year spread to Germany, bp 41 50 60 70 70 70USD/NOK 6.42 6.30 6.10 5.76 5.63 5.63EUR/NOK 8.22 8.00 7.75 7.60 7.60 7.60

38


Nordic key economic data

SWEDEN


Gross domestic product 2.9 4.2 3.4 2.6Grossdomestic product working day adjusted 2.9 4.5 3.5 2.4Private consumption 2.4 3.4 3.7 3.2Public consumption 0.3 1.6 1.2 1.2Gross fixed investment 8.1 9.0 5.0 2.5Stockbuilding (change as % of GDP) -0.1 0.2 0.2 0.0Exports 6.6 8.8 5.6 3.6Imports 6.9 9.4 6.0 3.6

Unemployment (%) 5.9 5.4 5.2 4.5Employment 0.4 1.9 2.1 1.3Industrial production 2.6 6.5 5.5 3.2Consumer prices 0.5 1.4 1.9 2.1UND1X 0.8 1.2 1.1 1.5Wage cost 3.2 3.3 4.1 4.3Household savings ratio (%) 7.8 8.2 9.0 8.5Real disposable income 1.8 3.8 4.6 2.5Trade balance, % of GDP 5.5 4.5 5.3 5.5Current account, % of GDP 5.9 6.6 7.3 6.9Central government borrowing, SEK bn -14 -5 -60 -36Public sector financial balance, % of GDP 2.8 3.3 2.5 2.1Public sector debt, % of GDP 50 46 41 39

FINANCIAL FORECASTS Nov 16 Dec-06 Jun 07 Dec 07 Jun 08 Dec 08Repo rate 2.75 3.00 3.75 4.00 4.00 4.003-month interest rate, STIBOR 3,07 3,40 4,10 4,20 4,20 4,2010-year bond yield 3.58 3.90 4.05 4.10 4.10 4.0010-year spread to Germany, bp -17 -10 -5 0 0 0USD/SEK 7.07 7.09 7.01 6.74 6.52 6.52EUR/SEK 9.05 9.00 8.90 8.90 8.80 8.80TCW 123.9 123.7 122.8 121.4 119.6 119.7

FINLAND


Gross domestic product 2.9 5.3 3.3 2.6Private consumption 3.8 3.6 2.8 2.3Public consumption 1.6 1.1 1.0 1.2Gross fixed investment 3.3 6.0 4.1 3.1Stockbuilding (change as % of GDP) 1.0 0.0 0.0 0.0Exports 7.3 12.9 7.0 5.8Imports 12.3 10.1 6.5 5.7

Unemployment (%) 8.4 7.4 7.1 7.0Consumer prices, harmonised 0.8 1.2 1.5 1.9Wage cost 3.9 2.8 2.8 3.8Current account, % of GDP 2.4 5.3 4.9 4.3Public sector financial balance, % of GDP 2.6 3.1 2.9 2.6Public sector debt, % of GDP 41.0 38.0 37.0 36.0

39


International key economic data

EURO ZONE


Gross domestic product 1.5 2.7 2.3 2.0Private consumption 1.4 2.0 1.6 1.6Public consumption 1.4 2.2 1.5 1.4Gross fixed investment 2.8 4.4 3.9 3.6Stockbuilding (change as % of GDP) 0.1 0.0 0.0 0.0Exports 4.5 8.2 6.0 4.9Imports 5.5 8.1 5.8 5.1

Unemployment (%) 8.6 7.8 7.3 7.1Consumer prices, harmonised 2.2 2.2 2.0 1.8Household savings ratio (%) 10.8 10.6 10.5 10.4

US


Gross domestic product 3.2 3.2 2.1 2.5Private consumption 3.5 3.1 2.4 2.4Public consumption 0.9 2.0 1.1 0.4Gross fixed investment 7.5 3.7 3.0 4.7Stockbuilding (change as % of GDP) -0.3 0.2 -0.3 0.0Exports 6.8 8.6 6.2 6.1Imports 6.1 6.5 4.3 4.7

Unemployment (%) 5.1 4.5 4.9 5.2Consumer prices 3.3 3.2 1.9 2.2Household savings ratio (%) -0.4 -0.5 0.6 1.2

LARGE INDUSTRIAL COUNTRIES

Yearly change in percent2005 2006 2007 2008

GDPUnited Kingdom 1.9 2.6 2.4 2.6Japan 2.7 2.9 2.3 2.0Germany 0.9 2.5 1.9 1.8France 1.2 2.4 2.3 2.1Italy 0.1 1.7 1.6 1.6

InflationUnited Kingdom 2.0 2.2 1.9 2.0Japan -0.6 0.2 0.4 0.7Germany 1.9 1.7 2.2 1.8France 1.9 1.7 1.4 1.8Italy 2.2 2.1 1.8 1.8

Unemployment (%)United Kingdom 4.8 5.7 5.5 5.3Japan 4.4 4.2 3.9 3.7Germany 11.7 10.8 10.2 10.0France 9.9 9.0 8.5 8.2Italy 7.7 7.3 7.1 7.0

40


International key economic data

CENTRAL AND EASTERN EUROPE

2005 2006 2007 2008GDP, yearly change in percentCzech Republic 6.1 6.2 5.2 4.8Estonia 10.5 11.5 8.0 7.0Hungary 4.2 3.6 2.0 2.8Latvia 10.2 10.8 9.2 8.5Lithuania 7.6 7.8 7.0 6.5Poland 3.2 5.4 5.0 4.8Russia 6.4 6.8 6.2 5.8Slovakia 6.1 6.5 6.5 6.0Ukraine 2.6 6.0 6.5 7.0

Inflation, yearly change in per centCzech Republic 1.6 2.9 3.5 3.0Estonia 3.6 4.5 4.3 4.0Hungary 3.5 3.7 7.0 4.3Latvia 6.9 6.4 5.5 4.8Lithuania 2.7 3.8 4.0 3.0Poland 2.2 1.3 2.3 2.1Russia 12.4 9.9 9.0 8.5Slovakia 2.8 4.4 3.2 2.7Ukraine 13.5 8.0 7.0 6.0

FINANCIAL FORECASTS

Nov 16 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08Official interest ratesUS Fed funds 5.25 5.25 5.00 4.50 4.25 4.25Japan Call money rate 0.25 0.25 0.75 1.00 1.50 1.75Euro zone Refi rate 3.25 3.50 4.00 4.00 4.00 3.75United Kingdom Repo rate 5.00 5.00 5.00 4.75 4.75 4.75

Bond yieldsUS 10 years 4.64 4.80 4.60 4.50 4.50 4.50Japan 10 years 1.71 2.00 2.10 2.20 2.50 2.70Germany 10 years 3.76 4.00 4.10 4.10 4.10 4.00United Kingdom 10 years 4.58 4.60 4.50 4.50 4.50 4.40

Exchange ratesUSD/JPY 118 120 117 110 106 105EUR/USD 1.28 1.27 1.27 1.32 1.35 1.35EUR/JPY 151 152 149 145 143 142GBP/USD 1.89 1.91 1.92 1.86 1.88 1.88EUR/GBP 0.68 0.67 0.66 0.71 0.72 0.72

GLOBAL KEY INDICATORS

Yearly percentage change2005 2006 2007 2008

GDP OECD 2.7 3.2 2.5 2.4GDP world 4.9 5.2 4.6 4.5CPI OECD 2.3 2.5 2.0 2.0Export market OECD 7.0 9.3 7.4 7.1Oil price, Brent (USD/barrel) 54.2 64.0 62.0 66.0

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NO nov 2005 Eng omsl · 2008. 11. 21. · based upon it. Opinions contained in this research report...

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