SEB Report: World Economy Close To Recession

Nordic Outlook
A world economy on the edge of recession Euro zone approaching a critical crossroads
Economic Research November 2011
Contents
International overview Theme The United States Japan Asia The euro zone The United Kingdom Eastern Europe The Baltics Sweden Denmark Norway Finland Economic data 5 12 14 17 18 20 23 24 25 26 29 30 32 33
Boxes A 25 per cent probability of deep recession Geopolitical unrest helps keep oil prices up GIIPS economies in different crisis stages Living standards have suffered a blow Greater risks of a Chinese hard landing scenario 6 8 13 15 19
Nordic Outlook November 2011 | 3
Economic Research
This report was published on November 22, 2011. Cut-off date for calculations and forecasts was November 17, 2011.
Robert Bergqvist Chief Economist + 46 8 506 230 16 Daniel Bergvall Economist +46 8 763 85 94 Ann Enshagen Lavebrink Editorial Assistant + 46 8 763 80 77 Andreas Johnson Economist +46 8 763 80 32
Hkan Frisn Head of Economic Research + 46 8 763 80 67 Mattias Brur Economist + 46 8 763 85 06 Mikael Johansson Economist + 46 8 763 80 93 Tomas Lindstrm Economist + 46 8 763 80 28
Gunilla Nystrm Global Head of Personal Finance Research + 46 8 763 65 81 Susanne Eliasson Personal Finance Analyst + 46 8 763 65 88 SEB Economic Research, K-A3, SE-106 40 Stockholm
Ingela Hemming Global Head of Small Business Research + 46 8 763 82 97 Johanna Wahlsten Small Business Analyst + 46 8 763 80 72
Contributions to this report have been made by Thomas Kbel, SEB Frankfurt/M and Olle Holmgren, Trading Strategy. Stein Bruun and Erica Blomgren SEB Oslo are responsible for the Norwegian analysis. Thomas Thygesen and Jakob Lage Hansen are responsible for the Danish analysis.
4 | Nordic Outlook November 2011
International overview
Euro zone approaching a critical crossroads

Recession expected in euro zone US showing cautious signs of strength Soft landing in EM sphere, but greater risks New ways must be tried to save the euro Continued extremely low interest rates
inflation perspective, there is thus room for central banks to stimulate economies by using the means left in their toolkits. We thus expect continued exceptionally low key interest rates and non-conventional monetary policies of various kinds from major OECD central banks. In such an environment, bond yields will remain depressed to historically exceptional levels.
The world economy is still characterised by great uncertainty. The European debt crisis continues to unfold. Rescue measures undertaken so far have not been enough to restore confidence. Necessary austerity programmes are being implemented in various countries, yet mistrust and the resulting high borrowing costs remain. Meanwhile the banking system is under pressure due to higher capital requirements and write-downs of assets. In the United States, macroeconomic figures have nevertheless led to upside surprises in recent weeks and recession worries have eased, but the US economy is hampered by high unemployment and continued debt retirement needs, especially in light of a persistent decline in home prices. The banking system is in better shape, but risks of contagion from Europe are creating uncertainty and caution. Our main scenario for 2012 foresees an overall GDP decline of 0.4 per cent in the euro zone and US growth of 1.7 per cent: well below trend. Average growth in the 34 countries of the Organisation for Economic Cooperation and Development (OECD) will be 1.2 per cent, pulled up somewhat by a rebound in Japan after its 2011 natural disasters. In 2013, too, we predict below-trend growth. The US will move up to slightly firmer ground, but debt retirement will continue. In the euro zone, difficult adjustment processes remain ahead, though the most acute pressures on growth will ease somewhat in 2013. A slowdown is also under way in emerging market (EM) countries. Given the increased role of intra-regional trade and ample room to ease economic policy as needed, we are sticking to a soft landing as our main scenario, but the risks of a hard landing in China for example due to problems in credit and real estate sectors have increased. In some respects, there is also greater uncertainty about Middle East developments (see box). Our main scenario implies global GDP growth in 2012, adjusted for purchasing power parities (PPP), of 3.2 per cent: just above the 3.0 per cent that the International Monetary Fund (IMF) has defined as the upper limit of a global recession. In 2013, growth will climb to 3.8 per cent. The inflation rate is now rapidly falling after an earlier, commodity price-driven upturn. The next couple of years will be characterised by low inflation, with deflation risks. From an
Year-on-year percentage change 2010 2011 United States 3.0 1.8 Japan 4.1 -0.3 Germany 3.7 3.1 China 10.4 9.1 United Kingdom 1.8 1.0 Euro zone 1.8 1.6 Nordic countries 2.9 2.5 Baltic countries 1.4 6.0 OECD 2.9 1.7 Emerging markets 7.3 6.2 World, PPP* 5.1 4.0 World, nominal 4.4 3.3
Source: OECD, SEB
Global GDP growth
2012 1.7 2.0 0.4 8.0 0.8 -0.4 1.3 2.5 1.2 5.2 3.2 2.5
2013 2.3 1.2 1.3 8.2 1.8 0.8 2.0 3.5 1.8 5.6 3.8 3.1
* Purchasing power parities
A deepening euro zone crisis
A combination of political turmoil, fiscal austerity measures and a tighter credit environment is creating a downward economic spiral. The slowdown has accelerated in recent months, and economic weakening is evident throughout the euro zone. Its contagious effects are hurting all parts of the world economy in varying degrees. The measures to combat financial market volatility and to aid countries with acute liquidity problems that were proposed at a summit meeting in late October currently seem to have failed. These actions have instead revealed the flaws in todays faltering system, with its common currency system but weak political coordination and weak institutions at the euro zone level. In a separate Theme article, we discuss the background to these failures and how conflicting interests are facing off with each other in a way that seems to be blocking a solution. Fiscal austerity measures in crisis-hit countries do not pay off in the form of increased confidence, as long as there is lingering uncertainty about the sustainability of such policies. Meanwhile German political leaders want to avoid for as long as possible having to provide collateral for other countries without receiving solid guarantees that programmes to restore financial order in crisis-plagued countries will continue vigorously. To the greatest possible extent, the European Central Bank (ECB) wants to avoid departures from its treaty mandate or from its
task of ensuring price stability. Fearful of losing credibility in its battle against inflation or of reducing pressure on national governments, the ECB is acting cautiously. Meanwhile it seems difficult for the institutions responsible for restructuring the financial system to back-pedal from rule changes such as stricter capital adequacy requirements for banks that are aimed at creating a more stable long-term financial system but now threaten to cause an excessively abrupt credit crunch. It seems as if the crisis must become even deeper before todays rigid positions will change. One signal that we are entering a new phase is that the crisis is also leading to rapidly widening bond spreads between Germany and other core countries in the euro zone. Euro zone crisis has reached the core
10-year government bond spread to Germany, per cent
2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00 Jan Mar May Jul 10 Sep Nov Jan Mar May Jul 11 Sep Nov 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00
Italy: PMI indicates clear decline in growth

GDP lagged 3 months
65 60 55 50 45 40 35 30 00 01 02 03 04 05 06 07 08 09 10 11 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7
GDP growth, year-on-year percentage change (RHS) Purchasing managers' index (PMI), composite (LHS)
Source: Markit Economics, National Institute of Statistics
Better US outlook despite political deadlock
In recent months, US macro data have mainly provided upside surprises. This positive trend has also gained strength in the past few weeks. GDP growth recovered during the third quarter, reaching 2.5 per cent in annualised terms, among other things because lower household saving helped sustain consumption.
Recession indicator for the US
Possibility of recession within one year
0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: SEB
0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00
Austria
Finland
France
Source: Reuters EcoWin, SEB
Netherlands
Of the major euro zone countries, the current negative dynamic is strongest in Italy, where we expect a GDP decline of 1.5 per cent next year. Even the previously robust German economy is now weakening. Although the IFO business sentiment index remains somewhat above its historical average, the trend is clearly downward. We anticipate that German growth will reach only 0.4 per cent next year and that unemployment will climb.
A 25 per cent probability of deep recession

The great uncertainty in the euro zone is creating a need to discuss various alternative growth scenarios. We are assigning about a 60 per cent probability to our main scenario, in which the euro zone enters a recession period during 2012 but the rest of the industrialised world muddles through with low but positive growth. We are assigning a 25 per cent probability to a more serious scenario, in which the euro zone crisis leads to a deep recession, including a large-scale financial crisis and contagion. In this scenario, GDP would fall in accumulated terms by about 2 per cent during 2012 and 2013 in the OECD countries as a whole. The corresponding GDP decline in Western Europe in this scenario would be 4-5 per cent. A firmer solution to the systemic crisis in the euro zone might lead to a more favourable trend than in our main scenario. Another upside risk is that the American economy may experience a more normal recovery dynamic earlier than expected. Overall, we estimate the probability of a more favourable growth scenario as about 15 per cent.
GDP, OECD countries
Index 2000 = 100
127.5 125.0 122.5 120.0 117.5 115.0 112.5 110.0 107.5 105.0 04 05 06 07 08 09 10 11 12 13 127.5
15%
125.0 122.5 120.0
25%
117.5 115.0 112.5 110.0 107.5 105.0
Recession
Recovery
Slowdown
Source: OECD, SEB
The positive US trend has been important in slowing the negative dynamic in the world economy. In particular, the resilience of American stock exchanges has had a stabilising effect. Yet there are factors that will hold back growth ahead, preventing the US economy from regaining strength to the extent that it can lift up the entire global economy. The US banking system is in better shape than in Europe, but stress symptoms due to risks of contagion cannot be entirely avoided. Households need to continue their debt retirement, especially in light of continued home price declines. Fiscal policy is hampered by profound mistrust between political parties. Even though we expect some progress during the autumn, fiscal policy will have a tightening effect in the next couple of years. Our conclusion is that the US will avoid a recession but that growth will remain weak for another few years.
spending. Capital spending will mainly be driven by a continued strong housing market and by the oil industry.
Year-on-year percentage change 2010 2011 Sweden 5.6 4.3 Norway 0.3 1.3 Denmark 1.3 1.1 Finland 3.6 2.9 Nordics 2.9 2.5 Estonia 3.1 7.0 Latvia -0.3 4.4 Lithuania 1.3 6.5 Baltics 1.4 6.0
Source: OECD, SEB
GDP growth, Nordic and Baltic countries

2012 0.7 2.2 1.0 1.2 1.3 2.0 3.0 2.5 2.5 2013 2.0 2.5 1.4 2.0 2.0 3.0 4.0 3.5 3.5
Slower growth and lower inflation in Asia
The poorer OECD outlook will also slow the expansion in Asian emerging economies. The deceleration we have seen will thus continue, yet strong domestic demand will enable these countries to maintain decent growth. We are thus sticking to a soft landing as our main scenario, but risks of a more dramatic slowdown in China connected to the construction and housing market have recently increased. Small companies, especially in the construction sector, are having greater problems obtaining loans and must increasingly rely on the unofficial credit market. Also affecting the risk picture is heavy indebtedness among Chinas local authorities after the 2009 stimulus programmes. Inflation has now culminated in most countries. Monetary tightening has ended, and policy is starting to shift towards monetary easing. The central banks in Indonesia and Pakistan have already begun to lower their key interest rates. In 2012 inflation is expected to fall in emerging Asia, making it possible to stimulate growth with further rate cuts.
Sharp slowdown but no recession in Baltics
The economic downturn in Western Europe is on its way towards cooling off the export boom that led the three Baltic economies out of their 2008-2009 depression. This is occurring in a vulnerable situation, since domestic demand has only cautiously begun reawakening during the past year, yet we believe that these economies can avoid a recession. The cyclically sensitive portions of the economy, such as housing markets and capital spending activity, are already deeply depressed. Painful fiscal austerity measures and pay cuts ended in 2010. Estonia and Lithuania are now shifting to slightly expansionary fiscal policies. Purchasing power will also benefit as the energy and food price-driven inflation upturn of the past year fades. A clear overall slowdown in GDP growth will occur next year, especially in strongly export-oriented Estonia and Lithuania. Estonian GDP will increase by 2 per cent in 2012 and 3 per cent in 2013, after this years 7 per cent the highest growth in the EU. Lithuanias slowdown will follow roughly the same pattern and pace. Latvia, whose recovery has lagged behind the other two countries, will experience a gentler process in which growth will slow from more than 4 per cent this year to 3 per cent in 2012 and rise again to 4 per cent in 2013.
Below-trend growth in the Nordic countries
Despite relatively good fundamentals, the export-dependent Nordic countries are being affected by the slowdown elsewhere in Europe. Growth will end up well below trend in Sweden, Denmark and Finland in 2012 but hold up better in Norway. Due to a cyclically sensitive export sector, combined with falling home prices that will restrain consumption, GDP growth in Sweden will fall to 0.7 per cent in 2012. In 2013 we expect the government to take greater advantage of its fiscal flexibility, which will help growth to recover a bit. The international cyclically sensitive Finnish economy will also be hard hit by dampened exports, although domestic demand will hold up somewhat better than in Sweden. GDP growth will cool down to 1.2 per cent next year, leading to slightly higher unemployment. Growth in Denmark has slowed this year due to weak domestic demand and has thus significantly lagged behind the other Nordic countries. Now that weaker international demand will also hamper exports, GDP growth will hover around one per cent in the next couple of years, despite expansionary fiscal policy. Norway will show the greatest economic resilience in the Nordic region. Exceptionally good public sector finances and oil revenue, buoyed by still-high oil prices, will allow room for fiscal policies that will help sustain consumption and capital
Deflation risks will predominate
The inflation rate in the US and Western Europe is set to decline. With earlier commodity price upturns vanishing from the 12-month statistics, this decline will be relatively rapid during the coming six months. Looking ahead, weak growth will result in persistently low resource utilisation, creating underlying downward price pressures. In addition, inflation expectations have fallen during the mounting economic worries of recent months, especially in the euro zone. The picture is not entirely clear, however; several factors will help slow the decline in the inflation rate. In the euro zone, surprisingly high pay increases will keep cost pressure up. Developments in southern Europe, for example, show that cost adjustment efforts have hardly begun. Meanwhile certain tax increases included in fiscal austerity programmes will contribute to higher inflation. In the US, goods-related core inflation has shown a clear upward trend. This is partly a consequence of rising energy prices being passed on to consumers, but it
also reflects decreased deflation pressure in global merchandise trade. In addition, we expect relatively stable commodity prices ahead, due to sustained demand from China and other emerging economies. Overall, we expect core inflation in the range of 1 per cent in the next couple of years.
CPI inflation well below 2 per cent
Year-on-year percentage change
6 5 4 3 2 1 0 -1 -2 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
SEB forecast
this dilemma. Despite major risks, this pro-inflation strategy may win further support in public discourse, in a situation where traditional ways of achieving lower debt imbalances are beginning to seem more and more painful and problematic.
Difficult fiscal policy dilemma

6 5 4 3 2 1 0 -1 -2
The debt crisis is continuing to force various countries and regions to implement major fiscal austerity measures. The level of drama has escalated further, among other things because the future shape of the European financial safety net is unclear. The terms of Greeces debt restructuring have changed the way investors view the risks of holding European government securities, probably contributing to the increased pressure on countries like Italy.
Net lending
Per cent of GDP United States Japan United Kingdom Euro zone OECD
* Gross debt in 2012
Source: European Commission, OECD, IMF, SEB
Euro zone
US
Source: Eurostat, BLS, SEB
Our assessment is nonetheless that the deflation risk will be by far the biggest headache for central banks over the next couple of years. If the recession risk increases further, for example, it is likely that commodity prices will fall sharply, which would strengthen deflationary impulses. The risks of higher inflation apply mainly to the longer term and will be related to fairly dramatic changes in economic policies. The idea that todays debt imbalances are too big to manage in a low-inflation environment is gaining traction. Using high inflation to lower the real value of debts would be a way out of
2010 -10.3 -9.2 -10.2 -6.2 -7.7
2011 -9.2 -10.3 -8.5 -4.3 -6.7
2012 -8.4 -9.1 -7.0 -3.7 -5.8
Debt* 105 238 85 92 105
The uncertainty is on its way towards creating a vicious circle. When growth slows, austerity measures do not have as big a fiscal impact as the original calculations indicated. This, in turn, leads to calls for greater austerity, thereby further depressing
Geopolitical unrest helps keep oil prices up

While prices of food and industrial goods have fallen sharply during this autumns financial turbulence, oil prices have remained high. Looking ahead, we believe that oil prices will remain more resilient in the face of an international slowdown than prices of industrial metals, for example. We expect Brent crude oil to average USD 114/barrel during 2012. Low European oil reserves and seasonal effects in the US will help prop up oil prices in the short term.
Different trends for commodity prices
Index
200 175 150 125 100 75 50 25 Jan May Sep 08 Jan May Sep 09 Jan May Sep 10 Jan May Sep 11
Source: HWWI
average price of USD 120/barrel in 2013. More uncertain geopolitical conditions will also help keep oil prices up. These are largely connected to various aspects of developments in North Africa and the Middle East. Saudi Arabia has invested enormous sums to avoid being drawn into the currents of political changes generated by the Arab spring, especially by improving conditions for the Saudi population. In order to balance its budget, Saudi Arabia is thus dependent on significantly higher oil prices than before, and the government is thus trying to keep prices a bit above USD 100. There is still very great uncertainty in North Africa. Taken together, the Islamist success in the Tunisian election, the risk of newly emerging conflicts in Libya after Gaddafis death and question marks about Egypts future role in the region are creating a very unpredictable, complex situation. The status of the Iran question has definitely changed since the International Atomic Energy Agency (IAEA) reported that Iran is moving towards producing nuclear weapons. The threat of an Israeli bombing attack or similar actions will thus become more imminent. Iran will probably also become a contentious issue in the US presidential election.
200 175 150 125 100 75 50 25
Industry
Energy
Agriculture
Looking a bit further ahead, somewhat higher global growth will contribute to further oil price increases; we expect an
growth. The IMF has repeatedly pointed out that the problem of strongly synchronised austerity programmes must be taken seriously. One solution is that countries that have no acute credibility problems should hold off on cost-cutting. Another is to replace austerity measures to the greatest possible extent with structural reforms that improve the supply side of the economy, such as deregulation measures and pension reforms. We expect the general shape of fiscal policy to shift accordingly. This implies that the GIIPS countries (Greece, Ireland, Italy, Portugal and Spain) will carry out the very large austerity measures that have already been decided, but that any further writedowns in growth forecasts will not force them to enact new belt-tightening in the short term. The austerity programmes unveiled by France and Italy, totalling 1.0 per cent and 3.6 per cent of GDP respectively, will be implemented but after that we do not expect further austerity measures despite the risk that Frances credit rating may be lowered. The dose of austerity in the euro zone as a whole will be about 1 per cent of GDP annually in 2012 and 2013. Germany is now being subjected to international pressure to stimulate its economy, in order to offset the austerity measures, but we do not expect this to be done to any especially large extent. Germanys government debt is relatively high, and political leaders are probably very reluctant to risk their credibility in a critical situation.
future asset price bubbles or harmful effects on market pricing have been deemed relatively unimportant, compared to the risk of a new deep recession. The methods have varied, however. The Bank of England (BoE) and the Bank of Japan (BoJ) have chosen to expand their quantitative easing (QE) programmes, while the US Federal Reserve (Fed) has instead chosen to work with communication and the structure of its balance sheet (Operation Twist). So far the Fed has not launched any third round of quantitative easing (QE3) because it has deemed deflation risks less serious today than last autumn, when it launched the second round, QE2. However the BoE, despite high inflation, has announced that British inflation will fall below its target in the medium term unless new monetary stimulus measures are launched. The bank thus decided that it should expand its bond purchase programme to GBP 275 billion (nearly 20 per cent of GDP). Meanwhile the BoJ expanded its quantitative easing programme to JPY 55 trillion or 12 per cent of GDP.
Unconventional monetary policy actions
Central bank purchases of gov't bonds since 2008, % of GDP
25.0 22.5 20.0 17.5 15.0 BoE 25.0 22.5 20.0 17.5 15.0 Fed 12.5 10.0 7.5 5.0 ECB 2.5
Source: Federal Reserve, Bank of England, ECB, SEB
Change in structural balance as a percentage of GDP 2010 2011 2012 2013 United States -0.3 0.6 1.2 1.3 Japan -0.3 -1.0 0.0 1.0 United Kingdom 0.5 1.8 1.6 1.7 Euro zone 0.3 1.2 1.3 1.0 Of which GIIPS 2.4 3.3 1.0 0.6 OECD 0.4 0.9 1.0 1.1
Source: IMF, OECD, SEB
Fiscal tightening
12.5 10.0 7.5 5.0 2.5 0.0
0.0
The US and Japan have a certain amount of room to hold off on austerity measures because of their very liquid currencies and, in Japans case, high domestic savings. We believe that fiscal tightening will start next year in the US and increase over time. In Japan, too, major cost-cutting efforts will be postponed. The UK has implemented dramatic austerity measures, but a softening of these policies is expected next year. The Nordic countries show relatively or extremely strong public sector finances. Because of budget surpluses in Sweden and Norway, fiscal policy in these countries will be expansionary. In Denmark and Finland, where the situation is not as favourable, there is less room for manoeuvre. We expect expansionary fiscal policy also in Denmark and neutral policy in Finland over the next couple of years. Overall fiscal policy in the OECD countries will, however, shift in a contractive direction in 2012. This effect will be equivalent to 1.0 per cent of GDP and of about the same magnitude in 2013.
According to our forecasts, the Fed will launch QE3 during 2012; the most likely date is mid-year when Operation Twist ends. Previously implemented programmes have expanded the Feds balance sheet by more than 12 per cent of GDP (from 6 to 18.5 per cent). If the Fed chooses to expand its bond purchases by another USD 1 trillion (the same assessment as in the August issue of Nordic Outlook), the increase in relation to the size of the US economy would be about the same as the BoEs bond purchase programme. There has, however, been some increase in uncertainty as to whether the Fed will implement QE3. A new, large-scale bond purchasing programme by the Fed would probably run into criticism, both inside the US and from other countries. Many EM countries regarded QE2 as a deliberate strategy to weaken the US dollar, and QE3 might become a breeding ground for protectionist currents. Many observers also see QE2 as the main reason why commodity prices climbed sharply. This led in turn to soaring inflation and undermined purchasing power, especially in the US. Taken together, this indicates that the Fed may seek more gentle ways of easing monetary policy, at least as a first step. The Fed can influence expectations by linking its future key interest rate hikes to a certain unemployment level. Another possibility is to publish key rate forecasts. Such measures might postpone market pricing well into the future and thereby shift the entire yield curve downward.
Monetary policy will be loosened again
Because of the gloomier economic outlook, influential central banks have eased their monetary policy. Risks of inflation,
The ECB and the Nordic central banks still have a certain amount of room for traditional interest rate cuts. We expect the ECB to lower its refi rate to 1.0 per cent in December. The effects of further ECB rate cuts are more unclear. During 2009 the ECB chose not to cut the refi rate to below 1.0 per cent because the Euro Overnight Index Average (EONIA) rate was still being pushed down towards zero. Given the severe situation in the euro zone, the ECB will try all means of strengthening its stimulus dose, but we expect the level of its refi rate to be of lesser importance. We also assume that the ECB will leave the refi rate at 1.0 per cent and instead try out other strategies. This means that we expect the ECB to continue its liquidity-management measures and bond purchases and will thus be compelled to move beyond its treaty mandate (see Theme article). In Sweden, we expect the Riksbank to begin lowering its key interest rate within the next few months in response to rising unemployment, the absence of inflation threats and increasingly clear signs of a weakening labour market. We believe that the Riksbank will lower the repo rate from 2.0 per cent to 1.25 per cent by mid-2012. We also expect Norway to lower its deposit rate by 25 basis points late this year. Because of decent economic growth and high capacity utilisation, however, we assume that Norway unlike other OECD countries will hike its key interest rate by the end of our forecast period.
This gap will gradually shrink to zero, and a bit further ahead we expect American long-term yields to be at the same level as German ones. The assumption that the Fed will launch a Q3 programme in mid-2012 will help keep US yields down. The downward trend in government bond yields during the past few years raises the question of whether Western core countries are on their way towards a Japanese scenario of permanent exceptionally low yields. Over the next couple of years, there will undoubtedly be important similarities. Central banks in Western countries will probably need to pursue exceptional monetary policies for quite an extended period. The Fed has already signalled that it will keep its key interest rate close to zero until mid-2013, which will mean a period of 4-5 years with the key rate close to zero. But there are many indications that the Fed will need even more time to combat deflation and asset price declines. But the US and German trend still deviates in important respects from that of Japan. Above all, the difference in the inflation trend makes it hard for us to foresee significant room for US and German yields to fall further. This divergence is due to the fact that a continuous appreciation in the yen has made gradual deflation possible without major changes in competitiveness. Demographic trends also differ greatly, especially between Japan and the US. We expect Swedish 10-year yields to shadow German developments, since both the ECB and the Riksbank will be lowering key interest rates. Today Swedish 10-year yields are about 20 basis points below their German equivalents, and the gap will narrow slightly during the coming year to around 15 points. Because of good public sector finances, combined with a relatively robust krona, Swedish government securities will continue to appeal to investors. Norwegian government securities have been attractive to investors seeking a combination of high credit quality and good returns. The yields on most maturities have been below Norges Banks key interest rate, and the spread against Germany has been narrow. We expect the spread to remain at a historically low level and amount to 55 basis points in December 2012. During 2013 the spread will widen to 70 points because Norges Bank will be raising its key rate.
Continued very low long-term yields
Yields on long-term sovereign bonds in core markets have remained sharply depressed after their dramatic downturn in the spring and summer. Recently long-term US Treasuries have shown a stabilisation trend in the wake of improved short-term economic data, while German, Swedish, Norwegian and other yields have been pushed downward. 10-year government bond yields
Per cent
7 6 5 4 3 2 1 0 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
SEB forecast
7 6 5 4 3 2 1 0
European stock markets losing ground
US
Germany
Japan
Our yield forecast implies that 10-year German government bonds will trade in an interval around 2 per cent during the next couple of years. In the short term, key interest rate cuts, European recession worries, fading inflation pressure and general risk aversion will bring some further downward pressure. According to our main scenario, however, the very gloomiest macroeconomic scenarios which are being treated by the market as having a certain level of probability will not materialise. Combined with tentative steps towards a solution to the European debt crisis, this will lay the groundwork for yields to rise somewhat to 2.20 per cent by the end of 2012. During 2013 a further marginal upturn to 2.30 will occur. American 10-year yields are around 10 basis points above German ones today.
The escalating euro zone sovereign financial crisis and the subdued growth outlook have dealt a severe blow to global stock market performance. The downturn began late in July and continued during the autumn, with most markets bottoming out in late September. Since then there has been some recovery despite continued market turmoil and high volatility. US stock exchanges have shown considerably better resilience than stock markets elsewhere in the world. Relatively better economic performance and a declining risk of recession, combined with a more stable financial sector, have provided support. In Europe, stock markets have been pushed down by weakening economic signals combined with the failure of rescue actions to end the financial crisis. US stock exchanges are close to their levels at the beginning of 2011, while downturns in Europe are around 15-20 per cent; the decline for financial
sector shares has been especially dramatic. Stock markets in emerging countries have generally been unable to resist the downturn, despite decent economic fundamentals. The downturn has been about the same as in Europe. US stock exchange have been resilient
Index 100 = 2011
110 105 100 95 90 85 80 75 70 Jan Feb Mar Apr May Jun 11 Jul Aug Sep Oct Nov 110 105 100 95 90 85 80 75 70
flight to traditionally safe currencies. We thus expect the USD/ JPY rate to continue downward to 73 by December 2013. In an environment of great risk aversion and European debt crisis, however, the USD will continue to gain ground against the euro. We expect the euro to decline to a long-term EUR/USD equilibrium exchange rate of 1.25. One reason why the euro has not weakened more is that the euro zone as a whole has a balance in foreign trade due to Germanys strong competitiveness. Beyond global economic slowdown, a substantially tougher environment awaits the USD, given the large American budget and current account deficits. The US deficits will require 40 per cent of global savings to be invested in USD, making the USD vulnerable in a longer perspective since currency reserve managers want to reduce the role of the USD (which now accounts for 60 per cent of global portfolios). The recovery in the USD is one reason why we believe that Chinese authorities will ease their rate of currency appreciation, since the yuan will still follow the dollar upward against the euro. Because of subdued inflation pressure and domestic slowdown, China is more inclined to prop up export volume. Partly because of this, we expect an annual appreciation rate for the yuan of 3-4 per cent ahead. During the coming six months cyclically dependent currencies such as Scandinavian and commodity-related ones will encounter a tough environment, given a world economy on the verge of recession. But this will be offset to some extent by the fact that these are normally the currencies of fundamentally strong economies with relatively good public finances. We believe the cyclical disadvantage will predominate in the short term, but these currencies will be attractive in a slightly longer perspective. For the Swedish krona, this means that we expect short-term weakening as export order bookings deteriorate. Because the krona has gained the status of a safer investment, we do not expect any powerful speculative wave against the currency. At year-end, the EUR/SEK exchange rate will be 9.30. In tradeweighted terms, the downturn will be only 3-4 per cent in the coming months. Looking further ahead, we expect the krona to appreciate, with the EUR/SEK rate approaching 8.60 by late 2013. The outlook for the Norwegian krone is very favourable in the long term, based on widening key interest rate spreads and expected high oil prices. We expect the EUR/NOK rate to strengthen gradually to 7.50 at the end of 2012 and to 7.40 at the end of 2012. In the short term, however, weak flows and an interest rate cut by Norges Bank will prevent the krone from appreciating.
US Euro zone
Emerging markets Sweden
Nordic stock exchanges have been pulled down as well. The Nasdaq OMX Stockholm has underperformed leading stock markets. Cyclical sensitivity, comparatively weak liquidity and a relatively weighty banking sector are important explanations for this. In recent weeks the stock market has lacked a clear trend. Signals of an American recovery and hopes that more resolute measures in Europe will finally catch up with ever-worsening threat scenarios have offset the constant flow of negative news from the European debt crisis. As long as there is not a more permanent solution to the sovereign financial crisis, the volatile trend will probably continue. Deeper problems for the European banking sector and a disastrous trend for the euro project remain a clear downside risk. In themselves, the downside risks of weaker economic growth are limited; a sizeable downturn has apparently already been priced in. Overall, however, we expect it will take a relatively long time before the question marks are resolved in a way that will make a stable, lasting upturn possible.
FX market far from a normal situation
The foreign exchange (FX) market is in an exceptional situation, accentuated by the fact that central banks in five of the worlds most important economies are now carrying out extraordinary measures. In Japan and Switzerland, the central banks are intervening directly in the FX market, while the Fed, the BoE and the ECB are making large government bond purchases. The Swiss National Bank (SNB) has gone to the greatest lengths in efforts to weaken its currency, the franc (CHF). In September it announced that it was introducing a floor of 1.20 for the EUR/CHF exchange rate. This means that the SNB itself will buy unlimited amounts of foreign currency to defend its floor. The bank may possibly also raise the floor to 1.25 at its next monetary policy meeting on December 15. Last springs coordinated G7 intervention to weaken the yen has been followed by massive FX purchases by the Bank of Japan. In spite of this, the Japanese currency will remain desirable, and our downwardly revised growth forecasts underscore the FX market theme of
Theme
Conflicting interests are deepening the euro zone crisis

Strong mistrust of the EFSF solution ECB forced to assume greater responsibility Risks that the euro will disappear
but that now threaten to result in an excessively abrupt credit crunch. The proposal presented at the October 26-27 summit to stabilise the situation of countries in acute liquidity crises looks set to fail in important respects. Private investors as well as central banks and government funds are obviously very sceptical of the strategy now in effect. This failure is due to both technical limitations and shortcomings in the proposed solution, as well as more underlying confidence issues. The funding requirement of the GIIPS countries during 2012 (budget deficits and maturing loans) can be estimated at EUR 500 billion or more. The size of this requirement will depend on growth and additional bank recapitalisation needs. The credibility of the European Financial Stability Facility (EFSF), now responsible for Irelands and Portugals borrowing under a collective guarantee from the euro zone countries, is increasingly being questioned. Relatively soon, the EFSF will also start borrowing money on behalf of Greece. The EFSFs actual borrowing capacity today is EUR 440 billion. When the permanent European Stability Mechanism (ESM) replaces the current system, its lending capacity will be EUR 500 billion. In addition, the IMF is prepared to supply another EUR 250 billion.
Amended EFSF Guarantees
Per cent
Austria Belgium Finland France Germany Netherlands Italy Spain 19.2% Rest
2.4% 12.7% 3.0% 3.7% 1.9%
Recurring rescue efforts have failed to stop the negative dynamic in the euro zone. These actions have instead revealed the flaws in todays faltering system, with its common currency system but weak political coordination and weak institutions at the euro zone level. It is obvious how divergent interests and viewpoints are now creating obstacles to crisis management. National governments in crisis-hit countries face major strains. International pressure and acute default threats have forced Greece and other countries to enact far-reaching austerity measures. New governments led by Mario Monti in Italy and Lucas Papademos in Greece now have special mandates to ensure their implementation. But there are limits to how much real decision-making can be handed over to other countries or institutions without losing democratic legitimacy to the extent that it causes the political system to break down. For as long as they can, German political leaders want to avoid providing full collateral for other countries without receiving solid guarantees that programmes to restore financial order in crisis-plagued countries will continue vigorously. They are thus likely to continue opposing solutions that increase Germanys obligations in an increasingly uncontrolled way, for example by issuing euro bonds or accepting unlimited ECB commitments. To the greatest possible extent, the ECB wants to avoid departures from its treaty mandate or from its task of ensuring price stability. Fearful of losing credibility in its battle against inflation or of reducing pressure on national governments, the ECB is acting cautiously. Because of its responsibility for financial stability, the ECB is also reluctant to force banks to accept excessively drastic debt writedown requirements. Banks in the euro zone are naturally hesitant about accepting large debt write-downs, but also have reasons to oppose a recapitalisation of the banking system that takes place under excessively unfavourable conditions or at an unsuitable time. Shrinking their balance sheets and thereby creating a tighter credit environment may often be the most rational solution from a business perspective. Meanwhile it seems to be difficult for the responsible institutions to back-pedal from rule changes for example stricter capital adequacy requirements for banks that are aimed at creating a more stable long-term financial environment,
21.8%
6.1% 29.1%
Source: European Financial Stability Facility
These emergency funds may be used for direct loans or to buy government bonds in primary and secondary markets, but this is hardly an efficient utilisation of EFSFs capital, since there is a risk that emergency needs will grow rapidly if more and larger countries need bail-outs. The fact that three countries are already covered by its borrowing programmes has reduced euro zone countries guarantee commitments to the EFSFs by about 7 per cent. If Italy and Spain should also need to apply for financial bail-outs, guarantees would diminish by a further 30-35 per cent. A minor reduction can be accepted without EFSF lending capacity is affected, but if guarantees are reduced more significantly, EFSF lending capacity might also be affected. If France credit rating is worsened, it might lead to large consequences for EFSF ability to function as planned.
Theme
The October 26-27 agreement thus proposes two strategies 1. The EFSF will use its capital to guarantee a certain percentage of the nominal value of new bonds issued by crisis-hit countries. Hopefully this will give these countries a borrowing capacity of more than EUR 1 trillion in the best case. 2. The EFSF will also be able to invest in, or guarantee, part of the value of special purpose vehicles (SPVs). These SPVs, each perhaps tied to a specific crisis-hit country, will attract international capital from both private and government sources. The SPV will then invest, for example, in government bonds issued by the country in question. Politically, the hope was that the October 26-27 crisis solution would not need to be implemented, but that international confidence and thus international capital would instead return. At present, however, we can see a number of factors that throw this confidence into serious doubt: 1) The details of the agreed structure have still not been provided. 2) The solution requires political stability in the crisis-hit countries. 3) The way the Greek debt haircut was handled is frightening; it implied that political leaders can break agreements and change the size of a contractual write-down. 4) There are concerns about the creditworthiness of the EFSF itself. Obviously investments in EFSF bonds or SPVs will be regarded as riskier than lending via the IMF, for example. As for China, expanding the capital of the IMF would also boost that countrys international influence. In particular, the consequences of the voluntary private debt haircut that was part of the Greek debt agreement have become a problem. One outcome of this agreement that the ECB and others are aiming for, is that credit default swap (CDS) contracts will not be activated. That may have contributed to the recently increased pressure on Italy, since investors today do not know whether their insurance contracts will be valid if problems spread. Debt write-downs might also occur in other euro zone countries. Actual downgrades and threats of further changes in credit ratings have also created greater pressure for investors in the sovereign debt market to sell their holdings. Rising EFSF yields
5-year spread, basis points
200 175 150 125 100 75 50 25 Jan Mar Apr May Jun 11 Jul Aug Sep Oct Nov 200 175 150 125 100 75 50 25
banking system of undesired surplus liquidity. So far the ECB has bought nearly EUR 200 billion (2,2 per cent of euro zone GDP) worth of government securities from crisis-plagued countries. A new programme must be in the range of EUR 500 billion (5,4 per cent of GDP) to have a sufficient impact. Such a strategy would require overcoming the resistance of countries like Germany and of the ECB itself. Today the ECB justifies its purchases of securities by saying that it must protect the functioning of the market as well as the monetary policy transmission mechanisms. If the ECBs normal role is expanded to include an extraordinary role as a lender to governments, there is a risk that the boundary between fiscal/sovereign debt policy and monetary policy may be erased. This means that the credibility of the central bank and its ability to maintain price stability may be undermined to some extent in the future a price that the ECB must probably be prepared to pay. Our conclusion is thus that the euro project does not yet have solid ground under its feet. It will be subjected to severe tests ahead. A role for the ECB as the lender of last resort will allow some time for political manoeuvring, but it is not the solution to Europes solvency and competitiveness problems. This autumns events have confirmed that the world must recognise the possibility that the euro in its current form may disappear. 10-year government bond yield
Spread against Germany, percentage points
12 11 10 9 8 7 6 5 4 3 2 1 0 Oct Dec Feb Apr 09 12 11 10 9 8 7 6 5 4 3 2 1 0 Jun Aug 10 Oct Dec Feb Apr
France Ireland
Italy Portugal
Spain
Jun Aug 11
Oct
Source: Reuters EcoWin
GIIPS economies in different crisis stages

The situation of individual countries remains depressed, and in varying degrees these countries will be dependent on bailouts. Greece is facing an extremely deep crisis. Further debt write-downs will probably be required, and there is a high probability of withdrawal from the euro zone. Portugal is also in a situation so severe that debt write-downs will probably be necessary. The situation of Ireland has improved, since the country has managed to implement the measures it promised at the time of its bail-out package and has also enacted important structural reforms. Spain has major problems with regional deficits and sizeable foreign debt and will presumably need to apply for a bail-out, but the countrys political stability has improved because of the decision to build budget discipline into the constitution. Italy has better underlying potential to manage its situation, but crisis awareness among the people seems lower and political risks are thus higher. At present, our assessment is still that Italy will not have to apply for a bail-out.
To Germany
To EIB bonds
Source: Bloomberg, SEB
Our assessment is that that the problems of the euro zone cannot be solved unless the ECB is prepared to launch a very large-scale government bond purchasing programme, similar to those implemented in the US and the UK. In principle, a central bank has no balance sheet restrictions on purchasing government securities and then as needed draining the
The United States
Fiscal policy dangers lurking around the corner

Growth slowdown with risk of recession Gloomy households holding back recovery Fed will continue easing monetary policy
natural for households to save more, but this autumn we have seen the opposite behaviour. The household savings ratio has fallen sharply, and the gap between consumption and income changes has rarely been wider. The consumption upturn during the third quarter was driven by necessary expenditures such as electricity, water, gas and health care.
US economy muddles through
5.0 SEB forecast 2.5 0.0 -2.5 -5.0 -7.5 350 300 250 200 150 100 50 0 -50 -100 07 08 09 10 11 -10.0 07 08 09 10 11 12 13
Source: BEA, SEB
Since this past summer, US macroeconomic statistics have exceeded expectations. The main reason seems to be that households have cut back greatly on their saving. Lower energy prices and a rebound in industrial production after the downturn following the Japanese natural disasters last March have also contributed. Year-on-year GDP growth was 2.5 per cent during the third quarter, compared to 0.8 per cent in the first half. Unlike the situation in many other countries, US GDP is higher than its previous peak at the end of 2007.
Financial conditions and signs of bank stress
Index, basis points
108 107 106 105 104 103 102 101 100 99
5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0
Annualised
Year-on-year
SEB financial conditions index (LHS) 12 month LIBOR OIS spread (RHS)
As earlier, our assessment is that the US economy will slow during 2012. The risk of recession remains high: according to our model projections it has fallen to about 25 per cent, but betting companies are pricing in a significantly higher probability of recession in 2012. The sources of concern are numerous and difficult to assess: tighter financial conditions, an uncertain fiscal policy playing field, weaker global markets for manufactured goods, a recession in the euro zone and deep household pessimism. GDP will grow by 1.8 per cent this year, 1.7 per cent in 2012 and 2.3 per cent in 2013, slightly lower than consensus. Below-potential growth implies that unemployment will creep higher, but a falling labour supply will limit this upturn. As earlier, our assessment is that the most important key interest rate (the federal funds rate) will remain unchanged throughout our forecast period and that the Fed will try to stimulate the economy in other ways.
Yet it is worrisome that the future expectations of households are at historically low levels, since they are highly correlated with actual consumption during the next quarter or so. Aside from our indicator model, our consumption forecast is usually based on estimated associations between wealth and saving. This time, however, we have assumed a more cautious savings adjustment than the models indicate: the savings ratio will climb from 3.6 to 5 per cent by the end of 2012. A sharper upturn in this ratio cannot be ruled out. Our overall forecast is that household consumption will grow by 2.3 per cent this year and by an annual average of 1.4 per cent in 2012-2013.
Wages are falling in real terms
6 4 2 0 -2 -4 -6 -8 65 70 75 80 85 90 95 00 05 10
Source: BLS, SEB
6 4 2 0 -2 -4 -6 -8
Real average weekly earnings
Indicators pointing to weaker consumption

Household consumption has recently been far stronger than both indicators and income justify. In troubled times it is
The United States
Living standards have suffered a blow
American GDP per capita has regained about half its recessionary decline and is at its 2005 level. In the household sector, the decline is even larger: adjusted for inflation, median income fell by 7 per cent during the first decade of the 21st century and now stands at the same level as in 1996.
Median income down 7% in the last decade
Index 2000 = 100
102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0 82.5 80.0 77.5 75.0 70 75 80 85 90 95 00 05 10 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0 82.5 80.0 77.5 75.0
climbed sharply in September, thanks to a surge in construction of multifamily buildings, but the situation for single-family homes remains difficult. Despite a low construction level, excess supply was nearly 40 per cent (compared to sales of new single-family homes). A new downturn period thus cannot be ruled out. Mortgage applications are at their lowest level since the mid-1990s, indicating weak sales figures in the near future. Our overall assessment is that construction investments will grow by an annual average of 5 per cent in 2012-13.
Business surveys do not point to recession
Index
50 40 30 20 10 0 -10 -20 -30 -40 -50 05 06 07 08 09 10 11 75 70 65 60 55 50 45 40 35 30 25
Source: Census Bureau, SEB
Household debts have declined by USD 1 trillion during the past three years; indebtedness has fallen from 135 to 119 per cent of disposable income. According to the S&P/Case-Shiller index, home prices have fallen to the same level as in 2002, when indebtedness stood at 108 per cent of income. Debt retirement will thus continue for several more years affecting growth. It will consequently be some time before real median income again reaches its 1999 peak. According to a study in The Wall Street Journal, income will not reach this peak until 2021, illustrating how persistent these problems are.
Philadelphia Fed (LHS)
ISM Manufacturing (RHS)
The labour market is treading water
Good growth in corporate capital spending
The weakness in the household sector is partly being offset by positive news in the corporate sector. According to the Institute of Supply Management (ISM) index, manufacturing sector confidence has defied expectations of a downturn and has stabilised in recent months. Meanwhile the Philadelphia Feds business outlook survey, historically one of the most reliable economic signals, climbed sharply in October. After a sixmonth drop, the National Federation of Independent Business (NFIB) index of small business confidence also bounced back in September-October, but it remains depressed. Corporate capital spending for machinery and software is now growing rapidly; the rate of increase was a full 17 per cent in the third quarter. One reason may be the incentives for acceleration of investments launched by Congress last winter. Another reason could be that after several lacklustre years, replacement spending has picked up. Reversals during 2012 thus cannot be ruled out, but we foresee continued decent growth in capital spending. Companies will boost their investments by an average of more than 8 per cent in 2012-13. There are also bright spots in the housing market. In November, the National Association of Home Builders (NAHB) confidence indicator climbed to its highest level since last summer. This upturn has recently been reflected in construction sector share prices. For the first time since 2005, residential investments grew for two quarters in a row. Housing starts also
Year-on-year productivity growth has slowed sharply and is now far below its historical average. Slower productivity growth has often preceded economic downturns and weaker labour markets. If companies believe that a slowdown will not be short-lived, they must adjust their costs by cutting back on wages and salaries, their largest expenditure item. Nevertheless leading indicators such as data on initial claims for unemployment benefits have improved somewhat recently. Our overall assessment is that job creation will continue at a slow pace. The upturn will average about 90,000 jobs per month in 2012 and about 110,000 in 2013. Unemployment will be 9 per cent the same level as today at the end of 2013.
Fiscal policy risks are mounting
Since the 2012 presidential campaign is already under way, the political situation remains tense. It is thus very uncertain whether Congress will extend long-term unemployment benefits and household tax cuts, which expire at year-end. If such programmes are not renewed, federal budget tightening will total USD 270 billion (1.7 per cent of GDP), but our working hypothesis is that these measures will be extended for another year. Fiscal tightening at the federal level will thus be just below 1 per cent of GDP in 2012. Meanwhile belt-tightening will continue at state and local government levels, where consumption has fallen in eight of the past nine quarters. Another open question is whether the Congressional fiscal policy committee appointed last summer as part of the federal debt ceiling agreement can come together and craft a credible plan for reducing the budget deficit. Its task is to agree on expenditure cuts of at least USD 1.2 trillion for fiscal 2013-2022. If Congress fails to adopt the committees proposal before December 23, discretionary expenditures will be slashed auto-
The United States
matically starting in 2013. Entitlement-related spending such as health care costs will not be affected at all.
Falling government expenditures
9 8 7 6 5 4 3 2 1 0 -1 -2 -3 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 9 8 7 6 5 4 3 2 1 0 -1 -2 -3
avoiding deflation rather than boosting GDP growth. Given our inflation and growth scenario, new Fed bond purchases during 2012 are thus an uncertain forecast. The fact that it is an election year will also marginally lower the probability of quantitative easing. In spite of this, we are sticking to our forecast that the Fed will implement new bond purchases during 2012, which some FOMC members have also advocated. The most likely timing for QE3 is mid-2012, once Operation Twist ends. Since housing market problems are again a focus of attention, mortgage bond purchases are a logical complement to Treasury bonds, but it is uncertain how big an effect this will have in a situation where mortgage interest rates are close to historical lows. Meanwhile there are other ways to ease monetary policy. If the Fed wants to influence expectations, for example, a future key rate hike can be tied to a given unemployment level. Another possibility is to publish key rate forecasts. Such measures might shift market pricing far into the future and thus push down the entire yield curve.
Nominal GDP well below trend
USD trillion
17 16 15 14 13 12 11 10 9 17 16 15 14 13 12 11 10 9 8 7 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
State and local (12% of GDP)
Federal (8% of GDP)
Source: BEA, SEB
After President Barack Obamas big jobs package was derailed, the administration searched for other ways to stimulate the economy that do not depend on Congressional approval. It has recently announced financial relief for students, home owners and entrepreneurs, though the size of these measures has been modest. Judging from betting-company odds, Obama has an even chance of being re-elected in 2012, despite the bad economy. The Republicans seem to have difficulty in finding a strong candidate who can take advantage of the situation; right now, former Massachusetts governor Mitt Romney is heavily favoured to be the Republican candidate.
Lower inflation in 2012
6 5 4 3 2 1 0 -1 -2 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 SEB forecast 6 5 4 3 2 1 0 -1 -2
8 7
Potential GDP
Nominal GDP
Source: CBO, BEA, SEB
Core inflation
Inflation
Source: BLS, SEB
Inflation headed downward again
In the US, price formation is more sensitive to energy price fluctuations than in Europe. The CPI has consequently climbed faster in the US during 2011, but it will fall more sharply in 2012. Core inflation is now in line with the Feds target level, but here too we foresee a downturn. The weak labour market is an important force in holding down prices, with average hourly wages trending downward. Core inflation will peak at 2.2 per cent in December and then fall slowly, according to our forecasts. As annual averages, core inflation will end up at 1.6-1.7 per cent in 2011-12 and 1.2 per cent in 2013.
A new recession, with accompanying deflation risks, might meanwhile trigger the Feds heavy artillery. One possibility that is gaining ground in public discourse, although Fed Chairman Ben Bernanke remains unenthusiastic, is to introduce a nominal GDP target, with the aim of reverting to the long-term trend. Such a monetary policy target is compatible with the Feds dual mandate (maximum employment and stable prices), but from a Taylor rule perspective, employment would be assigned far greater importance. A nominal GDP target would also shift the focus from inflation rates to price levels. Given the sizeable gap between actual and potential nominal GDP, a nominal GDP target is compatible with massive monetary stimulus measures.
Further monetary policy easing
Most Federal Open Market Committee members still seem to view a third round of quantitative easing (QE3) as a way of
Japan
Bank of Japan intervening again to slow rise in yen

Global economic gloom is hurting growth but reconstruction will sustain it in 2012 Record-strong yen + deflation = BoJ action
The BoJ continues to intervene in the foreign exchange market in order to slow the yen appreciation, especially if a new wave of risk aversion due to the euro zone debt crisis pushes the yen even higher. Although there is some international sympathy for these actions, recurrent large-scale dollar purchases and yen sales similar to those carried out in 2002-04 are likely to cause irritation in other countries. Another method suggested by the IMF is for the BoJ to greatly increase its purchases of long-term government bonds. So far, however, the central bank has proceeded rather cautiously. Overall, we believe that the USD/JPY exchange rate can be stabilised at current levels, but the path to exchange rates more justified by fundamentals is being blocked by American weaknesses and the Feds low interest rate policy. In December 2012 the USD/JPY rate will be 73. Under these circumstances, we expect foreign trade to provide a weakly negative contribution to GDP growth in 2012.
Exports and the yen
Year-on-year percentage change and exchange rate
50 40 30 20 10 0 -10 -20 -30 -40 -50 05 06 07 08 09 10 11 12 13 SEB forecast 170 160 150 140 130 120 110 100 90 80 70
The Japanese economy is being affected by the global slowdown. We are thus revising our GDP forecast downward. But in the short term, reconstruction after last Marchs natural disasters and nuclear accident will sustain economic activity, spilling over into decent growth figures next year. After this years decline, GDP will grow by 2 per cent in 2012 and 1.2 per cent in 2013. This means there will still be plenty of idle resources in the economy: the output gap will be 4 per cent at the end of 2013, with GDP 2 per cent below its 2008 peak. Deflation will thus persist despite government and central bank attempts to stimulate the economy. Last autumn the Bank of Japan (BoJ) decided to expand its quantitative easing programme once again. But according to the banks forecasts, price stability 1 per cent core inflation will not be achieved during our forecast period, indicating the further monetary policy easing will occur. The key interest rate will remain at a record-low 0.1 per cent throughout our forecast period. Consumer confidence has recovered since bottoming out in April but remains below historical averages. We forecast consumption growth averaging 0.7 per cent in 2012-2013: in line with the average in the 2000 decade. Because saving has climbed sharply in recent years, the household sector is resilient. Industrial production has bounced back to some extent since the natural disasters but remains 15 per cent below its 2008 peak. The purchasing managers index in manufacturing is just above the neutral 50 mark, and machinery order bookings one of the most important industrial leading indicators point towards continued recovery driven by reconstruction work. We anticipate that industrial production as an annual average will be 2.5 per cent higher in 2012. Weak exports are holding back an even stronger industrial resurgence. Aside from weaker global demand, manufacturers are handicapped by sky-high exchange rates the yen has gained more than 35 per cent against the US dollar since 2007. For major exporters, especially companies with large US sales, current exchange rates are close to becoming unbearable, as indicated by both stock market indices and export figures. While exports to the EU (12 per cent of the total) are still growing by a decent 7 per cent year-on-year, export growth to the US (16 per cent) has approached zero.
Total exports (LHS) USD/JPY (RHS)
EUR/JPY (RHS)
Source: Ministry of Finance, Reuters EcoWin, SEB
Among OECD countries, Japans public sector debt (220 per cent of GDP in 2010) is by far the largest, but due to years of large current account surpluses the situation is nevertheless stable from a funding standpoint. Domestic investors hold most Japanese government bonds and see few investment alternatives. Budget deficits have been around 8-9 per cent of GDP in recent years and will remain high for the next few years. A third supplementary budget to finance reconstruction is being drafted, and public sector investments will grow by 15 per cent in 2012 and 7 per cent in 2013. A bit further ahead the question is what the new prime minister, Yoshihiko Noda, can do to restore order to public finances. Steps to deal with Japans long-term challenges, such as its ageing population, cannot reasonably be postponed indefinitely.
Asia
Slowdown to below-trend growth

Inflation has culminated Worsening risk picture in China Continued key interest rate hikes in India
will remain depressed, but due to good economic growth and strong fundamentals, appreciation pressure and capital inflows will resume further ahead.
China: Increased risks to economic growth
Asian emerging countries continue to sustain the global economy, although their growth slowed down further in the third quarter of 2011. Purchasing managers indices together with other indicators have kept falling in recent months, reinforcing the impression that this deceleration will continue.
Growth is slowing in Asia
GDP, year-on-year percentage change
14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 07 08 09 10 11 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0
Chinese growth continues to decelerate; third quarter year-onyear GDP growth of 9.1 per cent was the slowest since 2009. The purchasing managers index fell again in October to 50.4, a historically very low level. The first signs of a slowdown in export growth following recent financial market turmoil are discernible. In October, year-on-year export growth was just below 16 per cent, the lowest increase since 2009. The trade surplus was also below expectations. Chinas Ministry of Commerce has warned of a deteriorating export trend. There are many indications that the slowdown during the autumn was largely due to a drop in exports to the EU, but Chinese exporters have become less and less dependent on Western buyers, with sales to the GIIPS countries totalling less than 5 per cent of exports. Domestic demand still looks stable, with retail sales increasing at around 17 per cent year-on-year. There are clear problems in the construction sector, however; together with a general deterioration in the credit supply to companies, this will contribute to lower overall growth compared to earlier figures exceeding 10 per cent. We expect GDP to rise by 9.1 per cent in 2011, 8.0 per cent in 2012 and 8.2 per cent in 2013.
China: Inflation has culminated
25 20 15 10 5 0 -5 06 07 08 09 10 11 25 20 15 10 5 0 -5
China India
Indonesia Malaysia
South Korea Thailand
Source: National statistical offices
The weak outlook in the euro zone and the US will have an adverse effect on exports from Asia, although intra-regional trade has become increasingly important. Growth will thus continue to slow, ending up below trend in the next few quarters. The effects will be greater for open economies like Malaysia, while more closed economies like Indonesia will be more resilient, but strong consumption and private investments will buoy the economies of most countries. Severe flooding in Thailand will hurt economic growth in the fourth quarter but is not expected to affect the region as a whole. Inflation pressure remains high but has peaked in most economies. Inflation will fall during 2012 due to slower growth and culminating food and commodity prices. Key interest rates have been hiked during 2011, but culminating inflation means that monetary tightening has come to a halt in most countries. Falling inflation pressure next year will stimulate household consumption but also give central banks room to cut key rates as necessary to stimulate growth. This autumn many Asian currencies have been pushed downward as the financial crisis has helped strengthen the US dollar. Meanwhile earlier heavy capital inflows to the region have turned into outflows. In the short term, Asian currencies
CPI
Core inflation
Food prices
Source: National Bureau of Statistics
The inflation rate has culminated but remains high. In October, inflation fell further to 5.5 per cent, still well above the official target of 4 per cent. Unlike India, rising food prices this year do not seem to have led to price increases elsewhere in the economy. Core inflation has indeed climbed since early 2011 but has stayed around 2.5 per cent in recent months. We expect fullyear 2011 inflation of 5.5 per cent. Due to base effects and a clear deceleration in growth, inflation will slow to 4.2 per cent in 2012. Prices will rise 4.0 per cent in 2013.
Asia
Greater risks of a hard landing scenario

The risks are related to the threat of a negative dynamic connected to the housing market, the financial sector and local government debt. The housing market is continuing to cool. In September, prices measured as averages for 70 cities were 3.7 per cent higher than a year earlier. The number of sales has fallen. Chinese authorities triggered the slowdown by tightening their economic policies. While the housing market has slowed, monetary tightening has restricted the credit supply to companies. These problems are especially severe for small businesses, especially construction companies that have difficulty getting conventional bank loans. This forces them to resort to lending channels outside the regular banking system whicht evade official credit tightening measures. The construction sector, representing around 7 per cent of GDP, is thus being squeezed by a slowdown in the housing market as well as difficulty obtaining loans, leading to a clear deceleration in activity. The problems of this sector, in turn, affect local authorities that went into debt in conjunction with the 2009 stimulus programme and whose revenue largely derives from land sales: a source of income strongly linked to activity in the construction sector. Lending outside of the banks balance sheets is short-term and volatile, creating the risk of a scenario where an abrupt drop in this lending combined with lower external demand would quickly lead to big problems for export-oriented companies, small businesses and construction companies, which would risk dealing growth a major blow. Our main scenario, however, is that China can avoid a hard landing. A more lengthy process, in which capital spending-driven growth is now starting to draw to a close, is more likely. The authorities have already begun taking action. For example, they have unveiled an action package for small businesses and have proposed allowing local authorities to issue bonds. But this will not prevent construction sector and credit supply problems from now beginning to hurt growth. The Peoples Bank of China has raised its key interest rate three times during 2011, most recently early in July. Since risks to growth have increased while inflation has culminated, we believe that the hiking cycle that began in October 2010 is now over. But before the bank moves to cut its key rate, inflation must first fall clearly and approach the 4 per cent target. Our forecast is thus that the key rate will remain at 6.56 per cent in the next few quarters. Meanwhile heavy local government debt means that the potential for fiscal stimulus is limited. The US Senate has breathed new life into the currency conflict with China by approving a proposal for punitive tariffs on Chinese goods. The senators believe that the appreciation of the yuan is moving too slowly and Chinese imports are costing US jobs. The proposed actions will probably be ineffective, since other countries in Asia and Latin America are ready to replace
Chinese exports if the tariffs are imposed. The proposal is also unlikely to be implemented, since both business organisations and the Obama administration oppose it. As earlier, China has reacted strongly with talk of counter-measures and trade war. The most likely scenario is that the yuan will keep appreciating against the dollar. However, the marked slowdown in Chinese growth along with a decelerating rate of inflation and the strengthening of the dollar implies that the pace of appreciation will decrease. We expect a USD/CNY exchange rate of 6.10 at the end of 2012.
India: High inflation despite slower growth
Signs of deceleration have become clearer. The composite purchasing managers index dropped further to 50.6 in October. Leading indicators have also fallen. Industrial production has cooled in recent months, and the slowdown in the automotive industry is especially clear, but manufacturing accounts for only some 20 per cent of GDP. Unlike most other Asian countries, however, Indian exports have performed strongly in recent months. Exports have surged as the currency has weakened; since early August the rupee has lost more than 10 per cent against the dollar. GDP will increase by 7.4 per cent in 2011, by 7.5 per cent in 2012 and 8.0 per cent in 2013.
India: Continued high inflation
24 22 20 18 16 14 12 10 8 6 4 2 0 -2 07 08 09 10 11 24 22 20 18 16 14 12 10 8 6 4 2 0 -2
Key interest rate (%)
Inflation
Food prices
Source: Ministry of Commerce and Industry, Reserve Bank of India
The inflation rate remained at 9.7 per cent in October. A normal monsoon season has not yet markedly slowed the rise in food prices. The weakening of the rupee has also helped buoy the inflation rate. Inflation is expected to fall during 2012 but will still end up far above the Reserve Banks 5-6 per cent comfort zone. In October the bank hiked its key interest rate for the seventh time this year; it is now 8.50 per cent. Since the current tightening cycle began in March 2010, the key rate has been raised by 3.75 percentage points. We expect two further hikes, bringing the key rate to 9.0 per cent at the end of the first quarter of 2012. This will bring the key rate back to its peak level before the 2008-2009 crisis.
The euro zone
Recession awaits in 2012

Difficult choices in wake of debt crisis Clear signs of German slowdown Inflation will fall unemployment rising ECB will continue its stimulus measures
The other major euro zone economies France, Italy and Spain have already experienced serious growth problems, and the situation is being made worse by further austerity measures and tightening credit conditions. We expect both Italy and Spain to end up in a clear recession during 2012. In France we expect slightly negative growth, while Germany looks as if it can achieve weakly positive growth. All GIPS economies (Greece, Ireland, Portugal, Spain) except Ireland will be in recession in 2012. The euro zone will grow by 1.6 per cent this year. In 2012 we expect GDP to fall by 0.4 per cent. In 2013 growth will be 0.8 per cent: still below trend.
The euro zone growth outlook has turned considerably gloomier this autumn due to the escalation of the sovereign debt crisis. Financial market turmoil has forced various countries to enact further austerity measures, while indicators and hard data are showing a clear deceleration in growth. It is also increasingly evident that the banking crisis will make it more difficult for companies to borrow money. Recession in the euro zone 2012
Percentage change
5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 -12.5 03 04 05 06 07 08 09 10 11 12 13 forecast
SEB
5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 -12.5
Year-on-year percentage change 2010 2011 Germany 3.7 3.1 France 1.5 1.6 Italy 1.5 0.7 Spain -0.1 0.7 Greece -4.4 -5.7 Portugal 1.4 -1.9 Ireland -0.4 1.1 GIPS countries -0.6 -0.5 Euro zone 1.8 1.6
Source: Eurostat, SEB
GDP
2012 0.4 -0.2 -1.5 -0.9 -3.6 -3.4 0.7 -1.4 -0.4
2013 1.3 0.7 0.3 0.4 0.3 0.4 1.1 0.5 0.8
Quarter-on-quarter, annualised Year-on-year percentage change

Source: Euroframe, Eurostat, SEB
The sovereign debt crisis continues
Even in Germany, which resisted the downturn for a long time, the deceleration is becoming ever clearer. Exports, industrial production and order bookings have lost momentum and the labour market is showing signs of weakening. Although the IFO business sentiment index remains above its historical average, it has fallen sharply. The composite purchasing managers index (PMI) is barely above the 50 level that indicates growth.
Italy: PMI indicates clear decline in growth
GDP lagged 3 months
65 60 55 50 45 40 35 30 00 01 02 03 04 05 06 07 08 09 10 11 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7
The agreement reached by the euro zone countries late in October initially led to some sense of relief in financial markets. Such measures as a 50 per cent write-down of Greek sovereign debt to private lenders and expansion of the European Financial Stability Facility (EFSF) represented a step forward but substantially more far-reaching actions will be required. Political and financial market uncertainty is likely to continue for a long time to come. In recent weeks, the focus has been on Greece and Italy. In Greece, downward adjustments in previous overly optimistic growth forecasts made further austerity measures necessary earlier this autumn. These measures, in turn, are slowing economic activity even further, while popular discontent is making the political process chaotic. Now that Italy is in the spotlight, the problem has multiplied in size. Italy accounts for 17 per cent of euro zone GDP and is three times larger than Greece, Portugal and Ireland combined. The fundamental problem is lack of confidence in the way Italy manages its sovereign debt, which is equivalent to 120 per cent of GDP. The political process in Italy, too, has been chaotic, causing delays in belt-tightening decisions. The result has been sharply rising Italian bond yields, which reached record
GDP growth, year-on-year percentage change (RHS) Purchasing managers' index (PMI), composite (LHS)
Source: Markit Economics, National Institute of Statistics
The euro zone
highs even though the ECB has kept buying Italian government bonds in order to calm the market. Yields are now on a par with those where Greece, Ireland and Portugal lost market confidence and were forced to ask for bail-outs. 10-year government bond yield
Spread against Germany, percentage points
12 11 10 9 8 7 6 5 4 3 2 1 0 Oct Dec Feb Apr 09 12 11 10 9 8 7 6 5 4 3 2 1 0 Jun Aug 10 Oct Dec Feb Apr
nances will improve, thanks to higher tax revenue plus a correction of an error equivalent to 2.6 per cent of GDP. Germanys budget deficit will amount to 1.4 per cent of GDP this year and approach 1 per cent per year in 2012 and 2013.
Tighter credit supply for companies
France Ireland
Italy Portugal
Spain
Jun Aug 11
Oct
Source: Reuters EcoWin
The fragile euro zone banking system and the liquidity problems of the banks are in danger of harming growth. The ECBs latest Bank Lending Survey points out that financial institutions tightened their credit conditions considerably in the third quarter. They will probably tighten them further in the fourth quarter. Liquidity constraints and funding difficulties are the most important reasons behind these actions by banks. Corporate demand for loans fell during the third quarter, for the first time in a year. The slowdown in bank lending thus seems to be due to a combination of more restrictive lending at the same time as a gloomier growth outlook is causing both companies and households to lower their demand for loans.
Bank lending is levelling out
15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 04 05 06 07 08 09 10 11 15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0
Spains decision to build budget discipline into its constitution has been relatively well received. The oppositions landslide victory in the November 20 parliamentary election will set the stage for continued austerity measures and reforms, but Spain has major problems managing its large regional deficits and appears likely to miss its 2011 budget target. In Portugal, the situation remains serious. Further austerity measures will be needed, among other things to cover debt that Madeira had been under-reporting since 2004. Ireland has managed to carry out the measures agreed to at the time of its bail-out package and is also benefiting from a more flexible labour market, as well as structural reforms.
Large deficits and rising sovereign debts
Non-financial companies
Households
Source: ECB
This autumn, some euro zone countries have been forced to expand their austerity measures due to overly optimistic growth forecasts and financial market turmoil. In the euro zone as a whole, these measures will total just over 1 per cent of GDP per year during our forecast period.
Public budget balance, selected countries

Per cent of GDP Germany France Italy Spain Greece Portugal Ireland Euro zone 2010 -4.3 -7.1 -4.6 -9.3 -10.6 -9.8 -31.3 -6.2 2011 -1.4 -5.9 -4.1 -6.5 -9.7 -6.2 -10.5 -4.3 2012 -1.3 -5.4 -3.0 -5.2 -7.8 -4.8 -8.4 -3.7 2013 -1.1 -5.1 -1.9 -4.3 -7.1 -3.5 -7.5 -3.2
Further deterioration in the supply of liquidity to banks would hurt both corporate capital spending and household consumption. There is a risk that the situation will worsen due to requirements that banks boost their core capital to 9 per cent by June 30, 2012. If banks greatly reduce lending as a way of achieving this target, it will seriously hamper growth.
Weak labour market will get worse
Because of weak GDP growth, the labour market situation will now deteriorate. We have revised our unemployment forecasts upward compared to the August issue of Nordic Outlook. Germany is still showing the strongest labour market, but we expect deterioration there as well. In October, unemployment figures increased for the first time since early 2010, reaching 7 per cent. It will continue to climb somewhat in 2012. In Italy, unemployment is starting to climb earlier than we had expected in August. The French jobless rate continues to rise and will be somewhat higher than our earlier estimate. In Spain, disastrously high unemployment has continued to increase, reaching 22.6 per cent in September. Measured as annual averages, euro zone unemployment will end up at 10.1 per cent this year and 10.5 per cent in 2012. In 2013 it will be 11.0 per cent. It will thus be far above the non-accelerating inflation rate of unemployment (NAIRU), or equilibrium unemployment, of 8.5 per cent during our forecast period.
Source: European Commission, SEB
We have revised our budget deficit forecasts upward since the August issue of Nordic Outlook. Compared to the US, which is also grappling with serious government financial problems, the deficit for the euro zone is nevertheless far lower. The euro zone budget deficit will end up at 4.3 per cent of GDP this year, 3.7 per cent in 2012 and 3.2 per cent in 2013. Central government debt will climb from 86.5 per cent of GDP in 2010 to 93.5 per cent in 2013. In Germany, public sector fi-
The euro zone
Unemployment on the way up again

Per cent
25.0 22.5 20.0 17.5 15.0 12.5 10.0 7.5 5.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Prognos SEB
ECB will strengthen its stimulus dose

25.0 22.5 20.0 17.5 15.0 12.5 10.0 7.5 5.0
The timing of the ECBs key interest rate cut early in November, with Mario Draghi as the banks new president, surprised the market. There was no signal before the interest rate meeting, and given high inflation most observers had predicted that a rate cut would not occur before December. But considering the rapid deterioration of the euro zone growth outlook, the rate cut was logical; the ECB is expected to lower its growth forecast significantly at the next meeting. Meanwhile the ECB believes inflation will drop below 2 per cent in 2012. We thus expect ECB to cut the refi rate to 1.0 per cent at the December meeting.
Refi rate and EONIA rate
Per cent
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 07 08 09 10 11 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Germany France
Italy Spain
Euro zone
The worsening labour market has not affected the rate of pay increases to any great extent. Despite a great need for cost adjustment, labour costs have risen in Italy and Spain. However, they have continued to fall in Ireland, which has a betterfunctioning labour market. We expect the rate of pay increases to generally slow as the two sides in pay negotiations face a situation with a deteriorating economic outlook. We have thus lowered our forecast of pay hikes to around 1.5 per cent this year and 2 per cent yearly in 2012 and 2013.
Lower inflation in 2012
Harmonised Index of Consumer Prices (HICP) inflation in the euro zone rose early in 2011 but fell a bit during the summer. In September, however, it took off again and rose to 3 per cent, which was also the rate in October. During 2011, inflation has largely been driven by sharp increases in food and commodity prices. As these increases now vanish from the 12-month statistics, inflation will slow significantly in the coming months, bottoming out at 1.2 per cent in October 2012. Measured as annual averages, HICP inflation will end up at 2.7 per cent this year, 1.6 per cent in 2012 and 1.5 per cent in 2013. This past summers decline in core inflation HICP adjusted for energy and food was short-lived. In October, core inflation reached 1.6 per cent. Due to economic weakening, resource utilisation will fall, in turn keeping underlying inflation pressure down. Core inflation will end up at 1.4 per cent both this year and in 2012. In 2013 it will climb slightly to 1.5 per cent.
Inflation will decelerate in 2012
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 01 02 03 04 05 06 07 08 09 10 11 12 13 SEB forecast 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0
Refi rate
EONIA rate
Source: ECB, Reuters EcoWin
The effect of further refi rate cuts after that is doubtful. One reason why the ECB chose not to go below 1.0 per cent in 2009 was that the Euro Overnight Index Average (EONIA) rate at the time ended up clearly below the refi rate. If a 1.0 per cent refi rate causes the EONIA rate to be pushed down towards zero, this diminishes the impact of further rate cuts. It is also conceivable that further refi rate cuts might adversely impact the functioning of the money market by hurting interbank lending. Insurance companies may also have problems due to their return requirements. One advantage, though, is that a further rate cut would lower funding costs for banks. But given the serious situation in the euro zone, we expect the ECB to do everything it can to strengthen its dose of monetary stimulus. We also expect the ECB to continue its liquidity-management measures and bond purchases. In the prevailing serious crisis, the ECB will be compelled to serve as the guarantor of the entire euro systems stability. To some extent, this will mean going beyond its narrow price stability mandate and easing the pressure for fiscal austerity to some extent. For many national representatives at the bank, especially Germans, this will be a bitter medicine to swallow, but it is difficult to see any other way of avoiding chaotic developments in the euro system.
HICP inflation
Core inflation
The United Kingdom
Euro zone debt crisis infecting the British economy

Household purchasing power undermined Weak growth and rising unemployment Sharply lower inflation, risk of deflation Continued fiscal austerity programmes
we have adjusted our export forecast sharply downward. The difficulties of the manufacturing sector are reflected in business confidence indicators: the purchasing managers index (PMI) in manufacturing fell to recession levels in October. In the service sector, which accounts for two thirds of the economy, PMI is just above the neutral 50 mark. Taken together, these indicators are compatible with low GDP growth. GDP rose by a decent 0.5 per cent in the third quarter compared to the second, partly due to temporary factors: fewer working days around the time of Aprils British royal wedding, for example, kept GDP growth down during the second quarter. The big event next year, the London 2012 Olympics, will have a positive effect on GDP growth. Although British households and banks have paid down their debts for several years they are still heavily indebted. Public and private sector debt together total nearly 500 per cent of GDP. De-leveraging will continue throughout our forecast period, contributing to the weak outlook. We expect the economy to escape a new recession, though heavy debt and a weak labour market represent obvious downside risks. UK awash in debt
Government and private debt, per cent of GDP
500 450 400 350 300 250 200 150 100 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 01 02 03 04 05 06 07 08 09 10 11 50 0 500 450 400 350 300 250 200 150 100 50 0
The crisis in the euro zone is hampering growth in the UK via lower exports and effects on household and business confidence. We are again lowering our growth outlook and expect GDP increases of 0.8 per cent in 2012 and 1.8 per cent in 2013. The jobless rate, which hit its highest level in 16 years earlier this autumn, will climb further according to our forecasts. Unemployment will average 8.6 per cent in 2012-13. Inflation reached a high 5.2 per cent in September, but this did not prevent the central bank from launching another quantitative easing programme; inflation, pushed up by temporary factors, is expected to fall drastically. Inflation will be 2.4 per cent next year and 1.4 per cent in 2013. The combination of fiscal austerity programmes, high inflation and rising unemployment is reflected in depressed confidence indicators and weak consumption growth. With purchasing power being undermined, consumption will fall by 1 per cent this year, then level out in 2012. Not until 2013, when pay increases again exceed inflation, will consumption rebound somewhat according to our forecasts. Home prices will continue to move sideways in the next couple of years. UK inflation running well above earnings growth
5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
UK Japan Spain
France Italy South Korea
US Germany Canada
Source: TIME, SEB
Inflation Average weekly earnings regular pay (3-month average)
Source: ONS, SEB
One reason for our previous relative optimism was that strong employment growth in the private sector was offsetting massive public sector cutbacks. But businesses have now cut back on new hiring. This is largely due to the economic crisis in the euro zone, which is collectively the UKs most important trading partner (buying 30 per cent of British exports). Although exposure to the most crisis-ridden countries is relatively small,
In relation to its mandate, which focuses exclusively on inflation, the Bank of England seems to be pursuing the most expansionary monetary policy in the world. We expect the BoEs key interest rate to remain at its current record-low level throughout our forecast period. New bond purchases equivalent to GBP 75 billion (more than expected in our August forecast) were approved unanimously at the banks October monetary policy meeting. The quantitative easing program is now GBR 275 billion or just below 20 per cent of GDP. A combination of weak growth, subdued inflation expectations and an anticipated sharp decline in inflation BoE Governor Sir Mervyn King predicts deflation risks ahead in the economy indicate that further stimulus measures will come eventually. In spite of this, we anticipate marginal appreciation in the pound, with an EUR/GBP exchange rate of 0.80 at the end of 2012.
Eastern Europe
A gentler slowdown than in Western Europe

Relatively low public debts a positive factor High oil prices stabilising Russian growth Credit tightening in the West biggest risk
inflation upturn of the past year fades this winter. Underlying inflation will remain low in most countries, since output gaps are still large, but there are upside risks in Poland and Russia, where resource utilisation is relatively high. Russias GDP will increase by 4.0 per cent in 2011, 3.8 per cent next year and 4.2 per cent in 2013. Growth will be sustained in part by an expansionary shift in fiscal policy, coinciding with this winters elections, but the economy is strong because of continued high oil prices. The government expects next years federal budget to achieve a balance at oil prices of about USD 115/barrel. The slow pace of reforms as well as capital flight raise questions about longer-term growth. World Trade Organisation (WTO) accession may be on the way, and this would probably be beneficial to trade and investments. Polands growth will be increasingly driven by capital spending, via infrastructure investments, large EU funds and higher capacity utilisation. Growth will fall from 4.0 per cent in 2011 to 2.7 per cent in 2012 and 3.8 per cent in 2013. Monetary policy will shift as inflation drops into the target zone; the key interest rate will be cut twice in the first half of 2012. Ukraine will muddle through, with growth around 4 per cent, sustained in part by relatively high commodity prices. Several Eastern European currencies, including the rouble and zloty, have been squeezed during the prevailing global financial crisis, mainly due to general risk aversion. Confidence in the ability of these countries to pay their debts has remained relatively stable, except for Ukraine, Hungary, Romania and Croatia. We believe that the regions currencies will remain under pressure in the near term. In 2012 there will be a stabilisation and gradual appreciation due to relative advantages in terms of growth and interest rates. The risks in our forecasts are on the downside, mainly tied to fallout from tighter credit conditions in the euro zone and Western Europe. This tightening will have an impact both directly on credit supply and indirectly via poorer conditions for Western parent banks, but Eastern Europe is better equipped than in the 2008-2009 crunch, when large foreign loans and current account deficits helped bring economies like Ukraine and the Baltics to their knees. Since then, various countries in the region have corrected their external imbalances; Poland is an exception, but only a moderate share of its loans are in foreign currencies and its banking system apparently remains relatively solid. Bulgaria, Romania and Serbia are the countries most vulnerable to the Greek crisis via trade and banking systems. Bulgaria also stands out due to its high external funding needs this year.
Eastern (including Central) Europe has shown a solid recovery since its deep 2008-2009 recession. This past year, domestic demand has emerged alongside an earlier export-led upturn. In countries like Poland, Russia and Lithuania, consumption and capital spending have become the main drivers of GDP growth, which is about to weaken because lower global demand is hurting exports. The highly export-dependent Czech Republic, Hungary and Slovakia (with exports equal to 70-80 per cent of GDP) are especially vulnerable due to their strong ties with Germany. To some extent, we also expect slowing investments to push down growth, among other things because of a tougher credit environment. In many Eastern European countries, manufacturing sector purchasing managers indices have fallen in recent months (though with minor rebounds in Poland and Russia in October); as in Western Europe they are now close to the neutral 50 mark. Russian and Polish retail sales performing well
Sales in fixed prices, year-on-year percentage change
25 20 15 10 5 0 -5 -10 06 07 08 09 10 11 25 20 15 10 5 0 -5 -10
Russia
Source: Federal State Statistics Service Russia, Central Statistical Office Poland
Poland
But the slowdown in the regions economies will generally not be as abrupt as in the West. Exports are relatively competitive, and moderate public sector debt will make domestic demand quite resilient; Hungary, with public debt of 80 per cent of GDP, is an exception. Large budget deficits in Eastern Europe thus need not be corrected as sharply and quickly as in parts of Western Europe. Latvia, Poland and Ukraine will continue their moderate fiscal tightening next year, while fiscal policy will become stimulative in Estonia, Lithuania and Russia. Consumption and capital spending will thus hold up relatively well as export growth slows. Although the unemployment downturn of recent years will reverse in 2012 as GDP growth drops well below trend, purchasing power and real wages will strengthen as the relatively sharp, largely energy and food price-driven
Baltics
Rapid cooling in Estonia and Lithuania but no recession

Export boom in the Baltics will soon fade Reawakening domestic demand is providing support Major structural challenges
constant, at a level that was previously lower than the others. During the coming year, export growth will slow in all three countries, although improvements in competitiveness during the past few years will provide some support. Unlike the situation during the overheated pre-crisis years, wages and salaries are now growing at a slower pace than productivity. Meanwhile several factors indicate that domestic demand will gradually recover, which will help to avoid a new recession. Cyclically sensitive sectors like the construction and housing markets, as well as capital spending, are already at depressed levels after earlier large corrections in the wake of overheating in the middle of the last decade. Household purchasing power is strengthening, because the energy and food price-driven inflation pressure of recent years is easing. In addition, painful austerity policies, including the tough public budgettightening and pay cuts that began in 2008, ended after 2010. Latvia has admittedly continued its tightening and will do the same next year, with an eye to joining the euro zone in 2014, but in noticeably smaller doses. In Estonia and Lithuania, fiscal policies are largely neutral this year and will move in a mildly expansionary direction next year. Since 2010, Estonia has balanced its public sector budget, while the deficits of 4-5 per cent of GDP this year in the other two countries are continuing to shrink. Labour market improvements are proceeding slowly, however. The employment upturn will slow, and high unemployment of 13-16 per cent will level out next year after earlier downturns from 2010 peaks in the range of 20 per cent. Last years strongly energy and food price-driven inflation is now about to culminate. In Latvia and Lithuania, inflation will fall from this years averages of 4.4 and 4.0 per cent, respectively, to about 2.5 per cent in 2012. Estonian inflation will slow from more than 5 per cent this year but only to 4.0 per cent in 2012.
So far, the three Baltic economies have been resilient in the face of deceleration in the Western Europe. During 2011 growth has climbed to a relatively rapid pace. In the second and third quarter, year-on-year GDP growth was about 6.5 per cent in Lithuania and more than 5.5 per cent in Latvia, while Estonias growth slowed from 8.4 per cent (highest in the EU) to 7.9 per cent. Yet we believe that the Baltics are on the brink of a clear export-led slowdown. Meanwhile domestic demand has slowly begun reawakening this year, helping sustain growth; in Lithuania, domestic demand has taken over as the main driving force. Estonias GDP will grow by 7.0 per cent in 2011 and a mere 2.0 and 3.0 per cent in 2012 and 2013. Lithuania will lose almost as much of its dynamic, with growth of 2.5 and 3.5 per cent in 2012-2013. Latvia, which lagged the other two during the recovery, will see a gentler downshift. One reason is that there are pent-up purchasing needs after years of deep crisis, which hurt Latvia the most. This year Latvias GDP will increase by 4.4 per cent, in 2012 by 3.0 per cent and in 2013 by 4.0 per cent.
Decline in Estonian and Lithuanian business sentiment
Manufacturing sector, net figures
30 20 10 0 -10 -20 -30 -40 -50 06 07 08 09 10 11 30 20 10 0 -10 -20 -30 -40 -50
Structural problems
Estonia
Latvia
Lithuania
Euro zone
Source: European Commission
The previous export boom is now about to fade, due to weaker international demand, especially from the Nordic countries and Western Europe generally, which account for a relatively large share of Estonian and Latvian trade. This is partly visible in hard data: the rate of export growth in current prices culminated at 60-70 per cent early in 2011 and has slowed to 20-30 per cent in recent months. In highly export-dependent Estonia and Lithuania, the downturn in the mood of manufacturers has also been apparent this autumn, while corresponding sentiment indicators in Latvia have remained fairly
Overall, the Baltic countries have the potential to remain in good shape during the global economic slowdown and the European debt and financial crisis. But structural problems in the labour market and unfavourable demographic trends pose threats to their long-term growth capacity. Large new waves of emigration during the recent crisis period represent a serious challenge to all three countries; the Baltics also experienced a surge of emigration when they joined the EU in 2004. For example, the population of Latvia has shrunk from nearly 2.4 million in 2000 to just above 2 million in 2011.
Sweden
Growth far below trend despite resilience

Dependence on Europe will hurt industry Housing market a continuing concern Loose fiscal policy will keep up GDP Riksbank will cut key rate to 1.25 per cent
that the PMI stabilisation is temporary. Overall, we foresee unchanged merchandise exports on average in 2012, which means two consecutive quarters of falling exports. Including services, exports will increase slightly as an annual average.
Merchandise exports are set to stagnate
50 40 30 20 10 0 -10 -20 -30 -40 -50 99 00 01 02 03 04 05 06 07 08 09 10 11 25 20 15 10 5 0 -5 -10 -15 -20 -25
The economy is about to weaken due to the international slowdown. We predict that the economy will stagnate during the first half of 2012 and that GDP growth will reach only 0.7 per cent in 2012. In 2013 the economy will remain relatively weak, with GDP growth of 2.0 per cent: somewhat below trend. The slowdown will be driven primarily by weaker exports, but private consumption will also decelerate sharply. Unemployment will climb, while inflation pressure will remain low, paving the way for the Riksbank to cut its key interest rate to 1.25 per cent during 2012. Expansionary fiscal policy, especially in 2013, will also help to keep Swedish growth higher than the EU average, but the risks in our forecast are clearly on the downside, primarily because a large decline in home prices may lead to widespread effects in the economy.
GDP growth will slow in 2012
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 Q1 SEB forecast 10 9 8 7 6 5 4 3 2 1 0 -1 -2
New orders, NIER sentiment survey, net balance (LHS) Merchandise exports, year-on-year percentage change (RHS)
Source: NIER, Statistics Sweden
Industrial capital spending will level out
According to Statistics Swedens latest survey (in May), industrial firms were planning relatively large capital spending increases this year. In an environment dominated by shrinking demand and growing uncertainty, many investments will be cancelled or postponed, but since their level is still depressed after a major decline in 2009, a renewed downturn is unlikely. We thus expect industrial investments to level out next year. Residential investments have bounced back
Index 2007 = 100
160 150 140 130 120 110 100 90 80 70 60 50 40 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 160 150 140 130 120 110 100 90 80 70 60 50 40
Quarter-on-quarter percentage change (LHS) Year-on-year percentage change (RHS)
Q3 10
Q1
Q3 11
Q1
Q3 12
Q1
Q3 13
Source: Statistics Sweden, SEB
Export growth will decline during 2012
Exports continued to grow at a healthy pace in the third quarter, but sentiment indicators point to a clear deceleration towards year-end. According to the National Institute of Economic Research (NIER) Business Tendency Survey, order bookings have fallen sharply in a short period and are on a par with their lows during the early 2000s recession. The purchasing managers index (PMI) for manufacturing has however stopped falling in recent months. Given the ever-gloomier European outlook, new disappointments are likely; some 70 per cent of exports stay in Europe. Meanwhile Swedens heavy dependence on cyclically sensitive investment and intermediate goods implies extra large exposure to weaker global growth. We thus assume
Total Repairs and renovation
New houses and flats

Source: Statistics Sweden, NIER, SEB
In the past year and a half, residential investments have regained their entire decline since 2008, mainly stimulated by the introduction in 2009 of a temporary tax deduction for home repairs and renovations. New housing starts have also recovered somewhat, mainly due to increased construction of tenant-owned cooperative units. The residential home-building outlook is mixed. After a very long period of low housing construction, activity can probably be kept going, but this trend will be hampered by falling home prices and risks of a downturn
Sweden
after the very rapid upswing in repair and renovation. We believe that negative forces will outweigh positive ones and that residential investments will fall by a total of 15 per cent during 2012. This means that overall capital spending will be unchanged in 2012 and increase by 3 per cent in 2013.
Year-on-year percentage growth

Consumption Income Savings ratio, % of disp. income 2010 3.7 1.3 10.5
Household income and consumption

2011 2.0 3.0 11.3 2012 1.0 1.6 11.8 2013 2.1 2.2 12.0
Stronger dose of fiscal stimulus on its way
Room for expansionary fiscal policies is one important reason for Swedens economic resilience, but the government has made it clear that the need for safety margins in the budget enjoys a higher priority than stimulating demand. But given rising unemployment next year, the need for such stimulus measures will increase. We thus expect the government to make greater use of its fiscal flexibility. In 2012 its contribution to economic expansion will be only 0.3 per cent of GDP but this will increase to 0.4 per cent in 2013. Measures with a direct impact on demand such as labour market policy initiatives, infrastructure investments and central government grants are likely elements of these stimulus measures. We also anticipate various payroll tax cuts and a further reduction of taxes on pensioners by SEK 5 billion both in 2012 and 2013. We expect Swedens public budget balance to remain around zero during our forecast period, despite weak economic growth and further stimulus measures. This forecast is based on the assumption that no divestments of state-owned companies will be carried out in the next couple of years due to financial market turmoil. Since the economy will still be growing, government debt as a percentage of GDP will continue to fall, reaching 26.9 per cent of GDP at the end of 2013.
According to official statistics, home prices have levelled out or fallen marginally. Surveys and anecdotal information from estate agents signal a further weakening this autumn, and some segments of the housing market in major urban areas have seen double-digit price declines. According to SEBs home price indicator, households expect falling home prices even though the indicator has stabilised in recent months. We are sticking to our forecast that the decline in home prices will average 10-15 per cent, among other things because the Riksbanks key interest rate cuts will help sustain the market and offset the higher unemployment forecast. If the price decline is limited to this level, there is a good chance of avoiding a downward spiral of falling consumption, further labour market weakness and increasing strains on the banking system. The risks of larger price declines are obvious, though; the experiences of other countries indicate that a soft landing in home prices is unusual.
Home price downturn now under way
1.7 1.6 1.5 1.4 100 75 50 25 0 -25 -50 -75 -100 03 04 05 06 07 08 09 10 11
Public finances
2010 Net lending -0.2 Gen. govt gross debt 39.0 Central govt debt 33.5 Borrowing req., SEK bn 1
1.3
Per cent of GDP
2011 0.0 34.8 29.9 -51
2012 -0.2 33.1 28.4 -15
2013 -0.1 31.4 26.9 -9
1.2 1.1 1.0 0.9
Home prices, index (LHS) SEB home price indicator, per cent (RHS)
Falling home prices a risk to consumption
While the government budget for 2012 includes no tax cuts for households, the new value-added tax reduction on restaurant bills will provide some support to real household income and consumption growth by putting downward pressure on inflation. Aside from fiscal policy, the outlook for household finances is mixed. Accelerating pay levels and low inflation indicate that income will grow, while an expected downturn in employment will have the opposite effect. The Riksbanks key interest rate cuts will also help lower household interest rate expenditures. Private consumption held up relatively well in the first half of 2011, but falling household confidence indicates a significant deceleration in the second half. Signals of a clear slowdown in retail sales point in the same direction. Overall, we believe consumption will lose momentum but that a downturn can be avoided.
Higher unemployment in 2012
Unemployment continued to fall in the third quarter, but there are already signals that companies have become considerably more cautious about increasing their workforce. The jobless rate is very likely to level out late this year. Resource utilisation, according to both our own measure and the Riksbanks RU indicator, has declined in the past two quarters but remains close to its historical average. Assuming GDP growth far below trend, resource utilisation will continue to fall. We expect unemployment to rise gradually by about one percentage point, reaching roughly 8 per cent late in 2013. The wage round will enter a crucial stage early next year. Ongoing labour market deterioration will have a certain dampening effect on pay increases, but there are many indications that employee unions will stick to their demands for collective wage and salary hikes of about 3.5 per cent. The point of departure for employers is that there is close to zero room for pay hikes, yet the two sides do not seem further apart than normal. This
Sweden
indicates that the relative labour market calm of the past 20 years is likely to continue. We expect a two-year agreement with contractual pay increases of more than 2.5 per cent and total pay hikes of about 3.5 per cent both in 2012 and 2013.
Labour market is weakening
Three-month moving average
9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 05 06 07 08 09 10 11 12 13 SEB forecast 4700 4650 4600 4550 4500 4450 4400 4350 4300
Unemployment, per cent (LHS) Employment, thousands (RHS)
the past year or so. Now that the labour market is cooling off, the central banks justification for rate hikes is vanishing. With inflation below target, we expect the bank to lower its repo rate to help sustain growth. After the European Central Banks unexpected key rate cut in November, there is a possibility that the Riksbank will follow suit as early as December, but we believe it will wait until the February monetary policy meeting. The Riksbank was still intent on rate hikes in October and may want to see clearer signs that unemployment is actually starting to climb and that the housing market is in fact weakening. The December meeting will also be the last for Executive Board members Svante berg and Lars Nyberg, who presumably want to continue the policy of recent years. The disappearance of two members who have supported rate hikes over the past year increases the likelihood of rate cuts next year, although who will succeed them remains an open question.
Repo rate will be lowered to 1.25 per cent
5.0 4.5 4.0 3.5 3.0 2.5 2.0 SEB forecast 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 07 08 09 10 11 12 13 14
Source: Riksbank, SEB
Lower CPI inflation and below-target CPIF

During the past six months, CPI inflation has exceeded 3 per cent, driven among other things by sharply rising mortgage interest expenses. CPIF underlying inflation, which excludes interest expenses, fell to just above 1 per cent in October. Core inflation will rise only gradually
5 4 3 2 1 0 -1 -2 08 09 10 11 12 13 SEB forecast 5 4 3 2 1 0 -1 -2
1.5 1.0 0.5 0.0
Continued low bond yields
CPIF
CPIF excl energy and food
CPI
Inflation will remain low during the next couple of years, staying well below 2 per cent. The Riksbanks key rate cuts will have a major impact on CPI, which will fall from more than 3 per cent in October to just above 1 per cent in mid-2012. Accelerating pay increases and diminishing downward pressure from the kronas sharp appreciation in 2010 will nevertheless cause underlying inflation to climb somewhat. The trend of food prices is an important element of inflation analysis. So far, sharply rising world market prices until last spring have not had an impact on consumer prices, but rising import and producer prices indicate that a certain upturn is at hand. Since the world market price upturn has slowed, however, the effect will only be temporary. Downside risks for inflation during the coming year are mainly due to a rapid shift in energy prices, which was the main reason why CPI fell in many countries during 2009.
During the autumn, government bond yields fell to their lowest level so far. Because of Swedens strong government finances, the yield spread against Germany has been negative. The Riksbanks key rate cuts will make it likely that bond yields will remain low in the next couple of years, but further declines will presumably require a clearer deflationary threat. We expect 10-year bond yields to stay below 2 per cent in the short term, then rise marginally late in 2012 and during 2013. The spread against Germany will remain negative, among other things because German bond yields will be affected upwards by Germanys ever-deeper involvement in the euro zone debt crisis. During the current economic slowdown, the Swedish krona has deviated from its historical pattern of sharp declines. The most important reasons are changes in the behaviour of industrial companies related to forward contracts on export income, as well as greater foreign interest especially from central banks in investing in countries outside the euro zone with strong government finances. We believe that this shift in the cyclical sensitivity of the krona is permanent. Due to its limited liquidity, however, the krona can hardly establish the same status as currencies like the yen and Swiss franc as a safe haven. But in the short term, we believe that the krona may weak a bit against the euro as exports lose momentum and liquidity pressures mount in the European banking system. The EUR/SEK exchange rate will rise to 9.30 early next year, then turn downward again to 8.60 by the end of 2013.
Riksbank will cut repo rate to 1.25 per cent
Rising resource utilisation, credit expansion and related medium-term inflation risks were the main driving forces behind the Riksbanks key interest rate hikes from 0.25 to 2 per cent during
Denmark
Fiscal policy stimulus will sustain growth in 2012

Domestic demand has stopped increasing Exports waning as growth driver
12.5 10.0
Weak private consumption

Annual percentage change
30 25 20 15 10 5 0 -5 -10 -15 -20 03 04 05 06 07 08 09 10 11
The domestic economy has stagnated and exports are set to be the only major growth driver this year. Net exports will contribute negatively to growth next year while fiscal stimulus drives domestic demand. We expect growth in 2012 of 1.0 per cent, recovering to 1.4 per cent in 2013. The risks are to the downside, in line with the global forecast.
Export-led growth
Annual percentage change
10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 92 94 96 98 00 02 04 06 08 10 12 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0
7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5
Consumption, year-on-year % change (LHS) Retail sales, 3-month average, year-on-year % change (LHS) Consumer confidence, net balance (RHS)
Source: Statistics Denmark
Fiscal policy is reversed
The newly elected government has presented a budget proposal that contributes positively to growth, mainly by one-off transfers and public investments. Fiscal expansion is reasonable given the cyclical slowdown, a manageable public debt level and low funding costs.
Key interest rate spread and foreign currency reserves
2.00 500 450 400 350 300 250 200 150 100 03 04 05 06 07 08 09 10 11 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00 -0.25 -0.50
GDP
GDP excluding net exports

Source: Statistics Denmark
Sluggish domestic economy
Household consumption shrank in the first half of 2011, while retail sales and car purchases indicate no significant pickup in the second half. Financial market turmoil, a weak labour market, falling real wages and a stagnant housing market have caused consumer confidence to fall, leaving little prospect of consumption recovery towards year-end. Next year lower interest rates and inflation, as well as a one-off transfer due to a retirement reform, will mean an upswing in consumption, but continuous consolidation of private balance sheets will make the recovery subdued. Private debt accumulation during the housing bubble is still the Achilles heel of the Danish economy. Companies continue to hold back on hiring and capital spending. There is pent-up demand for investments, but it is unlikely to be released in a climate of global uncertainties and slow growth. Construction rebounded in the first half of 2011, but a subdued housing market means that housing investments will not be a major growth driver going forward. With a recession expected in the euro zone and a marked slowdown in other export markets, exports are set to slow dramatically in 2012, leaving net exports a drag on growth. The main difference between Denmark and the euro zone in 2012 will be the direction of fiscal policy.
DNB-ECB repo spread, per cent (LHS) Currency reserve, DKK billions (RHS)
Source: Danmarks Nationalbank
Denmark resilient in face of euro zone jitters

Recent euro zone turmoil has led to upward pressure on the Danish krone and rising currency reserves. The key interest rate spread to the euro zone is now negative for the first time, and government bonds have a small spread to Germany.
The central bank has started accepting a wider range of collateral from banks, which addresses liquidity problems and has reduced credit premiums in the money market, but a recent bank survey still shows a tightening of lending standards towards households and firms. A new bank law will facilitate consolidation in the banking sector before damaging failures materialise. The law has already been used successfully once, and more consolidation can be expected going forward.
Norway
Not quite like other countries

Domestic fundamentals still healthy: rising investment in the oil sector to add stimulus Economic policy has ample room to manoeuvre in a worst-case scenario Norges Bank will probably cut key rates and then hike again
indicators have weakened. Manufacturing sentiment has eased to the lowest level since spring 2010 but remained marginally above its long-term average in the third quarter, indicating trend-like growth. Meanwhile, the manufacturing purchasing managers index (PMI) finally moderated in October by declining to a 14-month low of 50.8. As such, these indicators do not by themselves signal a sharp turn for the worse for manufacturing output, which nonetheless should remain weak due to the negative outlook for exports of non-oil goods. Labour market is stabilising
3-month moving average
5 4 3 2 1 0 -1 -2 98 99 00 01 02 03 04 05 06 07 08 09 10 11 7.00 6.00 5.00 4.00 3.00 2.00 1.00
Headwinds from slower momentum abroad and heightened debt stress in Europe have started to take their toll on the Norwegian economy. The revival in non-oil exports up until mid-year 2011 proved short-lived as expected, and sentiment among consumers and in manufacturing has softened although not (yet) to an extent signalling an abrupt slowdown. However, Norway is not quite like other countries. First, part of the blow from abroad will be offset by strong growth in capital spending in the oil sector. According to the latest survey among oil companies operating at the Norwegian continental shelf, such investment looks set to increase some 20 per cent on aggregate in 2011-12. While part of it will be accommodated through imports, this very strong growth will add important demand impulses to the rest of the economy. Second, economic policy might provide stimuli in case of a slump in the economy, should global development be worse than expected. Although Norges Bank has fewer basis points to cut than during the recession of 2008-09, fiscal policy has ample room to manoeuvre. The budget proposal for 2012 thus saw the general government budget surplus at an extremely solid 11.5 per cent of GDP. Spending of oil revenues were put slightly below the fiscal policy rule, at 3.9 per cent of the Government Pension Fund Global rather than 4 per cent. In case of a downturn, however, the government will undoubtedly step on the accelerator: in 2009, a strong fiscal policy response contributed some 2 percentage point to mainland GDP (overall GDP excluding oil/gas and shipping). In all, the forecasts have been revised downward, but full-year growth in mainland GDP should nonetheless pick up from 2.1 per cent in 2010 to 2.4 per cent in 2011 and to 2.6 per cent in 2012, while overall GDP should be up 1.3 per cent and 2.2 per cent this year and next.
Employment, year-on-year percentage change (LHS) Unemployment, per cent (RHS)
Source: Statistics Norway
The momentum of private consumption has slowed since mid-year, but fundamentals remain rather solid. While signs of somewhat softer labour demand are discernible in a slower inflow of new vacancies, employment was still solid in the third quarter; it rose 0.8 per cent from the previous quarter and 1.8 per cent year-on-year. The unemployment rate was thus a low 3.2 per cent as measured by the Labour Force Survey. Households real disposable income should continue to grow robustly at almost 4 per cent in 2012, while a historically high savings ratio provides a cushion in the event of a more negative outcome in overall growth and the labour market.
Core inflation creeping higher
The year-on-year rate of core consumer price inflation, using the CPI-ATE measure (excluding taxes and energy), has been choppy for a number of months. However, looking through the volatility, it seems as if the 0.8 per cent average rate in the first quarter marked the trough and that there will be a gradual rising trend from the 1.2 per cent rate in October. The rise seen so far is in part due to somewhat higher wage growth filtering through, in addition to an upturn in food prices; these were still lower than a year earlier but should move up, as indicated by the sharp increase in producer prices. Prices for other domestically-produced goods and services should trend upward as well. At the same time, imported inflation should move sideways if not lower, following the sharp upturn from an
Gentler but still healthy momentum
The recovery in the Norwegian economy seems to have moderated since mid-year. Looking at the supply side of the equation, a revival in oil and gas extraction lifted GDP in the third quarter, as did a second sharp quarterly gain in electricity output. The manufacturing sector continued to languish as production declined slightly in the third quarter as well, while survey-based
Norway
average year-on-year rate of -1.4 per cent in June-August to 0.3 per cent in October. In all, core CPI should incrase towards 2 per cent over the coming year, with headline inflation running slightly stronger due to rising electricity prices and higher indirect taxes (for example on foods from January 2012).
Core inflation creeping higher
6 5 4 3 2 1 0 -1 -2 02 03 04 05 06 07 08 09 10 11 12 13 SEB forecast 6 5 4 3 2 1 0 -1 -2
act pre-emptively, since three months will pass until the next policy meeting in mid-March. Once the global outlook stops deteriorating, Norges Bank is expected to put more emphasis on domestic factors. This suggests that the bank will eventually be forced to accept a wider key rate differential vs. major trading partners in order to defend its inflation target. We expect Norges Bank to start hiking rates again in December 2012, followed by three 25 bp hikes in 2013 to end the year at 3.00 per cent.
Market pricing, SEB forecast and NB's rate path
4.00 3.50 3.00 2.50 2.00 1.50 1.00 Nov Jan Mar May Jul 11 12 Sep Nov Jan Mar May Jul Sep Nov 13 4.00 3.50 3.00 2.50 2.00 1.50 1.00
CPI
CPI-ATE
Source: SSB, SEB
Global factors guide Norges Bank
The Monetary Policy Report in October was even more dovish than expected, and Norges Bank is clearly focusing almost exclusively on global factors rather than a still solid Norwegian economy. After all, a closed output gap and inflation trending higher in the medium term to 2 per cent in early 2013 would suggest that policy rates should not be too far below neutral. However, the central bank lowered its optimal rate path by 150 basis points at the most, delaying the next key interest rate hike until next August at the earliest. The rate path indicates a deposit rate at 2.50 per cent at the end of 2012 and 3.50 per cent at the end of 2013, despite rather optimistic growth and labour market forecasts.
Factors behind changes to the October rate path
0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75 Q4 11 Q2 12 Q4 Q2 13 Q4 Q2 14 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75
SEB forecast Optimal rate path
Market pricing Low rate path
Source: Norges Bank, SEB
The market has a significantly more dovish view, discounting Norwegian key rate cuts in December, March and possibly also in May. Overall, the market expects a deposit rate of 1.63 per cent end-2012 and 2.13 per cent end-2013.
The NOK and Norwegian bonds in demand
The long-term outlook remains very favourable for the Norwegian krone, based on strong domestic demand, wider interest rate differentials and expected continued high oil prices. We expect fundamentally strong currencies to be favoured as global currency reserve managers continue to diversify into countries with solid internal and external balances. The EUR/ NOK exchange rate should gradually strengthen to 7.70 by mid-2012 and 7.60 by end-2012. In the near term, a weak flow outlook and Norges Bank rate-cutting will prevent the NOK from strengthening. We forecast an EUR/NOK rate of 7.80 and USD/NOK 5.91 by year-end. Norwegian government bonds have been in high demand from foreign investors seeking high credit quality and yield pick-up. This is reflected by most yields trading below the deposit rate and at relatively tight levels vs. Germany, but liquidity has been troublesome, resulting in high volatility. Our expectations of a continued low global yield environment will prevent any rapid upturn in the Norwegian 10-year yield, since the spread against Germany is expected to remain at tight levels in the near term. In 2013 Norges Bank rate hikes will push spreads wider again. We expect a 10-year government yield of 2.75 per cent at the end of 2012 and 3.00 per cent at the end of 2013.
Supplementary assessment Prices and costs Interest rates abroad Capacity utilisation Growth abroad Money market premiums
Total changes
Source: Norges Bank's MPR 3/2011
The optimal rate path assumes that the Greek debt crisis will not spread to other countries and that the euro zone will still show positive growth in 2012. We believe this forecast is too optimistic. The sovereign debt crisis has already intensified, with the focus shifting to Italy and Spain. Provided that the ECB cuts its refi rate by 25 basis points in early December and no improvements have occurred in the euro zone, we expect Norges Bank to deliver a 25 bp rate cut at its December 14 monetary policy meeting. In addition, Norges Bank is likely to
Finland
Export growth will slow significantly

Stable labour market sustaining consumption No need for public sector tightening
dence indicates that a deceleration is now on the way. Because of idle capacity in the economy, it is difficult to see any major underlying inflation pressure. HICP inflation, averaging 3.4 per cent so far this year, has peaked. It will continue downward towards 2 per cent in 2013. Falling inflation will help to boost real wages. We thus expect decent consumption growth of 1.5 per cent in 2012 and 2.0 per cent in 2013.
Rising number of job vacancies
9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 03 04 05 06 07 08 09 10 11 20.0 22.5 25.0 27.5 30.0 32.5 35.0 37.5 40.0 42.5
Despite decent GDP growth since the second quarter of 2010, Finlands GDP remains about 3 per cent lower than before the 2008-2009 crisis. In the first half of 2011, quarter-on-quarter growth slowed, although year-on-year growth was still above trend. We expect weaker performance ahead. Given Finlands dependence on exports (equivalent to some 40 per cent of GDP), growth will slow as international demand falls. GDP will increase by 1.2 per cent in 2012 and 2.0 per cent in 2013, driven mainly by household consumption and capital spending. Weak industrial production and exports ahead
30 20 10 0 -10 -20 -30 -40 00 01 02 03 04 05 06 07 08 09 10 11 40 30 20 10 0 -10 -20 -30 -40 -50
Unemployment, per cent (LHS) Vacancies, 12-month moving average, thousands (RHS)
Source: Statistics Finland, Ministry of Employment and the Economy
Manufacturing indicator (LHS) Manufacturing output, year-on-year percentage change (RHS) Exports, year-on-year percentage change, current prices (RHS)
Source: Statistics Finland
Indicators are pointing to weak performance, especially in manufacturing and construction sectors. The outlook for service businesses also looks worse, with a relatively sharp slowdown in the past month. Finlands exports are cyclical (machinery, electronics and forest products are large components), but indicator figures are not yet supported by actual export data. In current prices, exports continued to climb about 10 per cent year-on-year in August. They will continue to increase, but the rate will slow from 7.2 per cent in 2011 to just over 4 per cent in 2012. One factor benefiting exports is that growth in Eastern Europe is not falling as much as in the West. The 2008-2009 unemployment upturn was limited by government crisis measures aimed at preventing lay-offs. Joblessness has fallen since February 2010; the rate is now 7.7 per cent. The number of job vacancies is continuing to rise. Meanwhile changes in unemployment often occur late in the economic cycle. Given weak growth next year, we expect unemployment to rise slightly as an annual average from 7.8 per cent this year to 8.2 per cent in 2012. Household consumption rose by 4.5 per cent in constant prices during the first half of 2011, but sharply lower consumer confi32 | Nordic Outlook November 2011
The crisis has shown that fiscal manoeuvring room is important, especially for a small euro zone economy with a large export sector. Public sector debt rose by 15 per cent of GDP from late 2008 to 2010 but is now falling. Relatively robust public finances have been a strength, helping stabilise the economy. Aside from Luxembourg, Finland was the only euro zone country with a general government deficit below the Maastricht ceiling (3 per cent of GDP) last year, when the deficit was 2.5 per cent of GDP. Despite a slightly weakening of the budget in 2012, there is no immediate need to enact austerity measures that would make the recovery more difficult. One sign of market confidence is that the yield spread on 10-year Finnish government bonds has been stable at around 45-50 basis points against Germany in recent months, although the spread has increased to around 60-70 basis points in the last week.
Consumer confidence is falling
25 20 15 10 5 0 -5 -10 99 00 01 02 03 04 05 06 07 08 09 10 11 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6
Consumer confidence, net balance (LHS) Household consumption expenditure, y/y % change (RHS)
Source: Statistics Finland
Economic data
DENMARK
Yearly change in per cent Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices, harmonised Hourly wage increases Current account, % of GDP Public sector financial balance, % of GDP Public sector debt, % of GDP FINANCIAL FORECASTS Lending rate 10-year bond yield 10-year spread to Germany, bp USD/DKK EUR/DKK Nov 17th 1.20 2.05 16 5.53 7.44 Dec 11 0.95 1.85 15 5.64 7.44 2010 level, DKK bn 1,754 850 510 305 883 791 2010 1.3 1.9 0.3 -3.7 -0.2 3.2 3.5 4.2 2.2 2.3 5.1 -2.7 43.6 Jun 12 0.85 2.15 15 5.95 7.44 2011 1.1 -0.5 0.5 0.0 0.5 4.5 3.5 4.2 2.6 2.1 6.0 -4.0 46.0 Dec 12 0.85 2.35 15 5.95 7.44 2012 1.0 1.5 0.5 3.0 0.0 0.5 1.5 4.3 1.5 2.0 5.5 -5.0 50.0 Jun 13 0.95 2.45 15 5.73 7.45 2013 1.4 1.5 0.0 3.0 0.0 3.0 3.0 4.2 1.6 2.0 5.5 -2.5 51.0 Dec 13 0.95 2.45 15 5.73 7.45
NORWAY
Yearly change in per cent Gross domestic product Gross domestic product (Mainland Norway) Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices CPI-ATE Annual wage increases FINANCIAL FORECASTS Deposit rate 10-year bond yield 10-year spread to Germany, bp USD/NOK EUR/NOK Nov 17th 2.25 2.37 48 5.82 7.83 Dec 11 2.00 2.15 45 5.91 7.80 2010 level, NOK bn 2,257 1,760 992 498 445 992 694 2010 0.3 2.1 3.7 2.2 -7.4 3.2 -1.7 9.0 3.6 2.5 1.4 3.7 Jun 12 2.00 2.50 50 6.16 7.70 2011 1.3 2.4 2.5 1.9 6.9 1.0 -2.1 5.5 3.3 1.3 1.0 4.2 Dec 12 2.25 2.75 55 6.08 7.60 2012 2.2 2.6 2.7 2.4 7.4 -0.7 0.7 2.4 3.4 1.7 1.7 4.2 Jun 13 2.50 2.95 65 5.77 7.50 2013 2.5 2.9 3.3 2.3 5.1 0.0 1.9 4.2 3.3 2.1 2.0 4.4 Dec 13 3.00 3.00 70 5.77 7.50
Nordic key economic data
SWEDEN
Yearly change in per cent Gross domestic product Gross domestic product, working day adjusted Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Employment Industrial production Consumer prices CPIF Hourly wage increases Household savings ratio (%) Real disposable income Trade balance, % of GDP Current account, % of GDP Central government borrowing, SEK bn Public sector financial balance, % of GDP Public sector debt, % of GDP FINANCIAL FORECASTS Repo rate 3-month interest rate, STIBOR 10-year bond yield 10-year spread to Germany, bp USD/SEK EUR/SEK TCW Nov 17th 2.00 2.63 1.68 -20 6.80 9.16 125.0 Dec 11 2.00 2.65 1.50 -20 7.05 9.30 127.6 2010 level, SEK bn 3,308 1,604 893 589 21 1,652 1,452 2010 5.6 5.4 3.7 2.2 6.6 2.1 11.1 12.7 8.4 1.0 9.6 1.2 2.0 2.6 10.5 1.3 2.5 6.2 1 -0.2 39.0 Jun 12 1.50 2.08 1.85 -15 7.20 9.00 125.6 2011 4.3 4.3 2.0 0.9 10.0 0.3 8.9 7.9 7.4 2.2 9.3 3.0 1.4 2.5 11.3 3.0 2.8 6.4 -51 0.0 34.8 Dec 12 1.25 1.80 2.05 -15 7.08 8.85 123.9 2012 0.7 1.1 1.0 0.9 0.0 -0.7 0.6 -0.8 7.4 0.2 0.0 1.1 1.2 3.5 11.8 1.6 2.9 6.7 -15 -0.2 33.1 Jun 13 1.25 1.75 2.20 -10 6.69 8.70 120.6 2013 2.0 2.0 2.1 0.8 3.0 0.0 4.0 4.1 7.9 -0.2 2.5 1.4 1.6 3.7 12.0 2.2 2.9 5.0 -9 -0.1 31.4 Dec 13 1.25 1.75 2.25 -5 6.62 8.60 118.6
FINLAND
Yearly change in per cent Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices, harmonised Hourly wage increases Current account, % of GDP Public sector financial balance, % of GDP Public sector debt, % of GDP 2010 level, EUR bn 180 98 44 34 73 70 2010 3.6 2.7 0.6 2.8 0.6 8.6 7.4 8.4 1.7 2.6 1.8 -2.5 48.3 2011 2.9 2.3 0.3 4.0 0.0 7.2 6.0 7.8 3.3 2.4 2.5 -1.8 48.3 2012 1.2 1.5 0.3 4.1 0.0 4.2 6.6 8.2 1.9 2.9 2.0 -2.0 47.0 2013 2.0 2.0 0.3 4.5 0.0 5.3 6.4 8.2 2.0 3.0 2.0 -1.2 44.5
International key economic data
EURO ZONE
Yearly change in per cent Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices Household savings ratio (%) 2010 level, EUR bn 9,189 5,301 2,014 1,764 3,734 3,613 2010 1.8 0.9 0.4 -0.9 0.9 10.1 9.2 10.1 1.6 9.6 2011 1.6 0.5 0.4 2.5 0.5 5.5 5.0 10.1 2.7 9.3 2012 -0.4 -0.7 -0.2 -0.1 0.0 3.1 3.0 10.5 1.6 9.1 2013 0.8 0.0 0.0 2.5 0.0 3.6 3.1 11.0 1.5 9.2
US
Yearly change in per cent Gross domestic product Private consumption Public consumption Gross fixed investment Stockbuilding (change as % of GDP) Exports Imports Unemployment (%) Consumer prices Household savings ratio (%) 2010 level, USD bn 14,755 10,417 3,020 1,818 1,935 2,436 2010 3.0 2.0 0.7 2.6 1.6 11.3 12.5 9.6 1.7 5.3 2011 1.8 2.3 -1.9 6.6 -0.2 7.1 5.0 9.1 3.2 4.6 2012 1.7 1.4 -0.8 6.4 -0.2 6.7 4.1 9.4 1.7 4.2 2013 2.3 1.3 -1.0 9.3 0.0 11.4 8.2 9.1 1.3 5.3
LARGE INDUSTRIAL COUNTRIES

Yearly change in per cent 2010 GDP United Kingdom Japan Germany France Italy Inflation United Kingdom Japan Germany France Italy Unemployment (%) United Kingdom Japan Germany France Italy 1.8 4.1 3.7 1.4 1.5 3.3 -0.7 1.2 1.7 1.6 7.9 5.1 7.1 9.8 8.4 2011 1.0 -0.3 3.1 1.6 0.7 4.4 -0.2 2.4 2.2 2.7 8.0 4.5 6.0 9.8 8.3 2012 0.8 2.0 0.4 -0.2 -1.5 2.4 0.1 1.7 1.6 1.9 8.6 4.3 6.0 10.4 8.8 2013 1.8 1.2 1.3 0.7 0.3 1.2 0.3 1.9 1.5 2.0 8.6 4.4 6.7 11.0 9.7
International key economic data
EASTERN EUROPE
2010 GDP, yearly change in per cent Estonia Latvia Lithuania Poland Russia Ukraine Inflation, yearly change in per cent Estonia Latvia Lithuania Poland Russia Ukraine 2.3 -0.3 1.4 3.8 4.0 4.2 2.7 -1.2 1.2 2.7 6.9 9.4 2011 7.0 4.4 6.5 4.0 4.0 4.3 5.3 4.4 4.0 4.0 8.6 10.0 2012 2.0 3.0 2.5 2.7 3.8 3.8 4.0 2.4 2.5 2.8 7.3 9.0 2013 3.0 4.0 3.5 3.8 4.2 4.2 5.0 2.0 3.0 2.6 6.8 8.5
FINANCIAL FORECASTS
Nov 17th Official interest rates US Japan Euro zone United Kingdom Bond yields US Japan Germany United Kingdom Exchange rates USD/JPY EUR/USD EUR/JPY GBP/USD EUR/GBP Fed funds Call money rate Refi rate Repo rate 10 years 10 years 10 years 10 years 0.25 0.10 1.25 0.50 1.96 0.96 1.89 2.23 77 1.35 104 1.58 0.85 Dec 11 0.25 0.10 1.00 0.50 1.95 1.00 1.70 2.10 75 1.32 99 1.55 0.85 Jun 12 0.25 0.10 1.00 0.50 2.00 1.10 2.00 2.40 73 1.25 91 1.52 0.82 Dec 12 0.25 0.10 1.00 0.50 2.20 1.20 2.20 2.60 73 1.25 91 1.56 0.80 Jun 13 0.25 0.10 1.00 0.50 2.30 1.20 2.30 2.70 75 1.30 98 1.59 0.82 Dec 13 0.25 0.10 1.00 0.50 2.30 1.20 2.30 2.70 78 1.30 101 1.55 0.84
GLOBAL KEY INDICATORS

Yearly percentage change GDP OECD GDP world CPI OECD Export market OECD Oil price, Brent (USD/barrel) 2010 2.9 5.1 1.5 11.5 79.9 2011 1.7 4.0 2.6 5.9 110.0 2012 1.2 3.2 1.6 3.3 114.0 2013 1.8 3.8 1.3 4.9 115.0
Finland
St: Petersburg
Norway Sweden
Russia
Moskva
St. Petersburg
Estonia
Moscow
New York
Dublin
Denmark
Latvia
Beijing
Lithuania
Shanghai
London Germany Luxembourg Poland Warsaw Ukraine Kiev New Delhi
Hong Kong
Singapore
Geneve Nice
So Paulo
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SEMB0080 2011.11
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SEB Report: World Economy Close To Recession

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SEB Report: World Economy Close To Recession

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Nordic Outlook

Economic Research November 2011

Nordic Outlook November 2011 | 3

4 | Nordic Outlook November 2011

Euro zone approaching a critical crossroads

Global GDP growth

* Purchasing power parities

A deepening euro zone crisis

Nordic Outlook November 2011 | 5

Italy: PMI indicates clear decline in growth

Source: Markit Economics, National Institute of Statistics

Better US outlook despite political deadlock

Source: Reuters EcoWin, SEB

A 25 per cent probability of deep recession

125.0 122.5 120.0

117.5 115.0 112.5 110.0 107.5 105.0

6 | Nordic Outlook November 2011

GDP growth, Nordic and Baltic countries

Slower growth and lower inflation in Asia

Sharp slowdown but no recession in Baltics

Below-trend growth in the Nordic countries

Deflation risks will predominate

Nordic Outlook November 2011 | 7

Difficult fiscal policy dilemma

2010 -10.3 -9.2 -10.2 -6.2 -7.7

2011 -9.2 -10.3 -8.5 -4.3 -6.7

2012 -8.4 -9.1 -7.0 -3.7 -5.8

Debt* 105 238 85 92 105

Geopolitical unrest helps keep oil prices up

200 175 150 125 100 75 50 25

8 | Nordic Outlook November 2011

12.5 10.0 7.5 5.0 2.5 0.0

Monetary policy will be loosened again

Nordic Outlook November 2011 | 9

Continued very low long-term yields

European stock markets losing ground

Emerging markets Sweden

Source: Reuters EcoWin, SEB

FX market far from a normal situation

Nordic Outlook November 2011 | 11

Conflicting interests are deepening the euro zone crisis

12 | Nordic Outlook November 2011

Source: Reuters EcoWin

GIIPS economies in different crisis stages

Source: Bloomberg, SEB

Nordic Outlook November 2011 | 13

The United States

Fiscal policy dangers lurking around the corner

5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0

Source: Reuters EcoWin, SEB

Real average weekly earnings

Indicators pointing to weaker consumption

14 | Nordic Outlook November 2011

The United States

Living standards have suffered a blow

Source: Census Bureau, SEB

Philadelphia Fed (LHS)

ISM Manufacturing (RHS)

Source: Reuters EcoWin, SEB

The labour market is treading water

Good growth in corporate capital spending

Fiscal policy risks are mounting

Nordic Outlook November 2011 | 15