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SEB Nordic Outlook, May 2011 - The fundamentals are strong in the Nordics, and we see a gradual recovery in the Baltics, said the economist at SEB Research in Stockholm, Daniel Bergvall, as he and his colleague from SEB Estonia, Hardo Pajula, presented SEB’s recently published Nordic Outlook at a May 25th SCCE Business Lunch.

- The Baltic Sea is surrounded by 9 countries. The combined population of this region, counting only maritime provinces of Russia, Poland and Germany, is 47 million. The output, using the same weighting, is USD 1.200 billion. Both figures equal those of South Korea, said Hardo Pajula.

Daniel Bergvall’s and Hardo Pajula’s presentations, as well as the full SEB Nordic Outlook May 2011, are available online at links found at the end of this e-focus summary.

Estonia
- With its public finances under control, the lowest foreign debt in the EU, 6,6%, and larger exports, Estonia is better positioned for recovery than Latvia and Lithuania, says SEB’s Nordic Outlook. Additionally, Estonia’s unemployment fell unexpectedly fast from a peak of about 20% in the beginning of 2010 to less than 14% in the 4th quarter last year, a downturn mainly related to the export sector.

Estonia’s high inflation will soon peak, believes SEB.

- Inflation has climbed faster in Estonia than in Latvia and Lithuania, from zero early in 2010 to 5,4% in April, the highest figure in the euro zone. Since late 2010, the inflation has stabilized at this relatively high level, and the inflation expectations have failed to rise. We believe that these trends will mainly continue. Inflation will average 5% in 2011, and next year’s average will be 4%.

- Estonia’s inflation surge can be largely explained by higher global energy and agricultural/food prices plus base effects. Fiscal tightening measures have also contributed to some extent. Energy and food inflation will ease later this year, and base effects are already history.

- Meanwhile wages are rising slowly. Yet some price pressure still exists and prices of such foods as potatoes, apples and milk rose dramatically in March. There was also probably a minor inflationary effect related to euro zone accession on January 1st, 2011, with companies taking the opportunity to raise prices.

- One important restraining factor in our inflation analysis is weak money supply growth. Changes in money supply have turned out to have a relatively strong impact on underlying inflation. The money supply has recently been squeezed, and no major upturn can be expected as long as the debt adjustment process continues.

Dynamic exports

- To date, the economic upturn has largely been driven by dynamic exports, which have benefited from better competitiveness due to previous large pay cuts and a favourable geographic position. Improvements in competitiveness ended late in 2010 when private sector pay and inflation rebounded, but exports are continuing to enjoy good demand from nearby countries.

- For Estonia, the Swedish and Finnish markets are especially important, while expansion in Germany and neighboring Eastern European economies means more to Latvia and Lithuania.

Sweden
The Swedish economy is continuing its rapid expansion, though many indicators are beginning to show a slow down from extremely high levels, notes SEB.

Faster export growth - somewhat less expansive consumption

- The driving forces in the Swedish economy have shifted, with faster export growth and somewhat less expansive consumption. Uncertainty about how well the export sector would handle the stronger Swedish krona diminished early in 2011. Meanwhile the reaction of households to rising home mortgage rates has been unexpectedly clear.

- An expected slowdown in growth during 2012 will partly be a consequence of supply side constraints that gradually make themselves felt.

- Unemployment will fall below 7% as early as this year and move towards 6% by the end of 2012, somewhat below equilibrium level. We expect wages and salaries to rise at a total rate of nearly 4% during 2012, from about 2,5% per cent during 2010 and 2011. Because of demands for compensation for low pay increases during the crisis and high inflation expectations, the risks are on the upside.

The repo rate

- We still believe that the Riksbank will hike its key interest rate at every monetary policy meeting this year. Because of rising inflation expectations, as well as rate hikes by the European Central Bank, the Riksbank will proceed somewhat faster than it has announced so far. Increasingly strained resource utilization in the Swedish economy points towards continued rate hikes in 2012, and we expect a repo rate of 3,75% by September.

Inflation and State finances

- Despite international price increases for food and energy, Swedish inflation excluding interest rate changes, CPIF has been less than 2%. Core inflation will soon bottom out, but because of low increases in unit labour cost and continued krona appreciation, the upturn will probably be slow.

- Swedish government finances are continuing to improve faster than expected. Together with low government debt, this will allow room for further fiscal stimulus measures. We expect proposals equivalent to another SEK 5-10 billion to be unveiled in the September budget bill. Combined with the measures announced in the spring budget, this will bring total fiscal stimulus in 2012 to SEK 30-35 billion, equivalent to 1% of GDP. The change in policy mix towards more expansive fiscal policy and tighter monetary policy will thus continue.

The strong Swedish krona and exports

- Despite the strong krona, Swedish exports have now recovered. Companies’ responses in various surveys reinforce the view that the strong Swedish currency is not threatening their competitiveness; a large majority maintains that the exchange rate is not a problem. The quarterly reports of export companies, which reveal expansive future plans, confirm this picture.

- The strength of the international upturn will thus determine Sweden’s export prospects. Because of strong increases early in 2011 and continued strong forward-looking indicators, we are now expecting growth of more than 10% this year and 8% next year. This forecast implies that the level of exports will return to its long-term trend by the end of 2012.

The euro zone
- The euro zone debt crisis remains a significant problem, and it risks delaying the economic recovery in the currency union, says SEB.

- As expected, Portugal became the third debt plagued euro zone country to request a bail-out, after Greece and Ireland. The risk that Spain might also be forced to seek outside aid is high, and the question of debt restructuring mechanisms in Greece is another source of uncertainty.

- Our main scenario is that Greece will undergo a hard restructuring with a 50% write-down of the Greek debt in 2012, said SEB’s Daniel Bergvall, at SCCE’s Business Lunch, May 25th. It’s not an easy path, but better than leaving the euro zone. It will involve an analyze of the impact on the European banking system as well as new and tough negotiations to gain support from key countries in the euro zone.

The world economy will overcome new challenges
- Over the past few months, the global economic recovery has faced a number of challenges. Political unrest in the Middle East and North Africa, including a civil war in Libya, the Japanese natural disaster and a renewed wave of European sovereign debt crisis have created greater uncertainty about the sustainability of the recovery, says the Nordic Outlook.

- While our main forecast is a continued economic recovery, the global economy faces a number of risks and challenges. The climate of international cooperation, both in Europe and at the global Group of Twenty, G20 level, will be put to the test in an environment that includes the emergence of worrisome political tendencies towards isolationism and focusing on internal problems.

- Global imbalances are disturbingly large. Sizeable cyclical and structural differences are creating tensions in the global foreign exchange system. In many places, debts and assets are continuing to build up, leading to explosive risks.

- Central government debts are rising, and the European debt crisis is moving into a new phase. The sustainability of American federal finances is also beginning to be questioned in earnest, although an increased awareness of the problem is meanwhile contributing to a more sober approach to US fiscal policies.

- The sharp upturn in commodity prices that began in the summer of 2010 is on its way towards ending. The recent cool down in prices is mainly due to a correction of earlier speculative excesses. Later this year, the trend of commodity prices will begin a slow down based more on fundamentals.

Links to the presentations and the SEB Nordic Outlook May 2011:

- Daniel Bergvall's presentation
- Hardo Pajula's presentation
- SEB Nordic Outlook May 2011