SEB's Nordic Outlook: COVID-19 holds the world in an iron grip

Nordic Outlook: COVID-19 holds the world in an iron grip

Sweden: Government and Riksbank respond with new stimulus

A mixed picture is now emerging. After a surprisingly strong economic recovery in the third quarter of 2020, the second wave of the novel coronavirus is becoming significantly worse than expected. New restrictions will again lead to negative GDP growth during the fourth quarter, at the same time as stimulus measures are expanded. Because of the new overall growth curve, we are adjusting our forecast of  GDP growth in the advanced economies (the 37-country Organisation for Economic Cooperation and Development, or OECD) upward by one percentage point to minus 5.7 per cent. Instead we foresee a weaker GDP upturn in 2021 than we did previously: we have lowered our growth forecast from 4.6 per cent to 3.9 per cent. Although downside risks have increased, we do not expect the second wave of COVID-19 to have any crucial negative effects in the long term, and we believe that in 2022 GDP in the OECD countries will grow by 3.4 per cent, or well above trend. Meanwhile the historical disadvantages of stimulus measures will persist: wider economic gaps, reduced pressure for change, non-optimal allocation of capital and distortions in competition.   

Sweden’s GDP decline in 2020 will be limited to 3.1 per cent – half of what we projected in May. New restrictions will dampen growth in the short term. We have lowered our GDP growth forecast for 2021 to 2.7 per cent, from the previous 4.2 per cent. Unemployment will peak next spring at 9.7 per cent (0.5 points higher than today). Unutilised crisis funds totalling more than SEK 100 billion can be used in the near term to help businesses and others in need. Meanwhile we expect the government’s SEK 105 billion stimulus budget for 2021 to be expanded by SEK 50-70 billion. Despite Inflation that is well below the Riksbank’s 2 per cent target, due to a stronger krona and low contractual pay increases, the central bank will not cut its key interest rate. Instead it will expand its stimulative purchases of securities by SEK 100 billion to a total of SEK 600 billion.

Growth surprises are offset by serious COVID-19 reversals

A very powerful second wave of the coronavirus has hit Europe and the United States especially hard. The economic growth curve for 2021-2022 will be determined by the degree and duration of new pandemic-related restrictions, future access to COVID-19 vaccines and the expanded stimulus policies of central banks and governments. Our main scenario assumes that these restrictions will be milder than those that were imposed last spring and that large-scale vaccinations will begin during the second quarter of 2021. The president-elect of the United States, Joe Biden, will open the way for a growth- and job-oriented fiscal policy that will interact with the Federal Reserve’s near-zero key interest rate and extensive securities purchases. GDP will fall by 4.0 per cent in the US this year. In 2021 it will grow by 3.6 per cent and in 2022 by 3.8 per cent. American unemployment (6.9 per cent today) will reach 4.5 per cent. The European Union’s new EUR 750 billion recovery fund will supplement both new national fiscal stimulus measures and the European Central Bank (ECB)’s expanded securities purchases, now totalling EUR 500 billion. The ECB will buy virtually all euro area government bonds that are issued during 2021. In the euro area, GDP will fall by 7.6 per cent in 2020, then climb by 4.0 per cent in 2021 and 4.3 per cent in 2022. Unemployment (8.5 per cent today) will increase to 10.5 per cent. Inflation in the US and in the euro area will not reach central bank targets.

China will be a growth engine for Asia and the world

Despite a strong recovery in China, we have adjusted our forecast of 2020 GDP growth in emerging market (EM) economies to minus 3.3 per cent, mainly because India has been harder hit by the pandemic than expected. Our overall forecast of global GDP growth is largely unchanged at -4.4 per cent this year, 5.1 per cent in 2021 and 3.9 per cent in 2022. The mixed situation in the EM sphere is due to differences in export structure, fiscal manoeuvring room and how hard these economies have been hit by the COVID-19 crisis. China has managed to create a broad-based recovery for both production and consumption, despite pursuing a very cautious stimulus policy in order to avoid growing imbalances. The Chinese economy will grow by 2.0 per cent this year, 8.0 per cent in 2021 and 5.6 per cent in 2022. In the EM sphere as a whole, GDP will grow by 6.2 per cent in 2021 and 4.3 per cent in 2022. This forecast assumes that we will not see another clear wave of the coronavirus.

Nordics and Baltics show signs of strength, but new challenges await

So far, all of the Nordic and Baltic economies have performed unexpectedly well. They will experience milder GDP declines in 2020 than the European Union average. Broad-based lockdowns were relatively brief in most of these countries, while their sectoral structure – for example more food processing and manufacturing – has benefited the Danish and Finnish economies, for example. There are many indications that these regions can also emerge relatively unscathed – in economic terms – during the second wave of COVID-19 compared to the rest of Europe (see the table below for GDP forecasts). In Norway, fiscal policy makers will provide continued support as the recovery slows. Although households look set to manage nicely, growth will be hampered by low capital spending. Norges Bank will be one of the few central banks to hike its key interest rates before the end of 2022, due to rising home prices. New pandemic-related restrictions in Denmark raise questions about short-term growth, but the country’s 2020 recovery has been impressive. Private consumption will be the engine of Danish growth in 2021-2022. In Finland, forward-looking indicators suggest a decline in economic resilience. Although growth will be fairly healthy, structural weaknesses – an ageing population and weak productivity growth – will hamper economic performance further ahead.   

In Estonia, consumption will be an important driver of growth; it will be supported by an expansionary fiscal policy and a controversial pension reform. Despite somewhat looser COVID-related restrictions, the Latvian economy has been harder hit than its Baltic neighbours. Exports are driving the recovery. Meanwhile stimulus programmes have limited the upturn in unemployment and helped sustain households. In Lithuania, too, consumer confidence has been sustained, among other things, by an accelerating wage and salary growth: consumption is expected to lead the recovery in 2021 and 2022.  

Strong Swedish recovery encounters setbacks

After a strong third quarter of 2020, Sweden’s economic recovery will now lose momentum for the next six months due to new pandemic-related restrictions and fading growth elsewhere in Europe. This will mainly affect GDP growth in 2021, which we have revised downward to 2.7 per cent (from 4.2 per cent in Nordic Outlook, September 2020) after a GDP decline of 3.1 per cent this year (-3.8 per cent). Dismantling of restriction and further stimulus measures in 2021 will breathe new energy into the recovery during the second half of 2021. We expect GDP to grow by 4.4 per cent in 2022. GDP will nevertheless be 1-2 per cent below trend by the end of 2022. Residential construction will prop up total capital spending, and we expect home prices to remain flat or move slightly higher during both 2021 and 2022. Unemployment will increase this winter by 0.5 percentage points, peaking next spring at 9.7 per cent and then falling to 7.6 per cent at the end of 2022.Overall, households can count on a rapid rise in purchasing power in 2021 and 2022, mainly due to low inflation and yearly wage and salary growth of about 2.5 per cent, but also higher stock dividends.

Government will expand 2021 stimulus and Riksbank will raise QE limit

So far during 2020, fiscal stimulus has been utilised at less than the budgeted amount. This opens the way for further crisis and recovery programmes. The Social Democratic/Green minority government and the other two signatories of the "January Agreement” – the Centre and Liberal parties – are expected to expand the 2021 stimulus budget (today just over SEK 105 billion) by an additional SEK 50-70 billion. The budget for 2022, an election year, is also likely to include new unfinanced reforms. General government debt will climb from 35 per cent at the end of 2019 to 40 per cent at the end of 2022, which is still a low debt level. Sweden’s expansionary fiscal policy is reasonable and carefully considered, in light of low resource utilisation and the problems now facing the economy.

The Riksbank is under great pressure to deliver new actions. CPIF inflation (the consumer price index excluding interest rate change) will be 1.1 per cent in 2021 and 1.4 per cent in 2022, compared to 0.4 per cent this year. We believe that the Riksbank will expand its stimulative securities purchases by SEK 100 billion to SEK 600 billion but that the central bank will abstain from going back to negative key interest rates, since the disadvantages (such as a weak krona, pressure on the retail sector and an increased risk of negative interest rates on bank deposit accounts) outweigh the advantages. At the end of 2021, a euro will be worth SEK 9.85 and a US Dollar will be worth SEK 7.90. At the end of 2022, the EUR/SEK exchange rate will be 9.70 and the USD/SEK rate will be 7.60. 

This Nordic Outlook report includes five theme articles. One discusses the medium- and long-term consequences of the processes that will now shift production resources from shrinking to growing economic sectors. Another describes the potential impact of increased remote work on the global labour market. Other theme articles analyse the key role of the US dollar in the global foreign exchange market and the varying ability of emerging market countries to deal with the pandemic. Finally there is a theme article about the interactions between the Riksbank and Sweden’s employer associations and labour unions, in light of this year’s new collective wage and salary agreements.

Key figures: International & Swedish economy (figures in brackets are from the September 2020 issue of Nordic Outlook)    

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Attachment

• Nordic Outlook, November 2020