Nordic Outlook: A Difficult Balancing Act For The Swedish Economy

Last year’s aggressive policy reversal by central banks is slowing the recovery and increasingly appears to be the main downside risk to growth. We are revising our global GDP growth forecast slightly higher in 2022 and 2023, to 3.3 and 2.5 per cent, respectively, while lowering our 2024 forecast to 3.3 per cent. We are also revising our 2023 forecast for Swedish growth upward, but the 1.2 per cent GDP decline we foresee will still be clearly larger than the European Union average. Looser fiscal policy may soften this downturn, but high inflation will lead to a difficult balancing act. The Riksbank will hike its key interest rate to 3.0 per cent in February and will not begin its rate cuts until 2024. The Swedish krona is being weighed down in the short term by concerns about the housing market and tough signals from the European Central Bank, but by the end of 2024 it will be back at levels slightly above SEK 10 per euro.

“Monetary policy tightening has an impact after a time lag, which creates a risk that central banks will underestimate the interest rate sensitivity of the economy. In the US, the Federal Reserve has hiked its key interest rate at the fastest pace since the early 1980s. High public debt in weak southern European economies and highly leveraged households in Sweden and Norway are especially vulnerable, but growth prospects appear more balanced now that the inflation and energy outlook has improved,” says SEB’s Chief Economist Jens Magnusson.

Last year’s resilience has reduced the likelihood of a deep crisis
GDP growth in 2022 appears to have been stronger than expected in most countries. Savings buffers from the COVID-19 pandemic and the desire of households to return to a normal life provided support to private consumption. Businesses benefited from an easing of disruptions in global supply chains, as well as from continued relatively healthy demand. A recent decline in energy prices also reduced cost pressures. The delay in the downturn has contributed to some upward adjustments in our full-year 2023 GDP growth forecasts for both the US and Western Europe, while we have revised China’s GDP growth forecast upward after the lifting of COVID-19 restrictions.

“Resilience during 2022 helped us avoid a situation where the economy entered a recession while inflation was on the rise. Such a development might have created a ‘perfect storm’ for central banks to deal with. The time we have now gained has reduced the risks of a deep recession. This has already been reflected in rising share prices,” says Håkan Frisén, Head of Economic Forecasting at SEB.

However, the general increase in central bank hawkishness is delaying an economic rebound – one reason why we have revised our 2024 GDP forecasts downward. Key interest rates are nevertheless close to their peak, and long-term bond yields have already passed their peak.

Looking a bit further ahead, the inflation outlook has improved
The outlook for the energy market over the next couple of years has improved. The risk of an acute energy crisis in Europe has nearly vanished, and the risk of natural gas rationing this winter and next is very small. Yet the global market for fossil fuels is expected to remain tight, which suggests some renewed upturns in natural gas and oil prices. Meanwhile freight prices have tumbled, and agricultural commodity prices have fallen. In the US, the rate of increase in private sector wages and salaries appears to have slowed, although it is still worryingly high. In Europe, especially the Nordic countries, wage responses to inflation suggests that a destructive wage-price spiral is unlikely.

“The risk of a repeat of the 1970s, with persistently high inflation, has diminished. Relatively neutral fiscal policies also suggest that the mistakes of that era, including its excessive ‘fine-tuning’ ambitions, are being avoided. Because of base effects − when large price increases in the spring of 2022 begin to disappear from the 12-month figures − combined with some normalisation of bloated price levels, inflation risks will actually be on the downside at the end of our forecast period,” says Håkan Frisén.

Sweden: GDP decline this year due to lower housing construction and consumption
The Swedish economy showed impressive resilience last year, but GDP is now falling. We have revised our 2023 forecast somewhat higher, but this year’s 1.2 per cent decline will be clearly larger than the EU average. Because Sweden’s recovery will be delayed, we are lowering our 2024 growth forecast to 1.1 per cent. A sharp drop in housing construction and financially squeezed households are the main factors behind this year’s lower GDP, while the downturn in manufacturing will be moderate. We expect home prices to keep falling during the first half of 2023 and are sticking to our forecast that the overall downturn will reach 20 per cent. The decline in home prices, together with a surge in construction costs, will lead residential investments to fall by a total of 30 per cent in 2023 and 2024.

We expect the downturn in real household disposable incomes to be in line with developments in the early 1980s, but far milder than during the crisis of the early 1990s. At that time a collapse in employment was an important driver, while the labour market looks significantly more resilient this time around. Employment will fall during 2023, but we expect the decline to total only a moderate 1.5 per cent. Unemployment will climb from below 7.5 per cent now to 8.5 per cent by end-2023. Despite high inflation, we expect the Swedish national wage round to result in moderate pay increases. We estimate that total wage and salary hikes will end up at 4.5 per cent this year and 3.2 per cent next year, somewhat lower than in the euro area and Germany.

CPIF inflation below target at the end of our forecast period
Swedish inflation has risen to new highs for both CPIF (the consumer price index excluding interest rate changes) and CPIF excluding energy. Due to large base effects, both metrics will probably fall in early 2023. Over the next six months, various factors will keep core inflation up, such as plans for major price hikes in the retail sector and continued rapidly rising producer prices for consumer goods – partly due to a weak Swedish krona – plus administratively set fees and rents. However, the potential for lower inflation further ahead has improved. A slight decline in electricity prices suggests that CPIF inflation will end up below target in 2024. We expect the Riksbank to hike its key interest rate by another 50 basis points to 3.0 per cent in February.

“A gloomy growth outlook, falling home prices, a weak krona and high inflation are a continued dilemma for the Riksbank. Hawkish signals from the ECB and other central banks are putting pressure on the Riksbank to show that it is taking the fight against inflation seriously. But a relatively sharp decline in GDP and a gradually more apparent downturn in inflation suggest that this may be the final rate hike,” says Jens Magnusson.

During 2024 the Riksbank will begin to cut its key rate, which will reach 2.25 per cent by year-end. The bank has completely stopped reinvesting bonds that have matured, which means that its balance sheet is now shrinking rapidly. Riksbank representatives have raised the possibility of actively selling government bonds with long maturities. Such divestments would tighten monetary policy without significantly affecting household mortgage costs, given the short fixed interest periods of these loans. Divestments of Swedish government bonds might also attract foreign buyers and help strengthen the krona. We are forecasting that the Riksbank will begin such sales during the second half of 2023.

Sweden’s fiscal policymakers face a balancing act in terms of the need to soften the impact of the economic downturn without making it more difficult for monetary policymakers to fight inflation. Aside from electricity price subsidies, more targeted support is on the way for those who are under the greatest financial pressure, along with increased central government grants to the local government sector. The next budget will probably include new tax cuts. But we expect the central government budget to be in balance, while public sector debt will continue to fall.

“This is a remarkable feat during an economic downturn and indicates that Swedish fiscal policy is rather cautious at present. The likelihood of more fiscal stimulus measures once the downturn in inflation has come a long way poses an upside risk to our GDP forecast,” says Håkan Frisén.

Key figures: International & Swedish economy (figures in brackets are from Nordic Outlook Update, November 2022)