Wednesday, December 15, 2010

The ECB Outlook 2011 : A challenging year (Sweden , Norway )

Sweden – Rates will be gradually normalized 

The Swedish Riksbank left rates on hold for much longer than neighboring Norway, but has
started to normalize the key rate and should gradually continue to do so, as 2010 has
witnessed a very strong rebound in economic activity.
Sweden experienced a very harsh recession in 2009. GDP declined by 5.1%, compared to -
4.7% in Germany and -2.4% in the US. Even more so than in Germany, the recovery in
Sweden is proving increasingly dynamic and  GDP is set to expand by 5.2% in 2010
(following a much stronger-than-expected 2.1% qoq expansion in 3Q10) and by  3 ½ % in
2011. Until 2Q10, Swedish GDP was driven mainly by net exports (also due to the strong
linkage with the German economy), but fixed investments grew strongly in 2Q and 3Q, with
private consumption also staging a strong recovery in 3Q.  Private consumption growth
jumped by 1.4% qoq in 3Q, also flanked by the positive wealth effect stemming from the
Swedish housing market, where house price inflation is now running at close to 5% yoy.

Winter 2009-10 saw a housing market boom, with growth rates exceeding 10%, helped by the
fact that interest rates were left at 0.25% for a prolonged period of time (from July 2009 to July
2010), resulting in extremely low mortgage costs for Swedish households. With about 80% of
Swedish housing loans being variable rate, monetary policy pass-through to the real economy
is quite fast. In the meantime, the policy rate was hiked by 75bp to 1% in November. This has
probably contributed to preventing a house price bubble from emerging. An additional factor
stabilizing private consumption is the decline in unemployment from 9.3% in January to 7.5%
in October. Consequently, consumer confidence has gradually improved during the year, with
retail sales growth accelerating to 2% qoq from below 1% in spring.

Developments in  industrial production were very healthy, with production expanding by
8.6% yoy in the first ten months of 2010. Although industrial activity may have peaked
already, its rebound following the 2008/09 recession should remain robust. This view is
corroborated by the Swedish PMI, which although easing a bit during the last months,
remained at elevated levels above 60 in November, and by the fact that the OECD Leading
Indicator for economic activity in Sweden is still rising.

Inflation in Sweden is still clearly below the 2% inflation target of  the Riksbank, but has
increased from roughly 1% yoy between April and August to 1.8% in November. While the
November inflation surge may be mainly due to a very unfavorable base effect, we expect
inflation to gradually approach the 2% target during 2011.

While the real economy is going from strength to strength, financial market developments
have given the Riksbank more reason to worry and have contributed to the decision to lower
the forecast rate path by 40bp for 2011 and 2012. While the external environment in
Europe has clearly worsened, as highlighted by rising spread levels in the EMU periphery,
tensions in the Swedish money market, where 3M interbank rates now show a 75bp spread
over the policy rate, have led to more restraint on the monetary front, too. Still, the Riksbank
hiked the key rate to 1.25% at the December 15 meeting. We expect the Riksbank to go
further ahead with its gradual approach during 2011, bringing the key repo rate
eventually to 2.25% by the end of 2011.

Norway – Rates on hold until 2Q11 at least

In the near term, the Norwegian central bank should remain rather conservative regarding the
interest rate outlook. Inflation expectations are well-behaved, although the economic recovery
is gaining momentum. We do not expect the Norges Bank to raise rates before 2Q.
The Norwegian central bank remains very cautious on the rate outlook. While having been the
first European central bank to have raised rates following the credit crunch, total tightening in
this rate cycle now amounts to only 75bp, and the key depo rate was left unchanged at 2%
during the last four policy-setting meetings.

In the meanwhile, the growth picture has considerably brightened.  Mainland GDP
(excluding highly volatile off-shore activities such as oil and shipping) declined only by a
relatively mild 1.2% in 2009, and while the recovery proved quite anemic at the beginning of
2010, the economy now has expanded by 0.9% qoq in 3Q10, and probably by close to 1% in
4Q10. This implies that Mainland GDP should have grown by 2% in 2010 as a whole,
before accelerating to 3% in 2011.

The increasing caution the Norwegian central bank applies on the rate front has to be seen
mainly against the backdrop of  firmly anchored inflation expectations. Headline inflation
has come down from 3% yoy at the beginning of 2010 to just below 2% during recent months,
and core consumer price rises have gradually trended downwards from clearly above 2% to
just 1% in the same period. This means that both inflation measures currently remain way
below the 2.5% Norges Bank inflation target. The absence of inflationary pressures is partly
due to still subdued private consumption, although unemployment has fallen back below
3% in autumn and, therefore, should help private consumption to increasingly take the helm of
the recovery of the economy. Private consumption declined in 2Q10, following four positive
quarters, as fiscal stimulus was gradually phased out, but managed to recover in 3Q10. Now,
private consumption should increasingly contribute to the acceleration in activity, as quarterly
retail sales growth accelerated from a -0.1% decline in 2Q10 to a 1.4% expansion in 3Q10. In
the meantime, industrial activity in the manufacturing sector, which had been up by 2.8% yoy
during the first ten months of the year, is seen accelerating further, helping fixed investments
to recover somewhat. While growth rates of industrial activity seem to have peaked in
Sweden, Norwegian manufacturing production should gain further pace during the next
quarters, with the OECD leading indicator for Norway pointing to a further pick-up in overall
economic activity. The Norwegian PMI has been gradually rising from its below 50 level in
August, also suggesting that business sentiment is on the mend.

Although the growth momentum of the economy now seems to have become more robust,
and the recovery looks increasingly self-sustained, the Norges Bank has lowered its 2011
year-end forecast for the key rate to 2.45%  in its latest monetary policy report. However, we
remain slightly more optimistic on the rate outlook. While the key rate will remain on hold
at 2% at the December 15 meeting, and the decline in inflationary pressures and the current
jitters in sovereign debt markets will delay the next rate hike probably at least to 2Q11, the
key rate might still be brought to 2.75% towards the end of 2011.
Full report: The ECB Outlook 2011 :  A challenging year (Sweden , Norway )

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