SEB Nordic Outlook Update: Risks have increased, but global recovery is continuing

The European debt crisis occurred at a sensitive time for the world economy. Governments have largely run out of stimulus ammunition, while the financial system is in fragile condition. Powerful fiscal austerity programmes and financial uncertainty will hamper economic growth. Meanwhile there are global counterforces. The US recovery has reached firmer ground, and expansion in emerging economies is continuing. A weaker currency is also benefiting exports from the euro zone, especially the export-oriented German economy. Due to low inflation, major Western central banks can also hold off on key interest rate hikes.

Our current forecast implies a slight downward adjustment in the growth outlook, but global economic expansion will reach 4½ per cent both this year and next. Partly due to strong government finances, the Nordic countries are well equipped to resist international turbulence. Because of Sweden's continued strong exports, high domestic activity and unexpectedly robust economic performance early in the year, we are raising our forecast of Swedish GDP growth in 2010 from 3.0 to 3.6 per cent. But the risks of weaker economic growth have increased. In our judgement, the probability that the world economy will enter a new recession has increased from about 15 per cent to 25 per cent since our early May forecast.

Despite various steps to avert any further crisis in Europe, many signs of financial uncertainty remain. The risk premium for debt-ridden countries in southern Europe, for example, has again risen. This reflects uncertainty as to whether they actually have the stamina to implement the belt-tightening that is required to stop a runaway increase in government debt. Looking further ahead, the focus will be on institutional changes in the euro system. It remains uncertain whether euro zone member countries are genuinely prepared to coordinate their fiscal policies to the extent that a common currency requires. As a result, fundamental questions about the future and stability of the euro system remain.

The crisis will slow euro zone growth because of larger, accelerated belt-tightening combined with lingering uncertainties. We estimate that the total dose of austerity for the euro zone will be equivalent to about 1 per cent of GDP, but the weakening of the euro will have a stimulative effect via exports. Overall, we expect GDP growth of 1.3 per cent in 2010 and 1.4 per cent in 2011: a downward adjustment of 0.2 and 0.4 percentage points, respectively, from our May forecast.

US growth will be hampered by the crisis in Europe. Historically, however, the American economy has resisted international problems well. The crisis has thoroughly shaken up American stock exchanges several times but has not yet had any decisive impact on the country's cyclical pattern. Our assessment is thus that the US economy will mainly be impacted by the stronger dollar, which will hamper exports. Because of continued stimulus measures, the need for domestic adjustment will be postponed. US GDP growth will end up around 3½ per cent this year.

The Nordic countries have the potential to resist the crisis. Because of strong government finances, their fiscal policies remain relatively expansionary. Denmark and Finland are also benefiting from improved competitiveness due to the weaker euro, but in Finland and Norway, growth has been weaker than expected so far this year, justifying a slight downward adjustment in our GDP forecasts.

In Sweden, however, economic growth is increasingly beginning to stand out in a European perspective. We expect GDP to climb by 3.6 per cent in 2010 and by 2.5 per cent in 2011. Despite the large volume of trade between them, Sweden and the euro zone have often shown rather large divergences in growth rates. Sweden's GDP growth correlation with the US is as high as with the euro zone, despite substantially lower exports to the US. This reflects the dependence of Swedish manufacturers on the global industrial cycle, which is probably the most important driving force behind Sweden's grow

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