Global Recovery Continues Despite Wave of European Debt Crisis, Says SEB
The global recovery will continue, helped by the underlying power of the emerging market economies, low interest rates in the western world and optimistic, profitable companies, according to SEB. Cautious economic policy tightening in emerging market economies will lay the groundwork for a soft landing, while in the OECD countries the recovery has become sufficiently self-sustaining to withstand the challenges created by the disaster in Japan, unrest in the Middle East/North Africa and high prices for energy and other commodities.
Gross domestic product (GDP) growth in the OECD countries will reach 2.4% this year and 3.1% in 2012, a slight downward revision of SEB’s previous forecast for this year, but an upgrading of the growth prospects for 2012. Due to falling commodity prices and low cost pressure, inflation will fall next year despite rising resource utilisation and will reach normal levels in such countries as Germany, Sweden and Norway.
Although the recovery is progressing, it is following the pattern from the aftermath of previous financial crises. The pace of the upturn is relatively slow, and reversals easily occur when the economic and financial immune system is weak. Sovereign debts that are growing above 100% of GDP in the western world imply future risks. Global imbalances are also showing worrisome signs of beginning to grow again, in the shadow of a G20 that appears to be losing its crisis-driven reform momentum under the French chairmanship.
The European debt crisis has changed shape, from acute liquidity crises and rapid emergency responses to a focus on the sustainable payment capacity of countries and the long-term objectives of the European project. The expected third wave of the crisis has thus washed over the eurozone. This is occurring at the same time as economic divergences are widening in the eurozone and the German economy is gaining further ground, with unemployment falling below 5.5%.
However, this does not help Greece, which has now reached a situation where we believe that the level of sovereign debt and the country’s external position will make a debt restructuring in 2012 unavoidable. In SEB’s assessment, Greek sovereign debt will be written down by 50% (slightly less than market value) for the portion held by the private sector and the European Central Bank (ECB), among others. The other eurozone countries will then guarantee new Greek bonds collectively, which means that Europe will have created its own “Brady bonds”.
A new emergency loan to Greece will include recapitalisation funds for Greek banks. After the restructuring, which will also include privatisation of state-owned property, public sector debt in Greece will fall from about 150% of GDP today to 80%. SEB believes that the direct economic impact of Greece’s debt write-down will be manageable and that the restructuring can be managed within the framework of existing emergency mechanisms. Yet there will be major strains and risks, and the political consequences – particularly related to secondary effects on Portugal and Ireland – are difficult to assess. It is increasingly obvious that there is a widening gap between the voters and their representatives about how the eurozone crisis can be resolved in the long term.
SEB is adhering to a relaxed view of inflation. The bank expects inflation to decline around the end of 2011 when the commodity effect fades. Underlying price pressure remains relatively weak. While resource utilisation in Europe is showing large variations, it is still very low in the US. Because of earlier monetary expansion, inflation expectations will be especially important for central banks to monitor. SEB believes these expectations will remain stable, however, allowing central banks to proceed relatively cautiously, normalising their key interest rates step by step.
The ECB will hike its key interest rate two more times this year and four times in 2012; its refinance rate will stand at 1.75% in December 2011 and 2.75% in December 2012. The US Federal Reserve will leave its key rate unchanged until early 2012. When the Fed ends its quantitative easing (QE2) programme in June, SEB does not expect this to have any lasting impact on the interest rate or liquidity situation.
The US economy is benefiting from an improved labour market and expansive capital spending. SEB thus expects the deceleration of early 2011 to be temporary. It also believes that US fiscal policy is in the process of shifting towards a more responsible direction after the increased focus of recent weeks on the sustainability of federal finances. Congress will take advantage of the opportunities created by heightened crisis awareness to produce a plan, supported by legislation, which will slow the increase in federal debt. Failure to do so might have major consequences for the interest rate and foreign exchange markets late in 2011 and next year.
The Swedish economy is decelerating, but from high growth levels. GDP will increase by 4.7% in 2011 and 2.6% in 2012 (3.0% corrected for working days in 2012). The export sector is continuing to show its strength and is coping well with the pressure of a stronger krona. The effects of higher interest rates are beginning to be noticeable in the form of slowdowns in both credit growth and home prices. The expansion in retail sales has also cooled, but SEB believes there will be continued fairly strong growth in consumption over the next couple of years. It expects a decline in registered unemployment to 6% by the end of 2012: a level that is probably somewhat below equilibrium. Available indicators, such as labour shortages and the relationship between unemployment and job vacancies, hardly supports the belief that the equilibrium unemployment level has recently declined clearly.
The gradual recovery of the Baltic economies is continuing. Exports remain a major driving force, while domestic demand is slowly recuperating after the crisis. Growth will be 4-5% annually over the next couple of years, led by Estonia with 5% in 2011. SEB has made a slight downward adjustment in its forecast for Latvia. Inflation impulses have primarily been external, and a severe inflation surge similar to the overheating of 2005-2007 is unlikely. On the whole, Baltic financial imbalances have decreased significantly, but major structural problems in the labour market as well as budget deficits in Latvia and Lithuania pose continued challenges.