Economics Group Special Commentary Executive Summary Economic activity in Sweden has accelerated in recent quarters, and the country s nearly 4 percent year-over-year growth pace in Q3 was among the strongest in the developed world. Yet, despite robust growth over the past year or so, inflation is well below the Riksbank s (Sweden s central bank) 2 percent target. Most forecasters expect continued modest growth in Swedish real GDP, but few expect CPI inflation to return to target any time soon. As a result, the Riksbank is likely to maintain an accommodative policy stance for quite some time. Meanwhile, risks continue to develop in Swedish households balance sheets. In particular, explosive growth in home prices over the past two decades has caused the household debt-to-gdp ratio to shoot up. 1 Although the Riksbank is not likely to hike rates anytime soon, the flexible nature of Swedish mortgage rates means that the debt servicing costs of Swedish households will move higher when the inevitable tightening of monetary policy eventually arrives. Consumers may very well retrench if the central bank tightens policy too abruptly. Swedish GDP Surged in Q3 Data released today showed that real GDP in Sweden grew well ahead of analysts expectations in the third quarter. Real GDP grew 0.8 percent on a sequential basis in Q3 (3.4 percent at an annualized rate), double the 0.4 percent consensus forecast (Figure 1). On a year-over-year basis, real GDP rose 3.9 percent, the strongest year-ago growth pace since 2011. As we have observed in recent quarters, growth was underpinned by sturdy domestic demand (Figure 2). In particular, household consumption grew 0.7 percent from the previous quarter, while fixed investment spending rose 1.2 percent. Collectively, these two components contributed 0.6 percentage points to the 0.8 percent sequential growth rate in real GDP. Figure 1 Figure 2 1 1 Swedish Real GDP Bars = Compound Annual Rate Line = Yr/Yr % Change Compound Annual Growth: Q3 @ 3. Year-over-Year Percent Change: Q3 @ 3.9% 1 1 Contributions to Swedish GDP Growth Percentage Point Contribution to Year-over-Year Rate Domestic Demand: Q3 @ 3. Net Exports: Q3 @ 0. GDP: Q3 @ 3.9% Jay H. Bryson, Global Economist jay.bryson@wellsfargo.com (704) 410-3274 Erik Nelson, Economic Analyst erik.f.nelson@wellsfargo.com (704) 410-3267 How Long Can Strong Growth Last in Sweden? Growth continues to be underpinned by strength in domestic demand. - - - - -1-1 - - -1-1 - 2000 2002 2004 2006 2008 2010 2012 2014 2011 2012 2013 2014 2015 Source: IHS Global Insight and Wells Fargo Securities, LLC - 1 House prices fell by 3 percent from 2007-2009 and 4 percent from 2011-2012, but have more than trebled on balance since 1996. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.
Sweden s output gap is keeping inflation low. Activity in Sweden s external sector was also strong in the third quarter, as real exports rose 5.7 percent from a year earlier and edged out the 5.2 percent growth in imports. Net exports have added modestly to overall GDP growth in the past two quarters, likely boosted by the past depreciation of the krona, which is down nearly 10 percent on a trade-weighted basis from early 2014. On balance, today s report points to broad-based strength in Swedish economic growth fundamentals. As discussed in more detail below, the consensus forecast looks for continued modest GDP growth in Sweden over the next two years. No Inflation = Accommodative Monetary Policy Despite strong real GDP growth over the past year or so, CPI inflation in Sweden is essentially non-existent at present (Figure 3). Even though last year s collapse in oil prices is helping to temporarily depress the overall CPI inflation rate, measures of underlying inflation suggest that there are few price pressures in the Swedish economy at present. The Swedish economy still appears to be suffering from the hangovers of past financial crises, recent strong GDP growth notwithstanding. Real GDP in Sweden plunged more than 7 percent during the global financial crisis. After bouncing in 2010 the Swedish economy subsequently stalled in 2011 and 2012 as the Eurozone, to which Sweden sends 40 percent of its exports, slid back into recession during the European sovereign debt crisis. Consequently, an output gap in Sweden opened up in 2008-09 that has yet to close. That is, the Great Recession caused the level of real GDP in Sweden to fall below potential output (i.e., the amount of GDP that could be produced if all resources in the economy were fully employed), and actual output remains below potential output today. 2 As shown in Figure 4, the unemployment rate in Sweden remains elevated, which is indicative of an output gap. High unemployment has kept overall wage growth and CPI inflation in Sweden in check. Figure 3 Figure 4 Swedish Consumer Price Index Year-over-Year Percent Change 1 1 Swedish Unemployment Rate Seasonally Adjusted 12-Month Moving Average: Oct @ 7. Unemployment Rate: Oct @ 7. 1 1 9% 9% 7% 7% - - Overall CPI: Oct @ 0. - 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014-1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: IHS Global Insight and Wells Fargo Securities, LLC The Riksbank is likely to remain accommodative for quite some time. Price stability is the objective of the Swedish Riksbank, which policymakers interpret as a CPI inflation rate around 2 percent. With inflation so far below target at present, the Riksbank has adopted a policy stance of unprecedented monetary accommodation. The Riksbank took its main policy rate, the repo rate, into negative territory last February, and it has subsequently cut it even further. Today, the policy rate stands at -0.35 percent. In addition, the Riksbank has undertaken a program of quantitative easing (QE) whereby it envisions purchasing SEK 200 billion (about $23 billion) worth of government bonds by June 2016. Moreover, the Riksbank has publicly expressed its willingness to ease policy further, if necessary, in order to ensure that inflation eventually returns to the 2 percent target. Most forecasters anticipate that the central bank will keep its main policy rate in negative territory through the end of next year. 2 The Organisation for Economic Cooperation and Development (OECD) estimates that the output gap in Sweden currently is roughly 1.5 percent of potential output. 2
Challenges Ahead for the Swedish Economy We do not explicitly forecast economic growth in Sweden, but the consensus forecast expects that real GDP will grow between 2.5 percent and 2.8 percent per annum over the next two years. Although these growth rates, if realized, would be stronger than the annual average growth rates that were posted between 2011 and 2014, they would fall short of the growth rates that the Swedish economy was able to achieve in the years immediately preceding the global financial crisis. 3 There may be a few headwinds on Swedish GDP growth in coming years. Like most other European countries, the Swedish economy is very open to trade. Indeed, final spending in foreign economies accounts for one-third of value added (i.e., wages and salaries and profits) in the Swedish economy. As noted above, about 40 percent of the country s exports are destined for the euro area with another 20 percent headed for developing countries. Therefore, slow growth in the Eurozone and economic deceleration in the developing world likely will exert some headwinds on the Swedish economy over the next few years. The Swedish economy is very open to trade. Figure 5 Figure 6 2.00 Sweden Debt Indicators HH Debt to Disposable Income; Home Price Index, Q1 1996 = 100 400 1 Swedish Household Debt Service Ratio Interest Payments as a Percent of Disposable Income 1 1.75 350 1 1 1.50 300 1 1 1.25 250 1.00 200 0.75 150 0.50 100 0.25 Household Debt to Disposable Income: Q2 @ 1.81 (Left Axis) Home Price Index: Q2 @ 353.8 (Right Axis) 0.00 96 98 00 02 04 06 08 10 12 14 50 0 Debt Service Ratio: Q1 @ 10.9% 99 01 03 05 07 09 11 13 15 Source: IHS Global Insight, Bank for International Settlements and Wells Fargo Securities, LLC Of more concern is the rise in household debt in recent years. As shown in Figure 5, the household debt-to-disposable income ratio has risen from less than 80 percent about 20 years ago to 180 percent today. This increase in the household debt ratio has gone hand in hand with Swedish house prices that more than trebled over the same period. Rising house prices obviously necessitate larger mortgages. Although household debt has mushroomed, the marked decline in interest rates in recent years has restrained the overall rise in the debt service ratio (Figure 6). Due to the lack of inflationary pressure in Sweden, the Riksbank is not likely to hike rates anytime soon. However, once rates begin to rise, the debt-servicing cost for the Swedish household sector could begin to shoot up. One half of Swedish mortgages at present are variable rate, and more than 90 percent of the mortgages reset within 5 years. 4 Higher debt servicing costs would, everything else equal, weigh on consumer purchases of discretionary items. Therefore, when the Riksbank actually begins to hike rates, which likely will not be anytime soon, it is likely to tighten policy at a gradual pace. If the central bank were to hike rates too fast, consumers could start to retrench as debt-servicing costs rise. With the U.S. Federal Reserve likely to hike rates soon and with the Riksbank unlikely to tighten policy for the foreseeable future, we look for the Swedish krona to depreciate modestly vis-à-vis the U.S. dollar in 2016. Once rates begin to rise, higher debt servicing costs will weigh on consumption. 3 The Swedish economy grew at an annual average rate of 3.5 percent between 2003 and 2007. Between 2011 and 2014, real GDP growth in Sweden averaged only 1.5 percent per annum. 4 Ulf Holmberg, Hannes Janzén, Louise Oscarius, Peter van Santen and Erik Spector, An Analysis of the Fixation Period for Swedish Mortgages, Sveriges Riksbank Economic Commentaries, 7 June 2015 3
Conclusion Real GDP in Sweden, which grew 3.4 percent at an annualized rate in Q3 2015, was boosted by further strengthening in overall domestic demand. Yet, despite solid economic growth over the past year or so, there are few inflationary pressures in Sweden at present. Moreover, most forecasters do not expect the overall CPI inflation rate to return to the central bank s target of 2 percent before 2017. Consequently, the Riksbank is likely to maintain an accommodative policy stance for the foreseeable future, which should put some downward pressure on the value of the Swedish krona vis-à-vis the U.S. dollar in 2016. As noted above, most forecasters look for modest economic growth in Sweden through 2017. However, the seeds of the economy s next recession may have already been sown. That is, the sharp rise in house prices over the past two decades has caused the household debt-to-gdp ratio to rise to dizzying heights. Although the Riksbank is not likely to hike rates anytime soon, the flexible nature of Swedish mortgage rates means that the debt servicing costs of Swedish households will move higher when the inevitable tightening of monetary policy eventually arrives. Consumer expenditures could go into reverse if the central bank tightens policy too abruptly. 4
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