SEB Nordic Outlook: Lower interest rates to support the economy
Combating inflation has succeeded, and central banks are ready to take more reassuring steps to lower interest rates. In September, the US central bank Federal Reserve System (FRS) will begin cutting rates by at least 25 basis points as part of its rate-cutting cycle. A similar move is expected from the European Central Bank (ECB). Growth differentials are narrowing, with growth slowing in the USA and China, whereas the eurozone is growing moderately. According to the latest SEB Nordic Outlook forecasts, in the future, growth will be supported by stable labour markets, real wage growth and lower interest rates.
“Looking to the future, it should be acknowledged that the security situation continues to take precedence over all other factors. If security risks increase, growth may slow down and prices rise again. This poses a dilemma for central banks concerning the potentially negative impact on the stock markets. The most important developments shortly will revolve around the US presidential election and its outcome in the autumn,” says Dainis Gašpuitis, the macroeconomist of SEB banka.
Economic processes worldwide continue to be affected by climate change and will continue to do so in the future. For example, this applies to the Panama Canal, which is so important for global trade. Global economic activity and inflation have so far proved quite resilient to these developments. The high levels of national debt in both Europe and the USA will only allow limited room for manoeuvre for reforms or growth-enhancing policies. High government debt and large budget deficits are risk factors for growth and fixed-interest markets. Weak or moderate growth will not provide a solution here, even if lower interest rates will be a growth encouraging factor. In the meantime, many challenges remain: populism in politics, climate change, the energy transition, security policy and the impact of the inflation shock on consumers, to name a few. Balancing will be difficult, but in most cases, fiscal policy will only be neutral or even restrictive.
Price rise stopped, lowering of interest rates expected
Inflation rates continue the downward trend in the US as well as the eurozone, opening up an opportunity for a return to lower interest rates. Excess production capacity in China is also contributing to the falling prices. Meanwhile, employment continues to grow in both the US and the eurozone. The rate of wage growth remains high. Due to lower inflation, real wages will rise and consumption will be encouraged. Sentiment indicators, mainly in Europe, confirm that households are becoming more optimistic. Construction and other capital spending are expected to pick up as soon as interest rates decline.
The FRS will begin the rate-cutting cycle cautiously, with a cut of 25 basis points in September, followed by cuts in November and December. The ECB will review its interest rate again in September, which will be followed by a further cut at the end of the year. In 2025, the ECB and the FRS will continue with six and five interest rate cuts, respectively.
“The curbing of inflation will be achieved without a deep economic recession, even if historical patterns of economic development and other indications point to a possible recession. Every economic cycle has its unique differences. For example, unemployment in the US and the eurozone is rising primarily due to a growing labour supply rather than job losses. A risk factor such as the high level of private sector debt in the USA is not relevant this time. Favourable credit terms, falling interest rates, the prosperity of households and the amount of private debt in terms of GDP, which has fallen since the pandemic, could support future growth,” Dainis Gašpuitis expects.
Global economic growth of about 3%
Global growth of over 3% in the years 2022-2025 will be slightly below the average growth rate before the pandemic. From a historical perspective, such a result can be considered weak. Growth differences between the various regions are narrowing, with the previously resilient US economy slowing down while the eurozone emerges from stagnation. The German economy continues to stagnate, but growth in Southern Europe is driving the region upwards. Meanwhile, China’s downturn is being hampered by weak domestic demand, problems in the property sector and export-orientated policies that are facing growing international resistance. The USA will achieve growth of 2.5% this year, slowing to 1.5% next year. The eurozone economy will grow by 0.8% this year and accelerate to 1.6% in 2025.
Now that the FRS is prepared to cut its key interest rate earlier, other central banks will have to act more freely. Fiscal policymakers have limited room for manoeuvre in many cases. Central banks must therefore take the lead in responding to changes in the economy. Interest rate-sensitive countries such as the Nordic countries will receive a greater positive stimulus in the short term than the USA. If it becomes apparent by early 2025 that growth or inflation has slowed faster or interest rates are higher than necessary to stabilise the economy, central banks can cut interest rates faster or in larger steps. Although inflation is continuing to weaken, it will take a while for the inflation shock to be fully absorbed. The inflation rate in the service sector will remain high for some time. Wage growth in the USA, which reacts relatively quickly to the development of labour demand, is no longer as pronounced and the labour market is also normalising. In Europe, the correlation between the economic situation and wages is lower. We expect lower price volatility, although there are many upside risks. An escalation of the conflict in the Middle East may quickly change energy prices.
Electricity price impact – reserves offset risks
So far, the average oil price has largely corresponded to the average indicator for 2023. Fluctuations have been small and far below the usual level. This is because OPEC+ has been limiting oil production and controlling the price. OPEC+ has considerable production reserves, which reduces the risk of a sharp price increase. This is one of the reasons why oil prices have not reacted excessively to the conflict in the Middle East. The price of crude oil is expected to be slightly above USD 80 per barrel by the end of the year. As production volumes increase, the price could fall next year.
Compared to the oil market, the capacity of gas storage facilities is lower, which means that the uncertainty related to seasonality and conflicts is greater. In Europe, the situation has improved as gas consumption has fallen by 10% and the imports of liquefied natural gas (LNG) are also increasing. Delays in new LNG projects will maintain the tension until 2026-2027. This is longer than we previously estimated and may lead to further volatility depending on weather conditions and supply disruptions. Natural gas prices are expected to be around EUR 35 per megawatt-hour this year. After that, the price will rise slightly before falling to EUR 30 per MWh in 2027.
Stock market normalising after a turbulent phase
The stock market was quite turbulent in the summer of 2024. All-time highs in mid-July were followed by large fluctuations that brought down bond yields and share prices, as well as a weaker US dollar. The VIX volatility index (S&P500) rose to 66, its third all-time high. However, the turbulence subsided in August and the stock markets recovered. These developments are a reminder of how unpredictable the situation can be and how sensitive the financial markets are to economic data.
The economic situation is improving in Sweden and Baltic countries, and more prominent growth expected in 2025
In the first half of the year, the Latvian economy performed poorly. The decline in manufacturing and exports was expected, and this negative trend will continue in the coming months. The recovery in domestic consumption was unimpressive, and the plans to raise EU funds were not implemented. There is reason to believe that consumption will gradually recover and become more convincing in the second half of the year. The strong growth in real wages is continuing and fluctuations in the labour market have been insignificant. This year, the potential stimulus from EU funds will not materialise.
“Given the stagnant growth in the first half of the year, the outlook for this year has become more realistic, and the forecast for economic growth this year has been lowered to 0.8%, which still contains some confidence that it will strengthen in the second half of the year. Next year, growth will be stronger and accelerate to 2.2%. Structural challenges in the largest European economies suggest that growth will be hampered by uncertainty and the impact of a relatively weak external environment,” says Dainis Gašpuitis.
After strong growth at the beginning of the year, growth in the Lithuanian economy will be lower in the second half of the year. Strong growth in real wages will help to support domestic demand and will be an important driver of growth, as growth in manufacturing and exports will be weak. GDP growth will exceed 2.5% p.a. over the next two years. Employment is increasing and inflation has reached its lowest point. The Parliament has already passed tax laws to increase defence spending, but further changes could follow after the parliamentary elections in the autumn.
For the first time since 2021, the Estonian economy is growing again, although modestly. However, the recovery will not be as strong as previously expected, as fiscal policy has been changed significantly. The Estonian economy is expected to shrink by 0.7% this year but grow by 2.5% in 2025. Weak consumption continues to hold back growth, but the labour market is nevertheless stable, and the unemployment rate will fall in the coming years.
After more than two years of stagnation, the Swedish economy has created the conditions for a strong upturn. Lower interest rates and taxes will contribute to faster growth over the next two years. The main driving force will be private household consumption, which will be supported by real wage growth, an expansive fiscal policy and lower interest rates. Last year, growth was unstable and weak overall. After strong GDP growth of 0.7% in the first quarter, the economy contracted in the second quarter. However, sentiment indicators show that the situation is improving and that growth will accelerate in the second half of the year. We expect GDP growth of 0.6% this year and an acceleration of growth to 2.6% in 2025.
