SEB Nordic Outlook: normalisation continues despite increasing difficulties

The forecasting environment has become even more difficult at the turn of the year, with the geopolitical situation becoming particularly tense, central banks under pressure from inflation, and the rapid spread of omicron remaining negative. Although most countries are trying to create restrictions that are gentle on the economy, GDP growth will inevitably slow down in the short term, as it is concluded in the latest global and Baltic economic review of SEB “Nordic Outlook”.

Restrictions slow down demand, while the spread of Covid-19 damages the supply side. Absent employees reduce production capacity and create other problems, such as reduced access to health care. It also intensifies the pressure of inflation, especially in the transport sector.

There are also some positive aspects from the spread of the omicron tsunami. There are clearer signs that its symptoms are milder, but the situation varies from continent to continent. Hopes of greater natural immunity, high levels of vaccination and access to new vaccines and medicines have led health organisations to talk cautiously about ending the pandemic as early as mid-2022. The nature of the omicron wave has also rapidly changed the way the authorities fight Covid-19.

The variant is spreading so fast that morbidity and restrictions are the main factors of the slowdown in economic activity in early 2022. Again, services are hit the hardest. The experience of countries that have been hit by Omicron earlier, such as South Africa and the United Kingdom, shows that the morbidity peak and the subsequent decline are very rapid. The current wave in Europe is likely to culminate in a few weeks' time, although we cannot be 100% sure of this. The economic impact of Covid-19 is expected to diminish. Once the wave is over, we can get into a much more positive situation relatively quickly.

Higher energy prices decreases the purchasing power of households, and the impact of the omicron wave at the beginning of this year has led to a reduction in the 2022 GDP growth forecast for both the global economy and OECD countries to 4.1% and 3.7%, respectively. The eurozone economy is expected to grow by 4% this year and the US by 3.5%.

Financial markets will be more volatile and lack a clear direction this year

High inflation and tighter labour markets quickly forced central banks to change their monetary policy plans. It is now important to achieve a smooth interaction between the increase in key rates and the various quantitative restraint measures in order to avoid undermining the recovery or falling asset prices, which would jeopardise financial stability. Although inflation is likely to slow down by the end of 2022, it is clear that most central banks are now preparing to respond to existing threats of declining purchasing power and rising inflation expectations. Central banks will accelerate the normalisation of policies on both balance sheets and key interest rates. The US Federal Reserve is expected to start raising the base rate in March and then gradually move to 2.00 per cent by the end of 2023. The central banks of the United Kingdom and Norway will also raise rates again. The European Central Bank (ECB) and the Swedish Riksbank will start moving towards more normal base rates at the end of 2023. 

Unemployment is already close to pre-pandemic levels in many places

The US registered an unemployment rate of 3.9% in December, compared to 3.5% at the end of 2019. The situation is complicated by the fact that a historically large proportion of companies face difficulties in attracting employees. This is particularly the case in the euro area, where unemployment has already returned to pre-pandemic levels. Wages in the euro area have not yet responded to the tight labour market, but wage growth has clearly accelerated in the United States and the United Kingdom. Labour market problems are likely to ease as the effects of the pandemic begin to fade, but not everywhere. In the United States, there has been no significant impact on labour supply since the end of federal unemployment benefits and the reopening of schools. It is possible that rising wealth - higher equities prices and house prices - may be one of the reasons why older people who have left the labour market do not return. Wage growth in the United States and the United Kingdom will remain faster than in the euro area and the Nordic countries. In the U.S., pressure on wages will gradually ease as the pandemic recedes. In the Euro area and the Nordic countries, upward pressure on wages could emerge as inflation becomes more sustainable. 

The main risks relate to the inflation shock and related failures in the central bank's exit strategies. If there is a clear wage-price spiral, central banks should act quickly, which could lead to falling stock and house prices. If no such action will be taken, inflation expectations could make inflation even higher. Security tensions between Russia and the West are escalating and need to be taken into account in the risk analysis. Future developments are unpredictable, but experience shows that extraordinary events are needed to affect the long-term performance of the economy.

The needs of withheld consumption, combined with household savings, have a strong growth potential. To some extent, the dramatic omicron wave has helped to foster such a possibility. Strong consumption growth can also create a positive spiral with investments. Investments in productivity improvements are also needed, otherwise the consumption boom will cause obvious overheating problems relatively quickly. 

Delivery problems may reach their peak in the first quarter of 2022

Industrial companies are still suffering from supply-side weaknesses, although there are some signs that they are declining. Delivery costs have fallen slightly but remain historically high. Major ports on the west coast of the United States are now open 24 hours a day, thus reducing jams in the flow of goods. China is also trying to keep its ports open despite virus outbreaks and restrictions. The pressure is expected to ease soon, but the global logistics system is at risk of new failures due to virus disruption. Stock levels around the world are low and important components such as semiconductors are still lacking. Reducing supply costs in the long term requires a shift towards higher service consumption, investment in infrastructure and the digitalisation of the transport sector. 

Fiscal policy will inevitably become tighter in 2022 and 2023

Measures to deal with the effects of the pandemic are being phased out, but at the same time we are seeing various examples of economic recovery. These include both traditional demand stimulation and structural programmes, some of which focus on climate change and digitalisation. The European Union's Next Generation EU programme, which will together account for 5-6 percent of EU GDP. Overall, OECD countries will pursue fiscal austerity equivalent to 2 percent of GDP per year in 2022 and 2023. 

Energy prices remain the main driver of inflation

Energy prices have a growing secondary impact, especially in the US, but their impact may be limited. The momentum of inflation will be strong and permanent, which will also increase long-term risks. The average CPI in the first half of 2022 will be above 6% in the US and around 4% in the euro area. This will affect the purchasing power of households to such an extent that inflation will not only be a problem for central banks. Energy prices will peak and inflation could start to reduce in the spring, declining by the end of 2022. Rising international commodity prices will dampen the fall in the CPI. Some signs at the end of 2021 point to improvements in supply and production problems, but the omicron wave could create new problems and China's Covid-19 policy would increase the risk of recurrent supply disruptions.

Energy prices will be high and volatile, as the transition to global green capacity is a difficult balancing process. Due to the rapid recovery, supply was not flexible enough. In 2021, the price of carbon dioxide emissions increased from EUR 30 to EUR 80 per tonne, and in 2022 the average price is expected to be 100 EUR/t. This will, in fact, be the first time that a level has been reached that will have a real impact on the market, not only to speed up the energy transition but also to put further pressure on prices. Following previous extraordinary changes, the price of coal is three times higher, but natural gas is five times more expensive than usual, and the road to normalisation is long. Although the market is currently showing a decline in energy prices, the average price of natural gas will be 40-60 EUR/MWh, which is two to three times higher than usual. Oil prices will also remain high in the near future, sometimes above USD 90 per barrel (Brent), and could fall to USD 65-70 in the second half of 2022. 

Previously, rising prices encouraged new investments, which improved the balance of the energy market relatively quickly, and prices returned to normal. Currently the transition process is under way and both financiers and fossil fuel producers are cautious. The key is to ensure a balance in energy transition, both through energy efficiency measures and the appropriate development of green energy sources. This especially relates to those countries in the European Union that are completely dependent on imported energy.

In general, the Baltic economies will maintain a good growth rate in 2022. The economy of Latvia will grow by 4.6% this year, Lithuania by 3.6% and Estonia by 3.3%. In all three countries, high inflation will limit household consumption, but rapidly rising wages will provide a further increase in purchasing power. The inflow of EU funds in 2022 will significantly stimulate investment activity, stabilising the impact of external risks. 

The latest SEB World and Baltics economic review “Nordic Outlook”.