12 minute read
A difficult return to (some kind of) normalcy?
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Klas Eklund, Senior Economist, Mannheimer Swartling
After a year of wild gyrations in the wake of the pandemic, the global economy will gradually return to more normal growth. The “new normal” will, however, be different from the prepandemic normal. New virus mutations may come and go, and we will need continuous new vaccine jabs. Supply disruptions will be with us for some time, as will bottlenecks in the labour market. Inflation will be higher than before the pandemic. Central banks will struggle with exit strategies. Property markets will still be supported by low bond yields – but headwinds will increase as the demand pull from the pandemic and ultraloose policies wane. The main risk – both in the Nordics and other developed economies – is that inflation stays high and inflationary expectations rise, which would force central banks to abandon their loose policies and cause strains in asset markets.
All this holds also for the Nordics, who in general will perform better than Europe as a whole. Inflation will fall back after peaking this year and low rates will remain. Here, Norway is the odd one out, with a steeper return to normal interest rates. →
A strong rebound…
After the sharp contraction in 2020, the OECD economies have rebounded during 2021. The upturn has been stronger than anticipated, courtesy of the roll-out of the vaccine. This helped unwind many of the regulations and lock-downs that created economic havoc during the early phases of the pandemic. However, vaccination has been much slower in most emerging markets, meaning their economic recovery is hurting.
Another reason behind the strong recovery has been record-breaking expansionary policy, both monetary and fiscal. During the past year, both real key rates and bond yields have been negative in most countries, liquidity injections have reached new highs, and fiscal deficits have grown. In the US, where the fiscal stimulus was the biggest, personal disposable income rose sharply, despite slumping GDP and rising unemployment. As a result, several Western countries seem poised to reach pre-pandemic GDP levels already by year-end or in early 2022, although the UK and some countries in Southern Europe are still lagging.
Predictably, inflation has risen as a result of base effects (falling prices in 2020 autumn are not repeated in the 12-month statistical series), rising commodity prices, supply bottlenecks and high demand. These effects are stronger in the US than on the European continent, and American inflation has reached 5 per cent. Here, inflation expectations have risen and labour markets may start to tighten enough for wages to have inflationary effects. Although levels are lower in Europe, even in Germany inflation now has reached 3 per cent, and in Sweden 2.5 per cent. Most of this is, however, caused by transitory factors, and inflation will fall back in 2022. Wage inflation is not expected in Europe.
…will gradually cool
Looking ahead, these wild swings – first down, then up – will gradually turn into a more normal pattern. As the strong cyclical and political stimulus will fade, growth will gradually cool. This process has already begun, but the exit strategies will be rather slow as central banks are afraid to tighten prematurely, and as the political climate seems to favour fiscal expansion for some time yet.
Thus, the consensus view is that GDP in the Euro zone, after falling a whooping 7 per cent in 2020, will grow by some 5 per cent in 2021 and 4 per cent in 2022. Inflation will hover just below 2 per cent. The trend is similar in the UK, but inflation is higher and the cyclical swings are even stronger.
All this, of course, presupposes that new dangerous variants of the virus will be contained. This is not assured. It is likely that, after Delta, there will new mutations. New vaccine jabs will probably be needed, and regional restrictions will probably be necessary here and there. Furthermore, lack of containers, semiconductors and other inputs will put a brake on manufacturing and trade. This realization has dented consumer confidence and helped hold down real yields. But the forecasts lean heavily on the assumption that no lasting, general lockdowns will take place.
In China, the situation is aggravated by convulsions in the real estate sector. A macro risk would be if banks are hit by contagion, but the main forecast is that the government will protect them.
Globally, it is likely that mobility and travel will suffer for some time yet. Supply chain disruptions are hurting trade and cause local and sector bouts of price increases. Thus, there will be a whiff of stagflation in the air as the aftermath of the pandemic causes disruption to production as well as some inflation. Digitalization will continue to change the way we communicate, meet, shop and work. The labour market will see lingering negative effects on groups with poor education and lacking core competences.
A difficult exit from loose policy…
For the inflationary shocks to give permanent effects, they would have to cause higher wage increases and higher inflationary expectations. Such risks do exist in the US, but hardly in the Euro-zone or in the Nordic region. As inflation in most countries will fall back again, central banks will only gradually take their foot of the throttle. Among the big economies inflation risks are highest in the US, where labour shortages occur in all sectors and fiscal stimulus has increased real disposable income for households. Thus, the Fed will move first, reducing liquidity injections already this year, but being careful not to cause any “taper tantrum”.
The ECB has missed its inflation target on the downside for a full decade and will keep its key rate below zero at least another year. The huge pile of debt amassed during the pandemic
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could cause a financial crisis if rates are hiked rapidly. Both the Fed and the ECB have also adopted new strategies, according to which an overshoot of the old inflation targets can be accepted after many years of undershooting. The Fed and the US Treasury explicitly state they are aiming at more than full employment; a red-hot labour market to radically increase labour participation and reduce poverty.
With rates that low, budget deficits will not be regarded as dangerous. Also, political priorities are changing in the wake of the pandemic. Inequality is seen as more of a problem than before, and most governments will spend more to fight it. Vast programs for education, social insurance, infrastructure and against climate change will keep expenditure high in most countries all of 2022.
Jittery financial markets
The ultra-loose monetary policy has supported financial markets throughout the pandemic. Real bond yields have been extremely low – and fell further during summer as worries regarding the Delta variant hit the market. Equity markets have boomed, as well as property markets. Looking ahead, monetary support will still be there, but it will slowly weaken. Bond yields will still be historically low, but the trend will nonetheless point upwards. Also, after many strong years, stock valuations are historically high. It is not unreasonable to believe that we will see some profit-taking and cooler equity markets. The market will understandably be nervous and we are bound to see some volatility.
Property markets have set records in many countries, both with regard to prices and transaction volumes. The pandemic has triggered increasing demand for larger apartments and renovation of houses, in order to accommodate work from home. Also here, it is reasonable to see a →
somewhat slower development ahead as yields have dropped substantially already and the pandemic’s effects gradually wane.
Nonetheless, there will still be a lot of money chasing rewards and looking for investments. Investors will look for alternatives to stock markets. With only a slow rise of bond yields ahead, it is difficult to see any market-induced property crisis ahead. However, should inflation for some reason stay elevated longer than anticipated, there is a risk that central banks will rethink and that rates move up more rapidly. This would rock all financial markets, including property.
The Nordics and Baltics
The Baltic countries – Estonia, Latvia and Lithuania – have all recovered swiftly. The recession last year was milder than in the Euro zone as a whole, in particular in Lithuania. The rebound this year has been exceptionally strong in Estonia, but all three countries are back to their pre-pandemic GDP levels already. In all countries, the recovery has been broad-based, as well as helped by a massive inflow of EU funds.
Inflation will be slightly higher than in the Euro zone average, in particular in Lithuania, because of labour shortages and bottlenecks. But since all three countries have adopted the euro, key rates are set by the ECB, which means that real rates will be clearly negative.
In all the three Baltic states, property markets are been strong, courtesy of the factors mentioned above. Transaction volumes have been high and prices have risen.
The Nordics – Finland, Denmark, Norway and Sweden – have also fared better than the Euro zone. All the Nordic countries will have surpassed pre-pandemic GDP levels by year-end. Growth has been broad-based, and labour markets are improving. Here, monetary policy will move in different ways since the Nordic countries have different monetary regimes: Finland has adopted the euro, Denmark has a fixed exchange rate to the euro, Sweden has a floating exchange rate despite having no formal opt-out from the euro, and Norway is not an EU member at all.
Sweden Sweden is set for the fastest growth among the Nordics during 2021, and will still grow stronger than usual in 2022. Growth has been broad-based, with manufacturing leading the way but services are now catching up. A high household savings ratio enables increasing consumption.
Unemployment is falling, but from a high level, and wage increases remain subdued. Inflation follows the common pattern with a sharp rebound this year – but probably falling back next year. The Riksbank will gradually slow the pace of liquidity injections, but its repo rate will be held at zero all through 2022. Fiscal policy will remain expansionary, courtesy of low public debt and 2022 being an election year.
The property market has been strong, but both the Financial Supervisory Authority and the Riksbank have expressed concern that household debt is getting dangerously high. The FSA has consequently announced that compulsory amortization of mortgage loans (temporarily abandoned during the pandemic) will be re-introduced this autumn.
Denmark Denmark re-opened in the spring and has seen good growth since then. Already in the second quarter, GDP
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surpassed its pre-crisis level. As in Sweden, both manufacturing and services have rebounded, and looking ahead consumption will be bolstered by pent-up demand.
The labour market has recovered faster than anticipated and is approaching pre-pandemic levels. Labour shortages are clearly visible, and wage pressure is returning to some sectors, such as construction. Still, the consensus view is that inflation will remain low. Since the Danish krone is fixed to the euro, the central bank will continue to shadow the ECB. Recently the krona has been strong, which may open up for the central bank to actually make a small, symbolic cut of the policy rate.
The property market was booming during spring, with transactions growing and foreign capital flowing in. The residential market is strong, but it is reasonable to expect housing to cool somewhat next year. Supply of homes for sale has been limited, but residential construction is picking up speed. A tightening of amortization requirements has been discussed, but no changes have been announced.
Finland The recovery in Finland has been uneven this year, but picked up during summer. The positive cyclical forces have been strong, with household consumption from pent-up demand the driving force. Investments are also picking up speed. However, Finland has some structural ailments, with weak productivity growth and a shrinking working-age population. These underlying structural problems will remain, which means that growth will slow down again in 2023. Unemployment has stayed stubbornly high. Inflation will stay below the ECB target, and since Finland is part of the Euro zone, the ECB’s negative key rate will persist also in Finland. Public debt is clearly higher than in the other Nordic countries, and will continue to rise. Yield spreads will remain narrow, though.
The housing market has been strong, and the number of housing starts has been historically high this year. Liquidity has returned and the transaction volume rose sharply during summer. Foreign investors have shown increasing interest in the Finnish property market.
Norway The commodity-dependent Norwegian economy was hit by a double whammy last year – the pandemic and crashing oil process. Both these negative factors reversed this year as the economy is opening up and fossil fuels have made a recovery. GDP has surpassed the pre-pandemic level.
The recovery is broad-based, with both manufacturing and services contributing. Unemployment is falling. Inflation remains low. But while the other Nordic and Baltic central banks will stay put and/or follow the ECB, Norway’s is ready to hike. Norway has no obligation to shadow the ECB, since it is outside the EU with an independent central bank, its own currency and a flexible exchange rate.
One reason for tightening is the hot housing market. Norway has a history of over-heating property markets, and the central bank wants to act in a precautionary manner. During spring and summer the real estate market was boosted by new capital, also from foreign investors, and transaction volumes will set a new record this year. The housing market is expected to cool somewhat, but the central bank is still determined to hike.
Parliamentary elections have ushered in a change of government. A left turn can be expected, but the new labour-led coalition is not expected to undertake any policy changes which will impact the property market in any significant way. An important, yet undecided, issue is how the sovereign wealth fund should be used and if it will be politically affected.
Summing up
After the gyrations of recent years, the Nordic and Baltic economies are set to return to some kind of normalcy. The hectic pace of the rebound will slacken, but growth will still be decent. Unemployment is coming down, but inflation risks seem small. In all countries – bar Norway – key rates will stay where they are.
The underlying financial forces supporting property markets will therefore mainly remain in place. Transactions have reached or surpassed record levels all over the region, and prices have risen sharply. However, it’s not likely that property markets will stay quite as hot in 2022. Bond yields will rise, albeit slowly. The exceptional stimulus caused by pandemic relief will gradually shrink. Further, regulators are worried about debt levels.
Property markets, too, will see a return to some kind of normalcy after the hysterical pandemic episode.
