14 December 2005
REVIEW OF BUSINESS CONDITIONS
According to Tapiola Bank’s latest Review of Business Conditions, the economic outlook for Finland is good.
- The Finnish economy grows by 3 percent on average, the inflation remains slow and the unemployment rate will go below 8 percent. The growth is still depending on private consumption, estimates Tapiola’s Senior Economist Jari Järvinen. The long-term outlook for the Finnish economy is significantly weaker than the short-term outlook which requires immediate attention of the decision makers.
The increase of prices on the housing market is about to calm down, at least momentarily.
- Home buyers evaluate different alternatives more thoroughly than before. An increase of interest rates will not significantly raise monthly instalments for long mortgages, but the psychological effect on the prices might be more definite.
The Finnish economy can take higher interest rates than the current, and precaution on the housing market is good in the present situation.
- However, there is a risk that the increased precaution will slow down consumption and investments, Järvinen points out.
The global economic growth will slacken further and even out between continents.
- The ECB will continue to increase the interest rates which may even cause risks. In fact, the interest rate curve has already changed. The history has proven that the initial raise of interest rates will be followed by a second and third. In case the consumers overreact to the situation, slight changes in the interest rate levels might cause bigger changes in consumer behaviour. In the worst case, the change of policy will weaken both external and internal demand.
According to Järvinen the ECB could have waited for a couple of months.
– The recovery of the bigger economies in the euro area is still somewhat fragile, and inflation is not a problem. Excluding the increased energy prices, the inflation is still to decrease. However, the new German government’s plans to balance public economy by increasing taxes are not suitable for the current economic situation.
Tapiola's Review of Business Conditions 4/2005, Forecast Period 2006-2007
• The global economic growth accelerated slightly during the third quaternary period of the year. The overall growth 2005 is slower than the previous year. The peak of the economic cycle was reached in spring 2004, and after that the growth has constantly descended. During the forecast period the growth will decelerate from this year and due to that the global economy is starting to move from boom to a normal economic situation. The outlook has weakened due to the continuous high oil price and stricter monetary policy in the US and euro area. The real price of an oil barrel is still on the level of the first oil crises.
• The growth is also evening out between continents: In US and China the growth is slackening whereas in the euro area and Japan it is accelerating. A surprisingly heavy decrease in the US economic growth would easily abolish any positive surprises in the euro area and in Japan. Regarding the US current account deficit a slower but stabile growth in the continents is easier to maintain and therefore desirable.
• The hurricanes affected the US economy less than expected. The growth might even accelerate next year due to the rebuilding. In Japan the growth has increased as the focus has shifted from export to domestic consumption and investments. However, the new German government’s plans to balance public economy by increasing taxes are not suitable for the current economic situation.
• The economic outlook for Finland is good: The economy grows by 3 percent on average, the inflation remains slow and the unemployment rate will go below 8 percent. The growth is still depending on private consumption, but export will also increase due to the accelerated growth in the euro area and weaker euro. The growth of investments will remain modest.
• The FED’s cycle of raising interest rates is about to end. The increased short-term interest rates and stronger dollar have tightened the monetary conditions. The effects are already visible on the housing market. An increase of long-term interest rates would calm down the situation, but so far the increase of long-term interest rates has been insignificant.
• The ECB continues to increase the interest rates gradually towards a neutral level. The ECB could have waited for a couple of months and follow the development of economies and inflation estimates. The recovery of the bigger economies in the euro area is still somewhat fragile, and inflation is not a problem. Excluding the increased energy prices, the inflation is still to decrease. At worst, the change of policy will weaken both external demand (stronger euro) and internal demand (weaker consumption and investments). An expensive euro, slow growth, ineffective use of resources and cheaper oil price would have made it possible to continue on the previous interest rate level. The long-term interests in the euro area will remain low.
• The psychological effects of the increased interest rates are not be underestimated. Even though the change was minor and the interest rates remain low, the interest rate curve has already changed. The history has proven that the initial raise of interest rates will be followed by a second and third. The consumers have already noticed this series of interest rate raises, even though it would not immediately affect the market interest rates. Herein lies a risk: In case the consumers overreact to the situation, slight changes in the interest rate levels might cause bigger changes in consumer behaviour. In that case, it is not just a question of a raise of interest rates by 0.25 percentage units performed by the ECB.
• The Finnish economy can take higher interest rates than the current, and precaution on the housing market is good in the present situation. However, there is a risk that increasing precaution will slow down consumption and investments which will strengthen the euro. This might have significant effects on the real economy.
• The dollar continues to weaken in relation to the other major currencies, but probably not linearly. The stronger dollar in the beginning of the year can be mainly explained by the interest rate differences between the FED and the ECB. Along with a smaller interest rate difference the dollar might start to weaken in relation to the euro. In the long run, an adjustment of the current account deficit requires a weaker dollar.
• Home buyers evaluate different alternatives more thoroughly than before. The increase of prices on the housing market is about to calm down, at least momentarily. An increase of interest rates will not significantly raise monthly instalments for long mortgages, but the psychological effect on the prices might be more definite. The outlook for the entire real-estate market is positive. Ineffective use of premises will decrease especially on the office space market, which will become evident as a moderate increase of the rental rates.
• By Finnish perspective, the greatest risk relates to a surprising slackening of the global economic growth and mistakes in the monetary policy on the continents. At worst, these external risks combined could result in a major decrease in the Finnish economy.
• The long-term outlook for the Finnish economy is significantly weaker than the short-term outlook. Measures regarding ageing, long-term unemployment, Asian competition and the high income tax must be taken now and not later on.
• For debtors and savers the increased interest rates mean more expensive loans, but also better deposit rates. Despite the fact that the interest rates have started to increase, they will remain historically low during the next couple of years. A significant increase of interest rates would require measures which at moment are not on the horizon.
• For employees and entrepreneurs the uncertain growth and increased interest rates may decrease consumption and postpone investment decisions.
The complete review is available under the address www.tapiola.fi/suhdannekatsaus (in Finnish).
Tapiola will publish the next Review of Business Conditions in March 2006.
Further information
Review of Business Conditions:
Jari Järvinen, Senior Economist, Tapiola Group
Tel. +358 9 453 2049, forename.surname@tapiola.fi
Housing Market:
Vesa Immonen, Assistant Manager, Tapiola Group
Tel. +358 9 453 3412, forename.surname@tapiola.fi