12 Dec. 2007
REVIEW OF BUSINESS CONDITIONS
ECB forced to Cut Interest Rates
The Finnish Economic Growth is slackening. Tapiola Bank has slightly lowered the economic growth forecast for the next year. The Finnish economy will grow 2.3 percent next year, and the inflation is estimated to accelerate significantly as a result of wage increases. The unemployment rate is estimated to decrease further. The export will decrease notably as a result of the strong euro, high labour expenditure and the decelerating global economic growth.
The ECB is preparing to cut the interest rates. According to Senior Economist Jari Järvinen at the Tapiola Group, the overall financial economy of the ECB is already slackening the growth.
– The dim economic outlooks require a leaner financial economy, and therefore the ECB is forced to cut the key interest rate to 3.25-3.75 percent next year, says Järvinen.
FED Cuts Interest Rates
The estimates for global economic growth have turned more pessimistic during the autumn. In addition, the growth has become differentiated: the growth is slackening in the industrialized countries while increasing in the developing economies.
The FED will continue to cut the interest rates.
– The weak housing market has a significant impact on the US economy, and in general decreased housing assets have been followed by serious problems in the real economy, says Järvinen.
A deeper housing and credit crisis in the US may plunge the entire global economy into depression.
– I estimate that there is presently a 50 percent probability of an economic recession in the US economy, says Järvinen.
Until the ECB starts to cut its interest rates, FED’s interest rate cuts, the decelerating growth and the reduced difference between the interest rates will further weaken the dollar.
Dwelling Prices will stagnate
For some time the credit crisis on the global financial market will keep the money market interest rates high in comparison with the key interest rates. In general money market interest rates are applied as key interest rates in Finland, and therefore increased interest rates will deteriorate private household investment capacity. The increase of interest payable has already resulted in longer dwelling sales periods, increased number of dwellings for sale and fewer loans.
In the near future, the dwelling prices will probably stagnate, estimates Real Estate Investment Director Vesa Immonen at Tapiola Real Estate Ltd.
– The news of longer sales periods and a slight decline in prices of large dwellings on the most significant markets anticipate a calmer housing market. It is probable that the number of dwellings for sale is not going to increase significantly next year, and therefore changes in average prices will be moderate, says Immonen.
The complete review of business conditions can be found at Tapiolas website www.tapiola.fi/suhdannekatsaus (in Finnish). The next review of business conditions is published in June 2008.
Tapiola Bank’s Review of Business Conditions 2/2007, outlook for 2008-2009:
• The estimates for global economic growth have turned more pessimistic during the autumn. The outlook is undermined by the weak housing market in the US, the credit crisis and the high oil price. However, the economic growth in the developing economies has still been strong which reacts against a heavy decrease in the industrialized countries.
• In addition, the global economic growth is diverging between the industrialized countries and developing economies. Even though the economic growth in the industrialized countries is slackening, the growth is strong in the developing economies. However, the developing economies are not immune to demand crisis in the industrialized countries. A depression in the US economy would also slacken the growth of the developing economies, albeit they have gained in strength during the past years.
• In the US the dwelling prices have continued falling which has had a negative impact on the private consumption. The stagnation of the economic growth in Japan has continued, since the focus is shifting from export to domestic consumption. The growth in the euro area has been strong but the worsening operational environment raises questions on the growth sustainability.
• The Finnish economy growth will slacken, but it will still exceed the average growth in the euro area. However, as an open economy with major trade outside the euro area Finland will suffer from the strong currency more than the continental countries. Also, during the past years the unit wage cost development has lagged behind the most important competitors and created self-inflicted challenges regarding the competitiveness of the Finnish export industry.
• The FED will continue to cut the interest rates. The weak housing market has a significant impact on the economy, and in general decreased housing assets have been followed by serious problems in the real economy. On the other hand, decelerating growth does not automatically decrease the inflation, since the globalisation has shifted the inflation dynamics. Consequently the growth can decelerate without affecting the inflation.There is a risk that the FED causes medium-term inflation problems when dealing with short-term problems.
• The ECB is prepared to cut interest rates. The increase of short-term interest rates launched by the housing loan crisis in connection with the stronger euro has resulted in a stringent financial economy in the euro area. Already the overall financial economy is slowing down the growth. The dim economic outlook requires a leaner financial economy and therefore the ECB is forced to cut the key interest rate to 3.25-3.75 percent next year. Interest rate cuts do not necessarily result in lower interest rates or weaken the euro but curbs a stronger euro and increasing interest rates.
• There is still pressure for a weaker dollar due to the US current account deficit. However, a free fall is not expected since a controlled weakening of the dollar is in the benefit of the financiers of the debt-led growth. The FED’s decrease of interest rates, decelerating growth and reduced difference between the interest rates will weaken the dollar until the ECB starts to decrease its interest rates.
• For some time the credit crisis on the global financial market will keep the money market interest rates exceptionally high in comparison with the key interest rates of the central banks. Since money market interest rates are applied as key interest rates in Finland, the increased financing costs will deteriorate the investment capacity of private households and companies with high credit rating. The increase of interest payable has already resulted in longer dwelling sales periods, increased number of dwellings for sale and fewer loans.
• In short-term the rise in energy, food and dwelling prices as well as the wage increases exceeding the productivity growth will accelerate the inflation. In future the calmer housing market, the expected interest rate cuts and the unwinding of danger money regarding the money market interest rates will ease the inflation pressure. Regarding inflation development, the most significant risk is perhaps the impact the recent significant growth in energy and food prices as well as the expensive wage settlements have on the future inflation expectations.
• The wage settlements of the municipality sector burdens the public-sector economy and will probably result in higher municipal taxes. Respectively there is more pressure for governmental income tax relieves.
• From a Finnish perspective the greatest single risk is still an unexpected and intense stagnation of the US economic growth. Bad news from the US would affect the Finnish economy through slower export, weaker finance and commodity markets and decreased economic confidence indicators. A deeper housing and credit crisis in the US may plunge the entire global economy into depression. At present the probability of an economic recession in the US economy is 50 percent.
• The long-term outlook for the Finnish economy is still 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 employees and entrepreneurs the uncertain growth and increased interest rates may decrease consumption and postpone investment decisions.
• Dwelling prices will stagnate. The news of longer sales periods and a slight decline in prices of large dwellings on the most significant markets anticipates a calmer housing market. It is probable that the number of dwellings for sale will not increase significantly next year and therefore the change in average prices will be moderate.
• On the office rental market the demand is also in the future estimated to increasingly focus on modern and efficient premises and therefore the rents are expected to increase. Regarding old premises, rent increase expectations are more moderate.
• On the international real estate markets the return requirements has reached the bottom on several partial markets. The problems on the financing market caused by the US sub-prime crisis have appeared as decreased risk-taking on the real estate market. It has become more difficult to receive financing for real estate investments and there is also a stronger demand for return on some partial markets in Europe. The total return on real estate investments in Europe is expected to clearly undercut the previous year being under 10 percent.
Additional Information
Review of business conditions:
Jari Järvinen, Senior Economist, Tapiola Group
Tel. (09) 453 2049, forename.surname@tapiola.fi
Housing and real estate market:
Vesa Immonen, Real Estate Investment Director, Tapiola Group
Tel. (09) 453 3412, forename.surname@tapiola.fi