Stagnation of US Growth Poses Threat to Finnish Economy

13 December 2006
REVIEW OF BUSINESS CONDITIONS

Accordant with Tapiola Bank’s Review of Business Conditions, the Finnish short-term economic outlook remains good, and the economy will grow by 3.0 percent next year.

- Tapiola Bank has raised its growth estimate for 2007 by 2 tenths because the inflation will clearly remain under 2 percent, and the unemployment rate will go below 7 percent, Tapiola Group Senior Economist Jari Järvinen states.

From a Finnish perspective, the greatest single risk is an unexpected and intense stagnation of the US economic growth. In the worst case, a rapid stagnation of the US housing market and industry could significantly slow down the entire global economy. The current possibility for a minor economic slump in the US is approximately 50 percent. As a result of the stagnating US growth the the dollar will weaken in relation to other major currencies.

- The stronger euro will slacken the Finnish economy more than in the euro area in general. A 10% weaker dollar in relation to other major currencies will cut off approximately 0.6 percentage points from the growth of the Finnish gross production, Järvinen comments.

For employees and entrepreneurs the uncertain growth and increased interest rates may decrease private consumption and postpone investment decisions.

Interest Level to Remain Moderate

According to Järvinen, the ECB must be cautious when raising the interest rates, because a too aggressive interest rate increment weakens both export (stronger euro) and internal consumption as well as investments. This indicates that the inflation fears in the euro area still rise due to the increased costs, and there are no signs of demand-inflation.

- The FED’s cycle of raising interest rates is about to reach its peak. Despite the stagnating growth and cooler housing markets, the FED is not able to lower the interest rates before next summer. On the other hand, new raisings cannot not be totally excluded, Järvinen points out.

Housing Prices to Normalize

According to Immonen, the prices for different forms of dwelling are about to diverge. The sales prices for old apartments increased evenly during 2006. However, the prices for detached houses decreased in 2006 throughout the country, and the sales periods extended from last year.

The sales of new homes remain strong, even though it has slightly decreased from the top figures of last year. The increase of prices is about to calm down from the levels of the beginning of 2007.

Review of Business Conditions 4/2006, Outlook for 2007–2008

• The global economic growth decelerated during the third quarter, and the deceleration is expected to continue in the beginning of 2007. The outlook is undermined by the high oil price and higher interest rates in the US, euro area and Japan. The real price of oil is already approaching that of the second oil crisis.

• The growth is also evening out between continents: In the US the growth is decelerating whereas in the euro area it is accelerating. A surprisingly heavy decrease in the US economic growth would abolish any positive surprises in the euro area. Regarding the US current account deficit, a slower but stabile growth is easier to maintain.

• The stabilization of the account deficit requires that the big nations will cooperate in terms of currency rates and economic policies. In practice this means that the dollar should weaken in relation to the other major currencies, and the key interest rates should increase more than expected in the US and less than expected elsewhere.

• The US housing market is rapidly cooling down, which will have a negative effect on the private consumption. The economic growth in Japan will stagnate since the focus is shifting from export to domestic consumption. The growth in the euro area remains strong, but the external economic environment is rapidly slowing down, which creates some uncertainty around the sustainability of the growth. 

• The economic outlook for Finland during the forecast period remains good; the economy exceeds the growth potential, the inflation remains slow and the unemployment rate will go under its structural level. The growth in export will decelerate significantly next year as a result of a slower global economy growth and a weaker dollar. The stronger euro will slacken the Finnish economy more than in the euro area in general. A 10% weaker dollar in relation to other major currencies will cut off approximately 0.6 percentage points from the growth of the Finnish gross production.

• The FED’s cycle of raising interest rates will continue. Despite the stagnating growth and decelerating housing markets, FED is forced to raise the interest rates during this economic cycle. A weaker economic outlook does not automatically slow down the inflation. The inflation pressure is still demand and cost based, but also structural problems require higher real interest rates.

• The ECB continues to increase the interest rates gradually towards a neutral level. So far the increase of interest rates has not tightened the monetary conditions, and the key interest rate is below its real balance level. The strengthening of the euro in the beginning of the year corresponds to a single raise of 25 base points. The most significant increase of long-term interest rates in the euro area should already be over, but in the short run there is pressure for a cyclic increase of interest rates in the euro area. In the long run, structural factors will keep them low.

• The inflation in the euro area and the energy-excluded inflation are converging, and at the end of the year they will be on the level of about 2 percent. This indicates that the inflation fears still rise due to the increased costs, and there are no signs of demand-inflation. The ECB must be cautious when raising the interest rates, because a too aggressive interest rate increment weakens both the external (stronger euro) and internal demand (decreased consumption and investments). An expensive euro, slow growth and ineffective use of resources again next year will continue the historically low interest rate level.

• There is still a pressure for a weaker dollar due to the US current account deficit. In the short term, the expectations of continued raisings by the FED will support the dollar, but as the growth of the US economy decelerates towards the year-end, the dollar will weaken in relation to other major currencies.

• The Finnish economy can take higher interest rates, and the increased carefulness on the housing market is good news. So far the increase of interest rates has not significantly affected the housing market or lending. There is, however, a risk that the households become over-indebted and consequently use a major part of their assets to pay off their house loans. This reduces other consumption which has negative effects on the domestic enterprises and employment.

• From a Finnish perspective the greatest single risk is an unexpected and intense stagnation of the US economic growth. This unfavourable development would affect the Finnish economy through slower export, weaker finance and commodity markets and decreased economic confidence indicators. A rapid stagnation of the US housing market could slow down the entire global economy. The possibility for a new economic slump in the US is approximately 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 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 should remain historically low during the next couple of years. A significant increase of interest rates requires events which are not expected at moment.

• The sales of new homes have slightly stagnated from the top figures of last year, and the increase of prices has been slower than in the beginning of the year. The prices for detached houses decreased in 2006 throughout the country, and the sales periods extended from last year.

• The longer sales periods on the housing market can be considered as normalization of the market. The development of housing prices is expected to continue in 2007 in accordance with the level of income development. In the areas of strong demand, such as the Helsinki area, the prices will start to follow the income development later on.

• The office premises market has slowly started to recover. The investment-based demand in the Helsinki area is to remain active. The division of the office market into new or old premises tends to emphasize, and dilapidated premises require renovation to meet the demand.

• The outlook for the office premises market remains positive, but as a result of significant increase of premises supply, it remains to been seen how the supply and demand will meet in the future. The high demand is maintained by new international chains as well as consumers’ confidence on private economy. The buyers and users of the premises have started to state precise requirements with regard to the quality and location of the office premises.

• For employees and entrepreneurs the uncertain growth and increased interest rates may decrease consumption and postpone investment decisions.

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