13 JUNE 2006
REVIEW OF BUSINESS CONDITIONS
According to Tapiola Bank’s latest review of business conditions, the economic outlook for Finland remains good.
– The economy grows accordant with the growth potential, the inflation remains under 2 percent and the unemployment rate will go down to about 7 percent next year. The growth of global economy has accelerated in the first half of the year, but this, however, is only temporary. The outlook is weakened by the high oil price and increased interest rates, Tapiola Group’s Senior Economist Jari Järvinen estimates.
Private consumption will still be the engine for the growth, but the export is also increasing.
- 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. The housing prices are expected to develop in accordance with the development of income level. In future, moderately increased interest rates could affect the loan demand and even out the price development, even though the housing prices still might increase on the most active part of the market.
From a Finnish perspective, the greatest single risk is a stagnation of the economic growth in the US.
- 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, Järvinen states.
- There are great risks in the interest rate policies of the central banks. The ECB needs to be extremely cautious when raising the interest rates, since the fear for inflation is currently too big. The increased prices are a result of higher costs. In addition, the demand has not accelerated. Also, e.g. the highly observed German IFO index is no longer a sufficient growth indicator. Too aggressive raisings of the interest rates can weaken the economy. A stronger euro would decelerate the export and higher interest rates would decrease consumption and investments within Europe, Järvinen continues.
However, the debtors need not worry, since the interest rates will remain historically low during the next couple of years. The Finnish economy can take higher interest rates, and the increased carefulness on the housing market is good news. An expensive euro, slow growth and ineffective use of resources again next year will continue the historically low interest rate level, Järvinen estimates.
The effects of increased short-term and long-term interest rates are already visible on the US housing market and there is a risk for too aggressive raisings of the interest rates. This could decrease consumption.
The complete review is published in Finnish online at www.tapiola.fi/suhdannekatsaus.
Summary of review for 2006 and 2007
- The global economic growth accelerated in the beginning of 2006. However, the acceleration of the growth is temporary, and it will decelerate towards the end of the year. The outlook is undermined by the high oil price and higher interest rates in the US and euro area and eventually also in Japan. The real price of oil is already higher than that of the first oil crisis.
- The growth is also evening out between continents: In the US the growth is decelerating whereas in the euro area and Japan it is accelerating. A surprisingly heavy decrease in the US economic growth would 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.
- The stabilization of the account deficit requires that the big nations will cooperate in terms of currency rates and economic policies. In practise 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.
- This year the rebuilding due to the hurricanes will boost the economy but not enough to alone maintain the growth. The economic growth in Japan has increased since focus shifted from export to domestic consumption. In Germany, the domestic demand is still low and therefore the increase of VAT and stricter monetary policy fit poorly in the current economic situation.
- The economic outlook for Finland during the forecast period remains good; the economy grows accordant with the growth potential, the inflation remains slow and the unemployment rate will go under its structural level. Private consumption will still be the engine for the growth but the export is also increasing.
- The FED’s cycle of raising interest rates will continue. The strong US economy forces the FED to continue to raise interest rates. The effects are already visible on the housing market, and there is a risk that the interest rates will be raised too much.
- 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. The key interest rate is still about zero. The recent strengthening of the euro corresponds to a single raise of 25 base points. In the short run there is pressure for a cyclic increase of long-term interest rates in the euro area but 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.
- The IFO index exaggerates the acceleration of growth. In the spring the figures estimated a total production growth of 3-4% in Germany. The IFO index has lost significance as a prognosticator for national growth due to the fact that it nowadays reflects the optimism of companies’ management regarding the global economy. Companies move the production to countries with lower labour costs and as a consequence the profits increase regardless of the situation in Germany.
- There is 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 economic growth in the US. This would have a negative effect on the export, finance and commodity market as well as economic confidence indicators.
- 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.
- In Finland, the stabilization and partial stoppage of the increase of the housing prices are not yet in the horizon. The housing prices are expected to develop in accordance with the development of income level. The moderately increased interest rates could affect the loan demand and even out the price development, even though the housing prices still might increase on the most active parts of the market.
- The office, commercial hall and space market remains brisk. Moreover, new office space projects are launched actively, and international investors still find Finland as an interesting property market.
- 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 requires events which are not expected at moment.
- 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