21 September 2006
Review of Business Conditions
Accordant with Tapiola Bank’s Review of Business Conditions, the Finnish economy will grow by 4.8 percent this year and 2.8 percent next year. Tapiola Group Senior Economist Jari Järvinen states that the Finnish economic growth remained strong during the first half of the year.
Tapiola Bank has raised its growth estimate for 2006 and 2007 since both the economic growth within the euro area and the Finnish export numbers have been better than expected.
The adjustment was partly made due to the fact that the domestic economy growth last year was slackened by the industrial actions in the paper industry.
The Finnish export will stagnate next year as a result of a slower global economy growth and a weaker dollar. Due to a clear stagnation of the export, the growth of the Finnish economy is more dependent on private consumers.
ECB to Continue Interest Raisings
According to Tapiola Bank’s Review of Business Conditions, the ECB will continue to raise interest rates.
So far the increase of interest rates has not significantly affected the housing market or private lending. The Finnish economy can take higher interest rates, and the increased carefulness on the housing market is good news, Järvinen comments.
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. In the worst case, this leaves significantly less money to be used for private consumption. This may have a negative effect on the domestic demand.
US Economic Growth Decisive for Finland
The global economic growth will decelerate further towards the end of the year. This is a result of the high oil price and higher interest rates in the US, euro area and Japan.
Tapiola predicts that the US GNP will increase by 3 percent in 2006 and by 2.1 percent next year. In spite of the decelerating growth, Järvinen sees that FED will continue to raise interest rates. The expectations of continued raisings 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.
On the basis of statistics, the US housing market is about to cool down. In the worst case, a rapid stagnation of the US housing market could significantly slow down the entire global economy. According to Järvinen, the greatest single risk for the Finnish economy is still an intense stagnation of the US economic growth.
The complete review is published in Finnish online at www.tapiola.fi/suhdannekatsaus.
Review of Business Conditions 3/2006, outlook for 2006–2007
• The global economic growth decelerated during the second quarter, and the deceleration is expected to continue towards the end of the year. 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 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.
• 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 1-3 times during this economic cycle. 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 interest raisings in the euro area should already be over, but in the short run there is pressure for a cyclic increase of long-term 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 40 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 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, forname.surname@tapiola.fi