Nordic Update

There need not be a downside surprise in either output or inflation to strengthen such views as the consensus estimates will suffice. However, the risk does appear to be on the downside. The consensus estimates are good enough. A survey of surveys finds the consensus forecast is for a 0.5-0.9% decline in industrial output, which would fully offset July's 0.3% increase.

Recall that the August PMI slid from 50.6 in July to 45.1 in August (and then continued to fall to 44.7 in September). With 70% of Sweden's exports going to recessionary Europe, the drying up of foreign demand hurts Swedish producers. Domestic demand too has weakened, with retail sales falling 0.4% in August (consensus was for a 0.2% increase). The service PMI peaked in July at 54.8 and fell to 50.8 in August and then 47.3 in September. The weakness of the Swedish economy materialized faster than investors and policy makers expected.


The Case For Easing
Swedish inflation continues to undershoot the Riksbank's target of 2%. The underlying rate, which adjusts for mortgages, has not been near 2% since the end of 2010. It has been below 1% since May. The consensus is for it to be unchanged in Sept. form August's 0.9%. This provides the scope for the Riksbank to ease.

There is another concern, which was evident in the minutes of a Swedish bank regulator meeting published today -- the health of the financial sector. The regulators appear to be getting increasingly concerned that Swedish banks have too many assets being used as collateral. The minutes indicate that in international comparative terms, Swedish banks have a "relatively high degree of encumbered assets". The regulators are also concerned about that Swedish banks attach a low level of risk to mortgage lending, which is also growing rapidly. Swedish banks also are reliant on short-term funding markets.

Buffers And Transparency
Sweden appears to be trying to address these problems with macro-prudential policies, such as requiring higher levels of capital buffers and greater transparency regarding the amount of pledged assets. Yet one of the reasons why Swedish banks pledge assets (collateral) is to lower their funding costs. Therefore, the financial conditions in Sweden also should be included in the considerations favoring lower official rates.

Meanwhile, the Norwegian economy is doing considerably better. The tight 2013 budget announced yesterday (below the 4% spending rule) was partly meant to prevent favorable growth differentials from sending its currency even higher and having a detrimental impact on the non-oil exports.

Double Whammy
Norwegian officials are concerned about the twin problem of record high consumer debt and house prices. The IMF and OECD have also warned about the appearance of a housing market bubble in Norway. The IMF estimates that Norwegian house prices may be 20% overvalued. A strong case can be made for a Norwegian rate hike.

The central bank next meets on October 31, but given the global outlook, a hike then is not the most likely scenario. Nevertheless, with labor costs set to rise 4% next year, according to Finance Minister Johnsen, a rate hike at the December 19th meeting seems cannot be ruled out. These considerations suggest the NOK can continue to outperform SEK against the dollar and euro.