The monetary policy stance is very stimulative and ought to remain so for the time being. Both automatic and discretionary fiscal responses will continue to support demand as will the recent measures to limit long-term unemployment. As the recovery firms up, however, fiscal consolidation efforts will be needed to reach the medium-term budget surplus target.
The contraction appears to be coming to an end
Following four consecutive quarters of decline, real GDP increased in the second quarter of 2009, although this mainly reflected strong public investment. Industrial production continued to contract. Consumer and business confidence have been improving over the past six months and retail sales have picked up.
Financial market conditions have improved
Financial market conditions have also improved, with spreads on interbank and mortgage rates having reverted towards more normal levels. Lending to households has started to accelerate, although lending to firms is still slowing.
Unemployment rises and cost pressures will be low
The severe downturn has led to a rapid deterioration of the labour market, with the unemployment rate now over 8%. Faced with considerable spare capacity, firms are planning to r educe staff further. Therefore, unemployment is not expected to peak before the end of 2010. As firms' profitability has weakened and uncertainty about future demand growth remains, employment will continue to shrink and productivity to rise, which will reduce unit labour costs. This will contribute to a gradual decline in core inflation over the coming year.
Monetary and fiscal policy are expansionary
Headline inflation--which includes mortgage interest costs--is currently negative but will start to rise as interest rates move up. Short-term inflation expectations remain just below the inflation target of 2%. The central bank ought to keep official interest rates at around the current level of 0.25% until the recovery has firmed. Additional longer-term refinancing operations may be needed to ensure proper functioning of the money market and to anchor expectations of low interest rates. The monetary stimulus, automatic stabilisers and discretionary fiscal measures will support demand through 2011, although some of the temporary fiscal measures will be phased out. Recently the government has proposed various measures including additional income tax cuts, a reduction in employer contributions, higher transfers to municipalities (to dampen layoffs in the public sector) and new labour market programmes. These measures ought to limit the rise in unemployment and reduce the risk that it becomes entrenched. Over the medium term, the reduced nominal spending limits tabled in the recent budget proposal will contribute to closing the budget deficit but may not be sufficient to reach the surplus target.
GDP growth is on course to pick up gradually
The recovery will be led by exports as foreign demand picks up and the effects of the large effective exchange rate depreciation that took place over the past y ear take hold. However, given that exports consist mainly of manufactured and in vestment goods and that capacity utilisation abroad is generally low, the recovery is expected to be sluggish. Although unemployment will remain high, consumption will be supported by low interest rates and the contained fiscal stimulus through 2011.
Financial instability remains a key risk
In addition to the uncertainties surrounding the global financial and economic recovery, Swedish banks' exposure to Eastern Europe remains a key issue. The impact of further substantial losses in the Baltics would be cushioned by the Swedish government's financial sector measures, but the process of absorbing such losses could be extended and could delay the overall recovery. On the bright side, the recovery could turn out to be stronger than projected if global activity were to accelerate more than currently anticipated. However, this effect could be dampened b y exchange rate appreciation.
Sweden: Demand, output and prices 2006 2007 2008 2009 2010 2011 Current Percentage changes, volume prices (2000 prices) SEK billion Private consumption 1 372.8 3.1 -0.4 -1.2 1.7 2.4 Government consumption 762.5 0.6 1.1 1.6 0.7 0.6 Gross fixed capital 528.5 7.7 2.4 -1.7 -2.0 5.5 formation Final domestic demand 2 663.7 3.3 0.6 -3.8 0.7 2.4 Stockbuilding (1) 0.3 0.7 -0.5 -1.4 0.6 0.0 Total domestic demand 2 663.9 4.1 0.0 -5.3 1.4 2.4 Exports of goods and 1 494.0 6.0 1.6 -13.1 3.2 6.5 services Imports of goods and 1 257.2 9.6 3.1 -15.4 2.6 6.0 services Net exports (1) 236.9 -1.1 -0.5 0.1 0.5 0.7 GDP at market prices 2 900.8 2.7 -0.4 -4.7 2.0 3.0 GDP deflator 2.8 3.4 2.2 1.3 2.1 Memorandum items Consumer price index (2) -- 2.2 3.4 -0.3 1.4 3.2 Private consumption -- 1.1 3.0 2.5 1.9 2.0 deflator Unemployment rate (3) -- 6.1 6.2 8.2 10.3 10.1 Household saving -- 9.1 12.1 14.5 14.3 12.9 ratio (4) General government -- 3.8 2.5 -2.0 -3.0 -2.0 financial balance (5) Current account -- 8.8 6.2 7.8 8.2 8.6 balance (5) Note: National accounts are based on official chain-linked data. This introduces a discrepancy in the identity between real demand components and GDP. For further details see OECD Economic Outlook Sources and Methods (http://www.oecd. org/eco/sources-and-methods). (1.) Contributions to changes in real GDP (percentage of real GDP in previous year), actual amount in the first column. (2.) The consumer price index includes mortgage interest costs. (3.) Historical data and projections are based on the definition of unemployment which covers 15 to 74 year olds and classifies job-seeking full-time students as unemployed. (4.) As a percentage of disposable income. (5.) As a percentage of GDP. Source: OECD Economic Outlook 86 database. StatLink http://dx.doi.org/10.1787/754103103162