The global economic upswing has stalled. Growth has slowed down in the euro area, China and the United States. The global economic downturn is also expected to continue. According to our forecast, the US economy will expand at a moderate pace this year, with growth forecast at 2.2 per cent. Next year the US economy is forecast to grow by only 1.6 per cent. The slowdown in growth is a result of the simultaneous weakening of the international economic growth, increased protectionism and the waning of the boost given by President Trump’s fiscal stimulus.
Etla predicts euro area GDP will grow by 1.0 per cent this year and 0.9 per cent in 2020. This year’s GDP forecast has been revised downwards by 0.1 percentage points and next year’s forecast by 0.4 percentage points. GDP growth was disappointing especially in Germany in the early part of the year and its economy is likely to fall into a slump in the current quarter. Germany’s export-driven economy is vulnerable to shocks caused by the global economy and Brexit. Britain, on the other hand, is suffering from the uncertainty caused by the chaotic Brexit process, which has not diminished at least in recent months. If a hard Brexit does occur, euro area growth will slow down by a few percentage points more than our base forecast. The Russian economy is projected to grow at an average rate of 1.5 per cent this year and next – i.e., at the country’s potential output growth rate with current capacity. China’s GDP is projected to grow by 6.1 per cent this year but next year by 6.0 per cent. The slowdown in the Chinese economy will nevertheless remain under control.
This year world GDP is expected to grow by 3.0 per cent, 0.6 percentage points lower than last year. World economic growth is forecast to slow by another tenth of a per cent next year, with growth forecast to be 2.9 per cent in 2020.
The downside risks are significant. Political uncertainty in the United States is at its peak during the entire Trump presidency and at almost the same level as immediately after the Brexit referendum. The trade war between the US and China is escalating further. In addition, the trade war between the US and the EU may intensify again. The average US tariff on Chinese imports has risen from 3.1 per cent at the beginning of 2018 to 21.2 per cent in September this year. China’s US import duties, on the other hand, rose from an average of 8 per cent in early 2018 to 25.9 per cent in September this year.
Global economic development is also overshadowed by the potential impact of political risk. The British government has continued on a path that threatens to lead the country into a chaotic no-deal EU withdrawal, which is particularly damaging to the economy. The actions taken by Parliament at the beginning of September bring some hope of getting the situation under control. The global geopolitical situation may also deteriorate at any time given President Trump’s unpredictability.
Euro area GDP growth has decelerated markedly since mid-2018. In the second quarter of this year, growth of 0.2 per cent was carried over from the previous quarter. The outlook for the third quarter is nevertheless very weak, based on figures regarding industry and consumer confidence.
The slowdown in economic growth in the eurozone has been the result of the economic slowdown in Germany and Italy in particular. The German economy is expected to decline in the current quarter. The weakness of the German economy originates mainly from industry, but according to recent figures it is spreading, at least in part, to include services.
We forecast GDP will grow in the euro area by 1.0 per cent this year and 0.9 per cent next year. Growth will accelerate slightly in 2021, when we forecast it will be 1.3 per cent.
All euro economies are projected to grow, but there are differences in growth rates. Growth in Spain and the Netherlands is forecast to remain favourable this year, close to 2 per cent. The French economy is also growing at a rate of well over 1 per cent. By contrast, the German economy is forecast to expand by only 0.4 per cent, while Italy is not forecast to grow at all this year. Export-dependent euro area countries are vulnerable to world trade disruptions such as tariff hikes. The sheer uncertainty of future tariffs will dampen companies’ investment. The uncertainty brought about by Brexit and the resulting surge in inventories in the UK are also reflecting on the German economy. This year, however, the euro area is gaining some support from easing fiscal policies, especially in Germany, the Netherlands, France and Italy.
Contrary to what we forecast in March, euro area monetary policy will be eased this year. Etla expects the ECB to lower its deposit rate from -0.4 per cent to -0.5 per cent. At the same time, monthly net purchases of securities will be restarted. The key interest rate will remain around zero at least until the end of 2021. The ECB will also seek to surprise the market with entirely new monetary policy tools.
The euro area is still vulnerable not only to political risk but also to banking risk. There are banks in Italy and a few other countries in southern Europe that are still weak. This justifies further reforms in the financial and banking sector of the euro area, in particular the capital markets union. So far, however, the pace of reforms has been modest.
According to revised national account figures, Finland’s GDP grew by 1.7 per cent last year. GDP growth was revised downwards by 0.6 percentage points. Exports grew slowly, i.e. by 1.1 per cent. At the same time, imports grew by 4.1 per cent, so net exports contributed as much as 1.2 percentage points to economic growth. According to preliminary data, private consumption increased by 2.0 per cent. Strong growth in real purchasing power boosted private consumption and prompted an increase in the household savings rate. Investments increased by 3.1 per cent. The change in inventories boosted GDP growth quite significantly last year.
We forecast Finland’s GDP to grow by 1.1 per cent this year. The growth figure has thus been reduced by 0.3 percentage points from last March. The outlook for the structure of growth has nevertheless remained broadly unchanged. We expect net exports to spur growth this year. Starting next year, growth will depend primarily on domestic demand. In our forecast, export growth will remain well above 1 per cent in 2020, while imports will grow at a rate exceeding 2 per cent. Net exports will therefore have a negative impact on growth next year. Investment will grow by about one and a half per cent this year, but less than one per cent next year. Next year, we forecast that Finland’s GDP growth will slow to 0.9 per cent. In 2021 we expect Finland’s GDP will grow by 1.1 per cent, corresponding to Finland’s potential output growth rate.
We expect the output gap to be slightly positive both this year and next. The Finnish economy is therefore operating at its full capacity. In our special theme article, we estimate that the Finnish economy will fall into recession with a probability of 18 per cent this year and 48 per cent by the end of next year.
Exports are projected to grow by 3.8 per cent in 2019. Exports of goods will grow by 3.5 per cent and exports of services by 5.0 per cent. Growth in goods exports is will be spurred by large ship deliveries this year as deliveries of two large cruise ships will take place. Exports of metal refining are increasing at a rapid pace, and an upturn in oil refining is expected to be reflected in exports this year. Germany remains clearly the most important destination for Finnish export goods. In our forecast, the euro will weaken against the dollar compared to last year’s average level, which will also foster export growth.
Exports are expected to grow by 1.3 per cent next year, clearly lower than this year. Exports of services are projected to continue to grow faster than exports of goods. In 2021 export growth is expected to accelerate slightly to 2.5 per cent. Continued export success requires that the rise in real earnings does not significantly exceed the growth rate of productivity or real earnings of competitor countries in 2020 and 2021. These developments will hinge upon this autumn’s wage bargaining round, where the Finnish wage model will be put to the test.
Investment is expected to grow by 1.4 per cent this year. Growth will be curbed by dwindling housing and public investment – residential housing construction growth is forecast to be zero this year. By contrast, investments in machinery and equipment and R&D are projected to pick up slightly this year.
In 2020 investment growth will slow further to 0.8 per cent. Residential housing construction growth is forecast to remain close to zero. Investment in machinery and equipment will continue to expand, but its growth rate will also slow down. Growth in non-residential construction is also expected to be near zero. There will be no significant change in the investment rate during the forecast period without significant new economic policy measures.
Last year’s increase in employment was much faster than expected. At the same time, the unemployment rate fell significantly. The number of employed is expected to increase by about 21,000 this year, thanks to the favourable development at the end of last year. In practice, this will occur if seasonally adjusted employment does not fall from its present level. As the labour force is expected to remain at last year’s level, the unemployment rate will fall to 6.5 per cent. At the same time, the employment rate is forecast to rise to 72.4 per cent on average.
Next year employment growth is forecast to come almost to a halt. The unemployment rate will nevertheless fall to 6.3 per cent due to a slight contraction of the workforce. The employment rate is expected to continue to improve slightly, to 72.7 per cent next year, as the number of employed persons aged 15–64 grows faster than the total number of persons in this age group. The availability of skilled labour will limit employment growth this year and next. We predict that the employment rate will rise to 73 per cent by 2023. The 75 per cent employment rate target of Prime Minister Rinne’s government is therefore unlikely to be achieved unless significant new employment measures are taken.
Growth in real income and other income as well as employment will boost consumption this year and next. Private consumption is forecast to grow by 0.7 per cent this year and 1.1 per cent next year. At the same time, the saving ratio of households and non-profit institutions serving households will remain at their current level.
In our forecast private consumption will still grow by 1.2 per cent in 2021, i.e. at the same rate as real purchasing power. A crucial factor for the development of private consumption in the future is the magnitude of pay hikes agreed in the wage negotiation round starting this year. Even more pivotal, however, is that the international economy does not bring any unpleasant surprises. In our forecast earnings will rise 2.5 per cent this year and 2.7 per cent next year. Next year’s earnings will be boosted by the end of the public sector fixed-term holiday pay cut.
Consumer prices are projected to rise 1.0 per cent this year. Inflation will be boosted this year particularly by rising housing costs as well as increases in food, alcohol and tobacco prices. Next year consumer prices will increase by 1.1 per cent. The development of housing costs as well as food and non-alcoholic beverage prices are the most important factors fuelling inflation. In 2021 consumer prices are projected to increase by 1.4 per cent.
The general government budget deficit will worsen over the forecast horizon. Last year the public sector deficit was still 0.8 per cent of GDP. The decision-based fiscal policy will provide a stimulus starting next year. Indeed, the current year’s public sector budget deficit is projected to be 0.9 per cent of GDP and next year’s deficit will be 1.4 per cent of GDP. The general government balance will weaken due to the slowdown in GDP growth but also as a result of spending increases by the new government.
In our forecast, the so-called public sector EDP debt will rise to 60.0 per cent this year. The public sector EDP debt is projected to be 60.4 per cent next year and 60.3 per cent in 2021. In our baseline projection, public sector EDP debt will rise to 60.6 per cent of GDP by 2023. The central government’s budget deficit will also deteriorate in the forecast years. The surplus of social security funds will shrink from last year’s 1.3 per cent to 0.8 per cent of GDP by 2023. Projections for the general government debt-to-GDP ratio have worsened significantly compared to the March forecast. Actual developments are nevertheless very sensitive to changes in the value of GDP. There are also big questions about whether the sitting government can foster a rise in the employment rate by means of its policy measures. Well designed and implemented, they would also have a positive effect on the fiscal balance of the public sector.
We estimate that Finland’s structural balance will not be sufficiently strengthened to meet its medium-term objective in 2019, when the structural balance is projected to be -1.2 per cent of GDP. However, due to the certain degree of flexibility when assessing the compliance with the norms, our view is that the level of the structural balance in 2019 will not breach the fiscal rules.
The structural balance will nevertheless be clearly below the minimum target of a structural deficit of 0.5 per cent in 2020. Hence, by 2020, fiscal policy will be significantly diverging from the adjustment path implied by the medium-term budgetary objectives. Based on our analysis, it appears that the risk of breaching fiscal rules is also significant when measured also by the expenditure rule.
Based on the above, Finland’s total output will be slightly above its potential level this year and next, which means that the output gap will be positive each year. Estimates of potential output are known to be sensitive, however, to the assumptions made and the methodology used.