The world economy is still experiencing an upswing, although one that is losing momentum. Global economic growth is gaining a boost from the US economy, which is expected to grow by 2.8 per cent this year and 2.4 per cent next year. After this, the country’s growth is expected to slow down considerably. In addition to international demand, US growth is driven by President Trump’s fiscal policy stimulus and the continuation of strong private consumption. At the same time, Trump’s protectionist trade policy presents a major risk to global economic growth.
GDP in the total EU area is forecast to grow by 2.1 per cent this year, 1.8 per cent in 2019 and 1.6 per cent in 2020. We have lowered our growth forecasts for this year and next year, due to disappointing growth figures in the beginning of this year in many key European countries such as Germany and France. The economic growth of many euro area countries is based on exports, which are sensitive to increased trade barriers. Britain is experiencing significantly slower growth than before the Brexit vote. If an agreement on Brexit cannot be reached, growth in the UK and the euro area will slow down more than in our baseline forecast. The Russian economy is projected to grow slightly more than 1.5 per cent during 2018-2019, bolstered by rising oil prices. In the medium term, however, Russian growth prospects are weak. China’s GDP growth will slow down gradually but remain clearly above 6 per cent until 2020.
This year global economic output is expected to grow by 3.7 per cent, i.e. only 0.1 percentage point lower than last year. Global economic growth is nevertheless decelerating as next year the world economy is forecast to grow by only 3.4 per cent and by 3.1 per cent in 2020.
The risk of worse-than-predicted growth has increased recently. A trade war is already brewing and it threatens to escalate between China and the United States. At present, the countries have imposed reciprocal duties for a total of 100 billion dollars’ worth of imports. The United States imposed aluminium and steel duties on the EU in June, to which the EU responded by imposing duties on specific US consumer goods. The situation in trade negotiations between the United States and the EU is currently stable, but the risk of the situation deteriorating is fairly high.
Developments in the global economy are also overshadowed by the debt management problems of some emerging economies, such as Turkey and Argentina, which have escalated in the wake of the Fed tightening its monetary policy. In addition to the currencies of Turkey and Argentina, the currencies of countries such as Brazil, India and Indonesia have depreciated significantly against the dollar. The currencies of Russia and China have also depreciated. In the former case this has occurred due to new sanctions set by the United States and in the latter case due to the trade war and a slowdown in economic growth. There is a risk of these problems spreading more extensively, also affecting more developed economies.
Politics also pose a risk within the euro area, as the government formed in Italy in spring is quite reluctant to comply with EU-level agreements on budget deficits. The problem is exacerbated by the fact that Italy is the third largest economy in the euro area, with a public debt of over 130 per cent of GDP. In the financial markets, Italian risk has been priced in since early summer, which has been reflected in a distinct rise in Italian government bond yields: the yield on the country’s ten-year government bonds is almost 3.2 per cent currently, while it was about 1.8 per cent in April.
Total GDP growth in the euro area has slowed down from 0.7 per cent at the end of last year on a quarter-on-quarter basis to this year’s 0.4 per cent on a quarter-on-quarter basis. The slowdown was initially said to be attributable to a cold winter, strikes and even with an influenza epidemic, but its causes are more likely to be associated with increasing trade policy tensions in the world. The strength of the euro during the beginning of the year also probably reflected negatively on the development of the export-dependent economic area.
We forecast the euro area GDP will grow by 2.1 per cent this year and 1.8 per cent next year. Growth will slow down to 1.5 per cent in 2020, which is close to the potential growth rate of the region.
All euro economies are projected to grow, but there are differences in the growth figures. This year growth is strong in Spain and the Netherlands, closer to 3 per cent. Germany’s economy will grow at a 2 per cent rate while the French economy expands by slightly less than 2 per cent. In Germany the public sector is already clearly running a surplus and the financial positions of public sectors in other euro area countries are also improving. The high public debt levels in relation to GDP in some countries, such as Italy, Greece and Portugal, are a cause for concern and they are declining slowly if at all. These sorts of debt levels make the countries vulnerable when the next recession hits.
The monetary policy of the euro area remains easy for now, but it will begin to be tightened gradually towards the end of this year. Net purchases of securities will be halved from 30 billion to 15 billion euros from October onwards, after which they will be discontinued completely next year. Key interest rates are not forecast to rise from zero until the end of next year, as inflation in the euro area this year is still below the central bank’s target (just under 2 per cent).
The euro area is still vulnerable not only due to political risk but also because of banking sector risks. In Italy and a few other countries, mainly in southern Europe, there are banks with weak solvency. This justifies moving forward on reforms of the euro area financial markets and the banking sector, especially the capital markets union.
According to the revised figures of the national accounts, Finland’s GDP grew by 2.8 per cent last year. Exports grew by as much as 7.5 per cent. As imports simultaneously increased by 3.5 per cent, net exports contributed strongly to economic growth. Private consumption increased more slowly in the revised figures than according to the preliminary ones, i.e. by 1.3 per cent. Consumption was boosted by growth in real purchasing power and strong consumer confidence. Investment increased by 4.0 per cent.
Finland’s GDP is expected to grow by 2.8 per cent this year. The growth figure is thus the same as we forecast last March. The view has nevertheless changed slightly with respect to the structure of growth as we expect it to be fuelled more by domestic demand this year than we predicted in March. Private consumption and investment will boost GDP growth strongly this year. Export growth, on the other hand, will remain at just over 2 per cent, although mainly due to the rhythm of ship deliveries. Next year, Finland’s GDP growth will slow down to 2.2 per cent as demand from the international economy and construction subsides. Private consumption will nevertheless boost GDP growth again next year as the development of real disposable income remain fairly positive. Exports will also increase at a 3.6 per cent rate next year, spurred by ship deliveries. In 2020 we expect growth in Finland’s GDP to slow down to 1.6 per cent, which is already close to the growth rate of potential output. Domestic demand will continue to sustain economic growth even more clearly in 2020.
In 2018 exports are projected to grow by 2.3 per cent. Exports of goods will grow by 2.6 per cent while services will climb somewhat more slowly. Exports are fostered by increased activity in export countries, increased competitiveness due to the competitiveness pact, and increased export industry capacity through investment. Growth in pulp exports is particularly strong due to the new capacity of the Äänekoski Biotechnology Plant. Overall, the exports of the forest industry will grow strongly this year. Exports of motor vehicles will increase even faster due to the expansion of the car factory in Uusikaupunki. Exports of other transport vehicles (mainly ships) are expected to decrease in comparison to last year. Machinery and equipment exports are forecast to grow at a positive rate. When examining the development of exports by country, it is clearly evident that the significance of Germany as the most important destination country for Finnish goods exports has gained emphasis this year.
Next year the volume of exports is forecast to grow by 3.6 per cent, which is faster than this year. The upswing in export growth stems from the delivery of ships – especially large cruise ships – and the recovery of oil refining from this year’s decline. Also, the exchange rate of the euro against the dollar is weaker in our forecast compared to the average level of this year, which contributes to the growth in exports. In 2020 growth in exports is expected to slow down to two and a half per cent as growth in international demand continues to slow. The continuation of strong export performance requires that the rise in real earnings does not exceed the growth rate of productivity significantly in 2019 and 2020.
Investment is forecast to grow by 3.9 per cent this year. Growth is dampened by the decline in non-residential construction, especially machinery and equipment investment. Residential construction, however, is expected to grow strongly this year. Public investment will be boosted by, among other things, increased investment in hospital buildings.
In 2019 investment growth will subside to 1.5 per cent. The slowdown is attributable above all to the stagnation of residential construction growth. Machinery and equipment investment will also grow slowly next year. In 2020 the growth in total investment will pick up slightly to 2.7 per cent as residential construction, for example, recovers moderately from its downturn in 2019.
Growth in employment this year has surprised almost all forecasters. Employment growth was particularly strong in the summer months compared to last year. At the same time, the unemployment rate also dropped significantly. The number of people employed is projected to increase this year by 55,000 compared to last year. As the labour force is growing at a slower pace than the number of people employed, the unemployment rate is projected to drop to 7.7 per cent. Next year employment is forecast to continue to rise, but at a much slower pace. The unemployment rate will nevertheless continue to decline, averaging 7.4 per cent. The employment rate is projected to average 72.1 per cent next year. The number of jobs is expected to increase by a total of 112,000 people in 2015-2019. Thus the government’s targets for both the 72 per cent employment rate and 110,000 jobs during the government’s term are projected to be realized. The unemployment rate for the year 2020 is projected to be 7.1 per cent. The availability of skilled labour and constraints on the supply of labour will begin to undermine employment growth next year as the output gap shrinks.
Growth in real earnings and employment will boost consumption this year and next. Private consumption is forecast to grow by 2.0 per cent this year and 1.8 per cent next year. At the same time, the savings rate for households and non-profit-making organizations will rise slowly but still remain clearly negative.
In 2020 private consumption will grow by 1.6 per cent in our forecast, which is in line with the growth of real purchasing power. The development of private consumption will hinge upon employment trends as well as the extent of wage increases to be decided in the next wage negotiation round at the end of next year.
In 2018 consumer prices are expected to rise by 1.1 per cent. Inflation will be fuelled by rising prices of oil, food, alcoholic beverages, education, as well as restaurant and hotel services. Next year the rate of consumer price increases is forecast to accelerate to 1.4 per cent due to, among other things, increases in housing and tobacco prices. Consumer prices will rise in 2020 by 1.8 per cent in our forecast. Rising interest rates will boost inflation in 2020. Finland’s EU-harmonized inflation rate will eventually surpass the corresponding rate of inflation prevailing in the euro area during the forecast period after remaining below it until at least 2020.
Public finances will become balanced during our forecast period thanks to strong economic growth. Last year the public sector’s deficit was still 0.7 per cent of GDP. Government-related decisions on taxation and expenditures will increase the budget deficit slightly this year and next. On the other hand, previous freezes of indexed income transfers will continue to curb growth of public spending this year and next. The public sector’s budget deficit is projected to be 0.5 per cent relative to GDP this year and 0.3 per cent next year. The public sector’s financial position would reach zero per cent in 2020 according to our forecast.
The public-sector’s so-called Excessive Debt Procedure debt will fall to just around 60 per cent in our forecast this year. Next year the public sector’s EDP debt is projected to be 59.0 per cent and 57.9 per cent in 2020. In our baseline forecast, the public sector EDP debt will fall to 55.8 per cent of GDP by 2022. The central government’s budget will improve steadily in the next few years, but it will remain negative in our forecast until the year 2022. The surplus of social security funds will decrease from 1.2 per cent this year to 0.7 per cent of GDP by 2022. The trend is nevertheless very sensitive to changes in the value of GDP. There are unresolved issues related to major structural reforms, in particular social and healthcare reform and its impact on the financial position of the public sector. On the other hand, if implemented well, the structural reforms in the labour market can well improve the public sector’s financial position.
Finland clearly meets the 3 per cent limit for the public sector deficit. On the other hand, the structural deficit is estimated to be -0.4 per cent this year. It is estimated to grow to -0.8 per cent next year. In our forecast, the structural deficit exceeds the medium-term target level in 2019. As the deficit will nevertheless remain below 1 per cent and does not increase significantly, the EU-level criterion for structural deficit will also be met.
Based on the above, the Finnish economy will be somewhat above its potential output level in 2020. Potential output estimates are nevertheless known to be sensitive to the assumptions made and the methods used. The greater the difference between the potential GDP and the real GDP (negative output gap), the smaller the structural deficit is relative to the actual deficit.
More information: Head of Forecasting Markku Lehmus, ETLA, tel. +358-44-549 8455, email@example.com
ETLA Suhdanne 2018:2 (in Finnish)