Finland will also drift into a moderate recession at the end of this year, forecasts Etla Economic Research. Economic growth will slow down to two per cent this year and for next year is projected only zero growth. According to the forecast, exports will benefit from the recovery of service exports but at the same time private consumption stiffens as the prices of goods will increase. Inflation will remain high next year even though the increase of prices will slow down slightly.
Our forecast:
This year, the world economy will grow at a rate of 3.0 per cent and next year at a rate of 2.5 per cent. Economic growth is being curbed by Russia’s attack on Ukraine and its indirect consequences, tightening monetary policy and problems in China’s economy. The sanctions imposed as a result of the war is cutting the growth of Russia (and Belarus) in particular, but also the rest of the world. The euro area suffers more than many other economic regions.
Russia’s attack affects economic development through at least three mechanisms: increasing uncertainty, accelerating inflation and trade disruptions. More significant than the effects of the decrease in trade in goods are the consequences of a decrease or even complete cessation of Russian gas imports in Europe.
In many developed countries the economic picture is very similar: the beginning of the year has been moderately good, but clearly weaker development is expected for the rest of the year. The United States, however, drifted into a technical recession already at the beginning of the year, when GDP shrank for two quarters in a row. More than the war in Ukraine, the United States is affected by the strongly tightened monetary policy. We predict that the US economy will grow by 2.5 per cent this year and by only 1.4 per cent next year.
On the other hand, the probability of a recession in the euro area is high at the beginning of next year. The current year’s growth figure reflects the still weak base of comparison at the beginning of last year. We predict that the economies of the euro area will grow by 2.6 per cent this year and 0.8 per cent next year. Britain’s growth will also be weak in the summer of 2022 as inflation, which has already risen to more than 10 per cent, drastically cuts the purchasing power of households.
The forecast for the euro area and the rest of the world is subject to greater uncertainty than usual, as one can only attempt to predict the course of the war and its indirect consequences in general terms. It seems that Russia is nevertheless ready to use its gas exports as a weapon against the EU’s economic sanctions, which would have a drastic impact on economies like Germany that use a lot of Russian gas. Germany is already teetering on the brink of recession due to component supply problems in manufacturing and rapidly rising prices. It is very likely that Germany will drift into recession this year. The countries of southern Europe, on the other hand, will benefit from tourism that has recovered after the corona pandemic for at least this year, but they will also suffer from the indirect consequences of the war, such as the acceleration of inflation and deterioration of export demand.
The “Next Generation EU” recovery instrument agreed by the EU in 2020, from which EUR 390 billion in direct support and EUR 360 billion in loan-based support is distributed to the member states, is hastening the green transition of the member states and thus also supports the energy challenges of the escalating Russian crisis, even though the money is primarily allocated to the southern EU member states. Because of Russia’s actions, several European countries are also increasing their defence budgets. In addition, the wave of refugees from Ukraine increases public spending in many EU countries, although it increases their GDP in a slightly longer term.
According to our forecast, China’s economy will grow by 3 per cent this year and 4 per cent next year. China’s economy has not been able to recover in a steady fashion this year, as the country’s zero-covid policy has driven the administration to use lockdowns in large population centres, the most famous case perhaps being the one declared in Shanghai in the spring. Concern has also been raised by the country’s bloated real estate sector, which is indebted and inefficient, but accounts for about a third of the country’s GDP. The liquidity problems that started with real estate giant Evergrande are also feared to spread to the entire economy. The central government has great difficulties managing economic growth, on the one hand, and the problems caused by over-indebtedness and inefficiency, on the other.
A key driver of the global economy, in addition to the war and the slowdown in China’s economic growth, is the tightening of monetary policy in several pivotal economies. With inflation soaring in the United States between 8 and 9 per cent when this is being written, the Federal Reserve will raise its key interest rates several more times this year, according to our forecast to a range of 3.25 to 3.5 per cent by the end of this year. Next year, the Fed is anticipated to raise its key interest rate once more by 25 basis points.
The ECB has also had to accelerate the pace of its interest rate hikes as inflation has repeatedly been broader and higher than forecast. Inflation in the euro area also accelerated to almost 9 per cent in the summer. We expect the ECB to raise its key interest rates twice more this year and to continue raising them at the beginning of next year as well, despite the risk of a recession.
Finland’s gross domestic product grew by 3.0 per cent last year, according to preliminary National Accounts data. Private consumption grew by 3.6 per cent. Both exports and imports grew by 5.6 per cent. Investment increased by 1.1 per cent.
We predict that Finland’s total production will grow by 2.0 per cent this year. The growth figure has thus been revised downwards by only 0.1 percentage points from our forecast last March. Net exports will contribute negatively to Finland’s growth this year. Private consumption will boost Finland’s economic growth this year, but next year the growth rate of private consumption is projected to be zero.
According to our forecast, exports will grow by slightly under 1 per cent this year and slightly under 5 per cent next year. Investment will grow by more than 3 per cent this year and by less than 1 per cent in 2023. Private consumption will increase by more than 2 per cent this year as the consumption of services recovers. For next year, we predict zero growth for private consumption. In 2024, we expect Finland’s GDP to grow by 1.7 per cent, which is close to Finland’s potential output growth rate.
We estimate the production gap to be -0.7 per cent this year, so the Finnish economy is below its potential output level. Next year, the production gap will be even more clearly negative. This is primarily a result of the indirect effects of Russia’s actions on the Finnish economy.
We predict that the volume of exports will grow by only 0.8 per cent this year. Exports of goods will shrink by 0.1 per cent due to the slowing growth of international export demand, the decrease in Russian exports as a result of the war of aggression in Ukraine and a long strike at UPM (Finnish Forest Industry Company). Due to the strike, the export of the forest industry will weaken significantly this year. Despite the Russian sanctions, exports of the electrical and electronics industry and machinery and equipment are increasing somewhat. We have lowered the service export growth forecast to slightly under 3 per cent, because tourism from abroad to Finland was clearly lower than expected in the beginning of the year.
Next year, the volume of exports is predicted to grow by 4.6 per cent thanks to service exports. International export demand will weaken compared to this year, meaning that the export of goods will increase by about one per cent. The paper industry’s strong growth rate is the result of this year’s strike. The export of services is estimated to grow by approximately 13 per cent next year. For the year 2024, we expect export growth of 4.8 per cent. As the international economy recovers, the export of goods will increase by more than 3 per cent.
Investment is predicted to grow by 3.1 per cent this year. The growth is spurred, in particular, by the pronounced increase in residential construction. Residential construction is predicted to grow by 6.5 per cent.
In 2023, investment growth will slow down to slightly under one per cent. Residential construction will shrink by 3 per cent. Industrial investment will continue at a steady pace, bolstering the growth of machinery and equipment investment throughout the forecast period. The investment rate will remain stable in the forecast period.
The number of employed people is expected to grow by around 38,000 this year. The growth of the labour force was a positive surprise last year, but this year the rate of expansion will slow down. Thus, the unemployment rate will fall to 6.7 per cent this year. The employment rate is predicted to rise to an average of 73.7 per cent this year. The availability of skilled labour and the so-called labour bottlenecks have become bigger obstacles to employment growth than expected.
Next year, employment will grow only slightly as the economic situation weakens again. The unemployment rate will rise slightly to 6.8 per cent. Labour force growth will continue to slow next year. The employment rate is expected to remain at 73.8 per cent next year.
Growth in nominal earnings and other income as well as the upturn in employment will boost private consumption this year despite high inflation. In addition, the growth figure for the whole year is increased by the so-called carry over of growth from last year. The savings rate will decrease and households will spend their previous savings, although the possibilities for this vary considerably for different households. Rapid inflation eats away at real household income and the real wage bill will also decrease this year.
Private consumption is predicted to grow by 2.2 per cent this year and remain next year at the current year’s level. We estimate that private consumption will contract towards the end of this year and start to grow again only in the second half of next year. Since the growth carry over for next year will remain negative, private consumption will not grow on average next year. At the same time, the combined savings rate of households and non-profit organizations serving households will continue to decline slightly next year and will turn negative in 2024.
In 2024, private consumption will increase by 1.6 per cent in our forecast, when real purchasing power starts to increase again. According to our forecast, the nominal earnings level will rise by 2.4 per cent this year and 3.2 per cent next year. In 2024, earnings will increase by 2.8 per cent.
Consumer prices are predicted to climb by 6.8 per cent this year. Above all, inflation is spurred by the upswing in housing, transport and food prices. The rise in energy prices plays a very significant role in inflation, both directly and indirectly. In addition, there is an exceptional increase in prices, e.g. in materials related to home repairs and in consumer durables. In addition, the rise in market interest rates has started to increase mortgage interest rates for the first time in a long while, which will be clearly reflected in the housing price basket this year and next year. Next year, the rise in consumer prices will slow down appreciably, but its rate of increase will continue to be almost four per cent, because even though price inflation will cool down in broad terms, the so-called carry over of price hikes from this year will remain high. In 2024, consumer prices will rise by an average of 1.6 per cent in our forecast, as the downturn in the raw material price cycle is estimated to be reflected in consumer prices.
In the short term, the price of energy, especially electricity, creates risks for the inflation forecast. In the medium term, there is a risk of faster-than-expected wage inflation, which would increase companies’ costs and boost consumer prices and thereby simultaneously erode real earnings and Finland’s international cost competitiveness. In the current forecast, cost competitiveness will remain unchanged and may even improve slightly next year.
Last year, the public sector deficit was 2.7 per cent of GDP. Discretionary fiscal policy was expansionary last year, and some of the decisions made will affect this year as well. The acceleration of the rise in consumer prices and the economy’s recovery from the pandemic will spur increased tax revenues for the public sector, which will bolster the financial position of the public sector even this year. Despite the favourable economic situation, the public sector will continue to run a deficit of around 1.1 per cent this year. Due to slowing economic growth and the government’s discretionary actions, we predict that the deficit will rise to 1.8 per cent of GDP next year.
Public sector debt in relation to GDP will continue to decrease this year. We predict it will drop from 72.3 per cent last year to 71 per cent this year. We nevertheless predict that the debt ratio will rise again to 71.6 per cent next year and to 71.7 per cent in 2024. The general rise in prices will significantly affect the development of the public debt ratio.
The structural financial position of the public finances will improve this year, but it will weaken again next year. We estimate the structural deficit will be 0.8 per cent relative to GDP in 2022 and -1.0 per cent in 2023.
As a result of the exceptional economic conditions caused by the coronavirus, the European Union has introduced a general escape clause to the EU’s financial policy rules. Based on that, the rules currently do not limit the fiscal policy of the member states. At the moment, the developments in 2022 and 2023 do not indicate a return to the medium-term goal, i.e. a level at which the structural deficit should not exceed half a per cent of the level of potential production. It seems that the structural realignment of fiscal policy is going to be left for the next government to undertake.
