07-06-2021 10:55

Nordea's chief economist: "Expect a rapid economic recovery"

Helge J. Pedersen, chief economist.

The current state of the economy gives reason for optimism, we recently reported in our latest Economic Outlook. Chief economist Helge J. Pedersen comments on what this could mean in the long run: “The economic reboot will deliver solid growth over the next year, given that we come from very low levels due to the pandemic.”

Nordea’s economists expect a growth boom in the economy as vaccines are rolled out, the pandemic loses its grip and societies start to reopen

“We expect to see a degree of herd immunity where restrictions can be lifted and hotels, restaurants and traveling – all the service activities we’ve lived without for the past year – can resume,” says Nordea Group chief economist Helge J. Pedersen.

“That reboot will deliver solid growth over the next year, given that we come from very low levels due to the pandemic,” he adds.

Pedersen notes that the manufacturing sector, not hit by lockdowns, has continued to thrive over the past year. Expansionary economic policy has helped keep households’ purchasing power stable, supporting the demand for goods, and, in turn, manufacturing. Business confidence is also on the rise, which will drive investment activity, and further boost the manufacturing sector.

With the service sector also reopening, there is good reason for optimism, says Pedersen:

“We expect the world economy to be back at its pre-Covid-19 level in terms of economic activity by the end of this year, and the strong momentum we see now will continue into next year.”

An inflation comeback?

Expectations of a rapid recovery have even sparked concerns about inflation and rising interest rates – concerns Pedersen says are, to some extent, justified. Inflation is now surging, not least in the US, but that is largely due to so-called “base effects,” such as higher commodity prices and transport costs, Pedersen says.

“The big question is whether these price increases from the input side are temporary due to bottlenecks in the value chain or will turn out to be more permanent. I tend to see them as a temporary phenomenon,” he adds.

He does note that economic policy remains very lenient, particularly in the US, where the Biden administration managed to get a massive recovery package worth almost 10% of GDP through Congress and has proposed new major multi-year investment and family plans, which could further spur economic activity.

“We could see that inflation in the US could stay more persistently above 2%. If so, we would definitely see a reaction from the Federal Reserve, which is known to be a relatively active central bank,” Pedersen says.

He notes that the faster and sharper growth of the US economy, compared to the Euro area, could cause the interest rate differential to widen in favour of the US, which could have implications for the FX market, leading to a stronger US dollar versus the Euro.

However, he also notes that one consequence of the US’s highly expansionary fiscal policy is a sharp increase in the country’s debt-to-GDP ratio, which could have negative consequences in the long run for the US economy.

“We expect the world economy to be back at its pre-Covid-19 level in terms of economic activity by the end of this year, and the strong momentum we see now will continue into next year.”

Group chief economist Helge J. Pedersen

Listen to the full podcast with Helge Pedersen on the Economic Outlook 

Government debt worries

The dramatic increase in government debt during the coronavirus crisis is one thing that keeps Pedersen up at night.

“I am concerned about the development in the public debt in a number of countries during the pandemic,” he says. He points to Greece, where the debt-to-GDP ratio is over 200%, exceeding its level of around 180% during Europe’s sovereign debt crisis in 2012. Italy’s ratio has also risen sharply to around 150%.

The situation is only manageable as long as interest rates remain record low and central banks continue to hold the bonds on their balance sheets and finance the public expenditures. As soon as monetary policy normalises, the situation becomes unsustainable, Pedersen says.

“I’ve seen too many debt crises throughout my career to say this is something where you can just close your eyes and sleep with no fears or concerns,” he adds.

On the other hand, the public debt picture in the Nordics is completely different. Denmark, for example, came out of 2020 with the lowest government budget deficit of all EU countries. Only in Finland has the debt-to-GDP ratio surpassed the 60% limit set in the Stability and Growth Pact. But even there, it’s manageable, according to Pedersen.

Nordics the ‘global winners’

Pedersen says, thanks to their strong public finances, welfare model and robust IT infrastructure, the Nordics are likely to emerge from the coronavirus crisis as “global winners.”

The hospital systems generally haven’t been overburdened. The solid IT infrastructure has enabled working remotely as well as the shift from in-store shopping to e-commerce. The countries’ solid public finances have also allowed for generous government aid packages to keep the economies going.

“On both health and economic parameters, the Nordics have done really well during the pandemic,” Pedersen says.

One area that’s been running perhaps a little too hot is the housing markets, he notes. With financing costs record low, people’s mobility reduced and their purchasing power strong, housing markets have soared. However, Pedersen expects the heat to dissipate, as mobility increases and the high prices draw more sellers to the market, creating a better balance in housing supply and demand.

 

Top three downside risks

While Nordea’s outlook is quite optimistic, Pedersen does mention three main downside risks that cloud an otherwise sanguine picture:

  1. The pandemic itself

The outlook is predicated on the roll-out of effective vaccines.

“We could see new variants of Covid-19 emerge that aren’t responsive to the existing vaccines,” he says.

  1.  A geopolitical flareup

“There is a clear risk of geopolitical issues coming up again. We’re already seeing that now in the conflict between the Israelis and Palestinians,” he says.

  1. Higher-than-expected inflation

If the price increases from supply chain bottlenecks turn out not to be temporary, there could be second-round effects of wage increases in the labour market. Such a “price-wage spiral” could lead to high inflation and high interest rates.

“Such a situation could trigger financial market turbulence and could have a severe impact on both equity markets as well as housing markets,” he says.

I’ve seen too many debt crises throughout my career to say this is something where you can just close your eyes and sleep with no fears or concerns.

Economic Outlook
Markets and investment