Nordic outlook: Highly uncertain times

Denmark: Things can almost only get worse.
With low unemployment and strong activity, risks are to the downside.

Sweden: Stagflation but not recession.
Higher prices set to lower growth and send up interest rates, both moderately.

Norway: Pressures mounting, rates rising.
Strong growth has led to very little spare capacity and a need for tighter policy.

Finland: Eastern headwinds cool down the outlook.
Less trade with Russia has a significant impact.

The war is causing new challenges

Economies were heading for a new phase both globally and in the Nordics even before the Russian invasion of Ukraine. The recovery from the Covid-19 crisis is over in the sense that there is no longer elevated unemployment, but instead high demand and increasing inflation, meaning that growth has to slow. The war has further complicated the situation, especially by triggering higher and very volatile energy prices, which on the one hand reduces spending on other items, but on the other hand further increases inflation and constrains output. In some countries, such as the US, there is a clear need to dampen demand, while the picture is more nuanced in for example the euro area.

The Nordic countries have all come through the Covid-19 crisis with fewer scars than most other European countries, and have also all had strong recoveries, but they are nevertheless in somewhat different situations now. Finland has to some extent lost a significant trading partner, while the other Nordics only had very limited trade directly with Russia before the war. Consumers are feeling the effects of more expensive energy, but Nordic consumers tend to rely less on oil and natural gas and instead use more communal heating and electricity, and the prices of those items are to varying degrees decoupled from global energy markets. This means that the inflation shock is generally smaller in the Nordics, and hence also that the revisions to the growth outlook are generally smaller than in the euro area, again except for Finland.

Finding the right response

Uncertain times are difficult times for policy makers. Politicians struggle with how and to what extent to shield consumers from rising costs and in some cases boost spending on defence and refugees, while central banks must address rapidly rising inflation. Norges Bank already embarked on a rate hiking course in September and is clearly going to continue that. The situation is more complex for the Swedish Riksbank, which is also now facing high current inflation, but at the same time still has little indication that inflation is spreading to wages and hence becoming more permanent. For Denmark and Finland, monetary policy is set in Frankfurt. While Finland faces uncertainty over trade, the Danish economy is running rather hot compared to the euro area, which determines its interest rate because of the currency peg.

As small open economies, the Nordics are subject to the twists and turns of the global economy, but they are generally in a good position to handle the current uncertainty. Policy options remain available in case they are needed, and as we saw during the Covid-19 crisis, the Nordics can be quite resilient.

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