The combination of rising inflation and the monetary tightening to combat it led the Swedish economy into recession. Declining household consumption and residential investment were the main drivers. Although the situation is not expected to deteriorate further in 2024, this does not mean that a dynamic recovery is to be expected. However, although Sweden is experiencing significant difficulties, it still has many assets to support activity in the medium term.
In line with our expectations, the Swedish economy entered recession in the third quarter of 2023. Real GDP contracted (-0.3% q/q) for the second consecutive quarter (-0.8% q/q in Q2). Real GDP stands therefore at its lowest level since the end of 2021. However, the preliminary monthly data we have for Q4 2023 suggests a slight improvement during this quarter (1% m/m increase in GDP in October and 0.2% m/m in November). On the other hand, the possible recovery over the next few quarters is expected to be modest and growth is likely to be close to 0% for the entire year in 2024 due to still constrained demand.
A sustained fall in inflation
GROWTH & INFLATION Riksbank governor Erik Theeden recently said that he did not consider it necessary to raise the policy rate further, which currently stands at +4.0% (+400 bp between April 2022 and September 2023). This change in direction is due in particular to the significant reduction in inflation measured by the CPIF (Riksbank benchmark index, at a constant interest rate) in the second half of 2023. Inflation fell from a peak of +10.2% y/y in December 2022 to 2.3% a year later, with the process accelerating beyond central bank and consensus expectations in recent months. This acceleration has been made possible in particular by the easing of pressure on energy prices, combined with less rigidity in core inflation (+5.3% y/y in December 2023). The CPIF is expected to return to its target of +2% y/y by mid-2024, which, combined with sluggish activity, could lead to the central bank cutting rates for the first time as early as Q2 2024, despite the hawkish bias currently being maintained. In addition, while the weakening of the national currency, which reached its lowest-ever level against the euro in September 2023 (EUR 1 = SEK 11.95 on 15 September 2023), complicated the Riksbank’s task of combating inflation by fuelling imported inflation, the krona's positive performance at the end of 2023 contributed to the positive disinflationary surprise.
Sweden stands out for the speed with which the combination of rising general price levels and interest rates have weighed on household consumption. This component of GDP has contracted for six consecutive quarters, reaching its lowest level in more than two years. In addition to the loss of purchasing power caused by inflation, this marked decline in household consumption can be explained by the country's structural characteristics. Swedish households have one of the highest levels of debt in the world (196% of disposable income in 2022 according to the OECD dataset) with a predominance of variable-rate mortgages - more than half of all mortgages have a rate that changes every three months. This exacerbates the sensitivity of demand to monetary policy decisions. The process of disinflation and possible rate cuts could therefore help to reduce the pressure on household consumption prospects in 2024. Developments in the labour market have also contributed to the weakening of consumption in 2023, with an increase in the unemployment rate (7.9% in November 2023, +0.6 pp y/y) likely to continue in 2024. However, this must be set against the increase in the participation rate, which is now above 75%, highlighting a structural improvement (71.8% on average over the previous decade).
Two-speed investment
Like household consumption, Swedish residential investment has deteriorated significantly under the impact of monetary tightening. As measured by the national accounts, it has contracted for five quarters in a row, reaching its lowest level since Q1 2017. The parallel deterioration in housing starts is almost unprecedented, with the exception of the systemic crisis in the early 1990s and the 2008 financial crisis: their number has been divided by more than 4 between Q1 2021 and Q3 2023. As for housing prices, they started to fall at the end of 2022, culminating at -12% y/y in Q2 2023, but the shock has eased over the course of 2023. However, while it is now plausible that housing prices and housing starts have bottomed out, future developments - i.e. the likelihood and strength of a potential recovery - remain uncertain.
On the other hand, it should be noted that the non-residential component of investment has continued to show strength despite the slowdown in activity and monetary tightening. Productive investment has continued to grow, and in Q3 2023 was 24% above its pre-pandemic level (33% for intellectual property products). This is a definite asset for the national economy and is indicative of an underlying dynamism that should have a positive impact on the country's potential output.
Finally, although Sweden’s budgetary situation is particularly favourable, as illustrated by a public debt and deficit estimated at 30.5 and -0.1 points of GDP respectively in 2023, there is no question of introducing a major countercyclical policy despite the sluggish production expected in 2024. Although the government is forecasting an increase in the public deficit to -0.7% of GDP in 2024, against a backdrop of lower tax revenues, the Minister of Finance, Elisabeth Svantesson (centre-right), recently publicly reiterated her commitment to a prudent fiscal policy that does not contradict the restrictive approach of its monetary counterpart.
Article completed on 15 January 2024
