Tallinn - A recent Nordea Bank AP report sees more trouble ahead for Latvia and Estonia, predicting two years of economic contraction for the countries.
It goes on to warn that private consumption will be hit hard as a weakening housing market and high rates of inflation erode purchasing power. The Estonian economy started to cool down last year in step with the easing of the domestic credit boom.
"Private consumption is expected to decline this year. We also expect investment to fall markedly in 2008 as construction loses steam," Anssi Rantala chief analyst wrote in the report.
Rantala did put in a note of good news despite soaring inflation prices. "We expect inflation pressures to ease gradually, as the substantial commodity and food prices increases are over now and wage hikes will be moderated by a softening labor market," Rantala said.
According to the Nordea report, the Latvia economy has been growing way too fast during recent years. "The boom, fuelled by strong credit growth, cannot continue forever," Rantala said.
Nordea forecast Latvia's GDP to fall slightly throughout 2008 and 2009. In 2010 the economy will start to expand slowly as the international upturn starts, the housing market stabilizes and consumer spending gradually gains strength.
Nordea believe that Latvia is in for some long-term hard times as the economy will grow way below its potential for a few years as people wean themselves off of cheap credit and get used to living within their means.
Rantala said that the persistent inflation that Latvia has seen in recent times may be a threat to the peg of the Latvian currency to the euro.
Inflation reached almost 18 percent before turning down in the summer.
"We expect that the steep economic slowdown will help to keep inflation falling. â€¦ If the slowdown proves considerably deeper than expected â€¦ then the currency peg would be threatened and devaluation could be used in a desperate attempt to save the economy from a total crash," Rantala said.
The economic slowdown has hit all the Baltic countries due to stronger inflation and higher interest rates. There are also clear signs that the unemployment rate will raise in future after several years' downtrend.
Nordea's economists have lowered their forecast of coming years' economic growth in the publication Economic Outlook, published Tuesday. The U.S. slowdown coupled with a European currency at its strongest level ever has hit the European export sector hard, and a similar trend is evident throughout most of Asia.
At this juncture it has also become clear that there is no decoupling the U.S. economy from the rest of the world's.
"The credit crisis is not yet over and the housing markets in many countries are in serious trouble, which impacts the outlook for both private consumption and investment activities, and it is evident that we can expect a relatively long period with subdued growth 's also in the Nordic countries," Helge J. Pedersen, global chief economist at Nordea, said.
THE BIG PICTURE
Nordea predicts the slowdown will affect the whole of Northern Europe. The outlook for the Finnish economy has weakened further.
This time the reason is not merely the duller export outlook; the domestic economy is also directly hit by the inflation spike and high rates.
Overall, we estimate that economic expansion in Finland will slow to well below the average level as early as the second half of 2008, and a recovery cannot be expected until 2010. Still, the Finnish outlook is fairly reasonable compared to many other countries.
Overall, the macroeconomic balance is in good shape and the housing market has been more stable than elsewhere in the Nordic countries. Nonetheless, the risks related to economic growth are distinctly higher than before.
The Swedish economy came to a halt in the first half of 2008 and next year will only show very slow growth before a recovery will take place during 2010. Employment has risen sharply during the past few years, but layoffs have started to pick up and employment growth is now slowing.
Nordea expect employment to decrease somewhat over the next years, while unemployment is seen picking up. Inflation has been boosted by rising prices of energy and food, but with stabilizing prices of oil and other commodities, inflation is expected to fall going forward. Nordea expect inflation to reach the 2 per cent target by summer 2009. With falling inflation, slower growth and a less tight labor market we expect the repo rate to be lowered to 3.50 per cent.