High inflation slows down the economic recovery

At the beginning of the year, the Swedish economy was set for yet another year of dynamic growth, still recovering from the downturn of the pandemic. However, the Russian invasion of Ukraine changed this outlook dramatically. The EU sanctions against Russia and Belarus have only a small direct impact on the Swedish economy. In 2021, only 1% of all Swedish imports came from Russia and only 1.3% of its total exports went to it. The main impact comes instead from the export blockades, supply chain issues, and lower energy supply, which lead to a substantial increase in global prices, especially for energy and food. This pushed the yearly inflation rate in Sweden up to over 8% (and could even go higher), its highest level since 1991. The price pressures are eroding the purchasing power of private households. In 2021, their consumption had grown faster than their disposable income, which ate up some of their savings built during the first year of the pandemic. Furthermore, Swedish households invest a lot in financial markets, which have deteriorated lately. Together with rising interest costs, this will reduce their financial room for maneuvering. Some support is coming from the government, which temporarily reduced the fuel tax between June and October 2022. In addition, compensatory payments for car owners and electricity have been introduced in certain areas. Another stabilizing factor is the excellent shape of the Swedish labor market. The unemployment rate is still decreasing and has almost reached the pre-pandemic level. This gives the employees a better position when asking for higher wages. Nevertheless, this should not prevent household consumption from slowing down or even declining. To stabilize inflation expectations, the Riksbank has increased its policy rate by 75 basis points between January and July. For the rest of the year, more rate hikes - for a total of 125 basis points - are in the pipeline, with further to come in 2023, however, in smaller steps. Furthermore, Riksbank will reduce its asset holdings faster than formerly announced in the second half of the year. The sharply rising interest rates also caused trouble for private homebuilders with variable mortgages, as most mortgage contracts in Sweden have inconsistent interest terms. Since autumn 2021, house prices have decreased as fewer people can afford them. Due to the labor and construction materials shortage, construction costs increased noticeably in the last few years. Construction activity should therefore stabilize over this year instead of growing. Additionally, foreign trade will be slightly less favorable. Goods exports should increase slower due to supply-chain issues, trade barriers, and lower external demand. Nevertheless, foreign tourists should come back stronger this summer. While private investments should remain muted over the second half of 2022, some support will come from public investment as the government decided to implement a “reform package” of SEK 74 billion (0.9% of GDP) this year that includes investments into climate transition, digitalization and the strengthening of the welfare system. Some of these measures are combined with the EU Recovery and Resilience Facility that, includes disbursements for Sweden, worth 0.2% of GDP.

Almost back to a twin surplus

The country’s current account surplus should shrink slightly this year, as the decrease in the trade in goods surplus, linked to costlier imports, will not be balanced out by a higher trade in services surplus combined with higher investment revenues from abroad. The general government budget balance will remain in a slight deficit due to the slowdown of the economic growth dynamic and higher defense expenditures, and more robust household support measures planned. Still, the public debt should decrease further and remain very low.

First female Prime Minister sets Sweden’s NATO accession in motion

The Social democrat Magdalena Andersson is the first female Swedish Prime Minister. She succeeded Stefan Löfven towards the end of his four-year term in 2018, after his center-left-minority government broke apart in November 2021. After months of coalition fights, he stepped down and made room for his party colleague and former Finance minister Magdalena Andersson. Since then, Andersson is leading a social democratic minority government (the Social Democratic Party, SDP, has 100 seats out of 349 in the parliament). The government is passively supported by the social-liberal Centre Party (31 seats), the Left Party (27 seats), and the Green party (16 seats). The Russian invasion of Ukraine brought the first touchstone for the new government. Geopolitically, Sweden has had a long tradition of neutrality since the 19th century. Therefore, Sweden is one of the six EU countries not part of NATO but has had close relationships with the organization. Since the beginning of the invasion, public opinion has changed from favoring neutrality to joining NATO (parallel to the situation in Finland). 

Therefore, Sweden officially applied to join the organization on 18 May 2022, and NATO signed the accession protocol in early July 2022. Still, all NATO members’ parliaments must confirm this step, which could take up to a year. The confirmation is quite specific once Sweden finds a deal with Turkey (Sweden will lift its arms embargoes on Turkey and toughen their laws against Kurdish militant activists that Turkey sees as terrorists), which initially opposed this move. To avoid further escalation in the geopolitical tensions between the Nordic countries and Russia, Finland, and Sweden announced they would not host NATO bases or nuclear weapons on their territory. The next general election will take place on 11 September 2022. Andersson’s SDP is leading in the polls by 11 points ahead of the next party. Therefore, Andersson could remain in her office and build another center-left coalition.