Sweden’s recovery is close to complete, but challenges remain

Friday’s Swedish GDP data is likely to show that the economy came within a whisker of its pre-virus level during the second quarter.

In many ways that’s unsurprising – after all Sweden’s decision not to impose comparably harsh restrictions has helped limit the dip in economic activity. But the second-quarter bounce – likely to be a little shy of 1% quarter-on-quarter - also reflects a recovery in the harder-hit parts of the economy.

There has been a significant pickup in retail, recreation, and parks mobility data in all major cities since March. Meanwhile, Sweden’s Economic Tendency Indicator reached an all-time high this quarter, indicating that firms and households are optimistic about future developments in the economy. That should translate into a material improvement in the hospitality-related GDP, which as of the first quarter was still some 34% below pre-virus levels.

But despite the relative outperformance of the Swedish economy relative to some European peers, the outlook for the next few quarters looks much the same.

The Delta variant remains the biggest near-term threat, and while the current prevalence is lower than some other EU nations, the rate of increase looks remarkably similar. And while the bar in Sweden for fresh restrictions is probably higher than most, it’s worth remembering that voluntary caution from consumers poses an equal challenge to the recovery this winter.

Covid-19 is also potentially a minor spanner in the works for Sweden’s otherwise improving trade story. Closures in Asia and the subsequent impact on shipping and supply chains could potentially slow the recovery we’ve seen in Swedish exports. Shipments to Sweden’s top five trading partners are now substantially above pre-virus levels. The same is true of manufacturing production in general, which saw a sharp pick-up through the second quarter, in contrast to the likes of Germany and France where output has yet to fully recover from the pandemic and ensuing supply chain disruption.

Another familiar challenge in Sweden is the mismatch in the jobs market. This is a long-standing issue, but one that has been exacerbated by Covid-19.

Higher unemployment among low-skilled workers and immigrants has coincided with a shortage of highly qualified workers. That said, the tide of redundancies experienced last autumn has long since slowed, and in fact, we’ve seen a sharp increase in job openings in contact-intensive service sectors such as hospitality through the spring. The real question is whether this recovery in hiring will translate into higher wage growth. But wages are heavily influenced by a multi-annual negotiation - the latest of which didn’t result in a step up in pay growth.

For the Riksbank, the solid, if unexciting, outlook for GDP suggests there’s little need for fresh easing – and indeed we’ve long felt the bar for returning to a negative repo rate is still reasonably high. But a fairly benign inflation story for the next few years suggests that Sweden will be one of the latter countries to see interest rate hikes.

We don’t expect that to happen until 2024, as the Riskbank’s rate projection currently envisages.