Expected economic recovery requires continued growth in private consumption

Domestic consumption was strong at the beginning of the year, pulling GDP into slight growth, even though exports and investment remained in a slump. The expected economic recovery for the rest of the year requires continued growth in private consumption, but weak consumer confidence, the VAT increase and possible lower-than-expected rate cuts could dampen the recovery.

Finland’s GDP grew by 0.2% in the first quarter of the year. However, year-on-year growth in total output was still more than 1% in negative territory. The evolvement of demand factors was very polarised at the beginning of the year. The strong recovery of domestic consumption supported the economy, but exports and investments contracted sharply.

“Private consumption has been expected to be the key driver of the economic cycle, and we have now had the first taste of this. However, there is still a lot of uncertainty about the outlook for the household sector. Consumer confidence is still exceptionally low, and the threat of unemployment has increased”, says MuniFin’s chief economist Timo Vesala.

“Expectations of rate cuts by the European Central Bank have also waned in recent months, and the debt burden on borrowers seems to be easing more slowly than hoped. In addition, the increase in the general VAT rate, which comes into effect in September, will inevitably slow down the recovery of purchasing power”, Vesala continues.

Despite the frictions, a hesitant turn for the better is already on the horizon. Growth in the eurozone and the global economy is strengthening faster than expected, which is brightening the outlook for exports.

However, the speed of recovery of the Finnish economy is now exceptionally dependent on the ECB’s monetary policy. A significant decline in interest rates would support both consumption and investment.

Although the recession is slowly waning, MuniFin estimates that GDP growth for the whole of 2024 will remain negative by 0.5%. Next year, growth will be driven by a broad-based recovery in demand factors. Towards the end of the forecast period, green transition investments and the recovery of the construction sector will maintain growth momentum. MuniFin expects GDP growth to reach 2.0% both in 2025 and 2026.

The construction sector’s woes and the general increase in bankruptcies will keep unemployment on the rise for some time. MuniFin’s forecast for the average unemployment rate in 2024 is still 8.0%. Unemployment will only turn more clearly downwards in 2025, when it will fall to 7.5% and in 2026 to 6.8%.

Inflationary pressures have eased in Finland clearly faster than in the rest of the eurozone, but the VAT increase will push up prices at the end of the year. There will also be a technical jump in inflation in early autumn, when the impact of a calculation error in the electricity price index is removed from the figures for the comparison period. MuniFin therefore raises its inflation forecast for 2024 to 2.4%.

Falling interest rates expected to spur Finnish economic recovery

Finland’s GDP growth was weaker than expected last year, and 2024 has also started sluggishly, marked by industrial action. Therefore, MuniFin has slightly lowered its GDP forecast for the current year. However, consumption, investment, and exports are expected to recover next year.

Timo Vesala, Chief Economist at MuniFin, assesses that economic growth has been subdued for a long time, but the seeds of growth are beginning to accumulate.

“Monetary policy tightening has had a significantly greater impact on the Finnish economy than on peer countries. For Finland, it would be crucial for interest rates to start turning clearly downwards. Lower interest rates would support consumer confidence and help to kick-start the frozen housing market,” says Vesala.

In recent months, expectations of monetary policy easing have shifted somewhat further, but interest rates are expected to start falling this summer. Lower financing costs would also boost industry investments, and the recovery of the international economy will eventually provide tailwinds for Finnish exports.

Unemployment forecast weakened

MuniFin has weakened its forecast for unemployment. The average unemployment rate is expected to rise to 8.0% this year but fall to 7.5% next year.

“Compared to the weakness of GDP growth, employment has held up surprisingly well, but hours worked in the economy have already started to decline, which may indicate a broader deterioration in the labour market” says Vesala.

MuniFin has also lowered its GDP forecast for 2024 by 0.2 percentage points.

“Our view of this year’s economic trends in Finland has not changed significantly: the beginning of the year is still challenging, but the economic recovery will strengthen towards the end of the year. However, 2024 started from a clearly lower GDP level than we previously estimated, and the tense labour market situation has deepened the economic difficulties in the beginning of the year. Therefore, we have lowered our growth forecast for the current year to -0.5%. Next year, we expect a broad-based recovery in consumption, investment, and exports. We keep our GDP forecast for 2025 unchanged at 2.0%,” Vesala explains the change.

Vesala points out that the economy may grow faster than forecast next year if all the pieces of recovery fall into place already at the end of this year. However, there are also downside risks to the economy, particularly regarding the employment outlook.

The economy may recover quickly in 2024, but negative risks to the economic outlook are also increasing

The recession will persist in Finland through the winter, but recovery is expected to begin in 2024, driven by domestic demand.

In the latter half of this year, the Finnish economy is heading towards a recession. GDP declined by 0.9 percent in the third quarter. Consumer confidence and business sentiment indicators have remained exceptionally low throughout the autumn, suggesting that the economic contraction is likely to persist into the final quarter of the year.

The economic development in the fall has, broadly speaking, followed MuniFin’s expectations. However, due to data revisions, MuniFin is lowering its GDP forecast for the current year to -0.5%, compared to the previous forecast of -0.3% in September. Meanwhile, GDP projections for the next few years remain unchanged at -0.3% for next year and +2% for 2025.

“The combined negative impact of factors burdening the economy will be strongest during this winter. We expect a positive turn to occur around the middle of next year”, says Timo Vesala, Chief Economist at MuniFin.

The unemployment forecast remains unchanged, despite the employment situation worsening slightly more than expected this year. On the other hand, consumer price inflation seems to be slowing down somewhat faster than MuniFin’s previous estimates. According to the new forecast, the average inflation rate for 2023 is still expected to reach 6.3%, but it will decrease to 2.0% next year and 1.7% in 2025.

“While changes to macroeconomic forecast figures are mostly technical adjustments, the risks to the economic outlook have increased. The final depth of the recession in the construction sector and its potential spillover effects on other industries are difficult to assess, and there is still uncertainty regarding the inflation outlook in the eurozone”, Vesala assesses.

“On the other hand, a recovery faster than our baseline forecast is entirely possible. In the best-case scenario, a decline in interest rates could strengthen demand more significantly and broadly than expected, leading to an unexpectedly sharp economic upturn.”

Next year’s GDP forecast down, but green transition provides potential for growth

MuniFin’s economic forecast anticipates a challenging year ahead, with the abrupt slowdown in housing construction exerting a drag on Finland’s economic growth. The route to recovery lies in supporting the sources of growth, and we must seize the opportunities offered by the green transition.

MuniFin has revised its forecast for next year’s economic growth downward by nearly one

percentage point. In the economic forecast published in June, MuniFin projected Finland’s GDP to grow by 0.5% in 2024. The just published September forecast predicts a decrease of 0.3%. The main factors explaining this change are the steep slowdown in housing construction and poor-performing exports. 

“The construction sector is particularly affected by the increase in interest rates and material costs, as well as the stagnation in housing sales. There have been numerous bankruptcies, and the industry is a significant employer. The ripple effects of the downturn in the construction sector are expected to be most pronounced in 2024”, according to MuniFin’s Chief Economist Timo Vesala. 

MuniFin does not predict a deep or prolonged economic recession. It is also expected that unemployment will only rise moderately. 

“Fortunately, the purchasing power of wage earners is starting to rebound, and the peak in interest rates is also on the horizon. However, inflation is proving to be so persistent that we should not expect significant interest rate cuts from the European Central Bank just yet”, Vesala assesses. 

The green transition provides the seeds for growth 

According to MuniFin’s forecast, achieving economic balance requires productivity improvements and new sources of income. The challenges facing public finances cannot be resolved solely through savings and cutbacks. Fortunately, behind the challenging economic outlook, there are also signs of potential growth. 

“Investments of around EUR 140 billion are being planned for the green transition in Finland. It is likely that only a portion of these projects will come to fruition, but even a few percent would provide a much-needed boost for both the national economy and municipalities”, according to Esa Kallio, President and CEO at MuniFin.

The forecast also reminds us that the realisation of these investments necessitates a significant expansion of renewable energy production, requiring investments in electricity transmission capacity and energy storage. 

If these investments set off a positive cycle, economic growth could accelerate considerably more than expected. In the best-case scenario, the economy could achieve growth rates in the latter half of the decade that haven’t been witnessed as a sustained trend since the financial crisis, reflects Vesala. 

Tighter financial conditions pushing the economy into a mild recession

MuniFin has revised its growth forecast for the year 2024 by one percentage point to 0.5 percent and predicts a slight increase in unemployment. MuniFin maintains its GDP forecast for the current year at -0.5 percent.

According to the latest statistics on national economy, Finland’s gross domestic product grew by 0.2% in the first quarter of the year. This marks an end to the economic contraction of the previous six months, but growth prospects are looking weak, notes Timo Vesala, MuniFin’s Chief Economist.

The historically rapid tightening of monetary policy will truly begin to reduce demand this year. The rise in financing costs is already shaking the economy’s most interest-sensitive sectors, such as the real estate market and construction. The sharp contraction in construction investments will significantly cut GDP growth this year and the next.

Wage earners’ purchasing power has fallen back to 2009 levels

Economic outlook is affected by private consumption, which is currently in a downright anaemic state. According to Vesala, rising living costs have put many households in a tight spot, eroding consumer purchasing power.

“Real earnings have fallen back to levels last witnessed 14 years ago. The increases in purchasing power gained after 2009 have been wiped out in a short time, and no quick recovery is to be expected. Households likely still have some leftover extra savings from the period of the COVID-19 pandemic, but at some point, consumers will reach a limit.”

MuniFin lowered its growth forecast for 2024 by one percentage point to 0.5% and predicts a slight rise in unemployment. The GDP growth forecast for 2023 remains unchanged at -0.5%.This cold shower on the economy will also cool down price pressures.

According to Vesala, food prices will probably take a downward turn after a period of rapid increases. The falling demand will also ease inflationary pressure.

Inflationary pressures are gradually easing

Inflation has been running at a faster pace than expected in the early months of the year. Fortunately, food prices may be turning downwards after a rapid period of increase. Additionally, cooling demand will dampen inflationary pressures.

However, the realized price increases in the current year have been significant enough for the average inflation rate for 2023 to reach 6.0 percent. In the following year, consumer price inflation will slow down closer to normal levels, reaching around two percent.

High employment continues to support the economy

The labour market situation has remained surprisingly strong despite the headwinds in the economy, and there are still few signs of weakening, unless one counts the slight increase in the number of furloughed workers or the slight decrease in job openings.

The number of employed individuals, the employment rate, and the total hours worked are all either at or near record levels. The robustness of the labour market is partly indicative of a chronic labour shortage, which is indeed the primary factor restricting the long-term growth potential of the economy.

Despite structural labour availability issues, the economic downturn will inevitably weaken overall employment to some extent and lead to a slight increase in the unemployment rate. Unemployment is expected to rise particularly in sectors connected to the housing market and construction.

Cost pressures put a strain on households and municipalities alike

Rapidly rising interest rates are hitting households hard and putting real estate business and construction firmly on hold. On the other hand, the declining price of energy, the unexpectedly strong economic development in the euro area and promising signs of Asian exports picking up are lending support to the Finnish economy. MuniFin maintains its GDP forecast unchanged at -0.5% for 2023 and 1.5% for 2024.

Finland’s economy slid into a technical recession in the latter half of 2022, with demand taking a broad turn for the worse in the final quarter. A particularly steep downhill was experienced in exports and investments.

“Russia’s war of aggression and its resulting effects seem to have hit Finland’s economy harder than euro area economies on average. The weak development of net exports, the rising cost of living and the rapid interest hikes are whittling away at growth prospects”, says MuniFin’s Chief Economist Timo Vesala.

The unpredictable inflation development is causing uncertainty in the outlook in monetary policy and economy.

“The latest inflation figures again exceeded all expectations. The European Central Bank may have to hike its interest rates much more than it seemed at the start of the year”, Vesala notes.

MuniFin revised its inflation forecast for the current year from 4.5% to 5.0%. In 2024, we expect inflation to decrease to 2.3%.

MuniFin also projects how inflation, interest hikes and the aftermath of Finland’s recently implemented health and social services reform will reflect on the development of Finland’s municipal sector. MuniFin’s calculation of the pressures on municipal finances take into consideration the rising inflation and interest rate costs and it indicates that starting from 2024, the municipal finances will weaken more that the municipalities themselves have predicted.