Riksbank risks another hasty retreat 

Robert Sierra - 10 May 2017

In 2010, against the grain of the US Fed, ECB and the Bank of England, the Riksbank decided that the time had come to lift interest rates from their post-GFC lows and over the course of the following year the policy rate reached 2 per cent. Its motivation for the hikes was to discipline exuberant asset price growth and rising household leverage. Soon after, the Swedish Krona appreciated and the inflation rate plunged into negative territory, bringing an embarrassing reversal of monetary tightening. Today, despite ongoing house price appreciation and no reversal of household leverage, the Riksbank still has no appetite for rate increases.

Sweden’s economy is running hot, household indebtedness is still climbing, the housing market is frothy and the currency is generally thought to be undervalued, post the 2015 depreciation. The Riksbank’s reaction? To ease monetary policy still further, of course! Not only has the Bank held its repo rate at negative 0.5 per cent for the past 2 years, it has also bought, via its QE programme, almost half of the SEK650bn Swedish government bond market. A further purchase of SEK15bn was made in April. Is the Riksbank so chastened by the failed 2010 tightening that it risks having to beat another hasty retreat? This time it would entail a belated tightening rather than a premature one.

Like the train that never comes, Sweden’s underlying inflation has been dormant for the past six years stubbornly failing to shift from its prolonged slumber. It is this adherence to the inflation target of two per cent that has led the Riksbank to adopt a very loose monetary policy stance to the exclusion of other considerations. Keeping the Krona sufficiently weak to engineer an upswing in inflation has been the Bank’s stated aim even if the currency’s weakness is “not really logical”, to quote the country’s finance minister. Last month, the Riksbank pushed out the likely timing of its first rate rise by another six months to mid-2018. 

The Bank stands ready “to make monetary policy more expansionary” if the upward trend in inflation were to be threatened. The upshot of this loosening has been a tripling of national real house prices and a six-fold rise in Stockholm apartments prices since 2000; rapid population growth and a property supply shortage don’t help either. Growth is also firing on all cylinders. Recent projections by the finance ministry will see the economy expand by 2.6 per cent this year and a further 2.1 per cent in 2018 from previous growth forecasts of 2.4 per cent and 1.8 per cent in December. The government also plans to generate a budget surplus every year of the current parliament from 2015 until the next general election in late 2018.

Such exuberance was not always the norm. The Swedish banking system was heavily regulated by a comprehensive set of controls of domestic and cross-border flows of credit until 1985 with the Riksbank holding the total volume of credit roughly at a constant level relative to GDP. In the second half of the 1980s financial deregulation changed the benign landscape and the previously stable credit ratio took off in earnest creating the boom-bust cycle of 1986-94 that resulted in a sharp contraction of the economy. The recession forced the Riksbank to abandon the pegged exchange rate and to introduce the current inflation target of 2 per cent.

But as the economy recovered in the mid-1990s following the earlier banking-housing crisis, total credit-to-GDP doubled between 1995 and 2008 while household debt-to-income surged to 180 per cent by the end of last year. To put this into context, Sweden´s ratio exceeds the peak in the US at the start of the financial crisis and is currently at the same level reached by the UK in 2008.

Sweden’s failed attempt to use interest rates to rein in a credit and asset price boom led to the adoption of macro-prudential policies, outsourced to the Finansinspektionen.  These actions have so far proved largely ineffective.  Time is running out for the negative interest rate and QE regime: the re-emergence of inflation could send Riksbank into a belated tightening cycle and a painful reality check for its overindebted consumers.

Data Source: Riksbank and BIS


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