Sweden: Riksbank maintains policy rate in July amid uncertainty over Brexit
July 5, 2016
The results of the 23 June Brexit referendum drove the financial world into turmoil in the days following the vote. Although the medium- to long-term effects of the Brexit results and the uncertainty over what they mean for the UK, the EU and the global economy, are difficult to discern, the Riksbank considered it necessary to maintain its accommodative policy stance in order to shield Sweden from adverse effects of the vote. At its 5 July policy meeting, the Riksbank decided to hold its repo rate at the record low of minus 0.50% and postponed the future interest rate hikes it had planned.
The Riksbank is unsure of what the effects of the Brexit will be on Sweden. Considerable uncertainty has followed in the wake of the Brexit, the UK does not appear to have an exit strategy and a leadership void has appeared in Westminster. It is highly likely that the UK will experience slower growth stemming from this uncertainty. The Riksbank pointed out that UK households and companies will become more cautious and hesitant with regards to investment and consumption. Higher risk premiums, lower interest rates and lower credit growth will hurt banks, both in the UK and Europe. This could have a negative impact on demand for Swedish goods and services. Direct trade between the UK and Sweden may be affected as well. The Bank felt that these factors warranted a 0.- percentage-point cut to their 2016 GDP growth forecast and a 0.5-percentage-point reduction for 2017 (the Bank’s forecasts are now 3.6% and 2.2%, respectively). The decision to hold the repo rate at its historic low is an attempt by the Bank to mitigate negative effects of the Brexit.
Aside from concerns over Brexit, the Riksbank is still faced with its long-standing inflation predicament. Inflation has been below Riksbank’s 2.0% target for nearly five years, and at every policy meeting since 2011 the Bank has pushed back the date by which it expects inflation to return to this target. The lengthy spell of below-target inflation has begun to increase inflation expectations and has led to questions over the credibility of the Bank’s repo rate forecasts, since their hikes continue to be postponed. Still, inflation is gradually picking up. It hit 1.0% in June, the highest figure since June 2012. Although the Brexit is expected to impact GDP growth, it is unclear what, if any, effects it will have on inflation.
In April the Bank had indicated that the first repo rate increase would take place in the first quarter of 2017. The rate hike that has been postponed in light of the Brexit vote is now foreseen in mid-2017. The Riksbank’s quantitative easing program—SEK 45 billion worth of government bond purchases by the end of the year—was affirmed by the Riksbank. Via the purchase of government bonds, the Bank hopes to bring down government bond yields, which act as a benchmark for other yields in the economy and drive down the costs of financing for banks and other businesses. This puts downward pressure on the krona by making krona-denominated assets less attractive.
There were a variety of concerns related to the Bank’s negative interest rate experiment, yet thus far it has been smoother than expected. There were concerns that Stockholm’s over-heated housing market could be the catalyst for a major market correction, however so far the market has avoided any sharp jolts. This is due in part to regulatory authorities: earlier this year Sweden changed mortgage laws, which essentially makes borrowing more expensive. The lack of any seriously adverse impact from negative rates will embolden the Bank to maintain, or even decrease, the repo rate again should it feel that the economy, or more particularly inflation, has become compromised. The next policy meeting is scheduled for 6 September, although the Bank reserved the right to make policy decisions at irregular dates between scheduled meetings.
Author: Robert Hill, Economist