Sweden: Riksbank takes repo rate further into sub-zero territory
February 11, 2016
On 10 February, the Executive Board of the Riksbank decided to cut the repo rate to minus 0.50% from the previous minus 0.35%. Although markets had expected a downward rate adjustment, the magnitude of the cut took analysts by surprise. The drastic cut demonstrates that the Rabobank is committed to achieving its 2.0% inflation target and that it is prepared to challenge monetary policy orthodoxy in order to reach this goal. The Bank stated that it will continue its plan to purchase government bonds as announced in its October meeting.
The Bank noted that its decision was driven by the downward revision in expected inflation expressed in its December Monetary Policy Report. The Bank stated that inflation excluding energy prices was lower than expected. This has resulted in lower inflation expectations in the beginning of 2016. The protracted period in which inflation has been below target has also contributed to lower inflation expectations, as market participants begin to question the Riksbank’s ability to push inflation closer to target. When inflation deviates from its prescribed target, producers and employers have difficulty in setting prices and wages, which creates instability in the market. It also increases the potential for a downward trend in prices, which can have serious consequences for consumer expenditure.
The Bank acknowledged the risks associated with its extremely accommodative monetary policy stance. Low repo rates are transmitted via commercial banks to consumers who take advantage of low rates by increasing their borrowing. This has spurred the Swedish housing market and increased the potential of a rebalancing in the country’s housing market. Such a correction would be very costly for an over-indebted economy. The Riksbank has been acutely aware of potentially problematic levels of over-indebtedness and has encouraged policy makers to clarify the Financial Supervisory Authority’s macro-prudential policy in order to mitigate such risks.
Despite such risks, the Riksbank deemed that low inflation and the waning of credibility regarding the inflation target were bigger threats to financial stability. Financial markets reacted immediately to the Central Bank’s decision and the krona weakened significantly, however, it did quickly return to its previous position against the euro. In January, the Riksbank held an unscheduled meeting, where it granted Riksbank governors the ability to intervene in FX markets should they feel that any currency appreciation is compromising the path of inflation. The Riksbank has been forced to act to protect nascent inflation developments from further easing decision made by the ECB and other Central Banks, which have put upward pressure on the krona.
The Riksbank reiterated its readiness to cut rates even further or to implement other monetary policy actions regarding government bond purchases or to intervene in FX markets. The Bank stated that, “the Executive Board therefore still has a high level of preparedness to make monetary policy even more expansionary, even between the ordinary monetary policy meetings.” The Bank’s recent actions make it clear that this is indeed the case and that it is willing to explore creative policy avenues to reach its target. The next meeting is scheduled for 20 April.
Author: Robert Hill, Economist