A Swedish Rate Cut Doesn't Make Sense
Many market-watchers think Sweden's Central Bank, in its decision to be announced Thursday, will follow the central banks of Japan, Europe and others by sending rates even further to negative territory. Applying logic to the behavior of the Riksbank may be foolhardy -- real rates of -1.25 percent for a country growing at nearly 4 percent seems odd to start with. But a further rate cut now makes little sense.
The weakness of equity markets (not just Sweden's), and the decline in oil prices since the last meeting in December, has fueled speculation of a cut. But any central bank that reacts to monthly moves in these markets will find itself changing rates every meeting, creating volatility rather than encouraging stability. It is not clear that these moves will be sustained or that they will have a significant impact on inflation.
A look at the key factors that should influence any rate decision in Sweden suggests the conditions for further easing don't exist.
Is there evidence of a weakening in the Swedish economy or a loss of confidence? No. The economic tendency survey -- the best short-term indicator of gross domestic product -- rose again in January and is at the highest level since 2011. Sweden's real GDP is expected to grow 3.2 percent this year, double the eurozone average of 1.6 percent.
Are inflation expectations falling back to troublesome levels? It's too early to say. The December monetary policy report showed inflation, at 0.9%, somewhat weaker than the projected 1.1 percent. It is projected to rise sharply in January, but that data won't be out until next week and surveys show inflation expectations to be largely unchanged.
Is the exchange rate too strong? No. After strengthening sharply around the turn of the year, the Swedish krona has weakened in the last few weeks to the lowest level since late December (based on the KIX Index that the Riksbank use). It is in line with the Riksbank's projected path and much weaker than expected a few weeks ago.
Is there a need to cut rates for other economic reasons? Quite the opposite. As credit growth remains strong and the Riksbank continues to highlight the risks related to excessive household indebtedness, further easing would seem to encourage the creation of bubbles.
Will other central banks cut rates, leading to a stronger krona? Quite possibly, and this is probably the best reason to expect a Riksbank rate cut at some point. However, in the absence of other justifications for a rate cut, there is less reason to expect the Riksbank to control currency strength by lowering rates. The ECB may well cut rates next month, in which case the krona may strengthen, but there is no need to pre-empt this, as the outcome is unknown. The Riksbank may allow some currency strength or may choose to try to control it with intervention rather than a rate cut.
The Riksbank, in its recent history, has preferred a dovish approach -- "when in doubt, ease," seems to be the message -- but the strength of the economy, high household indebtedness, strong credit growth and the central bank's apparent willingness to use intervention to control the currency if necessary suggests it has no intention to move unless inflation weakens significantly.
Surely it is better to wait for the January inflation data and until after the ECB action to decide. A cut now would be seen as a panicked response to market turmoil. That is no way for the Riksbank to show it has a steady hand on the wheel.
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