Riksbank Holds Rates in Bet Deflation Threat to Fade

Sweden’s central bank kept its main interest rate unchanged and stuck to a plan to tighten policy at the end of next year in a bet that a surprise half-point cut in July was enough to fight back the threat of deflation.

The repurchase rate was held at 0.25 percent, the Stockholm-based bank said today. All 15 analysts surveyed by Bloomberg predicted the outcome. The bank said it sees the rate at 0.23 percent in the fourth quarter and 0.22 percent in the first and second quarters next year, signaling a chance for another reduction. The rate in the fourth quarter next year will average 0.4 percent, the bank said.

“As in the previous forecast, it’s assessed to be appropriate to begin raising the repo rate towards the end of 2015, when inflation is clearly higher,” the Riksbank said.

The decision follows the bank’s July signal it won’t tolerate below-target inflation. Consumer price growth has lagged behind a 2 percent target for almost three years and Nobel Laureate Paul Krugman has warned Sweden faces a Japan-like deflation trap. In July, the six-member board split over the size of its rate cut, as a majority overrode Governor Stefan Ingves’s vote for a smaller move. He has warned excessive easing may fuel Sweden’s record consumer debt burden, a warning the bank repeated today.

The krona strengthened 0.1 percent to 9.2048 per euro as of 9:41 a.m. in Stockholm.

The board was unanimous today for the first time since February.

Swedish Election

The Riksbank’s failure to deliver on its inflation mandate has made it a focus of Sweden’s election campaign, with the Social Democrat-led opposition seeking a review of monetary policy. The bloc, which polls show will win Sept. 14 elections, has signaled it wants the Riksbank to pursue policies that support employment.

Economists at Swedbank AB, SEB AB and Royal Bank of Scotland Group Plc have predicted the Riksbank will need to ease policy further to prevent krona strength from suppressing price growth. Those calls have grown louder as the European Central Bank pledges to do what it can to shield the euro area from deflation.

The ECB today unexpectedly cut rates to spur economic growth and stave off the threat of deflation. The ECB reduced all three of its main interest rates by 10 basis points. The benchmark rate is now 0.05 percent and the deposit rate is now minus 0.2 percent.

Knut Hallberg, an economist at Swedbank, said the Riksbank’s 3 percent growth forecast for next year was unrealistic.

Cutting Again

“We think that they will be forced to cut rates again in December,” he said. “Growth will be worse and inflation will be lower than what the Riksbank predicts.”

After lowering to 0.1 percent “it’s unavoidable that the market will start speculating in what the next step will be and that discussion will intensify during the winter,” he said.

Inflation slowed to 0.04 percent in July from 0.2 percent a month earlier, the statistics office estimated. Prices fell the previous five months, on an annual basis. Traders’ two-year inflation expectations dropped to 1.5 percent last month, while a survey from the National Institute for Economic Research showed consumers’ one-year inflation view sank to 0.2 percent in August.

The bank today predicted no inflation this year, and 1.3 percent next year and 2.9 percent in 2016.

Sweden’s government last month cut its forecast for economic growth and inflation citing weak demand from Europe.

The country’s property prices have almost tripled since 1995 while consumer debt has nearly doubled to about 175 percent of disposable incomes. That’s sparked concerns of a housing bubble and prompted the government to raise bank capital requirements to curb lending.

“The low interest rates still entail risks linked to the high level of household indebtedness,” the bank said today. “Reducing these risks requires further measures aimed directly at household demand for credit. In addition, reforms are needed for a better-functioning housing market. The responsibility for this lies with the government and other public authorities.”

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