Premature Liftoff Risks Haunt Sweden as Inflation Goal Debated

As Janet Yellen looks set to deliver the first Fed rate increase since 2006, a central banker with some experience in premature tightening is doing everything he can to ensure he doesn’t start raising borrowing costs too soon.

The governor of Sweden’s central bank says it would be fine for inflation, now and then, to exceed the official 2 percent target. Overshooting that goal for a brief period wouldn’t necessarily warrant a rate increase, he said.

“It’s difficult to steer inflation towards exactly 2 percent,” Governor Stefan Ingves said on Tuesday in an interview in Stockholm. “That means we have to live in a world where sometimes inflation is a bit over and sometimes a bit lower.”

Robert Bergqvist, chief economist at SEB AB and a former Riksbank researcher, says “it feels like this is preparation” for restoring a tolerance band around Sweden’s price target that existed until half a decade ago. He predicts it may be back by early next year.

Back in 2010 when the tolerance band was dropped, the Riksbank started raising rates over seven meetings, only to reverse the steps when it became clear the anticipated recovery hadn’t taken hold by late 2011. The episode made the Riksbank the target of numerous critical articles by Nobel Laureate Paul Krugman, who famously called the bank’s board “sadomonetarists” for withdrawing stimulus too soon.

Sweden has since struggled through a bout of deflation that dogged the Riksbank through much of last year. Underlying inflation has been below the bank’s target since the beginning of 2011.

Now, Ingves is looking for consistent proof that prices really are stabilizing around the 2 percent growth target. He kept the benchmark repo rate at minus 0.35 percent this week, and said it won’t be raised until there’s evidence of stable 2 percent inflation, which the Riksbank estimates will come in the first half of 2017.

“If we were to get a period of time when inflation is a little bit higher than 2 percent, there’s no real reason to immediately react,” he said. That’s “provided that we make a forecast that inflation will eventually approach 2 percent again. So 2 percent remains, but it’s a way of expressing that it’s no big thing if inflation fluctuates a little bit around two percent.”

The comments represent a “softer communication than before,” Anna Breman, chief economist at Swedbank, said by phone. Scandinavia’s biggest bank, Nordea, says its predictions for a rate rise by the end of next year may need to be pushed back. The new language around inflation “is a strong signal that there’s a risk in our forecast on the first rate increase,” said Torbjoern Isaksson, an analyst at the Stockholm-based bank.

The more flexible approach comes amid an external evaluation of the merits of altering the Riksbank’s mandate based on an assessment of its performance from 2010-2014. Former Governor of the Bank of England, Mervyn King, is one of the experts involved in conducting the analysis.

Ingves says it’s an “open question” whether the bank should again operate with an interval around its inflation target. Deputy Governor Per Jansson said earlier this month there are grounds for considering whether an interval should be restored. The one the bank used until 2010 “served us well,” Ingves said.

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