Riksbank Inflation Review Signals Tighter Policy, Analysts Say

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Sweden’s central bank is pondering changing its main inflation gauge and re-introducing a tolerance interval, which analysts said could pave the way for less stimulus as the bank struggles to defend its elusive inflation target.

The most natural candidates should it opt change its gauge from CPI -- the consumer price index -- would be CPIF or HICP, the Riksbank said in a 40-page report discussing the pros and cons of a new inflation gauge. It also said that re-introducing a tolerance interval would make it easier to communicate policy.

“Changing the target variable, and particularly the introduction of a tolerance interval, could provide the Riksbank with greater room to maneuver,” Torbjoern Isaksson, chief analyst at Nordea Bank, said in a note. “In the short term, this could mean that the Riksbank would not be so eager to press the accelerator, even if inflation is below the 2 percent target.”

Swedish policy makers are re-examining their inflation targeting measure after being forced to unleash a battery of stimulus -- including negative interest rates -- to jolt the economy out of deflation. Central bankers around the world are struggling to meet inflation targets amid rising global competition and aging populations in developed nations.

The Riksbank, which hasn’t met its 2 percent price target for almost half a decade, has also failed to live up to its target over the past 20 years. Since 1996, the CPI measure has risen at an average annual rate of 1.04 percent, the CPIF has gained 1.48 percent and the HICP 1.42 percent, according to the report.

According to today’s report, re-introducing a tolerance band scrapped in 2010 could help keep long-term inflation expectations closer to target by preventing criticism that inflation is too low. It also said that its current gauge creates the illusion of disinflation when rates are cut since it include mortgage costs.

Both CPIF and HICP measures strip out the effects of mortgage costs changes. The Riksbank said that switching to HICP would have the advantage of being used both by the European Central Bank and the Bank of England.

According to Knut Hallberg, an analyst at Swedbank, the report seems to favor HICP as the new inflation gauge, which he predicts will be up to 0.2 of a percentage point lower than CPIF in the coming years.

But perhaps more important in the short term, “the study seems to be in favor of a reintroduction of the tolerance interval around an inflation target,” Hallberg said. “Thus, we interpret the study’s conclusions as slightly hawkish, at least in the short term.”

To be sure, the Riksbank highlighted in its conclusion that any switch to a new inflation gauge could damage confidence in the price target. While the current consumer price index is “somewhat problematic,” it said that switching the measure could create “uncertainty” and “lead to expectations that it may be replaced again,” it said.

Even so, changing to another index or re-introducing a tolerance interval would have limited impact, the Riksbank said.

“Changing target variable to CPIF or HICP or reintroducing a tolerance band could have consequences for the Riksbank’s communication of monetary policy and its ability to build confidence for the inflation target,” it said. “However, the basic features of the monetary policy being conducted would not be affected appreciably.”