4th July 2014 by Shaun Richards
Yesterday saw an event which was simultaneously rather extraordinary and also managed to highlight several themes of this blog. So let me without further ado let the Riksbank in Sweden explain events.
Economic activity continues to strengthen in the Swedish economy.
That may have lulled readers into a false sense of security as a few short sentences later we we told this.
The repo rate is now being cut by 0.5 percentage points to 0.25 per cent, at the same time as the repo-rate path is revised downward substantially.
I know that there is a Monty Python revival going on but this initially looks like taking fan worship somewhat too far! So they are cutting interest-rates because the economy is strong? Perhaps the Ministry of Silly Walks has some competing ministries.
Immediately we have the thought that even a central bank claiming it has a strong economy can now cut interest-rates. How times change! Also it is a substantial cut from 0.75% to 0.25%, after all it would be technically true to say that they had slashed them to a third of what they were. As we mull this we can also note that the theme of moves to negative interest-rates gets another nudge.
The interest rates in the Riksbank’s standing facilities will be lowered at the same time to -0.5 for the deposit rate and 1.0 per cent for the lending rate.
My understanding is that the deposit rate is infrequently used but nonetheless it might be and it is now negative. So we are left to consider an economy has a forecast growth rate of 2.2% for 2014 and 3.1% for 2015 and yet apparently requires an interest-rate cut.
Step Back in Time
On the 24th of May last year I pointed out that Sweden’s economy was showing signs of trouble.
So on today’s journey we have seen that whilst it may have appeared that Sweden was escaping the effects of the second wave of the credit crunch they are in fact washing at her shore. Whilst she starts from a relatively strong position we see that her currency has strengthened and trade has fallen substantially.
It was something of a metaphor for these times that pronoucements back then by the Riksbank that things were going well were accompanied by riots in Stockholm. We get an idea of how on the ball this particular central bank has been by noting what is told us then.
Slow increases in the repo rate are not expected to begin until the second half of 2014.
So its version of Forward Guidance has turned out to be wrong by 180 degrees as rather than raising rates as forecast they have cut them. That is the worst Forward Guidance type performance I can think of so far although it is a moving target.In many ways it is something of a cheek that the Riksbank feels that its guidance is of any value at all although those who have used it as a reverse indicator will no doubt like it to continue with it. Perhaps in a spirit of compromise they could present the forecasts wearing sackcloth and ashes.
The theme highlighted here is that timing matters in monetary policy and the Riksbank should have acted back then rather than now. Monetary policy operates on a lagged time frame and needs to get ahead of events if it is to work properly. Instead we are seeing it chase events which seldom ends well.
Food for thought for the UK
This time last year Sweden had a set of circumstances which will sound rather familiar. For example the Swedish Krona had been appreciating from 11.7 to the Euro in 2009 to 8.3 in early 2013 so monetary policy had tightened via the exchange rate. Also the central bank was promising interest-rate rises in the future. Let me offer two other factors highlighted by Bloomberg.
Apartment prices rose 11 percent and house costs climbed 5 percent in 2013……In Sweden, apartment prices have almost tripled nationwide since 2002, while house prices have more than doubled.
As Sweden’s house prices have soared, consumers have amassed record debt burdens. Households owe their creditors almost 180 percent of disposable incomes,
Does this sound/read like a country we know right now? If Karl Marx was right about history repeating itself then next year could the UK see Base Rate cuts rather than rises?
This is regularly being trumpeted as a policy solution for house price inflation. However Sweden has been trying it as for example there is an 85% loan to value limit for mortgages and there have been restrictions on the supply of credit. Here is the International Monetary Fund on how that is going.
House price increases have picked up again, exceeding 7½ percent annual growth for single-family homes and 12½ percent for tenant-owned apartments in April. Household credit growth also remains strong…
So not so well then which was rather the experience of such measures in the past. I gather from recent research that we have been rather insulting about Goldfish and their supposed lack of a memory and sometimes I think that we might apply that mirror to ourselves. Let me introduce a word from back in those times which looks as though it will undergo a renaissance, disintermediation.
The IMF does not share this view and feels that macroprudential policies simply have not been tried hard enough which reminds me of my musical critique of QE (Quantitative Easing) from Andrea True Connection.
More, more, more
How do you like it?
How do you like it?
How do you like it?
Keep squeezing in that manner and you could very quickly turn a boom/bubble into a crash. One thing we can be sure of is that should that actually take place it will be nobody’s fault.
Meanwhile the IMF was busy telling us only 3 weeks ago that the Swedish economy was doing rather well.
Sweden’s economy is gathering speed……The outlook is for accelerating growth.
Why did the Riksbank cut interest-rates?
Readers may well be wondering this as you do not have to travel very far south from Sweden to countries which would love to have economic growth forecasts like it. If we also plug in a booming house market which is in bubble territory then cutting interest-rates seems even more odd. The official rationale is below.
There has been a broad fall in inflation and it is now assessed that underlying inflationary pressures are clearly lower than assessed in April.
Their assumption that a cut in interest-rates will boost inflation is in my view somewhat dubious. Some mortgage rates have already fallen but on the other side of the coin deposit rates will be dropping too and the experience in the credit crunch era is that these offset as we approach 0% interest rates rather than provide a boost. As ever these days the strongest influence comes from the exchange rate which did fall -for example by 1.7% versus the UK Pound- but what is required is a sustained fall and we cannot be sure about that. What we do end up thinking is that this is not entirely dissimilar to the competitive devaluation strategy of the 1920s.
Oh and if house price inflation was more directly reflected in Sweden’s consumer inflation numbers they would not be anything like as low would they?
As of May interest-rate falls were reducing measured consumer inflation rather than raising it. Something of a technical flaw there you may think!
The main factor behind this month´s inflation rate was the decreased cost of interest rates (-5.6 percent since May 2013), which contributed downwards by 0.3 percentage points.
Perhaps this played a part in the Riksbank’s move.
Industrial production decreased in May by 3.2 percent compared to April, corrected for seasonal effects.
Service production decreased by 1.0 percent in May 2014 compared to April in seasonally adjusted series.
Sweden is often considered in the UK as an example of how to do things. For example it is often held up as a paragon in the world of education and reviewed favourably to the UK. However its move yesterday poses a clear question which is very contradictory to the theme of higher interest-rates in the UK being on their way. Please do not misunderstand me as the UK’s growth path is higher and with our level of institutionalised inflation Base Rate cuts are far from the immediate agenda. But we learn that not much of a downturn could bring them into play if we note that economic growth forecasts for Sweden are in the region of 3% for 2015 and 2016.
Therefore we are left with some consequences. Firstly negative interest-rates are on the march even in a period of relative economic recovery. This poses the question of what we do in the next downturn? Also in such an environment how feasible is an interest-rate rise? Would the respective currency then immediately “overshoot”? Things were already complicated enough but another layer has just been added to the mix.