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Central Bank Watch Sweden
Down to zero, but then what?
Torbjörn Isaksson
+46 8 614 8859
[email protected]
Twitter: @TorbjrnIsaksson
Nordea Research, 22 oktober 2014
We expect the Riksbank to cut its repo rate to 0.05% at next week’s monetary
policy meeting. Also, the inflation forecast and the rate path will be significantly revised downward.
Andreas Wallström
+46 8 534 910 88
[email protected]
Twitter: @andreaswjonsson
Looking further ahead, we do not see a repo rate below zero or the launch of
unconventional measures. If unconventional measures were to become relevant anyway, a floor for the krona exchange rate against the euro is the most
likely choice.
Surprisingly low inflation, again...
Inflation continues to puzzle the Riksbank. In September CPIF inflation was
as low as 0.3%, no less than 0.4% point below the central bank’s forecast.
The Riksbank has been clear in saying that there is little tolerance for
surprisingly low inflation readings; this is a strong signal that the bank will
cut rates and lower the rate path on 27 October (announcement 28 October).
Too low inflation…
The ECB’s surprise rate cut and its announcement of other measures two
days after the Riksbank’s September monetary policy meeting are additional
reasons for an easier monetary line. In addition, the outlook for the
international economy has deteriorated, underlined by the declines in equity
markets.
… soft ECB and darker
outlook…
The sharp oil price fall is also likely to contribute to a marked downward
revision of the Riksbank’s inflation forecast. If fuel prices remain at current
levels, this will contribute to reducing the CPI by as much as 0.25% point,
something that the Riksbank’s forecast did not incorporate. So drastic
measures are in store as regards the inflation forecast.
In all likelihood the Riksbank will cut its repo rate next week. We expect a
repo rate cut by 20 bp to 0.05%, aligning the repo rate with the ECB’s refi
rate. Both a larger and a smaller rate cut is possible.
Lower oil price pushes down CPI
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… clearly suggest lower
policy rate and rate path
Down to zero, but then what?
A major downward revision of the rate path is also expected. Firstly, the rate
path appears to signal a probability of another rate cut short term. We would
not preclude a rate path even somewhat below zero near term.
The rate path is becoming an increasingly important tool with the repo rate
approaching zero. In the September report the endpoint was 2.25%, which is
high compared with the market’s pricing and signals from other central
banks. An endpoint around 1.5% is conceivable.
Expect verbal intervention!
For some time several Executive Board members have emphasised that they
would not vote for a rate hike until CPIF inflation has stabilised at a certain
level. There is likely to be more of this type of verbal intervention at the
October meeting. We would not be surprised either if the members
emphasise that they are prepared to overshoot the inflation target. Such
rhetoric is aimed at lifting inflation expectations and in this way bringing
down real interest rates.
The Riksbank’s tool box when the repo rate is zero
What happens after October?
On the back of the expected sharp downward revision of the inflation forecast, the Riksbank will probably show that the Riksbank can and will take
other measures if necessary. Discussions of further measures will likely be
an important part of next week’s monetary policy report. It is likely that
several alternative scenarios will deal with just this, and that could attract a
lot of market attention.
The Riksbank’s Economic Review 2/2009 included an article on monetary
policy when the interest rate is zero. The measures analysed in the article can
be divided into three categories:
1. Influencing the expectations of individuals for future inflation and interest
rates.
2. Influencing other interest rates in the economy than the policy rate and
facilitating the provision of credit.
3. Using the exchange rate to stimulate the economy.
A repo rate below zero
cannot be ruled out
The first point largely describes what is expected to happen next week: cutting the repo rate and lowering the rate path and also in other ways signalling
low rates for long. Here, however, there is room for going further. For example, a future repo rate cut to just below zero cannot be precluded. Such a
measure appears to be technically feasible and manageable in financial markets.
The Riksbank ready for QE
Redo for QE…
… though unlikely
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The second point mainly relates to what is usually called quantitative easing,
where a central bank, often by buying government bonds, mortgage bonds
and corporate bonds, expands its balance sheet and the money supply in the
economy. We see this type of measures as the least likely if extraordinary
measures were to be relevant. The main reason is that Sweden’s problem
does not involve the transmission mechanism. Yields are low on all types of
fixed income securities and they benefit households and businesses.
Down to zero, but then what?
Also, the Riksbank is deeply worried about household indebtedness and
housing market trends. That the bank in such a situation would buy mortgage
bonds and drive down mortgage rates therefore seems highly unlikely. Nor
are there any strong reasons for the Riksbank to buy government bonds as
government yields are very low across the maturity spectrum. The Swedish
corporate bond market is very small, precluding intervention by the
Riksbank.
There are some legal questions marks regarding quantitative easing, and it is
uncertain whether the Riksbank will challenge the legal framework.
However, the bank has prepared a channel for quantitative easing. In May
2012, the Riksbank reintroduced a portfolio for assets in SEK, mainly 2-year
and 10-year government bonds. The portfolio “aim to promote financial
stability or to help monetary policy have the desired effect “.
Reintroduced portfolio
facilitates for the Riksbank
to move quickly
The portfolio mainly is a tool handling turmoil in financial markets but
seems also to be a preparation for asset purchases. The Riksbank discusses
the portfolio in its review for operational framework for the implementation
of monetary policy from March this year. In the review, it is emphasised that
the financial crisis 2007-2010 showed that “short-term interest rates may
approach zero in a crisis situation. If further stimulation of the economy is
desired in such a situation, one alternative is to directly influence long-term
interest rates by buying bonds on the market.”
Currency intervention more likely measure
SEK-floor is more likely
We see the third and final category – exchange rate intervention – as a more
likely measure than quantitative easing. The Riksbank’s problem is isolated
to the low inflation and the credibility of the inflation target. The exchange
rate is important for inflation and a weak Swedish krona would also provide
relief for the struggling export industry.
It is increasingly likely that the ECB will launch large-scale quantitative
easing measures. This has the potential to trigger massive krona appreciation
versus the euro also after the Riksbank has cut interest rates to zero. In turn,
this would reduce inflation (which is already too low) further.
About ten years ago, the Riksbank intervened in the currency market with
limited success. At the time the goal was to prevent a weakening, which is
more difficult as the intervention is limited by the size of the currency reserves. Now it would more likely be about weakening the krona or actually
countering krona appreciation.
”…easy to defend a currency that is in the process
of strengthening”
In the Economic Review article the Riksbank notes that currency intervention would be credible: “Unlike defending a currency that is expected to
weaken, it is easy to defend a currency that is in the process of strengthening.
To do so, the central bank buys foreign currency. As the central bank has
unlimited access to its own currency, it can buy foreign currency as long as
the credibility problem remains”.
Most likely the euro would be in focus in case of currency intervention.
What exchange rate would be fixed is difficult to predict. Initially the goal is
probably to avoid an appreciation, so a level near the current level would
probably be the obvious choice. It is also difficult to say for how long the
nordeamarkets.com/research
Down to zero, but then what?
intervention would last. Most likely this would be a matter of years rather
than months.
Currency intervention is also what happened in Switzerland. After the Swiss
franc temporarily strengthened to 1.05 against the euro, the central bank set a
floor of 1.20. Since then the franc has traded in a range of 1.20-1.25 against
the euro.
Unconventional measures not baseline scenario
Lower inflation of significantly stronger SEK required for extraordinary
measures to be relevant
We wish to emphasise that we do not expect the Riksbank to launch unconventional measures in the form of quantitative easing or currency intervention. For such measures to be relevant, inflation must remain near zero for an
extended period or the Swedish krona must appreciate markedly against the
euro.
Even though the September outcome was a very big surprise, the best assessment is nevertheless that inflation will head higher in future, despite
falling oil prices. The main reason is the krona weakening over the past year.
In contrast to many other countries with policy rates near zero, the Swedish
economy does not face serious structural problems or cyclical problems. As
mentioned earlier, the transmission mechanisms also function well. As regards economic activity, exports are admittedly subdued. Domestic demand
and employment, on the other hand, has accelerated sharply.
Outcomes since the September report have reinforced the picture of a favourable domestic economy. Q2 GDP has been revised up, especially
household consumption and investment, and employment trends have been
better than anticipated.
Household credit growth and home prices have accelerated further recently.
It remains to be seen what effects the new amortisation guidelines from the
Swedish Bankers’ Association will have. We think they may have a dampening effect, but they will hardly break the rise in home prices or credit growth.
Read more about the housing market here.
Rate cut and very soft signals
In sum: Lower repo rate
and rate path as well as
soft signals in October
Summing up, there is every indication that the Riksbank will cut its repo rate
at next week’s monetary policy meeting. Also, the rate path will probably be
subject to drastic measures. The bank’s verbal intervention will aim at pushing down interest rate expectations and lifting inflation expectations.
Looking further ahead, we do not see a repo rate below zero or the launch of
unconventional measures. The Swedish economy is working well, with wellfunctioning credit channels, and the housing market is becoming increasingly heated. Inflation forecasting has become more difficult, but we judge that
inflation should move somewhat higher over the next six months. If unconventional measures were to become relevant in contrast to our expectations,
a floor for the krona exchange rate against the euro is the most likely choice.
nordeamarkets.com/research
Down to zero, but then what?
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