Sweden Acts On Interest Rates

Well Sweden has just put the cat among the pigeons. Taking advantage of its ability to apply an independent monetary policy, the Riksbank has decided to cut its base lending rate from 2.0% to 1.5%. The reason why is not hard to discern, apart from the reduced growth forecast for this year, the inflation rate is falling dangerously low, at just 0.2% year on year in May, dropping from a 0.4% y-oy in April and 0.5% y-o-y in March. Obviously Sweden is on deflation alert, and in fact a greater reduction (say 1%) might have been justified.

This is bound to spark all sorts of additional debate about the euro, and its advisability. Finland would be the best point of comparison here. The Finnish inflation rate was 0.6% y-o-y in May, but it has been hovering precariously near the zero level for the last month, anything which gave a sudden push to the disinflation process, like a sudden bust in commodity prices, would certainly clearly knock Finland over the line.

The bank, announcing its decision after a rate-setting meeting on Monday, said it was cutting its growth and inflation forecasts for this year, warranting a 50 point reduction.

?The future direction for monetary policy will depend on new information on economic developments in Sweden and abroad and the effects this may have on inflation in Sweden. Monetary policy is now considered to be well-balanced,? it said.

Several analysts interpreted the comments as opening the doors for further rate cuts.

?Two things are surprising to us: the size of the reduction of their GDP forecast and that they cut inflation forecasts as much as they do,? said Nordea economist Jorgen Appelgren.

?Looking at an ordinary rule of thumb, 50 basis points aren?t enough to get inflation up and they have room for further interest rate cuts,? he added.

The bank slashed its gross domestic product forecast to 1.9 percent for this year, down from 3.2 percent. It expected growth to rise to 2.7 percent in 2006 and be the same in 2007. Both 2006 and 2007 forecasts were lower than previous estimates.

It cut its forecast for inflation in a year?s time to 1.1 percent from 1.6 percent. The June 2007 forecast was 1.6 percent. It reduced the forecast for UND1X underlying inflation, which it watches closely, to 0.9 percent in a year?s time from 1.4 percent. The estimate for June 2007 was 1.5 percent.

The Riksbank, which targets 2.0 percent inflation over a two-year horizon, said the risks to inflation were on the downside.

Extracted from the Financial Times article linked above.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

5 thoughts on “Sweden Acts On Interest Rates

  1. The number one reason above all to cut interest rates has been the constant pressure from the government, the labour unions and every other social-democratic institution during the last year.

    Most of the ministries and governmental angencies that are supposed to be indepentent and make objective forecasts have been more and more influenced by the government, a government who?s main promise and objective is to reduce unemployment before the upcomming election.

    The social-democratic idea (at least in sweden) is that lower intetrest rates is the only waty to do this..

  2. “It isn’t considered.”

    No, but this doesn’t mean they weren’t thinking about it at the Riksbank. Lets run an argument. The fact that they put down the rates when the situation isn’t dire, means that they believe that monetary policy is an important instrument.

    I say ‘they believe’ since this is a view which is clearly held at the US fed, more or less accepted at the BoE, but often questioned by some key people at the ECB in Frankfurt. Essentially they don’t change rates often (the ‘twirp’ policy) because they don’t give it the same importance as they give to their attempt to control monetary aggregates. In this sense some of them are simply ‘old fashioned’ monetarists, and even if this doesn’t matter too much, they are simply wrong. Monetary policy does work reasonably well.

    Now where it doesn’t have much impact is when inflation falls below 0%. This has been Japan’s major problem. If the bankers in Sweden believe in monetary policy, then they are worried by the possibility of deflation.

    Maybe cultural factors are important. In the US it is regarded as important to discuss some things more openly than it is traditional to do in many european societies. This is in part the transparency thing.

    Now deflation is partly about expectations, so I think some might feel you shouldn’t talk about it, because you don’t want to create a climate of expectation.

    Incidentally, when the Bundesbank chief spent some of his time listening to Joaquim Fels, I have the feeling that deflation would be one of the issues he would have been thinking about. It is clear that people who think about this would be worried about two things: an oil ‘bust’, and a serious slowdown in China. Both of these would have a major downward impact on general prices. Anyone with an annual CPI rate of around 1% or below would be at serious risk. Germany fits that profile, and so any serious central banker has to run a ‘what if’ gedanken experiment. The issue is really that the last thing the ECB is equipped for is what is called ‘unconventional’ monetary policy. I guess we will get into all this when the time comes.

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