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.