Sweden Riksbank Review: Policy Peaking
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There was no surprise at this latest 25 bp hike (to 4.0%). Notably, and chiming with its previous projections, the Riksbank suggested that inflation will return to target and stay there in the latter part of its 2-3 year forecast horizon (Figure 1) and the economy may be back in formal recession given both the large GDP decline seen this year and the inter-related contraction in credit. There was a clear concern about a weak currency, possibly explaining the lack of any dissent among the Board. Regardless, the Riksbank inflation outlook was largely retained, an implicit, if not explicit, reflection that policy is restrictive, as the Riksbank takes policy to a terminal rate of around 4% it signalled in June and that this will be adhered to well into 2025 (Figure 2).The Riksbank is somewhat equivocal about whether rates have peaked but is also not suggesting any near-term policy reversal. We think instead that rate cuts may emerge by mid-2024, not least given the even more sizeable output gap the Riksbank is anticipating out to 2025, embracing cumulative 2 ppt GDP drop by mid-2024.
Figure 1: Inflation Back to Target By Next Year
Source: Riksbank
Sizeable Output Gap
Indeed, we doubt there are grounds even for this hike as economic and particularly domestic demand fragility persists and accentuates recent signs of a broader fall in inflation, this very evident in seasonally adjusted m/m readings for both overall CPIF and the CPIF ex-energy.Indeed, while August CPI inflation did fall sharply, albeit due to base effects, adjusted data very much showed a much softer profile of late, even excluding energy.Thus, the risks may be that inflation returns to target earlier and possibly undershoots target than that thought by the Riksbank from still pointing to return to the 2% target in the coming year (Figure 1).
We would suggest that the bond sales are also having an effect, they helping explain the marked drop in bank credit and deposits now occurring.
Moreover, the Board’s updated scenario analysis is again at risks on inflation and policy in both directions, a contrast to projections prior to April which assessed only upside inflation risks and which now encompasses an implicit recognition of a much more two-way policy outlook.All of which reflects more policy flexibility being demanded and flagged by the Board.
This time around the Riksbank is also made no major adjustments to its GDP projections but where a greater fall of 0.8% was penciled in for this year, now accompanied by slight drop for 2024.But even then perspective is needed as the Riksbank now points at a 1.9 ppt fall between mid-2022 and Q1 next year and which explains the drop in GDP in 2024.And this masks what has been even weaker consumer spending data which we think may not just persist but deepen amid a 4% drop in real disposable incomes, this explaining the very weak consumer confidence numbers.
Hiking Hurting Ever Harder
Clearly, this is a reflection of Riksbank hiking biting even more clearly via mortgage rates which have risen sharply over the last year and may yet rise further. Unlike many other economies, a large share of the mortgage stock (up to 80% in fact) is tied to variable interest rates which means that rising Riksbank interest rates have a rapid impact on households’ interest expenditure and thus on their consumption.But there also seems to be a further avenue through which Riksbank policy may be biting, through the reduction in its balance sheet where the year-long non-reinvestment of its bond portfolio has occurred alongside (and hence possibly caused) an unprecedented drop in bank deposits, with the latter now seeing a sharp fall in private sector credit levels as well as a marked reversal in broad money growth.
Figure 2: Riksbank Sees No Early Easing
Source: Riksbank, last three Monetary Policy Reports
We continue to think that the Riksbank is ignoring the broader impact of its policy tightening. After a year of interest rate hikes, monetary policy is assessed to be contractionary and the Board underscores that it will continue regularly to evaluate how the economy responds to the policy rate hikes already implemented and will adjust monetary policy accordingly. In conclusion, this hike is very much likely to be the last and we still see rate cuts starting from as soon as Q1 next year.