Sweden Riksbank Preview (Sep 21): A Final Hike as Inflation Succumbs
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Recent data have been mixed but do not seem weak enough to dissuade the Riksbank from exercising the hiking bias set out last time around; thus we see a further 25 bp hike (to 4.0%) at the policy verdict due on Sep 21.Admittedly, existing Riksbank projections suggest 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 in Q2 and the inter-related contraction in credit. But, a clear concern about a weak currency, exacerbated by fresh recent drops, and actual inflation above Riksbank projections, will take precedence. Regardless, the Riksbank inflation outlook will be 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).This also explains the assessment made in June that the risks for future inflation during the year have become more symmetrical.
Figure 1: Inflation Back to Target 2024
Source: Riksbank, last two Monetary Policy Reports, % chg y/y
Domestic Weakness to Continue
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, August CPI inflation is likely to fall sharply, albeit still remaining above Riksbank short-term projections. But this is unlikely to dent the Riksbank from still pointing to return to the 2% target in the coming year (Figure 1), and this may mean that the decision this month may see some dissent within the Board echoing that seen back in April. There was no dissent in June but the hiking bias was toned down somewhat with only one more hike envisaged at worse and where the press statement very much acknowledging that Riksbank’s policy rate increases are having an effect. 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 likely to look 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 unlikely to make major adjustments to its GDP projections but where a greater fall may be penciled in that the existing projected 0.2% contraction for this year.But even then perspective is needed as the Riksbank already points at a 1.5 ppt fall between last quarter and end year \and which risks a 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 Modest Further Hiking
Source: Riksbank, last two 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.