Riksbank cuts key rate to zero as deflation fight deepens

2014-10-28 12:18:56

Sweden’s central bank ventured into uncharted territory as it cut its main interest rate to zero and delayed tightening plans into 2016 in a bid to jolt the largest Nordic economy out of a deflationary spiral.

“The Swedish economy is relatively strong and economic activity is continuing to improve,” the Stockholm-based bank said in a statement. “But inflation is too low.”

The benchmark repo rate was lowered from 0.25 percent, the third reduction in less than a year. The bank was seen cutting to 0.1 percent in a Bloomberg survey of 17 economists. Only two economists predicted a cut to zero. The bank said it won’t raise rates until “inflation clearly picks up” in mid-2016.

“This was more or less as aggressive as they could be,” said Knut Hallberg, an analyst at Swedbank AB. “More surprises on the downside will have to happen both on in terms of growth and inflation for there to be any talk of further measures, so it’s not our main scenario that more will be needed.”

The bank has come under attack from former board members, politicians and economists to do more to prevent deflation from taking hold. Consumer prices have dropped in seven of the past nine months and inflation has stayed below the bank’s 2 percent target for almost three years.

Plan Needed

The krona slid 0.8 percent to 9.334 per euro as of 10:33 a.m. local time.

The Riksbank today predicted that inflation will remain below the 2 percent target until July 2016. It lowered its estimate for growth next year to 2.7 percent from 3 percent and raised its forecast for 2016 to 3.3 percent from 3.1 percent.

Analysts immediately questioned whether it will be enough.

“They should have presented a clear plan of attack,” said Roger Josefsson, chief economist at Danske Bank A/S in Stockholm. “This is what we might do and, for example, say, which measures would be first in line. Not just push back the repo rate path. Is it QE, is it a currency floor?”

Governor Stefan Ingves, who’s also chairman of the Basel Committee on Banking Supervision, has been reluctant to lower rates out of fear of stoking a build-up in consumer debt.

‘Sadomonetarist’ Policy

Ingves raised the benchmark rate quickly after the financial crisis showed signs of easing in 2010. His reluctance since then to cut rates prompted Nobel Laureate Paul Krugman in April to accuse the Riksbank of a “sadomonetarist” approach to policy he said risked creating a Japan-like deflation trap.

Now, Ingves is shaping Swedish policy to reflect moves elsewhere and bringing rates in line with those at the European Central Bank, whose benchmark is 0.05 percent, and the U.S. Federal Reserve, which has held its key rate close to zero since 2008. The ECB and Fed have also expanded their balance sheets through asset purchases to further stimulate growth.

Lars E. O. Svensson, who left the Riksbank in protest last year after failing to win support for deeper cuts, said last week the bank may also need to resort to unconventional measures such as asset purchases and possibly even a currency floor.

Traders’ two-year inflation expectations were for 1.6 percent last month, while a survey from the National Institute for Economic Research showed consumers’ one-year inflation view sank to zero last month.

A coalition led by the Social Democrats last month ousted the government after accusing it of not doing enough to reduce Scandinavia’s highest unemployment. It has discussed forcing the Riksbank to include a jobs target amid criticism the bank has focused too much on Swedes’ record-high debt burdens.

Swedish property prices have almost tripled since 1995, while consumer debt has nearly doubled to about 175 percent of disposable incomes. In a bid to avoid regulation, the Swedish Bankers’ Association recently proposed forcing homeowners to amortize all new mortgages worth more than 50 percent of their properties.

Swedish household borrowing growth accelerated at a faster-than-expected 5.7 percent last month, up from 5.1 percent at the beginning of this year, according to Statistics Sweden.

The bank said today that it’s now “even more urgent” to manage risks from high household indebtedness.