What does yesterday’s interest-rate cut in Sweden teach us?

4th July 2014 by Shaun Richards

Yesterday saw an event which was simultaneously rather extraordinary and also managed to highlight several themes of this blog. So let me without further ado let the Riksbank in Sweden explain events.

Economic activity continues to strengthen in the Swedish economy.

That may have lulled readers into a false sense of security as a few short sentences later we we told this.

 The repo rate is now being cut by 0.5 percentage points to 0.25 per cent, at the same time as the repo-rate path is revised downward substantially.

I know that there is a Monty Python revival going on but this initially looks like taking fan worship somewhat too far! So they are cutting interest-rates because the economy is strong? Perhaps the Ministry of Silly Walks has some competing ministries.

Immediately we have the thought that even a central bank claiming it has a strong economy can now cut interest-rates. How times change! Also it is a substantial cut from 0.75% to 0.25%, after all it would be technically true to say that they had slashed them to a third of what they were. As we mull this we can also note that the theme of moves to negative interest-rates gets another nudge.

The interest rates in the Riksbank’s standing facilities will be lowered at the same time to -0.5 for the deposit rate and 1.0 per cent for the lending rate.

My understanding is that the deposit rate is infrequently used but nonetheless it might be and it is now negative. So we are left to consider an economy has a forecast growth rate of 2.2% for 2014 and 3.1% for 2015 and yet apparently requires an interest-rate cut.

Step Back in Time

On the 24th of May last year I pointed out that Sweden’s economy was showing signs of trouble.

So on today’s journey we have seen that whilst it may have appeared that Sweden was escaping the effects of the second wave of the credit crunch they are in fact washing at her shore. Whilst she starts from a relatively strong position we see that her currency has strengthened and trade has fallen substantially.

It was something of a metaphor for these times that pronoucements back then by the Riksbank that things were going well were accompanied by riots in Stockholm. We get an idea of how on the ball this particular central bank has been by noting what is told us then.

Slow increases in the repo rate are not expected to begin until the second half of 2014.

So its version of Forward Guidance has turned out to be wrong by 180 degrees as rather than raising rates as forecast they have cut them. That is the worst Forward Guidance type performance I can think of so far although it is a moving target.In many ways it is something of a cheek that the Riksbank feels that its guidance is of any value at all although those who have used it as a reverse indicator will no doubt like it to continue with it. Perhaps in a spirit of compromise they could present the forecasts wearing sackcloth and ashes.

The theme highlighted here is that timing matters in monetary policy and the Riksbank should have acted back then rather than now. Monetary policy operates on a lagged time frame and needs to get ahead of events if it is to work properly. Instead we are seeing it chase events which seldom ends well.

Food for thought for the UK

This time last year Sweden had a set of circumstances which will sound rather familiar. For example the Swedish Krona had been appreciating from 11.7 to the Euro in 2009 to 8.3 in early 2013 so monetary policy had tightened via the exchange rate. Also the central bank was promising interest-rate rises in the future. Let me offer two other factors highlighted by Bloomberg.

Apartment prices rose 11 percent and house costs climbed 5 percent in 2013……In Sweden, apartment prices have almost tripled nationwide since 2002, while house prices have more than doubled.

As Sweden’s house prices have soared, consumers have amassed record debt burdens. Households owe their creditors almost 180 percent of disposable incomes,

Does this sound/read like a country we know right now? If Karl Marx was right about history repeating itself then next year could the UK see Base Rate cuts rather than rises?

Macroprudential policy

This is regularly being trumpeted as a policy solution for house price inflation. However Sweden has been trying it as for example there is an 85% loan to value limit for mortgages and there have been restrictions on the supply of credit. Here is the International Monetary Fund on how that is going.

House price increases have picked up again, exceeding 7½ percent annual growth for single-family homes and 12½ percent for tenant-owned apartments in April. Household credit growth also remains strong…

So not so well then which was rather the experience of such measures in the past. I gather from recent research that we have been rather insulting about Goldfish and their supposed lack of a memory and sometimes I think that we might apply that mirror to ourselves. Let me introduce a word from back in those times which looks as though it will undergo a renaissance, disintermediation.

The IMF does not share this view and feels that macroprudential policies simply have not been tried hard enough which reminds me of my musical critique of QE (Quantitative Easing) from Andrea True Connection.

More, more, more
How do you like it?
How do you like it?
How do you like it?

Keep squeezing in that manner and you could very quickly turn a boom/bubble into a crash. One thing we can be sure of is that should that actually take place it will be nobody’s fault.

Meanwhile the IMF was busy telling us only 3 weeks ago that the Swedish economy was doing rather well.

Sweden’s economy is gathering speed……The outlook is for accelerating growth.

Why did the Riksbank cut interest-rates?

Readers may well be wondering this as you do not have to travel very far south from Sweden to countries which would love to have economic growth forecasts like it. If we also plug in a booming house market which is in bubble territory then cutting interest-rates seems even more odd. The official rationale is below.

There has been a broad fall in inflation and it is now assessed that underlying inflationary pressures are clearly lower than assessed in April.

Their assumption that a cut in interest-rates will boost inflation is in my view somewhat dubious. Some mortgage rates have already fallen but on the other side of the coin deposit rates will be dropping too and the experience in the credit crunch era is that these offset as we approach 0% interest rates rather than provide a boost. As ever these days the strongest influence comes from the exchange rate which did fall -for example by 1.7% versus the UK Pound- but what is required is a sustained fall and we cannot be sure about that. What we do end up thinking is that this is not entirely dissimilar to the competitive devaluation strategy of the 1920s.

Oh and if house price inflation was more directly reflected in Sweden’s consumer inflation numbers they would not be anything like as low would they?

As of May interest-rate falls were reducing measured consumer inflation rather than raising it. Something of a technical flaw there you may think!

The main factor behind this month´s inflation rate was the decreased cost of interest rates (-5.6 percent since May 2013), which contributed downwards by 0.3 percentage points.

Today’s news

Perhaps this played a part in the Riksbank’s move.

Industrial production decreased in May by 3.2 percent compared to April, corrected for seasonal effects.

Service production decreased by 1.0 percent in May 2014 compared to April in seasonally adjusted series.

Comment

Sweden is often considered in the UK as an example of how to do things. For example it is often held up as a paragon in the world of education and reviewed favourably to the UK. However its move yesterday poses a clear question which is very contradictory to the theme of higher interest-rates in the UK being on their way. Please do not misunderstand me as the UK’s growth path is higher and with our level of institutionalised inflation Base Rate cuts are far from the immediate agenda. But we learn that not much of a downturn could bring them into play if we note that economic growth forecasts for Sweden are in the region of 3% for 2015 and 2016.

Therefore we are left with some consequences. Firstly negative interest-rates are on the march even in a period of relative economic recovery. This poses the question of what we do in the next downturn? Also in such an environment how feasible is an interest-rate rise? Would the respective currency then immediately “overshoot”? Things were already complicated enough but another layer has just been added to the mix.

16 thoughts on “What does yesterday’s interest-rate cut in Sweden teach us?”

  1. theyenguy says:

    You write, monetary policy operates on a lagged time frame and needs to get ahead of events if it is to work properly. Instead we are seeing it chase events which seldom ends well.

    I respond how true.

    Therefore we are left with some consequences. Firstly negative interest-rates are on the march even in a period of relative economic recovery. This poses the question of what we do in the next downturn?

    I respond, times are changing: the world central bankers are now communicating their common intention to develop macroprudential regulation tools for financial system stability, and turn away from traditional interest rate policies.

    David Wessel posts in the WSJ Central Bankers Appear to Line Up their Defenses … Create The Macroprudential Maginot Line … http://tinyurl.com/pstcbnz … It looks like there has been some international coordination of monetary policy rhetoric lately.

    With price and wage inflation not a concern right now, we aren’t going to raise interest rates and throw a lot of people out of work to avoid excesses in financial markets or to head off possible asset bubbles, they said. There may come a day when our worries about financial stability will prompt us to hike interest rates, but rates are “the last line of defense.” Not now. The “first line of defense” is making the financial system more resilient so it can better withstand shocks and using our supervisory and regulatory “macroprudential tools” to rein in excesses, as we are doing now.

    This inquiring mind asks just what are “macroprudential regulation tools” for financial system stability? And what might they include?

    Macroprudential regulation tools are central bank clubs. One tool might be for banks everywhere to be integrated with the government and be known as the government banks or gov banks for short. In the US most every bank, that is Money Center Banks and Regional Banks, have US Government Treasury Notes, TLT, residing at the Fed. As the Benchmark Interest Rate, $TNX, rises banks might be tempted to withdraw these monies from Mother Fed. So I believe the Fed will put a hold on such action and start to integrate banks into the Fed.

    The Fed will be changing and morphing into the North American Fed, and will become the Atlantic compliment to the ECB, that is a North American Continent, that is Canada, Mexico, and America Regional Central Bank, which will serve as the singular banking institution for CanMexAmerica, that is the Regional Financial Hub, for the soon coming North American Union

    1. Forbin says:

      oh dear when I read

      Maginot Line – I read Maggot line

      “The “first line of defense” is making the financial system more resilient …”

      They dont say ! Its a bit late isn’t it? brings to mind horse>bolted>lock gate !

      2 nd thoughts – hang on if they are moving to “regulate” more and we’re at “emergency ” interest rates ( with Sweden joining us) , then this poses the question – why ? The banks are still bust then ? After all that money they’ve had? Really ?

      3rd thoughts – the Banks have been “rescued” then , sort of, see above , and if they merge then what?

      I dont elect BoE Carnival , I should then, shouldn’t I ?

      Then what again for “free” markets ? These questions are more than economics I know but what you suggest / posit means the end of Western Democracy , atleast from this seat ….

      Grabs another bag of popcorn …..

      Forbin

      PS: I dont expect Shaun to answer the political questions but from an economics front this looks rather diasterous

      1. Noo 2 Economics says:

        “what you suggest / posit means the end of Western Democracy” we’re already there Forbin, arrived in 2008.

      2. Anonymous says:

        Hi Guys

        I think that events- not only are central banks using a lot of powers but they are about to use even more- reinforces my argument that they should stand for election. Currently elected politicians are taking responsibility for ever less whilst unelected central bankers are taking responsibility for ever more. It is definitely an anti-democratic theme.

  2. Anonymous says:

    Hi Shaun

    Properties fell over 50% in the USA, Spain etc. 85% LTV – valuation fees paid by buyers needing finance. what could go wrong ?

    1. Noo 2 Economics says:

      Was exactly like that when I bought in 1987 Expat. Valuer was appointed by Building Society and I had to pay him, if I didn’t accept and pay him no mortgage – simple as that. He demanded to know ask price before proceeding with valuation. Valuation came back at 80% of ask price, when queried he said he only valued bricks and mortar.

      Clearly on the side of the Building Society then even though I was paying him – things are not always as simple as they appear.

      1. Anonymous says:

        A building society who will hold the mortgage has vested interest in making sure they can sell at “book value”.

        In contrast, the 2000s US boom had investment banks packaging up bundles of liars loans for onward sale. Nobody in the chain had any incentive to keep valuations down to a sensible repossession resale price.

  3. dutch says:

    ‘Their assumption that a cut in interest-rates will boost inflation is in my view somewhat dubious.’

    it seems guranteed to induce asset inflation.a price to pay for reversing a widening trade deficit

    1. Anonymous says:

      Hi Dutch

      Yes which is why the various establishments and elites go to so much trouble to avoid having asset prices in consumer inflation indices. After all it is awkward for them when they are in effect telling equity holders and home owners they are richer to have worries that it is in effect inflationary!

  4. Noo 2 Economics says:

    I think Sweden’s problems are directly linked to the Eurozone as 70% ish of it’s exports go there, until the EZ problem is resolved Sweden remains a hostage to the EZ’s fortunes – the dark side of having a positive balance of payments.

    1. Anonymous says:

      Hi Noo2

      The list of countries that are hostage to the Euro area’s fortunes is growing. Even Switzerland got sucked in as the Swiss Franc surged and it had to take action. This also via the Carry Trade caused problems for the foreign currency mortgages in Eastern Europe. Only this week Erste Bank had another “surprise” which would be no surprise at all to those who read my post of 1110/11.

      Now Sweden joins the list of those struggling via an appreciating currency. It makes me think who else has an appreciating currency? Oh yes the UK…

      Will the Euro area “export” negative interest-rates to the UK?

  5. Anonymous says:

    Very interesting, Shaun. I hadn’t heard anything about what the Riksbank did until I read your column.

    One thing regarding the Swedish CPI. When you write: ” if house price inflation was more directly reflected in Sweden’s consumer inflation numbers they would not be anything like as low would they” I suppose you just mean that if the Swedish CPI had a net acquisitions approach to owner-occupied housing their inflation would be a lot higher. However, the Swedish CPI does already include house prices in its mortgage interest component, which is really more like a component for mortgage interest and the opportunity cost of owner’s equity in the home. This is why, as you noted, the change in the interest rate has such a big impact on the CPI. Depreciation is a component, as in the RPI, but an index of repair costs is used to measure it for some reason, not a house price series as in the RPI or a dwelling price series as in the Canadian CPI. The attached paper by Klevmarken et al contains a description of the existing method along with a proposed method:

    http://uu.diva-portal.org/smash/get/diva2:277429/FULLTEXT01

    As far as I know this proposed method has not been implemented, so the method described still obtains. It also only applies to owner-occupied houses. OOH costs for owners of condominium apartments are proxied using imputed rents.

    I have spent a lot of time studying actual and proposed Swedish indexes for OOH and it always gives me a headache. If someone were looking for a good way to calculate OOH costs in an upratings index, they would be far better to imitate the UK RPI than the Swedish CPI. Andrew Baldwin

    1. Anonymous says:

      Hi Andrew

      As an EU citizen so to speak then Sweden will have a Eurostat style OOH index from September. Should the fall in mortgage rates stimulate the housing market further then it will provide some interesting answers to say the least…

      Thanks for the link and the information. If we project it forwards then we could reasonably expect such proposed changes to be having more of an effect now via higher weights. As to the current Swedish CPI methodology I had taken a look and noted that it was similar to the RPI and take on board your critique that it is in fact an inferior version of it.

      As well as the methodology I noted the results because CPI (with a housing element) is at -0.2% whereas HICP is at 0.1%. In a house price boom? Oh dear…..

      1. Anonymous says:

        Thank you for your reply, Shaun. An inferior version of the RPI methodology for OOH would be a good way to describe the Swedish OOH component for houses, with a CPIH treatment extended to owned flats.
        “Oh dear” is right. The Swedish house price index was up by 7,0% from 2012Q4 to 2013Q4. (There must be something more current available but I couldn’t find it.) The Swedish Riksbank will be foolish if it doesn’t look at switching to the Swedish HICP with the new OOH component tacked onto it as their target inflation indicator. It would be a way better inflation measure than their existing CPI.

  6. Ian says:

    The bank has to create inflation otherwise the whole thing collapses.

  7. Londoner says:

    If you fiddle the inflation figures long enough, eventually you end up believing them, when the original purpose of the figures was to stop the mess that you now get into so easily.
    Human beings are cunning, but not wise.
    If you have a debt ceiling but keep raising it, then it serves no purpose.

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