The Riksbank’s Tension Over a Possible Interest Rate Cut Increases: Decision Support

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(Bloomberg) — The Riksbank will either cut borrowing costs this week to aid the economy or else shirk from a move to avoid weakening the krona, in one of its most suspenseful decisions in years.

A quarter-point reduction of the benchmark interest rate to 3.75%, as predicted by two thirds of the 20 economists surveyed by Bloomberg, would mark the first clear instance this century when Swedish officials started easing before the European Central Bank and the US Federal Reserve.  

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Maintaining policy stance on Wednesday, as expected by other forecasters, could help support the currency and stave off an inflation setback from import price increases – but at the cost of further slowing the economy, which has contracted for four straight quarters.

The dilemma highlights how developed world central banks must weigh their options at a time when the broadly synchronized easing that once seemed likely in rich economies is being replaced by the Fed’s need to keep interest rates high in the face of stubborn inflationary pressures hold, was destroyed.

Governor Erik Thedeen prepared for Sweden’s narrow exit in the last decision in March, when he expected a cut in either May or June. With inflation data since then coming in lower than expected, Annika Winsth, chief economist at Nordea Bank Abp, says policymakers need not hesitate.

“If you look at the domestic factors, there is a strong case for a rate cut,” she said. “Our forecasts show that inflation will be at 1% in June and it would be very strange to keep the rate at a restrictive level in this situation. Then why increase unemployment and slow growth?”

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What Bloomberg Economics Says…

“A move next month would prevent unwanted pressure on the troubled currency as it would bring the Riksbank’s first steps closer to those of the ECB and Fed that we expect in June and July, respectively.”

—Selva Bahar Baziki, economist. For a full preview click here

A cut in the Riksbank’s key interest rates would be only the second among developed market peers this cycle, following the Swiss National Bank’s groundbreaking move in March. It would be a “first” if officials did so while their counterparts in the U.S. and euro zone have not, Par Magnusson, chief interest rate strategist at Swedbank, said in a report last week.

“That this is happening in a situation where core inflation is above 2% makes it even more unique,” ​​he said, pointing to the underlying consumer price indicator that excludes energy.

A reduction in borrowing costs would be welcome for households struggling with the highest debt costs in years in an economy marked by its weakness. The European Commission forecast in February that Sweden would post the weakest growth in the European Union this year. New forecasts will be published next week.

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But the prospect that the easing could drive up import prices is a concern for policymakers. The krona has lost around 1.5% in value against the euro since the Riksbank’s March meeting. This is the worst performance in the group of 10 most traded currencies.

In neighboring Norway, the central bank signaled last week that it may postpone plans to cut interest rates after the krona weakened more than forecast.

For Nordea’s Winsth, such concerns should not prevent a move as inflation is expected to be below the Riksbank’s 2 percent target and the lower exchange rate is mainly due to the strength of the dollar.

“There is a limit to how far their policies can deviate from the ECB’s, but I don’t think one or two cuts would be a big problem,” she said. “Also, I don’t think the crown weakness is a Swedish problem at the moment. The Norwegian krone is in the same situation and Norges Bank’s hawkish stance isn’t really paying off.”

The dilemma could lead to a split among officials after 12 months of unanimity. Last time, Deputy Governor Per Jansson warned that delays in easing restrictions elsewhere could lead to further weakening of the crown. Martin Floden, who will leave the Riksbank after this week’s decision, stressed that a cautious approach after an initial move could support the currency.

Whatever happens, Winsth warns that expectations of relief from the economy are likely overblown – even if the three cuts in borrowing costs announced in March actually materialize.

“Many households hearing about interest rate cuts probably haven’t fully calculated what that will mean in monetary terms,” she said. “I think people will be disappointed.”

– With support from Zoe Schneeweiss and Harumi Ichikura.

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