Swedish Riksbank Likely to Cut Benchmark Rate Again on Thursday

October 22, 2008

After running one of Europe’s tightest monetary policies earlier this year, the Riksbank participated in the round of concerted rate cuts on October 8th and is poised to reduce its repo rate by at least 25 basis points on Thursday. Global and domestic economic circumstances are worsening. Swedish share prices have dropped around 10% since October 7th, including a decline of more than 4% so far today. The policy meeting was held today, and officials will reveal lower growth and inflation forecasts tomorrow. Real GDP contracted marginally in the second quarter and posted a gain of only 0.7% from 2Q07, down from on-year growth of 2.1% in the first quarter. The minutes from the October 8th decision to cut rates by 50 basis points to 4.25% revealed a unanimous decision “to mitigate the consequences of the financial crisis for the real economy.” At that hastily called policy meeting, officials observed a deteriorating U.S. economy, falling commodity prices, and softer Swedish trends in retail sales, industrial output, orders and trade. Much of that had been anticipated, but Riksbank officials were particularly unnerved by the lowest reading since 1994 on the country’s PMI (42.3), which suggests a clear further slowdown ahead. The latest 12-month change for industrial production is -1.8%.  Retail sales have flattened, with a drop of 0.5% in July followed by an uptick of 0.4% in August. The labor market is worse. Meanwhile, Riksbank officials noted that expected inflation is receding and that the weaker growth prognosis implied a lower flight path for inflation. Officials are now prepared to overlook the fact that on-year CPI inflation in September of 4.4% was at its highest since 1993 and are less worried about the krona’s year-to-date decline of somewhat more than 10% against the dollar. Also by early October, Swedish officials could detect signs of a mounting credit squeeze on Swedish banks and realized that it was necessary to reduce the repo rate if they wanted to avoid a tightening of monetary conditions.

The rate cut on October 8th, which was undertaken also as a sign of support for needed concerted action against the global recession and financial market crisis, represented a turning point for the Riksbank. Earlier in 2008, the repo rate had been increased by 25 basis points each on February 13th, July 3rd and, in a split vote, as recently as September 4th. That final move was the 13th increase of the cycle dating back to January 2006, and it was accompanied by a lower indicated likely future path for interest rates, which signaled an end to the streak of policy tightenings. If the Riksbank cuts by 25 basis points on Thursday, the repo rate will become 4.0%, the same level as at the beginning of 2008. A 25-bp cut would mirror the Bank of Canada’s pattern of reducing rates by 50 basis points on October 8th and by a further 25 bps yesterday. However, the Bank of Canada started to ease last December from a peak of 4.5% and has already cut its target rate by half to 2.25%. Even accounting for higher current inflation in Sweden than Canada’s 3.5%, the Riksbank appears to be further behind the curve than the Bank of Canada. A Swedish easing of 50 basis points thus appears more appropriate than one of 25 basis points. Officials will announce their decision at 11:30 GMT and hold a press conference afterward.

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