A Full-Court Press to Lift Inflation in Sweden

October 28, 2014

Drastically low inflation and expected inflation call for extraordinary action.  The Executive Board lopped off the last 25 basis points on its benchmark repo rate today.  The interest rate had been at 2.0% prior to December 2011 but reduced a percentage point to 1.0% by end-2012.  Another cut of 25 bps was administered in December 2013, and the rate was cut by 50 bps in early July.  Like the July reduction, today’s 25-bp cut exceeded expectations, which had been that the authorities would cut by 15 bps.

Today’s decision was accompanied by a statement that does not mask the intent of boosting inflation and expected inflation.  The timing of the decision follows new inflation forecasts that are substantially lower.  Projected total CPI inflation in 2015 was revised to 0.4% from 1.3%, and the forecast for 2016 was cut to 2.1% from 2.9%.  The likeliest timing of the first rate increase was moved to mid-2016 from late 2015, and the probable end-2016 level of the repo rate is now considered 0.75% compared to 1.63% assumed at the previous policy review.  In times more normal, this path would be recklessly loose, but frustration is expressed with the repeated need to revise projected inflation lower “despite the fact that both GDP and employment have increased at a relatively good rate over the last 12 months…. The broad downturn in inflation and the repeated downward revisions to the inflation forecast imply that underlying inflationary pressures are very low and lower than previously assessed. This, taken together with lower inflation and a weaker development of economic activity abroad, means that it is expected to take longer for inflation to reach 2 per cent….The repo rate needs to remain at this level until inflation has clearly picked up.”

Swedish monetary officials are essentially declaring that deflation would be much worse than inflation and that it is appropriate, even prudent, to steer policy in an aggressively pro-inflation way to extinguish deflationary psychology from the system.  The same no-holds-barred approach, only in reverse, is being taken that former Chairman Volcker applied to ending inflationary psychology in 1979.  One can infer that the statement is in part intended for ECB policymakers, who have been slow to learn that lesson.  Currency traders should understand that exchange rate adjustments need to play an important role.  Dollar/mark rose from 1.70 marks to 3.47 between the start of 1980 and early 1985.  The Swedish krona and euro now need to drop substantially and enduringly.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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