Sweden’s Negative Central Bank Interest Rate Becomes Even More So

February 11, 2016

The Riksbank experience with monetary policy normalization after the Great Recession preceded the Fed’s current attempt by over five years and serves as a lesson of what can go wrong.  From a low of 0.25% at the beginning of 2010, the Swedish repo rate was lifted by a full percentage point that year and by another 75 basis points to 2.0% in 2011.  By late 2011, Sweden’s economy wasn’t handling the normalization at all well, and the Executive Central Bank Board authorized a 25-basis point cut in the final month of the year.  A second cut followed in February 2012, another in September 2012, and a fourth in December 2012 by which time the rate was back to 1.0%.  A year went by before the fifth cut in December 2013.  The ante was raised to 50 basis points in July 2014.  The seventh reduction in October 2014 pinned the repo rate at zero, only that proved not to be the bottom.  A negative 0.10% repo rate was adopted a year ago in February 2015, followed by a 15-basis point cut in March and a 10-bp reduction to -0.35% last July.

Seven months had passed without any further change, and analysts were not expecting the repo rate to get modified at this week’s Executive Board meeting.  But the experts were wrong, and today’s released statement justified a further 15-basis point cut to -0.50% in three one-sentence assertions:

  1. The economy continues to strengthen but inflation is expected to be lower during 2016 than previously forecast.
  2. The period of low inflation will therefore be longer.
  3. This increases the risk of weakening confidence in the inflation target and of inflation not rising towards the target as expected.

New forecasts were released.  Projected CPI inflation was halved to 0.7% from 1.3%.  Core CPI was cut 0.4 percentage points (ppts) to 1.3%.  Inflation in 2017 is also expected to be lower than imagined before.  As for the repo rate itself, officials do not think such will be as high as zero before the first quarter of 2018 and accept the possibility that negative 0.50% may not even be the cyclical floor.  The paramount goal is to “safeguard the inflation target” with whatever it takes.  “It is the Executive Board’s assessment that the risks inherent in an unchanged policy are greater and that monetary policy therefore needs to be more expansionary.”  Officials are providing quantitative stimulus and determined not to allow maturing asset holdings to trim its portfolio, so those are getting reinvested.  They are also looking into other steps that can be taken to enhance existing steps to maintain negative rate levels.

The lesson for all economies where short-term interest rates have been lowered to zero or practically zero is that any exit policy from such a state is going to be extremely precarious.  One ordinarily would expect zero interest rates to be associated with very robust growth in borrowing and real aggregate demand.  That hasn’t been the case.  Policymakers cannot afford to proceed in rapid fashion as the Fed did from mid-2004 to mid-2006 or in big increments of 50 basis points or more at a time.  It’s going to take a long time for rates to reach escape velocity, that is a height where economies will be somewhat sheltered from unexpected shocks because the scope for monetary policy responses is broad enough to look credible.  In this era of excessive private debt, geopolitical strain, insufficient fiscal support, and polarized political leadership, it’s become a fact of life that shocks are happening with much greater frequency than assumed.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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