This week, Sweden’s central bank, the Riksbank, surprised the market by cutting its benchmark interest rate to zero. The cut was larger than expected, as the market was looking for only a 10-15 bp rate cut. This aggressive move puts Sweden’s main repurchase rate, or repo, lower than it was before the Lehman crisis, and lower than the European Central Bank’s (ECB) repo rate of 0.25%.
What’s interesting is that this bold move is a complete reversal of Riksbank’s previous policy. Back in July 2010, the central bank had started to raise rates to curb Sweden’s overheated housing prices and household debt.
At one point the repo rate touched 2%. But then from December 2011 on, Riksbank began seeing a drop in consumer prices and started to ease its monetary policy. Many felt that easing process was too slow. The central bank was criticized as quick to respond to inflation but slow to respond to deflation, and they were lumped into central banking’s “Hall of Shame” with other central banks that flip-flopped their monetary policies, such as the Bank of Japan in 2000 and the ECB in 2011.
Today the same level of household debt persists. Not only that, Sweden’s gross domestic product growth is one the strongest among developed nations, standing above 2% for the first half of 2014, and forecasted to grow faster in the second half. So clearly, the Bank’s decision to chop rates to 0% was not based on growth concerns. It was based on the material concerns of “lower inflation trend,” as consumer prices in Sweden have dropped in seven of the past nine months. The Bank now forecasts inflation to be at just 0.4% in 2015, which is still well below its 2% target.
My view: A country that wants more inflation would like to see its currency remain weak. I believe if the Swedish krona (SEK) should start to strengthen against the U.S. dollar – or more importantly against the euro – there will be a good chance that the Riksbank will intervene to sell the SEK in order to buy time until its inflation level hits the desired 2%.
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