Thursday, February 11, 2016

Riksbank cuts rates deeper into negative territory

Sweden’s central bank moved its interest rates deeper into negative territory with an unexpectedly large cut, intensifying fears that global policymakers are being forced to take more extreme action to tackle low inflation.
The Riksbank cut its main repo rate by 15 basis points to minus 0.5 per cent, despite the fact that the country’s economy is booming. The bank said it felt forced to act because of “weakening confidence” in achieving its inflation target of 2 per cent.

The move rattled currency markets, sending the Swedish krona down 1.6 per cent against the euro, while the yen hit a 14-month high of 111.39 against the US dollar.It warned that monetary policy could be made “even more expansionary if this is needed to safeguard the inflation target”.
Core European bond yields dropped to new record lows after the Riksbank caught markets off guard with its move, while a broader stock market sell-off across the continent accelerated.
The 10-year Gilt yield dropped 9 basis points to a record low of 1.31 per cent. The German 10-year yield has shed 9 bps, taking it to a 10-month low of minus 0.166 per cent, nearing its all-time low of 0.049 per cent hit in April.
Bank shares resumed their slide, led by Société Générale, which tumbled 13 per cent. Deutsche Bank dropped 6.6 per cent, Santander lost 5.6 per cent, while UniCredit sank 7 per cent. The pan-European Stoxx 600 fell 3.3 per cent.
The Swedish cut followed the Bank of Japan’s decision to lower interest rates to minus 0.1 per cent in January, a move which stunned financial markets. At the meeting to approve the cut, some members of the BoJ’s policy committee warned of a global race with other central banks to set the lowest interest rates.
The European Central Bank lowered its deposit rate to minus 0.3 per cent in December and is expected to make another cut of at least 10 bps at its next full meeting in March.
But rate-setters also have to balance any such move against the possible impact on commercial banks’ profitability, given that many lenders have been reluctant to pass on the costs of negative rates to their customers.
Sweden is in the unusual position of having very strong economic growth currently but weak inflation, causing an acute policy dilemma for the Riksbank. It forecasts that economic growth will be 3.5 per cent this year, a little lower than the 3.7 per cent in 2015.
But inflation was just 0.1 per cent in December while core inflation, more closely watched by the Riksbank, was 0.9 per cent.
Andreas Wallstrom, chief analyst at lender Nordea, said the Riksbank was in a position where it ignored all other economic data aside from inflation, despite the fact that Sweden’s employment rate is the highest in the EU and its economy buoyant. “It’s hard to see the problems in the sense of the urgency of this decision,” he added.
The Riksbank has been under intense scrutiny in recent years, first for increasing rates prematurely after the global financial crisis and then for becoming the first central bank in the world to cut its main repo rate below zero — rather than the deposit rate as at the ECB or the rate paid on new bank reserves in Japan.
Sweden’s 2010-11 rates hikes have been cited critically by Federal Reserve chair Janet Yellen and her predecessor Ben Bernanke. Mr Wallstrom said the latest move by the bank was likely to be another controversial topic of policy debate.
The Riksbank itself was split over the new cut, with two of the six members of its executive board advocating no change in rates. Some economists have criticised the Swedish central bank sharply for continuing to cut rates as they believe it has little influence over the forces affecting inflation.
The Riksbank acknowledged this in its decision on Thursday, saying: “Growth in the Swedish economy is high and unemployment is falling, which suggests that inflation will rise in the period ahead. In addition, the downward revision of the inflation forecast is to a large extent due to factors that have little to do with the underlying demand-driven inflation in the Swedish economy.”
But it added that the recent weakness in Sweden’s inflation rates combined with global economic uncertainty meant it felt forced to act. This was made more urgent by its concerns that the Swedish krona could strengthen more than forecast, further jeopardising its inflation forecast.
James Pomeroy, economist at HSBC, said: “Given the booming economy and rampant housing market, the decision may only serve to further raise financial stability concerns.”
The Riksbank has been open about its desire to keep the krona weak as part of a global battle to depreciate currencies. The central bank earlier this year delegated authority to its governor and one deputy governor to intervene in the currency markets at any time, a move that has spurred some concern among politicians in Stockholm and dissent from another deputy governor at the Riksbank.

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