Sweden’s central bank, the Riksbank, took markets by surprise by delivering a bigger-than-expected cut in its repo rate. The central bank cut rates by 15bps to -0.50% from -0.35%. Analysts were expecting only a 10bps cut to -0.45%. Citing low inflation as the main reason for today’s decision to loosen monetary policy, the bank said CPI is expected to be lower in 2016 than previously forecast.
In its latest projections, the central bank cut the forecast for CPI to 0.7% from 1.3% in 2016, and from 2.5% to 2.1% in 2017. Although inflation has somewhat strengthened in recent months, it remains stuck at just 0.1% year-on-year. The bank is worried that the downside risks from low energy prices and subdued rent increases in Sweden could blow inflation off course and away from its 2% target. The gloomy inflation outlook comes despite a strong economy with an enviable growth rate of over 3%.
A stronger krona is also making it difficult for inflation to pick up. The Swedish krona has gained around 3.5% versus the euro since early December when the ECB cut its deposit rate deeper into negative territory.
In addition to the cut in the repo rate, the Riksbank decided at its meeting to reinvest the maturities and coupons from the government bonds that it purchases as part of its quantitative easing (QE) program. The central bank launched its QE program in February 2015 and is set to expire in June 2016. It also made it clear that it thinks there is scope for further cuts in the repo rate if the outlook for inflation worsens.
This could potentially lead to divisions within the bank’s Executive Board as two Deputy Governors (Martin Floden and Henry Ohlsson) had reservations against today’s decision to cut the repo rate. Another obstacle is the property bubble and high level of household indebtedness in the country, which could pose serious risks to financial stability.
Strong reservations for future cuts could force the bank to resort to currency intervention as a last resort to devalue the krona and boost inflation. The Riksbank already signalled in its statement today that it is prepared to intervene in the foreign exchange market at anytime as a complementary monetary policy measure.
The Swedish krona tumbled by around 1.3% against the euro after the announcement. The euro jumped from around 9.48 kronor to a 5½-month high of 9.6105 kronor. But it soon fell back to around 9.50 kronor as the immediate impact receded and the possibility of the ECB cutting its rates further in March looms over the pair. The dollar saw similar moves, climbing to 8.4747 kronor after the news but dropped back to 8.3850 in mid-European session.
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