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The global economy is wallowing in a deep trough. Despite this, Sweden had a growth rate of over 4 per cent in 2015, and with many forecasters predicting further growth in the quarters ahead the Riksbank was expected to start to raise the repo rate.
But, the Riksbank’s plans were an early casualty of the June 23 vote by the UK to leave the EU. On July 6, the Riksbank’s Executive Board announced that it was likely that the bank would postpone planned rate hikes beyond mid-2017. The Riksbank also announced that it would keep the repo rate on hold, at -0.5 per cent, and that purchases of government bonds would continue over the remainder of 2016.
In a press release communicating the decision, the Riksbank remarked that the Brexit vote meant increased uncertainty, and that while global growth would continue to strengthen, it would do so at a lower rate than forecast previously. The Riksbank said that the Swedish economy was in good shape, being propelled by expansionary monetary, but that it was difficult to predict the effects of the referendum. If the economic effects were more negative than the bank assumed, then it was prepared to make monetary policy even more expansionary; including further cuts to the repo rate and asset purchases, as well as intervening to ensure that the Kronor does not appreciate against other currencies.
The financial press immediately noted that this was another in a long-line of downgrades to forecasts. As the chart below shows, the Riksbank has missed its own forecasts of the repo rate on every occasion over the last 5 years.
In its coverage, The Wall Street Journal highlighted the risk that delay in returning the repo rate to normal settings could have on the house price bubble.
Further evidence of strength in the Swedish economy emerged in the data from the Economic Tendencies Survey, published on 27 July. The main indicator did record a fall after the UK referendum, but only from 103.0 to 102.2. A 3.3 unit fall from households was the chief negative influence on the index. The manufacturing, construction and retail sectors all remained positive, and the number of companies reporting labour shortages reached the highest level since 2008.
2Q16 GDP misses expectations
It was therefore a shock on July 29th when second quarter GDP growth was reported at just 0.3 per cent, an annualized rate of 1.2 per cent, well below the market’s expectations. Nordea had forecast a growth rate of 0.5 per cent for 2Q16. A poor export environment was part of the reason for lower growth, but the turndown was broad-based. Market sentiment has suddenly reversed and appears to be moving towards a view that the economic boom is over.
The challenge that the Riksbank faces in forecasting the direction of the economy and thereby fine-tuning its monetary policy is highlighted by the fact that its own forecast for 2Q16 growth of 0.7 per cent was made just 3 weeks before the number was released. With the growth rate now well below the Riksbank’s expectations the repo rate can be expected to stay lower for longer, especially if the UK drags Europe back into a recession.
Note: This is a shortened version of the original. Tables and footnotes are only available in the subscriber version of this article.