European Daily: The Case for a Riksbank Policy Shift
- The Riksbank’s Executive Board signalled that rates will remain on hold until the second half of 2024, a dovish stance that stands in contrast to the recent trend in global central bank communication and in stark contrast to Sweden’s neighbour, Norway. We see four reasons for a near-term hawkish policy pivot at the Riksbank.
- First, Swedish underlying inflation is high, and rising. Second, inflation nexpectations in Sweden are sensitive to spot prints, and as such have been picking up sharply, risking de-anchoring. Third, given low reliance on gas and limited direct trade exposure to Russia and Ukraine, we expect the economic impact of the war to be limited in Sweden. Fourth, broader Swedish financial conditions remain remarkably accommodative amid high house price growth.
- We therefore continue to expect the Riksbank to lift off in September, followed by three further back-to-back 25bp hikes to rein in inflation, taking the policy rate to 1% in Q2 next year. Given the 3-3 split vote on the size of asset holdings at the February meeting, we think it likely that lift-off will be preceded by an announcement that balance sheet holdings will be reduced gradually at the June meeting, following a delay at the April meeting to assess the impact of the war in Ukraine on the outlook. We see risks skewed towards a later but steeper lift-off schedule should the demand shock be greater than we anticipate.
- We leave our forecast for Norges Bank unchanged and revise up our GDP forecast for Norway slightly on account of high oil prices. We expect the next two hikes to come in June and December, followed by two hikes every six months until the terminal rate of 2.5% is reached in mid-2025. We see risks as two-sided: a larger consumer demand shock could delay further hikes, while a bigger boost from oil prices to activity could accelerate the hiking schedule.
The Case for a Riksbank Policy Shift
The Riksbank continues to guide for lift-off in the second half of 2024, leaving the Executive Board with an unusually dovish monetary policy stance, a contrast perhaps most starkly illustrated with the policy of its neighbour, Norges Bank. In today’s Daily we therefore reiterate the case for a Riksbank policy shift, and update our expectations for both the Riksbank and Norges Bank’s policy outlooks.
Underlying Inflation Is Rising …
We see four main reasons for a Riksbank policy turnaround this year. First, underlying inflation pressures, not just headline inflation, have picked up rapidly in recent months in Sweden (Exhibit 1, left). While the Riksbank argues that inflation will fall back as energy price pressures ease, this seems less certain given some likely pass-through from energy prices to underlying inflation, the effects of FX depreciation, and further pressures from supply chain disruptions. While the latter is a global phenomenon, it is notable that underlying inflation pressures are better contained in Norway, where policy tightening is already well underway (Exhibit 1, right).
… And Inflation and Wage Expectations Are Picking Up
Second, as spot inflation has picked up, so have inflation and wage growth expectations (Exhibit 2, left). The pick-up has been more pronounced in Sweden than in Norway, where long-term inflation expectations are less sensitive to spot prints, and are therefore better anchored (Exhibit 2, right). Lack of policy tightening therefore risks a de-anchoring of expectations in Sweden, and we think likely requires a significantly faster policy tightening, if not an overshoot, later on.
A Limited Growth Hit Amid Macroprudential Concerns …
Third, given Sweden and Norway’s limited direct trade exposure to Russia, we expect a manageable activity hit due to the war in Ukraine (Exhibit 3, left). Sweden’s reliance on natural gas, at less than 2% of total energy consumption, also means that the risks around gas shortages are lower than in the Euro area. We therefore only expect slightly slower near-term growth on account of a real disposable income squeeze, and lower consumer confidence. Given our commodities team’s forecast for a persistently higher level of energy prices, we expect some of the activity shortfall to remain over the forecast horizon (Exhibit 3, right). We therefore expect 2022 growth of 3.5% in Sweden, compared with the Riksbank’s forecast of 3.9%. In Norway, we expect somewhat faster growth in the near term, as higher oil and natural gas prices boost petroleum-related investment and provide fiscal headroom. The academic literature suggests that a 10% increase in the oil price raises the level of Norwegian mainland GDP by about 0.25%. Given that our commodities team’s forecast for oil prices is about 20% higher than the conditioning path of Norges Bank’s forecast, we assume a 0.5% boost to mainland Norwegian activity, with some near-term offset due to lower real disposable income. We now look for Norwegian mainland GDP to grow at 4.3%, a touch higher than Norges Bank’s expectation of 4.1%.
Fourth, broader financial conditions remain highly accommodative, in particular in light of rapid house price growth (Exhibit 4). While sequential house price growth has slowed somewhat in Sweden, at over 10%yoy it remains high, and well above nominal GDP growth. High household indebtedness is one factor behind the Riksbank’s assessment that financial stability risks remain elevated, and as such macroprudential concerns could be cited as a secondary reason for the need of tighter policy.
… Leading to a Sizeable Shift in Riksbank Policy
We therefore think that a shift in Riksbank communication and policy is imminent. Given the strong spot data, our range of Taylor rule estimates point to notably tighter near-term policy (Exhibit 5, left). But given the communication challenge ahead, we continue to expect the Riksbank to lift off in September, followed by three further consecutive 25bp hikes to rein in inflation, taking the policy rate to 1% in Q2 next year — a steeper hiking path than we had previously assumed. At the April meeting, we look for the Executive Board to signal a significantly more hawkish stance given incoming data, but delay any policy action on account of the uncertainty induced by the war in Ukraine. In particular, we expect the repo rate path to be moved forward by about 5 quarters, indicating some probability of a repo rate rise in the first half of next year. Given the 3-3 split vote on the size of asset holdings at the February meeting, we think it likely that lift-off will be preceded by an announcement that balance sheet holdings will be reduced gradually at the June meeting. Beyond the initial hiking phase, we expect the Riksbank to hike by a further 25bp every six months, until terminal rate is reached in mid-2025 (Exhibit 5, right).
Given the Riksbank’s dovish communication so far, we see risks around this forecast as skewed towards a later, but steeper lift-off. While we think a reduction of the balance sheet size in the near future is likely, the Executive Board could argue that this is sufficient tightening of the monetary stance and delay lift-off until November or early next year. In such a scenario, we would expect the Riksbank to have to hike significantly faster to control both spot inflation and inflation expectations. We therefore view market pricing as too aggressive at this stage, given the significant communication challenge ahead.
We leave our forecast for Norges Bank policy unchanged, and expect the next two hikes to come in June and December, followed by two hikes every six months until the terminal rate of 2.5% is reached in mid-2025. We see two-sided risks: a larger hit to consumption either via lower consumer confidence, or a reduction in real disposable income or the higher cost of consumer debt servicing could delay the hiking schedule, given that Norges Bank is already well into its hiking cycle. However, more inflationary pressures, for example through additional global supply chain disruptions, or a bigger boost to output from higher oil prices could require a faster pace of tightening. In our base case, we therefore agree with market pricing in the near term, but see risks skewed towards a more gradual tightening pace further out.