This morning has brought an event which for a while seemed even more unlikely than impossible or what I have seen described as unpossible. It also has echoes on the other side of the world and events in Japan. So let me start with the worlds oldest central bank returning to the world of positive interest-rates.
Inflation has risen to the highest level since the 1990s and will be high for some time. To counteract the high inflation from becoming entrenched in price and wage-setting, the Executive Board has decided to raise the repo rate from zero to 0.25 per cent.
It seems that they have not only spotted that there is inflation around but also that it is here to stay. As you can see they have made quite an about turn on what they told us as recently as the 10th of February.
As energy prices have increased rapidly, inflation is now high but the Riksbank expects it to fall back over the year. Monetary policy needs to provide continued support for inflation to be close to the target in the medium term.
As you can see they were trying to push inflation higher at the time which is the policy error of the 2020s and maybe this century. This bit was a particular forecasting disaster.
The Riksbank does not expect energy prices to continue to rise this year. This means that inflation will fall back.
It is tempting to type they have been unlucky with the war in Ukraine but it is also true there were warnings about it. Anyway it is now 2024 or something like that.
The forecast for the repo rate indicates that it will be raised in the second half of 2024, which is slightly earlier than in the assessment in November.
As I point out regularly people who are so poor at forecasts should stay away from Forward Guidance.
An International Perspective
Often events are not only relevant in themselves but they are in comparison to events elsewhere and earlier this morning there was more confirmation from the Bank of Japan that it intends to resist the trend towards higher interest-rates.
The Bank will purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit so that 10-year JGB yields will remain at around zero
percent…… the Bank will offer to purchase 10-year JGBs at 0.25 percent every business day through fixed-rate
purchase operations, unless it is highly likely that no bids will be submitted.
This matters if we move to the world of exchange-rates where the Japanese Yen has fallen again and has now passed 130 to the US Dollar or if you prefer a time machine has gone back to 2002.
The Swedish Kroner now buys 13.4 Japanese Yen which is up 2 big figures on the end of February as we see the consequences ( so far) of the two policy decisions.
Back to Sweden
Inflation
This is the obvious starting point and the inflation that was expected to fall back has in fact done this.
CPIF inflation was 6.1 per cent in March, which is the highest level since the beginning of the 1990s. Last year’s upturn in inflation was largely explained by rapid increases in energy prices, but since the monetary policy
decision in February, inflation has become significantly higher than expected, even disregarding energy prices. Outcomes point to the upturn now being broad.
This is an utter failure of forecasting and planning to which typically they respond to by claiming that it is nothing to do them at all.
Monetary policy cannot affect the fact that commodity and shipping prices are high. It is therefore unavoidable that the rate of increase in consumer prices of, for example, energy, food and certain other goods, will remain high for some time yet.
This is quite a contrast when they were patting themselves on the back for claimed policy successes. If policy works in that direction (easing) then surely it has to work in the opposite one? They should get called out more often on this.
Suddenly they think it can work and you may note the latter bit where they are now acting to make people worse off by restricting real wages.
However, the Riksbank can conduct monetary policy to counteract the higher inflation becoming entrenched
in price-setting and wage-formation.
This is a clear perversion of their role.
Another Forecasting Failure
This is a more conceptual one. Central bankers like to point to what they call core inflation measures ( excluding food and energy) because they claim they are a smokescreen for true trends. Yet we have seen completely the reverse as they in fact provided a valid warning.
When adjusted for energy prices, inflation was relatively moderate last year, but it rose rapidly at the start of the current year . Measured as CPIF excluding
energy, inflation was 4.1 per cent in March.
If they had followed my view on the matter they could have got ahead of events rather than having to turn tail later on.
In particular, prices of food and other goods have contributed to the rapid upturn, but prices of services have also increased faster than usual. Underlying inflation is expected to continue rising in the coming period, and to be over 5 per cent until the end of the year.
Forward Guidance
The forecast for the repo rate is that it will be raised a further two to three times this year and will be slightly below 2 per cent at the end of the forecast period.
So 2024 will see an interest-rate of 2% apparently as opposed to the 0.25% they forecast only 2 months ago. On response inflation will return to target..
With this monetary policy, inflation is expected to fall
back next year and be close to 2 per cent from 2024
Or maybe not.
The Riksbank adapts its monetary policy to developments in the economy and is prepared to raise the repo rate faster if needed to ensure that inflation returns to the target.
Comment
There is a domestic and an international perspective to this. If we start with the domestic then this is a case of doing the right thing at the wrong time and timing really matters in monetary policy. Putting it another way we can simply compare an interest-rate of 0.25% with an inflation rate of 6.1%. There is a further issue here as they delay means they are acting when the economy is slowing. Even the Riksbank admits this.
Even if Sweden’s direct trade with Russia and Ukraine is small, the war entails significant effects on developments in the euro area, which accounts for an important part of Sweden’s foreign trade. In the Riksbank’s forecast, growth in the euro area is expected to slow down in the short term, although no recession is predicted.
Next comes the impact of the interest-rate rises on a society that has been encouraged to borrow especially via mortgages.
A further uncertainty factor concerns how the highly-indebted households in Sweden will be affected by rising interest rates.
They dodge the issue which I think is the most material. At the end of 2021 the Swedish government reported that hourly wage growth was 1.9% and that real wages were falling by 2.2%. With inflation having risen by 2% since then I expect the real wages have fallen faster and the economy will do worse and maybe much worse than they are forecasting.
Oh and on the other hand it is still trying to raise inflation via QE.
This year, bonds in the Riksbank’s asset portfolio will mature to the value of around SEK 154 billion, or on average around SEK 38 billion per quarter. In accordance with the decision in February, the Riksbank will purchase bonds for SEK 37 billion in the second quarter of 2022 to compensate for forthcoming principal payments.