Sweden’s Riksbank have joined the easing party, announcing yesterday that not only have they cut interest rates into negative territory, to -0.10%, but also that they would indulge in a spot of QE. They left the door open to further rate cuts, and further QE – even at “short notice”(i.e. intra-meeting). The krona duly fell 2% against the dollar, equities hit a new high, and 10yr bond yields fell almost 10bps. So far, so what, you might say. We know this story now: “Deflation gripping the world, particularly Europe – hit that printing button!”. A 2% move in the SEK is not out of the ordinary, so it would seem the market is indeed becoming inured to all of this easing.
Let’s just take a step back for a second though. Sweden buying government bonds – is this the same Sweden that has a debt to GDP ratio of just under 40%, one of the lowest in Europe? The country where house prices barely dipped during the crisis and are now at record levels? (See chart below from the excellent interactive house price tool on the Economist website)
To be fair to the Riksbank, their lurch into QE is thus far only small – at 10bn SEK for a government bond market that’s about 1 trn in size, they’re not exactly “doing a Draghi”. Not yet, anyway. They did say they were looking into a Funding for Lending scheme, and lending 100bn SEK to banks over a four year period. So their intention to signal easing of policy is clear.
So the question remains, why did they do it? It’s that old chestnut, inflation again. Slightly strangely, the Riksbank barely altered their inflation forecasts:
But the fact is that inflation has been stubbornly below their 2% target for some time. Ever since the financial crisis, in fact, when core inflation spiked above 2% but has been declining ever since:
The difference between Sweden and the Eurozone is that in April 2010 the Riksbank began hiking rates, taking them up to 2% by the middle of the next year. Now, almost four years later, they still face a deflationary threat. They’ve been roundly criticised for hiking back then, and failing to cut quickly enough ever since. Will the criticism keep their pedal to the metal? Are they doomed to be forever fighting the last war?
This is relevant for the ongoing round of central bank easing because it could mean that they are cutting at the wrong part of the cycle. That would mean even more stimulus going into economies where it will ultimately feed through at the point when it’s least needed.
This is why the Fed’s recent work on the relevance of monetary policy lags is so important. Spot inflation is lower because of the collapse in the oil price, but as the BIS pointed out, the speed and depth of the decline is likely to be driven by financial liquidity rather than supply/demand fundamentals. Once that stabilises, so will inflation, and over time, given base effects, the hit to inflation will prove temporary.
Mark Carney seems to have been reading from the same manual as the Fed, with his opening remarks at the BOE Inflation (or should that be Deflation??) Report yesterday:
‘the effects of these large, one-off falls in prices [from commodity prices are] likely to dissipate in around a year, we will look through them.’
Central banks should be forward looking, and the most important part of the Inflation Report was not the incredulous headlines about the UK entering deflation, but the fact that the BOE now see the output gap at only 0.5%, down from the 1% estimate just three months ago. So half of the output gap is estimated to have closed in that period! Wages are going up, with the BOE forecast for unit labour costs up 0.5% pt in 2016 and 2017.
The point is – spot inflation may be lower, but you can’t ignore improving developments in the labour market. This is very reminiscent of Yellen’s December Fed statement, and we wait to see if she will reiterate this in her semi-annual testimony on February 24th. We may get a hint with the release of the January Fed Minutes next Thursday. When it comes to market pricing, the first Fed hike is priced by September of this year, while the BOE first hike is now around April of next year. The truth of the matter is that both may go somewhere in the middle of that period – enough time for the base effects from oil to fall out of the inflation data, and enough time for a tightening labour market to show signs of wage increases. Maybe don’t book a long Christmas holiday for 2015 just yet….you might miss all the action in December!