by Solomon Teague
Rising unemployment figures this week invited yet more criticism of the Riksbank that its monetary stance – tighter relative to the average G10 real interest rate – has contributed to growing joblessness.
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The Swedish October unemployment rate increased from 7.3% to 7.5%, or from 7.7% to 8.1% on a seasonally adjusted basis. The krona fell on the news, but recovered quickly enough as Riksbank governor Stefan Ingves downplayed the possibility of FX intervention, even as the inflation rate hit minus 0.1% in October compared with the target of 2%.
An increasing number of analysts are calling for the Riksbank to introduce a Swiss-style floor with the euro. The Swiss currency floor sees the SNB maintain a cap preventing it rising above 1.20 Swiss francs to the euro.
“The Riksbank may be thinking about a Swiss-style floor,” says Geoffrey Yu, G10 FX strategist at UBS. “[Riksbank deputy governor Per] Jansson has said the krona would need to strengthen considerably from here before that could be implemented. It could cut rates further, though there isn’t much room to do that.
“So the most likely option is to keep rates at zero until inflation reaches 2%, or even keep it at zero without making it data dependent.”
ING agrees Sweden could be considering implementing some kind of managed currency regime on the Swiss/Czech model, suggesting such an outcome is likely. Although such a move is not imminent, given the Riksbank’s conservative nature, it believes the bank could act in around six months.
Bolder solution
However, there are calls for a bolder solution: asset purchases or quantitative easing (QE).
Yu at UBS says: “Our analysis shows there are enough domestic assets in Sweden for the Riksbank to consider QE, though it would probably mean purchasing a lot of covered bonds. But it could follow the European Central Bank’s (ECB) approach with ABS and encourage Swedish corporates to originate corporate bonds with the promise that it will buy them.”
ING states: “Between the QE and currency interventions/floor options, we see the latter as more likely.” QE would be seen as stimulating lending, in an economy that is burdened with high debt levels, and therefore might not be seen as the optimal approach, it explains.
While the Riksbank considers its options for fighting inflation, it has also been fending off calls for it to revise its mandate to a dual one that includes some form of employment focus. Various parties, including the ruling Social Democrats and Greens, have called for a debate about the merits of changing the Riksbank’s mandate to include full employment.
“While we continue to see Swedish CPI inflation as a key factor to watch to gauge further Riksbank moves, the unemployment rate may be set to gain more prominence,” says Petr Krpata, FX strategist at ING.
| The Riksbank will probably sit on its hands a bit longer and hope Draghi can do his QE and get things going again John Hardy |
Minister for finance Magdalena Andersson has suggested no such change is imminent, noting that the government has other priorities, suggesting the earliest the change could be implemented is 2018. However, even this might be optimistic: adjusting the Riksbank’s mandate could even require a European treaty change.
Nevertheless, if unemployment continues to rise, the pressure will increase and efforts to find a way to change the Riksbank’s mandate might be sought.
“The Riksbank is very reluctant to change its mandate due to the enormous complexities associated with employment,” says Yu. “It has done studies in this area and there are influential factors outside its control, like structural reform. A dual mandate approach would be a step too far.”
There is always the hope the spike in unemployment will prove temporary.
SEB suggests the latest employment numbers could be “a reaction to very strong growth during the summer”. Indicators suggest a firm trend in employment, it says, but “despite strong employment, there is, however, a risk that unemployment continues north as expanding working-age population drives the labour force higher”.
There is even some debate about whether all the hand wringing in Sweden over the higher numbers are justified.
“The employment numbers aren’t that bad for a high tax, high social-welfare country like Sweden, which will tend to have a relatively elevated natural unemployment rate,” says John Hardy, head of FX strategy at Saxo Bank.
In any case, monetarists argue asset purchases, QE and/or some form of forward guidance is more than justified now, without any shift in the mandate, because the Riksbank is singularly failing its price-stability objective. What’s more, a focus on employment would distract the Riksbank from its core competency.
“The best way of achieving a strong and stable economy over time is to commit and stick to an inflation target,” says George Buckley, chief UK economist at Deutsche Bank. “That is not to say the interpretation of inflation targets should not be flexible – to the extent that inflation tomorrow is influenced by demand today, an important part of inflation targeting is to use monetary policy to achieve stable growth at around its trend rate.”
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Market pressure for more aggressive action triggered tensions on the Riksbank’s board, according to the minutes of the most recent meeting.
While board members Cecilia Skingsley and Jansson requested a more thorough analysis of supply factors that might have contributed to the low inflation rate, Martin Flodén said: “It is not evident that the results of such an analysis would have implications for the monetary policy decisions, particularly in Sweden at the present time.”
The Riksbank is naturally cautious because of Sweden’s high private-debt levels and the ominous shadow cast by fears of a large housing bubble, the impact of which is aggravated by relatively low savings and a high reliance on international funding.
However, FI, Swedish financial supervisory authority, did propose new measures last week, which it suggested would decrease risks associated with household indebtedness.
It proposed bringing the loan to value (LTV) on new mortgages to 50%, with annual repayments of at least 2% made on loans down to 70% LTV and at least 1% annually down to 50% LTV. The FI believes households with a LTV of more than 40% to 50% are likely to cut back on consumption when economic conditions tighten.
“Additional measures from local regulators to tackle the household debt issue may free up the Riksbank to do more, particularly if inflation does not pick up materially,” says ING’s Krpata. If the introduction of the new LTV measures undermines consumption by pushing up repayments, it could increase the need for further Riksbank easing, he adds.
Saxo's Hardy says: “The Riksbank will probably sit on its hands a bit longer and hope Draghi can do his QE and get things going again. But something is going to have to happen. The declining krona may lead to inflation creeping up for a while, but Japan is exporting deflation and if China devalues next year that will export even more.
“So low inflation is likely to remain a problem. The Riksbank will have to do something.”
For now, the krona looks set to trend lower, with long NOK/short SEK a good way to play the trend, says Yu.
However, with SEK still heavily influenced by Europe, any longer-term forecasts are impossible before there is more clarity on what the ECB has planned.