RBS, HSBC and JPM Reveal Bets on How Far Swedish Riksbank Can Go

By Johan Carlstrom

As Sweden’s central bank considers new measures to fight deflation, economists at some of the world’s biggest banks are speculating on how far policy makers will need to go to regain credibility.
At Royal Bank of Scotland Group Plc, clients are being advised to brace themselves for negative rates in February. The Riksbank will then also need to buy assets and may even resort to currency interventions, according to RBS.
“If they don’t do anything, the market will probably be very disappointed,”Par Magnusson, head of Scandinavian rate strategy at RBS in Stockholm, said by phone. “To do nothing is not an option.”
The world’s oldest central bank said yesterday it will keep its main rate at zero into the second half of 2016 and raised the specter of non-standard measures. But with
deflation now entrenched -- consumer prices have dropped in nine of the 11 months measured this year -- many economists say something drastic is needed to reverse the trend.
SEB AB, Scandinavia’s biggest foreign-currency trader, predicted today that the Riksbank will start a “relatively small” balance sheet expansion by buying government bonds and possibly provide collateralized loans to banks.

Increasing Liquidity

“This is partly a way of increasing liquidity in the banking sector, which will increase the downward pressure on short-term rates and maintain pressure on the krona,” said Jussi Hiljanen, SEB’s head of fixed income in Stockholm in a chat. The Riksbank will also cut its deposit rate for fine-tuning, but probably won’t cut its key rate, he said.
And as the bank tries to find the right tools to deliver the necessary stimulus, it’s still haunted by past missteps. Governor Stefan Ingves, who started a tightening cycle that lasted a year at the height of Europe’s debt crisis in 2010, said yesterday currency interventions would mark a “last resort” for the bank. Besides that, he hasn’t ranked other possible measures in any order of likelihood, he said.
The Riksbank’s actions have attracted comment outside Sweden. Nobel Laureate Paul Krugman described Ingves’s policy steps during the debt crisis as “sadomonetarist” and blames him for Sweden’s descent into deflation. The effect has been to undermine confidence in the Riksbank’s ability to deliver on its price mandate.

‘Too Cautious’

Krugman’s former colleague at Princeton University, Lars E. O. Svensson resigned from the Riksbank board last year after failing to convince Ingves of the need for rate cuts. At his last meeting in April 2013, when the bank kept its main rate at 1 percent, Svensson had argued for a cut to 0.5 percent. Eight months later, the bank lowered its repo rate to 0.75 percent.
“It would have been reasonable to cut the rate now and then say that if this is not enough we will return in February with a whole package of measures,” Svensson told reporters in Stockholm today. “It’s worrying that the Riksbank seems too cautious and ambivalent and won’t do everything possible.” The bank “doesn’t seem to be taking the situation seriously,” he said.
The Riksbank now estimates it will reach its 2 percent inflation target, adjusting for mortgage costs, in the second half of 2016. HSBC Holdings Plc says that won’t happen.
“My expectations for inflation and growth are significantly lower than the Riksbank’s own forecast,” said James Pomeroy, an analyst at HSBC in London. He expects the bank to push back the timing of its first rate increase into 2017.

History Lesson

“There comes a point, probably around April, where I expect them to have to cut the repo rate to negative,” Pomeroy said. Given the current policy, “I can’t see how Sweden gets 2 percent inflation at any point during 2016,” he said.
And the group of economists who no longer believe the Riksbank’s inflation estimates is growing.
“If you look at the inflation forecast that they have over the last two years, it’s always one where inflation returns to target over the medium-term,” said Raphael Brun-Aguerre, an analyst at JPMorgan Chase & Co. in London. “History has proven over the last few years that this is not what happened so the likelihood that they are again surprised in the same way I think is pretty substantial.”
For now, the Riksbank should try to talk up inflation expectations. One way to do that would be to say it won’t raise rates until inflation reaches a certain level, according to Brun-Aguerre at JPMorgan. Still, it’s doubtful the bank will go down that road, he said. Other unconventional measures such as quantitative easing may not be “very effective,” he said.
The most likely scenario is an extension of zero rates into the third quarter 2017, Brun-Aguerre said. “They really have to stress their intention to do more.”