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Sweden's Hike Holds a Lesson for the ECB

Sweden's Hike Holds a Lesson for the ECB

(Bloomberg Opinion) -- If you’re searching for an example of how not to deal with negative rates, look no further than Sweden. The Riksbank chose to raise its repo rate back to zero on Thursday, after years of negative rates, but it’s not at all clear why.

Sweden’s economic outlook hardly suggests a hike is needed. Inflation is running at 1.7%, which is just below the central bank’s target of 2%. Growth (adjusted for calendar effects) is expected to slow to 1.2% in 2019 and 1% in 2020, from 2.3% last year. In its Monetary Policy Report, the Riksbank highlights risks to both external and internal demand, because of the trade conflict between China and the U.S. and a decline in consumer confidence. Yet two deputy governors expressed reservations about the move.

There’s a risk, then, that policymakers may need to reverse course soon. So what was the real rationale for Thursday’s hike?

The stated reason was concern about financial stability. But the central bank provided little evidence for this in its report, which says that, so far, financial markets “have been able to manage negative interest rates relatively smoothly.” It also sees no negative effect on the lending capacity of banks, and predicts that housing prices will rise “at a modest rate,” which hardly sounds alarming.

Rather, policymakers seem worried that if they keep the policy rate in negative territory for too long, it may prove harmful to households down the road. In particular, they fear that banks may choose to introduce negative deposit rates for consumers, as they have in Germany and Denmark.

Yet it’s not at all clear why that should be a problem. A research paper at the European Central Bank shows that negative interest rates actually encourage lending when they’re passed on to bank customers. The Riksbank fears that subzero rates may push households to alternative forms of storing cash. But this would have a cost too; it’s not clear why savers would go to such lengths instead of paying a small fee to their bank.

There’s no doubt that central banks need to pay close attention to financial stability. But there are other ways to contain excessive exuberance. The rise of house prices — if it were to get out of control — can be slowed by imposing tougher loan-to-value and loan-to-income ratios. Regulators could also impose stricter capital demands on lenders (although Swedish banks are already the best capitalized in Europe).

There’s a lesson here for the ECB. After cutting its deposit rate to minus 0.5% in September, it has faced significant criticism from banks, which are seeing reduced profits. But policymakers should only increase rates when they think inflation is heading comfortably back on target — which is their primary mandate, after all — and the ECB is nowhere near its target of below, but close to, 2%. It forecasts that the inflation rate will only reach 1.6% in 2022. There’s no justification for a hike.

It’s possible that the Swedish economy will outperform the central bank’s gloomy expectations. In that case, policymakers should rightly feel vindicated. But, at the moment, the ECB and other banks experimenting with subzero rates should look at Sweden with a dose of skepticism. There’s no reason to panic about negative rates.

To contact the editor responsible for this story: Timothy Lavin at tlavin1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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