Europe’s Post-Subzero Rate Experiment Faces Next Big Test

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Riksbank officials are finding out that ending negative interest rates is far easier than convincing people the policy will stick.

Little more than a month since Sweden’s new benchmark level officially kicked in -- after the central bank raised it to zero in December -- the jury is still out on the move. The narrative of sustainably strong inflation that the Riksbank clung to while justifying the increase looks set to unravel, leaving investors to speculate whether it might eventually need to revert to more stimulus.

Sweden’s central bank is the only one of five globally to have dared to end negative rates, in an experiment its counterparts have been watching carefully. The risk for Governor Stefan Ingves is that, having engineered the escape from a regime deemed harmful to the finance industry, a deteriorating inflation outlook forces an embarrassing U-turn.

“If the Riksbank wants to handle this in a smart way, it should already now adjust its own inflation forecast,” said Thomas Elofsson, head of portfolio management at Catella, a Stockholm investment firm. “The risk is that the market will price in rate cuts, and that would be very unfortunate, as I think that the Riksbank really doesn’t want to return to negative rates.”

While delivering its rate increase in December, the central bank was already forced to trim its forecast for inflation every year through 2022. As policy makers announce their first decision of the year on Wednesday, the outlook has only worsened, after a warm and wet winter filled water reservoirs and threatened to depress electricity prices, while oil costs have also fallen.

Olle Holmgren, an economist at SEB in Stockholm, now expects inflation to fall to 0.8% by the summer. That’s a far cry from the 2% that officials target, and beyond the lower end of their prediction for this year. Meanwhile, a survey by SEB of its trading room participants shows 85% expect the Riksbank to stick with a forecast that rates will be unchanged in the coming years.

“I see no sign of inflation -- rather that the Riksbank will have a hard time delivering on their target,” said Magnus Billing, chief executive officer of Alecta, Sweden’s biggest pension fund. “There are large forces that keep inflation pressures low such as demography, productivity, a high savings ratio, rapid technical development.”

An outcome of dissipating price pressures may put Swedish policy makers in a bind. Doing nothing could risk letting weak inflation become self-reinforcing, while adopting more stimulus, either by cutting interest rates again or stepping up quantitative easing, would amount to a rapid reversal.

What Bloomberg’s Economists Say

We expect the central bank to stand pat for at least a year, but the risks to inflation and the monetary policy outlook are to the downside.

-Johanna Jeansson. Read her RIKSBANK PREVIEW

For the Riksbank, which endured sustained criticism for what Nobel laureate Paul Krugman called a “sadomonetarist” cycle policy of tightening that began in 2010, the embarrassment of another perceived error and subsequent backtracking would probably be painful.

But equally, the central bank was determined to exit negative interest rates after becoming increasingly uncomfortable with negative side effects that ranged from curbed profitability of financial companies to encouragement of excessive risk taking.

What’s more, with other central banks fretting they may not have enough fire power to tackle a new crisis, the Riksbank has taken a key step toward replenishing its arsenal.

“It’s been a mistake to have negative rates and I think that history will show that it created more problems than it solved,” said Frans Lindelow, CEO of Skandia, a Swedish insurer and bank. “It fundamentally is a good thing that the Riksbank has risen to zero.”

The example shown by Sweden has thrown focus on counterparts about whether they too should follow suit and exit subzero policy. European Central Bank President Christine Lagarde has insisted that she wouldn’t want to draw conclusions from the move, while Swiss National Bank chief Thomas Jordan is adamant that the same conditions don’t apply in his country.

For now, the new Riksbank policy has only been operational for a few weeks, so any conclusions on its impact may be premature. If the institution has to change course, officials have stressed that returning to a negative rate stance is still an option. Ingves has hinted however that he would prefer large-scale asset purchases instead.

“It’s not our main scenario, but if the central bank decides to act again, we see prolonging or expanding bond purchases as more likely than a cut in interest rates,” said Bloomberg Economics economist Johanna Jeansson.

--With assistance from Zoe Schneeweiss.

To contact the reporters on this story: Niclas Rolander in Stockholm at nrolander@bloomberg.net;Love Liman in Stockholm at jliman1@bloomberg.net;Rafaela Lindeberg in Stockholm at rlindeberg@bloomberg.net

To contact the editors responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net, Craig Stirling

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