Struggling to raise inflation, Sweden edges toward currency intervention
STOCKHOLM: Sweden’s central bank is close to making its first foreign exchange intervention in 15 years in a desperate attempt to push up inflation, but critics say any effort to weaken the crown is likely to be futile.
The Riksbank has struggled to combat a largely strengthening currency despite cutting interest rates to record negative lows, due to a booming economy and loose monetary policy in much of the outside world. With its monetary tools to ward off deflation dwindling, the Riksbank board gave Governor Stefan Ingves powers earlier this week to intervene immediately in the currency market.
Minutes published on Friday of a meeting last month suggested that some policymakers believe intervention is the right way to go. “Several members … noted that if the exchange rate appreciated too rapidly, currency interventions could be necessary,” said the minutes of the rate-setting meeting held in mid-December.
The ultra-low interest rates helped the economy to grow 3.9 percent year-on-year in the third quarter, the third highest rate in the European Union. Data on Friday showed industrial production was up 6 percent in November from a year earlier. But with the main lending rate at -0.35 percent and the Riksbank pumping money into the economy by buying bonds, it faces a quandary.
The loose monetary policy is failing to raise inflation but encouraging a rise in house prices and household debt, which per capita is one of the highest in Europe. Many people also fear a housing bubble. “The tool box is getting empty,” said Nordea analyst Torbjorn Isaksson.
That leaves currency intervention to weaken the currency in the hope of pushing inflation towards the Riksbank’s target by raising the cost of imported goods and services. Analysts believe the Riksbank could start selling crowns at somewhere between 9.00 to 9.15 to the euro versus 9.26 on Friday.
Critics say the bank’s obsession with its 2 percent target is unrealistic. But the board does not dare to wait for the strong domestic economy to push up inflation, wary of past policy mistakes that undermined its credibility. The Riksbank raised rates fast in 2010 and 2011, worried about the housing bubble that was already inflating, even though the global economy had yet to recover from the 2008 financial crisis.
Nobel Laureate Paul Krugman called the policy “sadomonetarist” while US Federal Reserve chief Janet Yellen held up premature Swedish rate increases as a mistake to avoid. Former Bank of England governor Mervyn King and US economist Professor Marvin Goodfriend are due this month to present a post mortem report on the last few years of Swedish monetary policy, including the viability of the inflation target.
Consumer prices have been flat or falling for most of the last three years, and a meager pick up toward the end of last year has stalled, largely due to the stronger crown. CPI rose by 0.1 pct in the year to November. Many people think that if the Riksbank resorts to currency intervention, it will be unable to beat the market.
“The crown is in our opinion – and according to the Riksbank – undervalued so they are fighting against gravity,” Nordea’s Isaksson said. The problems with currency intervention were highlighted only last year when the Swiss central bank was forced to scrap its cap on the Swiss franc versus the euro.
In a sign of a split within the Riksbank, Deputy Governor Martin Floden entered a reservation against the board’s decision to give Ingves the powers to intervene immediately. On its trade-weighted index, the crown has strengthened 5.8 percent since April and is 2.9 percent stronger since the day before the Riksbank cut rates at an unscheduled meeting in March.
Threats of currency intervention have caused the crown to weaken from its strongest levels in December, but the index is still stronger than the Riksbank’s latest forecast, at 109.06 versus 110.7 seen around now. A Reuters poll on Thursday showed that despite the prospects of currency intervention, market strategists expect the crown to reach 9.00 by the end of the year.
Many believe currency intervention will be backed by other policy measures such as further rate cuts and more bond buying. In Friday’s minutes, Floden advocated further rate cuts. However, critics says they cannot be cut infinitely below zero and market participants are already complaining of low liquidity even though the Riksbank has yet to complete purchases of more than 30 percent of outstanding government bonds.
The last time the Riksbank intervened in the currency market was in 2001. At that time, the problem was the opposite: a weakening Swedish crown meant there was a risk of higher inflation than the Riksbank’s 2 percent target.
A 2006 study published by the Riksbank itself showed that interventions had been of little value, also after a currency peg that the bank upheld at tremendous costs, including a 500 percent policy rate, until 1992, was scrapped. “That the Riksbank alone could resist the whole of the market’s flows or its will to affect the crown, I just don’t believe in that,” said Anders Skoldberg, portfolio manager at the Second Swedish National Pension Fund.