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June 21, 2006

Sweden's Riksbank Becomes More Hawkish
by Victoria Marklew

Today's 25bp rate hike from Sweden's Riksbank, which took the repo rate up to 2.25%, had been flagged for the better part of two months. Like the previous hikes in January and February, it was triggered by concerns about the inflation outlook. With the economy growing at a healthy clip, there had been some debate about whether there would be two more rate hikes this year, or three (the Riksbank's six-member Executive Board only holds eight policy meetings a year). After today, there is little doubt that - unless the economy suddenly changes direction - it will be three, starting in August.

The Riksbank targets underlying inflation (UND1X, ex-indirect taxes and interest rates) of 2.0% over a two-year forecast horizon. UND1X rose 1.6% on the year in May, up from 1.5% in April.

Although inflation is currently on an upward trajectory, it hardly seems worrisome. However, as we've noted before, the Riksbank is concerned with where inflation is headed over the next two years. According to its own revised outlook (also released today), underlying inflation will hit 1.9% in June 2009, "based on the assumption that monetary policy will gradually become less expansionary." The bank noted that domestic inflation is expected to rise relatively quickly in the future as economic activity improves and the labor market continues to strengthen. It also noted that household indebtedness and house prices "are continuing to rise rapidly."

The economy certainly surprised on the upside in Q1, with real GDP growth (expenditure basis) of 1.1% on the quarter and 5.6% on the year, up from 0.8% and 2.9%, respectively, in Q4 2005. The Riksbank has revised its forecast for 2006 GDP growth upward, from 3.5% to 3.7%.

The manufacturing sector has been particularly robust, boosted by exports. And, the unemployment rate is finally responding to the economy's resurgence, with the AMS labor board reporting a jobless rate of 4.2% last month, down from 4.6% in April and the lowest level in four years. Statistics Office employment data is due tomorrow, and will likely show an improvement from the 5.5% rate recorded in March and April.

After its February rate hike, the Riksbank sounded fairly sanguine about the outlook, and even hinted that it might be able to slow the pace of tightening. The slew of strong data since then, however, seems to have changed its mind. Today, the bank stated that "it is reasonable to assume that the repo rate will need to be increased further. It is possible that there will be a need for slightly more rate increases over the coming year than the recent market expectations have implied." (Our emphasis.)

Translation: If the economy continues on this trajectory, we'll probably be hiking again in August (29-30), as well as in October (25-26) and December (14-15), and may well hike once or twice more in the first half of next year, too. However, it looks like 25bp each time will be sufficient. (The minutes of yesterday's policy meeting deliberations will be released on July 3rd.)

Meanwhile, the crown jumped from a close of 7.39/US$ and 9.29/€ yesterday to around 7.34/US$ and 9.22/€ this morning. With today's more hawkish comments from the Riksbank, the prognosis for the crown in the second half of this year looks good, particularly against the US$.

Victoria Marklew
The Northern Trust Company
Economic Research Department
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Copyright © 2005-2008 The Northern Trust Company

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