CORRECTED-MNI INTERVIEW: Riksbank Could Cut 2-3 Times More
Former deputy governor of Central Bank of Ireland talks to MNI on switch in Riksbank policy
(Corrects Stefan Gerlach's former position in first paragraph)
MNI (LONDON) - The Riksbank is moving from a period of policy driven solely by inflation overshoots to one in which it has to factor in weak output, and could cut its benchmark rate two or three times more before the end of the year, former deputy governor of the Central Bank of Ireland Stefan Gerlach told MNI.
Gerlach’s modelling of the Swedish central bank's policy setting through the Covid inflation era from February 2021 onwards shows that it initially focused on the difference between the policy rate and inflation, but now, with inflation at target, economic activity will matter much more.
"They tightened monetary policy dramatically when they got going, and this weighs increasingly on economic activity. And now with inflation back to about 2% they change track ... I could imagine they could cut two or three times here between now and the end of the year," said Gerlach, now chief economist at EFG Bank.
Gerlach’s model indicated that headline inflation rather than underlying measures has been the best metric for explaining Sweden’s rate-setting, though he cautioned "When inflation is so far off target it doesn't really matter what you look at. I don’t think this finding should be overinterpreted."
On the Riksbank's CPIF target measure, which measures consumer prices with a fixed interest rate, inflation has fallen from a peak just over 10% to 1.7% in July. CPI, which peaked at over 12%, rose by 2.6% last month.
FX FACTOR
Unlike some other advanced economy central banks, the Riksbank tends not to react to currency swings, he said, despite a decade of krona weakness "that does not appear to have affected policy."
"This is textbook central banking, but there are very few central banks that do textbook central banking,” Gerlach said.
Governor Erik Thedeen has highlighted how European Central Bank and Federal Reserve decisions factor into Riksbank policy calculations, but Gerlach said differences in policy rate levels between the central banks should not matter in themselves. (See MNI INTERVIEW: Krona A Factor In Riksbank Cut Timing - Thedeen)
“What really matters is why the ECB would cut. If the ECB cuts, because ... the German export sector is slowing dramatically then you would expect that to impact on Swedish economic conditions and the Riksbank to cut," Gerlach said. “But there is no need for the Riksbank to match the ECB cuts one-for-one because of the exchange rate.”
Evidence shows no strong correlation between levels, rather than changes, in rate differentials and the exchange rate, he added, pointing to Switzerland as an example of a country with low rates and a strong currency.
Currently for policy setting 'what is important is the exposure of the Swedish economy to a slowdown in the euro area and the fact that the export sectors are tied so closely together," Gerlach said.