The risky masterstroke of the Swedish central bank

It seemed for a moment that the Swedish central bank was shooting itself in the foot with an early interest rate cut. The Riksbank prefers a strong crown over a weak one. However, the currency is regaining ground and the Swedish economy is climbing out of the slump.

In recent years, central bankers were mainly concerned about high inflation. Other issues are now also gaining more attention. In Sweden, the Riksbank is performing a delicate balancing act. On one hand, inflation in the Scandinavian country has still not dropped to the official target of 2%. But on the other hand, the economy needs a boost. After a recession in 2023, Sweden is heading for a growth rate of only 0.7% in the current year. Lowering interest rates is a proven method to give the economy a push. Moreover, there are few countries where this has more impact than in Sweden.

High debt burden and short-term mortgages
Some explanation is needed here. In recent decades, the debt burden of Swedish consumers has increased significantly. Just before 2000, the total household debt was slightly smaller than the average income. However, that debt has now doubled. Additionally, Swedes take out their mortgages for a very short period. According to the Riksbank, the average remaining term is less than two years. In the Netherlands, for example, it is over six years and in Belgium even more than twelve years. When interest rates rise or fall, this has a much quicker impact on household mortgage costs in Sweden than in many other countries. The interest rate cut announced by the Riksbank in early May was good news for the economy.

Interest rate move pays off
A policy rate adjustment not only affects the economy but also the currency markets. A lower interest rate makes it less attractive for financial institutions and other parties to hold assets in the respective currency. Following the interest rate cut, the Swedish crown took a step back in the aftermath. The Riksbank prefers not to see this. A cheaper currency makes various items from abroad relatively more expensive. These rising prices fuel inflation, which the central bank is trying to control. However, the Riksbank's interest rate move seems to be increasingly turning into a masterstroke rather than a blunder.

All eyes on the ECB
Inflation expectations have hardly risen after the interest rate cut, and attention in the currency markets is shifting more towards the European Central Bank (ECB). It would be very surprising if the policy rate in Europe is not lowered a notch this coming Thursday. Due to the prospect of the interest rate difference narrowing again, the crown has rapidly risen since mid-May to the highest level since late March. The currency's future trajectory in the coming weeks largely depends on the ECB's outlook. If more interest rate cuts are expected, the crown may continue its ascent. However, it is important for the Riksbank to resist the temptation to give the economy a new boost with another interest rate cut for the time being.

Joost Derks

Joost Derks is a currency specialist at iBanFirst with over twenty years of experience in the foreign exchange market. This column reflects his personal opinion and is not intended as professional (investment) advice.

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