The basic arguments for the Riksbank cutting interest rates have been known for a long time. What has happened since last month's meeting to justify changing its mind and actually reducing rates? Currently, while the market sees a 50/50 chance of a July cut, we think it far more likely they will do so.
- The Riksbank has already signaled a cut. Most Riksbank members indicated at the April meeting that they plan to cut rates in July. Although the likelihood that they will do so is slightly less (26%) than before the last reduction in December (28%), we think the evidence sufficient and fully consistent with previous signals. I.e. the rate path indicate a July cut.
- ECB cut exerts pressure on the Riksbank. Usually, the Riksbank's policy rate reflects any changes in its ECB counterpart. This is hardly surprising given the close interdependence between both economies. European economic indicators have deteriorated further in recent weeks, contributing to the ECB lowering its interest rates last week. This strongly suggests the Riksbank will follow suit. A decision by Norges Bank also to cut its own rates this week (which we expect) would further increase pressure on the Riksbank.
- Not cutting rates would strengthen the Swedish krona. In trade-weighted terms, the SEK is close to its highest level in over 20 years. Although the Riksbank does not regard the currency as overvalued, it continues to depress inflation, which is already too low. If the central bank decides not to lower interest rates in July, the krona will appreciate further, making the achievement of its inflation target even less likely. Today, conducting monetary policies at odds with the rest of the world includes major risks for the exchange rate, something the Riksbank does not wish to chance.
- FSA to raise risk weights on mortgages. Riksbank governor Stefan Ingves has already made it clear that household debt represents the biggest obstacle to lower interest rates, declaring at the same time that if others do not take responsibility for restricting such lending, the Riksbank will have do so. In response, we expect a near-term sign that others are prepared to step up. In particular, the Swedish FSA will likely decide to increase bank risk weights on mortgages ahead of the Riksbank's July meeting, requiring lenders to set aside more capital in connection with housing loans made. However, with banks having already adapted to this change, the actual effects of such a measure will be limited. Nevertheless, the Riksbank would still be able to argue that the FSA had assumed greater responsibility for limiting lending, enabling the central bank itself to step back and lower rates a little.