Why the Riksbank won’t be the next central bank to cut rates

Who will be the next central bank to cut interest rates? That’s the question markets are focused on, but the latest comments from Riksbank Governor Stefan Ingves and Deputy Governor Anna Breman suggest it won’t be them.

The duo has said that it is 'too early to determine' the impact coronavirus will have on the economy. But being a small, open economy, policy easing in Sweden is nevertheless fairly likely.

That poses increased risks for core inflation. January’s numbers have been dismissed as displaying temporary drags, but the virus is likely to hit the numbers through the first half of this year. As consumption dips, airfare prices will be first to take the hit, probably closely followed by leisure and entertainment.

This will lower core inflation, and plunging oil prices will be a further drag on the consumer price index with a fixed interest rate or CPIF. This also poses a risk given the ongoing wage negotiations due to be wrapped up in Spring. The labour market already appears to be weakening and inflation expectations among employee/employer organisations are muted.

But having only increased the repurchase rate back in December, officials are clearly wary about lowering it again so soon. Don’t forget that December’s decision was motivated more by a desire to prevent negative rates becoming a permanent state of affairs than it was due to any economic strength.

That suggests any initial action is likely to be focussed on other tools. One of the key concerns globally is the impact the virus will have on small businesses and their cashflows. A rate cut is unlikely to do too much in that regard, which is why the Riksbank has hinted that it is looking at other measures to ensure that credit continues to flow to affected companies. As a result, the Bank might end up using some of the policies it used back in the crisis, including loan facilities.

Quantitative easing also appears to be fairly high up the list of tools. That might include an increased rate of government bond purchases. Currently, policymakers are reinvesting roughly 50% of what will (or has) matured between April 2019 and December 2020 (most of this is centred on one large maturity towards the end of this year).

This policy means that the size of the bank’s government bond holdings will fall by the end of the year, relative to where they were in April 2019. However, policymakers said on Tuesday that the balance sheet shouldn’t reduce this year, which potentially opens the door to increase that rate of reinvestment of government bonds.

Policymakers are also hinting that the purchase programme could be expanded to include other assets, including corporate bonds.

Some kind of easing looks fairly likely, but the real question is when will this take place.

The next Riksbank meeting isn’t until the end of April, by which time the epidemic is likely to have spread further. So while policymakers have hinted easing measures are not imminent, we can’t rule out some action before the formal meeting. Either way, rate cuts are unlikely to be the first line of defence.