Riksbank Review: Flexibility in Future Policy Decisions

Summary

• The Riksbank hiked the policy rate to 2.50% (+75bp) following a unanimous vote.
• The forecasted policy path was revised higher, indicating a 25bp hike in February, and leaving flexibility for a 2.75% or 3.00% terminal rate.
• Asset purchases will mature and roll off the balance sheet from 2023.
• CPIF is forecasted to peak in February at 10.2% YoY while unemployment must average 6.95% through November and December to meet updated forecasts.
• Minutes will be published on 5 December. It will be key to watch why neither Governor Ingves nor First Deputy Governor Breman dissented, they were dovish members of the Board at the September meeting.

Hawkish Changes to Riksbank Outlook

The Riksbank hiked the policy rate to 2.50% (+75bp), in line with market consensus. There were a few key changes to forecasts:

• They revised the forecasted policy path higher (Chart 1). The path indicates a 25bp as well as a terminal rate of 2.84%. That is, they are leaving themselves open to a 2.75% or 3.00% terminal rate. Further afield, they have failed to forecast any cuts. Previously, they forecasted the policy rate to slide 17bp lower.
• The decision was unanimous. We expected Ingves and Breman would spearhead any effort to hike by 50bp. This could have been reflected in a dissenting vote. We will understand once the minutes are released (5 December).
• And on the balance sheet, the Riksbank will cease asset purchases beyond year-end. Thereon, they will let previous purchases mature and roll off the balance sheet (Chart 2). Holdings are expected to decrease by c.SEK490bn, thus being halved by end-2025.
• The Riksbank has forecasted CPIF to peak at 10.2% YoY in February and CPIF excluding energy to peak at 8.3% YoY in December (Chart 3 and 4).
• SEK (KIX) forecasted to strengthen (Chart 5). SEK TWI has proved weaker than previous forecasts and left retailers struggling to raise prices at the same rate as SEK depreciation.
• Unemployment is expected to trend higher as the employment rate peaks (Charts 6 and 7). On the former, given unemployment printed at 7.7% through October, it implies that it must average 6.95% through November and December.

Alternative Scenarios

The additional articles that the Riksbank includes tend to be highly useful. This time, they published two articles: 1) Alternative scenarios for inflation and monetary policy and 2) Why has the krona weakened this year?.

Unsurprisingly, it was the former that was of most interest. While a lot was described, the importance came through scenario analysis in their macroeconomic model, MAJA. Here are the important details:

• They run the model based on an unfavourable scenario where inflation is driven up by higher domestic price pressures and rising inflation expectations.
• In this scenario, high inflation outcomes are assumed to be broad-based. Importantly, with CPIF rising more than expected (Chart 8).
• As a result, long-term (five-year) inflation expectations unanchor from two percent.
• This would spiral to higher and more persistent inflation. The Riksbank would then be forced into hiking to a projected 4.65% terminal rate by Q1 2024, before cutting down to 4% in Q3 2025.

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)