After zero rates, Sweden ponders next steps to avoid deflation

Thu Nov 27, 2014 5:13am EST
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By Simon Johnson

STOCKHOLM (Reuters) - What should a central bank do next when it already has zero interest rates and arguably still faces the threat of Japanese-style deflation? If it's the Swedish Riksbank, it should keep cutting, and do so soon, says Lars Svensson.

Svensson no longer has a say; he quit as a deputy Riksbank governor last year after failing to persuade fellow board members to cut rates aggressively. Last month, they heeded his advice, lowering the repo rate to 0 percent and pushing back the official forecast for when the Riksbank will start tightening monetary policy again to mid-2016.

After years of tense, polarized meetings that eventually led to Svensson's resignation, a united Riksbank now sees zero rates as enough to push inflation up toward its 2 percent target.

Svensson disagrees, saying Sweden should go into negative rates - effectively charging banks to deposit funds at the central bank - to avoid the deflation which has trapped Japan in low economic growth punctuated by periodic recessions for more than a decade.

"From this point it is unlikely that the current policy at zero is enough," he told Reuters. "They should lower to -0.25 or even -0.50. The next meeting would be the natural time."

The Riksbank's next policy meeting is on Dec. 15, with its decision announced the following morning.

Rate-setters have not ruled out negative rates, but Riksbank Governor Stefan Ingves has rejected the comparison with Japan, pointing to expected Swedish growth this year of around 1.9 percent, with the economy moving up a gear again in 2015.

Nevertheless, Swedish consumer prices have been flat or falling for most of the last two years on an annual basis. Underlying inflation, the Riksbank's preferred measure which excludes interest rate effects, was 0.6 percent in October.   Continued...

Pedestrians walk past the Swedish Riksbank headquarters in Stockholm September 30, 2008. REUTERS/Bob Strong