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SEK takes strain as housing inflation addressed

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Swedish GDP expanded at 0.8% in the third quarter to the end of September and posted an increase of 2.9% compared with the same period last year, up slightly from the downwardly-revised rate of 2.7% in the second quarter but still far below expectations of a 3.6% rise.

Construction was buoyant, but the slowing housing market looks set to adversely impact this area of economic activity in the future.

Meanwhile, consumer prices rose by 1.9% year–on-year in November, a couple of notches up from October’s reading of 1.7%.

While consumer price inflation (CPI) has remained benign over the last decade, house price inflation has been anything but, with Stockholm prices doubling in ten years. However, to the relief of the Riksbank, this trend appears to have run its course. Indeed, with the housing market in major cities already slowing, it is perhaps surprising that the Finansinspektionen (FI), Sweden’s financial supervisory authority, is considering a further tightening of residential mortgage regulations. The market has already adjusted of late to the ruling in April 2016 that, as of June 2016, mortgages with an LTV of over 70% must be amortised annually by at least 2% and loans of under 70% must be amortised by at least 1% annually, until the LTV has dropped to 50%; but now further restrictions are being proposed.

Earlier last month, the FI announced that, with effect from 1 of March 2018, it is proposing to extend the amortisation rules such that borrowers with loans exceeding 4.5 times gross income must amortise the debt by a further 1% of the outstanding loan on top of the existing regulations. Thus a borrower with a loan of more than 4.5 times income and an LTV of over 70% would be obliged to pay down 3% of the outstanding debt. The FI argues that these measures will fall mostly on those enjoying high incomes, but the potential 3% amortisation requirement is quite a step and will increase the short-term cost of financing for those with large mortgages. Indeed, even higher incomes will be required to cope with the increased capital repayments.

The impact on the housing market of the tightening of repayment terms has been predictable, with anecdotal evidence that viewings of advertised central Stockholm properties are already in decline. Although the Riskbank still predicts that house prices will rise over the next five years, the Stockholm market looks very expensive compared to other European cities when net incomes are considered.

For the purposes of LTV calculations, properties may only be revalued once every five years. Therefore the benefit of improvements to a property, for instance, will not be felt immediately on the LTV ratio. In the case of a rising market, this proviso is

effectively a further restriction. However, in the case of a falling market, it would provide a little breathing room. The thought of a protracted nominal decline in the market will be almost unthinkable to many Swedes. However, stranger things have happened and falling prices, leading to higher LTVs and increased amortisation would have the potential to turn into a vicious downward spiral.

Such a scenario might sound far-fetched, but central banks (not just the Riksbank) have been trying to engineer general price inflation for the best part of a decade. To date, they have been unsuccessful but they have succeeded in creating huge asset price inflation, about which they are now all worried. It would be ironic then if the Riksbank, in attempting to deal with excessive asset price inflation in the form of the housing market, put downward pressure on CPI inflation. This is something that the Riksbank certainly does not expect. Both governor Stefan Ingves and deputy governor Martin Floden have recently been at pains to point out the virtue of the government’s having tightened the mortgage repayment rules. Floden went on to say on the 5 December that there is unlikely to be a major macro-economic impact from uncertainties in the housing market. However, just because the general level of inflation was unaffected by the house price boom does not mean that, should the market turn, house price deflation would necessarily have no downward impact on general inflation. The effects could well turn out to be asymmetric.

This point has not been lost on the foreign exchange markets which, clearly concerned about regulatory effects on the housing market, have marked EUR/SEK up from just above 9.5000 at the beginning of October to 9.9600 at the time of writing. The Riksbank is presumably of the view that a tightening of the mortgage repayment rules will rein in Sweden’s expensive housing market in a more targeted way than simply tightening monetary policy. Indeed, to any extent that housing market weakness affects the general economy, continued ultra-loose monetary and the weaker SEK will help mitigate the worst of the impact. The risk is that ongoing negative interest rates and a weak currency eventually lead to general inflation, even if house price inflation has turned negative. At that point, any tightening of monetary policy to control the general price level would risk hitting the housing market further. Now that the global interest rate cycle is eventually starting to turn, if the FX market ever senses that the Riksbank is reluctant to normalise interest rates on account of the adverse effect on the housing market, the SEK will come under serious selling pressure.

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