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With rates still at -0.5% and inflation on the rise – February’s CPI was +1.8% year on year – and a reasonably competitive currency, one might be forgiven for wondering why the Swedish economy is not growing even more strongly. We shall have to wait a while yet for data on the first quarter of 2017, but the slowdown that was widely predicted after the disappointing Q3 growth of just 0.3% failed to materialise in Q4, which posted an impressive full 1% of growth quarter on quarter. However, despite this, while overall 2016 growth was 3.3%, Q4 growth still slipped to 2.3% year on year.
Meanwhile, inflation is picking up. This is hardly a uniquely Swedish problem – this is also true of the US, the UK (though this is being exacerbated by sterling’s depreciation after the Brexit referendum) and even the eurozone. Eventually, it seems, ultra-loose monetary policy and stimulus packages will always work their magic.
As inflation increases, central bankers are likely, initially at least, to ‘look through’ it and maintain very easy monetary conditions. After all, inflation has been below target virtually everywhere for so long that failing to address rising prices immediately through tighter policy will be a great temptation. In Sweden, the decision for the Riksbank threatens to be more difficult than in most jurisdictions. This is on account of the Swedish housing market, the performance of which has been so strong that, for years, commentators have been warning of bubble conditions.
This did not matter so much from 2013 to 2016 when inflation was mostly just below zero. Since last year, however, inflation has been rising, as has the rate of increase. The Riksbank’s target is to maintain an inflation rate of 2% as measured by CPI, and that level looks likely to be breached, possibly as soon as next month, when March’s figure is released. The dilemma for the Riksbank is how to prevent a significant overshoot (a smallish one could be ‘looked through’) without causing rapid – and potentially destabilising – house price deflation. Any rapid slowdown in the housing market could have an adverse knock-on effect on the real economy since so many young Swedes have become used to house prices that only rise.
Although the restrictions on interest-only mortgages introduced in June last year have cooled the housing market, prices are still rising on an annualised basis – albeit at a slower rate, which is to be welcomed. However, the full impact of the changes to interest-only mortgages, announced in June last year, may yet to be seen, suggesting the housing market could be vulnerable to a more sudden slowdown, affecting general confidence.
It is not just the residential market that looks likely to be affected by regulation. The commercial property market is also under official scrutiny. Next week we shall see the report by a Ministry of Finance committee on the use of SPV-based ownership structures to avoid taxes on commercial property. Just as the residential property market is being cooled by ‘quantitative restraint’ – part of the Riksbank’s macro-prudential arsenal – so the commercial market may be cooled if investors lose significant tax-breaks. There is cross-party political support to stop the avoidance of capital gains tax and stamp duty as a result of ‘packaging’ real estate assets into SPVs. Therefore, it is highly likely that the committee’s proposals will be passed into law in a relatively undiluted manner.
The effect that the now virtually inevitable change in legislation will have on the commercial property market is difficult to assess – however, it is unlikely to be positive.
A further issue for the Riksbank, though arguably a more long-standing one, is that of the exchange rate. EUR/SEK rose last year all the way from a low of 9.1584 in late April to over 9.9600 in November, providing useful support to the economy but without any unwelcome, direct stimulus to the housing market. Since the November high, however, jitters over eurozone politics have caused the SEK to acquire relative safe haven status – as has often been the case – and EUR/SEK has declined to its current level of 9.5175. There appears also to be an increasing recognition in the markets that the Riksbank’s ultra-loose monetary policy’s days are numbered.
The Riksbank’s balancing act over coming months, as inflation rises and residential and commercial property markets respond to already-enacted and potential changes to legislation, will be challenging. However, the central bank can take heart that, in addition to monetary and macro-prudential policies, it can rely on the exchange rate to counterbalance economic surprises. Without such flexibility, the Riksbank’s balancing act would move from difficult to impossible.
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