January 28, 2015 / 11:17 AM / 5 years ago

Sweden's unconventional monetary policy would be no bazooka

* Negative rates seen as next step, may come in Feb

* QE seen problematic

* Currency intervention not on cards

By Simon Johnson and Johan Sennero

STOCKHOLM, Jan 28 (Reuters) - Sweden’s central bank may be the next to adopt unconventional policies to fight falling prices, but it is unlikely to match the impact of others as the bond market is small, yields are low and banks are already flush with cash.

The European Central Bank said last week it would pump billions of new money into the financial system through sovereign bond purchases, part of a plan to launch a “big bazooka” to revive the economy. The U.S. Federal Reserve and Bank of England have taken similar steps.

While growth in Sweden looks relatively solid at an expected 2.6 percent this year it may be knocked off track by European weakness. Even with that expansion, inflation is way under the central bank’s 2 percent target and cheap oil is adding to downwards pressure. Some economists say Sweden risks a deflationary spiral.

Having held its key rate at zero since October, the Riksbank has said it could take new steps as early as its next meeting on Feb 12. These could include adopting negative rates, offering cheap loans to banks and buying bonds but economists are not optimistic about their success.

“If any unconventional measure is launched, it will most likely not be a big bazooka but rather a quite small handgun,” Nordea said in a note.

The Riksbank’s first move is expected to adopt negative interest rates, possibly at its next meeting in February, following in the footsteps of Switzerland and Denmark.

But economists say there may be little room to cut without the risk of negative effects - such as dislocation in financial markets and the risk that depositors will pull money from banks.

“The Riksbank can cut again ... by 10-15 basis points, but not more than that,” said Roger Josefsson, Danske Markets chief economist.

Citibank said in a note last week it expected the Riksbank to cut its key repo rate to as low as -0.25 in February.

If this fails to send inflation - headline prices fell 0.3 percent in December on a year-on-year basis - back up towards the central bank’s target analysts expect a dose of quantitative easing (QE) will follow shortly after, maybe as early as March.

The crown has strengthened around 2 percent since the ECB’s announcement and any further gains would support the argument for extra steps as a stronger crown would mean cheaper imports, making it even harder for the Riksbank to hit its inflation target.

“QE is now our main scenario,” Citibank said.


The Riksbank, however, faces several complications.

It cannot influence the price of oil and commodity imports or affect increased competition at home - one reason it believes price pressures are low. Better demand for Swedish exports depends on recovery in Europe more than monetary policy at home.

Also, the relatively strong growth is driven by consumer spending and too much extra stimulus could increase imbalances, such has high levels of household debt, in the economy.

“It is a nightmare scenario for the Riksbank,” said Robert Bergqvist, chief economist at SEB. “Their tools are not powerful enough to hit the inflation target.”

Nevertheless, the Riksbank needs to show it is committed to meeting its inflation goal. Inflation expectations - key for wage setting and corporate investment - have already started to drift away from the 2 percent target.

Citibank expects the Riksbank to announce bond purchases of 15-20 billion Swedish crowns ($1.8-2.4 billion) per month as early as March or April, with the goal of pushing yields and the currency lower and encouraging banks to lend more money.

But Swedish central bank First Deputy Governor Kerstin af Jochnick warned last week that large purchases could affect the smooth functioning of the small bond market.

Danske Market’s Josefsson said a bond purchase programme of 5-10 billion crowns a month would be “pretty big”.

Sweden only has around 766 billion crowns ($92.9 billion) outstanding in nominal and inflation-linked bonds. The UK Gilt market, for example, tops $2 trillion. Yields on Swedish debt are already near record lows.

“If they are going to make big purchases, they would have to buy in the mortgage bond market, and the Riksbank may not be so keen on doing that,” Jesper Hansson, head of forecasting at National Institute of Economic Research, said.

Sweden’s mortgage market has outstanding debt worth 1.2 trillion crowns, but the Riksbank has been worried about an overheated housing market and cutting mortgage costs further would hardly help.

Targeted loans to banks would avoid stoking high levels of household debt. But banking system liquidity is already good.

Former Finance Minister Anders Borg told Reuters last week the central bank should think about currency intervention.

But central bank Governor Stefan Ingves has said that would be last of the options. Such a move could lead to accusations of competitive devaluation. ($1 = 8.2453 Swedish crowns) ($1 = 0.6600 pounds) (Additional reporting by Daniel Dickson and Johan Ahlander; Editing by Alistair Scrutton and Anna Willard)

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