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House prices, inflation will inform Sweden interest rate decision

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House prices, inflation will inform Sweden interest rate decision

The Swedish central bank has hinted at an interest rate rise in late 2018, but a precise time frame will likely depend on how house prices and inflation develop.

The Sveriges Riksbank on Feb. 14 left the main repo rate unchanged at negative 0.5%. It said changes to monetary policy will need to proceed "cautiously," but that "slow rises" in the repo rate are set to be initiated in the second half of 2018.

The bank's governing board was divided in its decision to hold the rate, as Deputy Governor Henry Ohlsson voted for an increase to negative 0.25% thanks to growth in the Swedish economy. But analysts and economists have not interpreted messaging from the Riksbank as especially hawkish, and are anticipating a rate rise either toward the end of 2018 or as late as the beginning of 2019.

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The central bank's next moves will be watched closely not just in Sweden, but overseas as well, since it was the first central bank in the current economic cycle to reduce the interest rate to below zero.

It adopted this unconventional approach to monetary policy in 2015 in a bid to encourage bank lending and stimulate the economy, while generating a healthy level of inflation. The central banks of Denmark, Switzerland and Japan followed suit in 2016, and all still have negative interest rates.

Housing market, inflation

Sweden is dealing with an elevated level of household debt and several years of runaway house price growth, both of which have increased the sensitivity of households to an interest rate rise. The household debt-to-income ratio in Sweden is among the highest in the world, at 180%.

Meanwhile the Riksbank said it needs to continue with expansionary monetary policy for the time being because inflation is still below target despite strong growth in both the Swedish and global economies. Consumer price inflation was running at 1.9% in December 2017, or 1.7% when adjusted for energy prices, which is slightly lower than the bank's expectations, and below its 2% target.

Analysts and economists diverge in their predictions for the exact timing of an interest rate hike.

Jonas Goltermann, developed markets economist at ING, wrote in a Feb. 14 blog post that he expects a hike either in the fourth quarter of 2018 or in early 2019. Andreas Wallström, chief analyst at Nordea Markets, said in a blog post that he is sticking to his prediction of an early 2019 rise.

While the Riksbank has plenty of reasons to prepare for an exit from loose monetary policy, it is "not there yet," largely because of uncertainty around house prices, Wallström wrote.

"The housing market developments provide an uncertainty regarding the outlook for the overall economy. In all, this also suggests that the Riksbank will move cautiously."

House prices have experienced rapid growth since 2015, fueled by the availability of cheap debt, but the market showed signs of a correction in late 2017, with prices falling by 7.8% in the three months to December, according to the Valueguard-KTH Housing Index (HOX) Sweden.

The increase in household debt, and the sensitivity of households to a rate hike, has "long been a concern" for the Riksbank, and the risks linked to it will need to be managed via a combination of housing policy, taxation and macroprudential policy, the Riksbank's said.

Economists at consultancy Capital Economics expect the central bank to start off by increasing rates by 25 basis points in September, with a gradual rise to zero by the end of 2018.

The Riksbank may actually be underestimating the outlook for domestic inflation, according to Stephen Brown, European economist at Capital Economics.

If domestic inflation accelerates in the way that Capital Economics expects it to, then the Riksbank may look to increase the interest rate "somewhat faster than the bank and the markets currently anticipate," he said in an email.

Impact on lenders

The exact impact of an interest rate rise on banks in Sweden will depend to a large extent on deposit beta, or the percentage of the interest rate rise that is passed on to customers, a banking analyst covering the Nordics said, speaking on condition of anonymity.

Banks will need to decide whether to pass the higher rates on to mortgage borrowers, for example, or to try to keep loans cheap in order to stay competitive in a crowded lending market, he said.