rfr · H30WRFR7 · 2016-01-19 00:00:00 — Furthermore, the internal analysis work conducted at the Riksbank has led to a significant lowering of the forecast for inflationary pressures. These three circumstances are the main reasons for the substantial cut in the repo rate and the repo-rate path proposed today”. “Given the current forecast for CPIF inflation, in which the target of two per cent will be reached in early 2016, we will have undershot the target for roughly five years. [I]t should be remembered that there is no specific time requirement for how quickly inflation should be returned to the target…[A] long period without attaining the target can lead to movements in inflation expectations. As well-anchored inflation expectations are a central element in price and wage formation in the economy, it is therefore justifiable today to support an additional clear easing of monetary policy” (Minutes, p. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 recalled that “at the monetary policy meeting in April he de- clared that his tolerance of further downward revisions of the inflation outlook in the near term had reached its lower limit. As the inflation outcomes since then are once again forcing the Riksbank to revise its inflation forecasts down- wards he will now consequently vote for a repo-rate cut. The only question is by how much, 0.25 percentage points or 0.5 percentage points”. noted two reasons favouring a smaller cut: 1) a larger cut would contribute more to a build-up of household debt and 2) the Financial Stability Council and had not yet taken sufficient measures to man- age the risks associated with household debt. then noted four reasons favouring a larger cut: 1) since October of 2013 seven of the total of eight inflation outcomes had been below the Riks- bank's forecasts, 2) this related to short-term forecasts, which are normally fairly accurate, 3) these shortfalls had surprised other forecasters too, and 4) the fall in inflation was broadly based, which became apparent when one stud- ied the different components of the CPI. Given this background, also noted that the extent of the forecast revision for CPIF inflation in the draft was not effectively captured simply by comparing the new and the old inflation forecasts. The new forecast is part of the main sce- nario that is conditional on a much more expansionary monetary policy (Minutes, p. went on to declare in favour of the larger repo-rate cut, because he “quite simply believe[d] that a forceful monetary policy intervention is the right thing to do at this point, where inflation has been far below target level for a fairly long time and where the status of the inflation target has been ques- tioned repeatedly and by many people in the monetary policy debate…[and he] above all emphasized that the consequence must never be that the nominal anchor is put at risk...[and that] he also holds to his earlier promise not to vote in favour of an increase in the repo rate until CPIF inflation accelerates and exceeds 1.5 per cent” (Minutes, p. earlier had explained that the policy easing was now so aggres- “monetary policy abroad is expected to be more expansionary than previ- ously with lower interest rates in the period ahead … This is primarily because the ECB has clearly stated that it sees a period of more expansionary monetary If interest rates are lower abroad, then interest rates in will also need to be lower to avoid the krona strengthening in a way that makes inflation move further from the target” (Minutes, p. The forecast for euro area GDP growth in the main scenario was revised down again from to for 2014 and from to for 2015 at the Monetary Policy Meeting compared to . euro area inflation was revised down from to for 2014 and from to for 2015. Forecast GDP growth in was revised down from to for 2014 on weaker export . Other forecasts, in particular, the forecasts for inflation and unemployment were changed. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 decided unanimously to keep the repo rate at until the end of 2015 and raise it gradually to just above by the end of the three-year forecast horizon. The decision essentially continued the policy stance from . 's reasoning for the policy decision was largely as it had been in . Importantly, however, the Board added a blunt warning to the Government and other authorities that “[a] low repo rate makes it more urgent for other policy areas to manage the risks linked to household indebtedness and to developments on the housing market. The most important effect of the macro-prudential measures taken so far is considered to be that the resilience of the Swedish banking system will be strengthened, while the effect on household indebtedness is considered to be slight…measures need to be taken to influence household demand for credit. The responsibility for this type of measure lies with the Government and other authorities. Examples of measures that should be considered are a more stringent mortgage cap, amortisation requirements, a change in the right to tax deductions for interest expenditure and that sound minimum levels are introduced in the discretionary income calculations included in the banks' credit assessments. Moreover, it is important to introduce reforms, which will lead to the housing market functioning better. The Riksbank will, as before, monitor and analyse risks and resilience in the financial system and ascertain how these affect general economic development and thereby monetary policy” (MPU, p. began the meeting praising the change in the way inflation was forecast in the . “In , decided to attach more weight to models than to judgement-based assessments in the inflation forecast, as it has become apparent that the models provide relatively good forecasts according to forecast evaluations carried out at the Monetary Policy Department. This change may have eliminated the tendency towards systematic overestimations of future inflation that the forecasts have shown for a time…she viewed it as a positive development that the latest forecast errors have entailed an underestimation rather than yet another overestimation” (Minutes, p. also commented on inflation developments since the early policy meeting, pointing out that: “The outcome for CPIF inflation in was just over 0.6 per cent. This was almost 0.3 percentage points higher than expected. Inflation was somewhat above the forecast in the already in , but the outcome for reinforced this tendency. One should of course not exaggerate the positive in such a short-term development. But after several months of systematic over-predictions of inflation it is naturally something of a relief…all else being equal, these positive inflation surprises mean that it has now become a more likely that the forecast of a more lasting upturn will de facto happen” (Minutes, p. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 In her closing comments at her last meeting, emphasized a point she had made at earlier policy meetings with regard to the inflation forecast in the main scenario: “…she considered that it could be worth clarifying that the overestimation of forecast inflation means that the real interest rate appears lower than it will be in reality. It is the real interest rate that determines how much stimulus monetary policy brings. If monetary policy decision-makers believe that the real interest rate will be lower than actually turns out to be the case, they will hold the nominal policy rate above what is actually required for the intended stance of monetary policy. For this reason, the inflation forecast is of crucial importance for interest rate decisions to really bring about the monetary policy stimulus considered appropriate by decision-makers” (Minutes, p. The forecast for euro area GDP growth in the main scenario was revised down again at the October 2014 Monetary Policy Meeting compared to Sep- tember from to for 2014, from to for 2015, and from to for 2016. Nevertheless, forecast GDP growth in was revised up from to for 2014 on stronger private consumption which offset the drag from exports. importantly, again the CPIF inflation fore- cast for 2014 was revised down from to for 2014 and down from to for 2015, though inflation was still predicted to average in 2016 in the main scenario while unemployment, forecast to be in 2014 was predicted to average in 2016. decided unanimously to cut the repo rate by to through the first half of 2016 and then to raise it to towards the end Thus, interest rate policy reached the so-called “zero lower bound”. Expected repo rates in markets again conformed closely to the Riksbank pub- path to mid-2016 and thereafter rose more slowly to only 50 basis points by late 2017. The reasoning for the policy action in the essen- tially carried over from previous meetings. 's comment on the inflation surprise reflected the feelings of other Board members. “[t]wo new inflation outcomes have been published since the Monetary Policy Update in . The latest outcome for was almost 0.4 percentage points lower than forecast in the Monetary Policy Update. [T]his was a real setback given that the outcome for was supposed to represent the starting point of a trend towards a higher rate of inflation”. went on to point out that “[t]he proposed forecast represents a signif- icant downward revision of inflationary pressures in the coming years, espe- cially when one considers that the new inflation assessment is conditional on a much more expansionary monetary policy. The reasons put forward in the draft are that inflation has repeatedly been lower than expected in the recent past, that international price pressures are now expected to be lower and that it is predicted that the development of oil and fuel prices will be weaker. Moreover, the draft also proposes a 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 rather substantial downward revision of the growth forecast for the euro area and the weaker economic outlook now applies to the German economy too” (Minutes, p. “[I]t is no exaggeration to say that it has been unusually difficult to make reasonably accurate inflation forecasts recently. Since the outcome for October last year, which can be said to mark the beginning of this period with particularly substantial negative inflation surprises, eight out of twelve monthly outcomes have been below the Riksbank's forecast. The results are no better for other forecasters. For them too, on average eight out of twelve outcomes have been lower than expected. This is particularly disheartening given that we are talking about forecasts for the short run…[and] it is most probably that the trend with unexpectedly low inflationary pressures has not yet come to a halt” (Minutes, p. Toward the end of the meeting, asked the question that must have been on the mind of other Board members: “[T]he question here was why the major stimulus measures in recent years have not had greater effects on economic activity and inflation. Structural problems may of course be an explanation in some countries, but it is more difficult to understand why this has been the case in countries with a monetary policy transmission mechanism that works, a relatively robust financial sector, and stable public finances” (Minutes, p. Governor Ingves closed the meeting by reflecting on whether it was possible to fine tune monetary policy in a small open economy, particularly one as open as the Swedish economy, with large exports, imports and no limits on capital flows. He thought it probable that inflation would continue to deviate periodically from the target (Minutes, p. Assessments and forecasts in the main scenario changed relatively at the Monetary Policy Meeting compared with October. A sharp fall in oil prices pulled inflation down. But CPIF inflation in was still expected to rise from in 2014, to in 2015, and to in 2016 as a result of the monetary policy easing that had been put in place. decided unanimously to extend its repo rate path from the first half to the second half of 2016 and then raise the repo rate only to instead of towards the end of 2017. justified its policy decision much as at previous meetings emphasizing this time that ”inflation expectations in the longer run have fallen slightly further and are below the inflation target of 2 per cent” (MPU, p. Governor Ingves noted that “the fall in oil prices is contributing to a slight downward revision of the forecast for inflationary pressures. Inflation expectations in the longer term have also fallen somewhat. This suggests that monetary policy needs to become somewhat more expansionary…” and he went on to say that “[it] is now time to prepare potential non-conventional measures which, if the need arises, could be presented at the next monetary policy meet- 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 [He added] that among such measures he did not wish to exclude a neg- ative repo rate or foreign exchange intervention, although the latter would in no way be his first choice” (Minutes, pp. spoke at some length about inflation . noting that “[t]he outcome for CPIF inflation in was approximately 0.6 per cent, which was marginally higher than expected”. “According to the latest Prospera survey, expectations of inflation five years ahead fell for all of the groups interviewed in compared to the preceding survey in . [And] the fall was largest in the case of the employer and employee organizations, where inflation is now expected to be around 1.7 per cent in five years' time rather than close to 2 per cent as ex- pected earlier” (Minutes, p. Although found the falling long- term inflation expectations worrying, he was optimistic, pointing out that “[s]ince , the repo rate has been cut by 200 basis points, from 2 per cent to zero per cent. At the same time, the date for the first repo- rate increases has been postponed by approximately four years. rate at the end of the forecast period has been lowered by approximately 200 basis points from around 3.5 per cent to 1.45 per cent. It is of course difficult to say precisely how long it will take for all these easing measures to have their But the effects will increase as time passes and the likelihood of inflation rising will thereby also increase” (Minutes, p. mentioned a list of measures that the Riksbank could take to ease monetary policy further if need be: negative interest rates, purchases of various securities, targeted loan facilities for companies and loans to banks. In addition he said “the Riksbank can intervene on the foreign-exchange mar- kets with the aim of weakening the krona exchange rate. is not really on the cards, however, as long as the krona exchange rate is rela- tively weak and the development of the real economy in is reasonably solid” (Minutes, p 9). , offered a similar list of options pointing out that “[c]urrency interventions could probably entail a clear and fairly rapid upturn in inflation”. But like , thought that deliberate exchange rate depre- ciation was not a viable option “when monetary policy abroad is also limited by the policy rate's lower bound, [since] the positive effects of currency inter- ventions on inflation in would probably fully come from negative ef- fects on inflation abroad”. therefore didn't see “currency interven- tion as appropriate in a situation where other countries are also struggling with low inflation and have problems in making their monetary policy more expan- sionary, and where the Swedish krona is also relatively weak” (Minutes, pp. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 Phase 6: Going Negative, February 2015-October 2015 Forecasts in the main scenario were relatively unchanged at the February 2015 Monetary Policy Meeting compared to with the exception that another collapse in oil prices depressed inflation forecasts somewhat both abroad and in . The price of a barrel of oil had fallen from in 2014 to around in February 2015. decided unanimously to cut the repo rate to negative 10 basis points, to delay lift off until the second half of 2016, and to raise the repo rate only to by early 2018. Market expected repo rates followed the Riksbank's negative repo rate path for 2015 and most of 2016 then turned up more slowly to only about 25 basis points. also announced that it would soon begin purchasing of government bonds. dissented preferring to put the bond buying program on hold until it was really needed. justified another easing of monetary policy as follows: “The recent development of inflation has been roughly as expected, but there is a risk that lower oil prices will dampen inflation expectations, and thus inflation, more than is assumed in the forecast. To this can be added the increased uncertainty about developments abroad and on the financial markets. In order to support the upturn in underlying inflation so that CPIF inflation approaches 2 per cent and to ensure that long-term inflation expectations are compatible with the inflation target, a more expansionary monetary policy is needed… The measures that the Riksbank is now taking…underline the Riksbank's determination to safeguard the role of the inflation target as a nominal anchor for price setting and wage formation. In order to ensure that inflation rises toward the target, the Riksbank is prepared, should the need arise, to quickly make monetary policy more expansionary, even between meetings. This will entail further repo rate cuts, postponing the first repo-rate increase and increasing the purchases of government bonds” (MPR, p. In effect, the extraordinary package of monetary policy actions including bond purchases and especially the negative repo rate, and the promise to do more if needed outside of regular meetings, demonstrated that the Riksbank was fully focussed on the objective of getting inflation back up to in a timely . At the meeting, noted that the outcome for CPIF inflation in was , the third month in a row that inflation rose faster than forecast. Nevertheless, he thought that a more expansionary monetary policy was needed because of a number of large risks that were difficult to quantify, but which if realized could significantly change the forecast for the worse. These involved i) , ii) and , iii) the ECB's decision to make extensive purchases of financial assets, equivalent to almost three times Swedish GDP, and iv) the continued fall in long-term inflation expectations. The latest available survey data showed expectations of inflation five years 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 ahead among money market participants was now compared to in (Minutes, p. , who joined in January 2015, was con- cerned about the negative repo rate causing problems with regard to existing laws, regulations, and contractual conditions. And he worried about the im- pact on the demand for currency, with its zero nominal return, that negative interest rates might create. To underline his absolute commitment to use these extraordinary policies to return inflation promptly to the target, Governor Ingves made an un- characteristically long statement of enthusiastic support taking up nearly six pages in the Minutes (pp. Governor Ingves was concerned in particular about the uncertain impact on from policy developments abroad. He observed: “The ECB has de- cided to conduct substantial asset purchases in order to make monetary policy more expansionary and to ensure that inflation rises…The Swiss central bank has abandoned its exchange-rate floor in relation to the euro and has cut its policy rate to -0.75 per cent. In , the central bank has intervened on the foreign exchange market and lowered the policy rate to -0.75 per cent to defend the fixed exchange rate in relation to the euro…[A]ll this means that it is extremely difficult to make mean value forecasts for the real economy and inflation, in both and abroad. It is particularly difficult to predict the development of exchange rates” (Minutes, page 18). Returning to this theme later, Governor Ingves observed: “Given the monetary policy conducted abroad, there is a risk that the krona will be stronger than in the draft Monetary Policy Report… The situation in Europe is uncertain. It is therefore important that the krona does not begin to strengthen too quickly…” (Minutes, page 20). He concluded that “measures now being proposed, which can be scaled up if necessary, can together be seen as a kind of insurance against … the back- ground of uncertain and diverging developments abroad that we have no con- trol over”. He added, “These actions will demonstrate our determination to safeguard the inflation target and the fact that we are ready to take further We are essentially prepared to do all we can to uphold the inflation target as an anchor for price setting and wage formation in . means that we must also be prepared to use our balance sheet to attain our target” (Minutes, page 21). On 18 2015 took an extraordinary repo rate policy action – the only one taken outside of regularly scheduled Monetary Policy Meetings during the period of our Review – de- cided to cut the repo rate from -to -, and to keep it there until the second half of 2016 and increase it more slowly than in February. also decided to buy government bonds for the sum of billion with maturities up to 25 years. The reasoning underlying the policy action taken on 18 was as fol- 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 At the end of February and the beginning of , the foreign exchange markets fluctuated substantially and in the space of a few weeks there was a rapid appreciation of the krona mainly against the euro [linked to the ECB beginning its large scale asset purchases]. A continued rapid appreciation of the krona rate was expected to constitute a tangible risk to the inflation forecast that formed a base for the monetary policy decision in February (See the April MPR, pp. 6-7; Riksbank Press Release 18 2015, No. 6, p.1). Forecasts in the main scenario for growth abroad and in were revised up slightly at the Monetary Policy Meeting compared to February. Most importantly, CPIF inflation was revised up for 2015 from to and for 2016 from to ; and CPIF inflation was forecast to be in 2017. unanimously decided to maintain the repo rate and repo rate path and to increase the repo rate to by the second half of 2018. decided to extend the purchases of government bonds with a further billion. The April monetary policy decision was justified by adding: “In an environment where monetary policy abroad is out of step, it is difficult to assess exchange rate developments. If the krona were to appreciate rapidly, there is a risk that it would stop the upturn in inflation” (April MPR, p. The discussion at the April meeting considered how much progress was being made against low inflation by the recent policy actions. reminded the Board that “the Riksbank has long had a forecast in which it is assumed that the repo rate will be raised much faster than policy rates abroad at the end of the forecast period. In February, market forward pricing indicated that the repo rate would be around 0.2 percentage points lower than … policy rates abroad at the beginning of 2018 while the Riksbank's forecast entailed the repo rate being 0.7 percentage points higher than policy rates abroad at that time. Now that the repo-rate path has been revised down, almost the entire difference disappears. Both market forward pricing and the Riksbank's forecasts indicate that the repo rate will be marginally lower than policy rates abroad at the beginning of 2018. It now becomes clearer that monetary policy in must adapt to the expansionary monetary policy with low interest rates abroad, not just in the short run, but also in the longer term” (Minutes, p. also expressed optimism about the effectiveness of monetary policy pointing out that: