SPEECH
SVERIGES RIKSBANK
DATE:
28 January 2019
SE-103 37 Stockholm
SPEAKER: (Brunkebergstorg 11)
First Deputy Governor Kerstin af Jochnick
VENUE:
Swedish Property Federation
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Cautious steps towards higher interest
rates*
Thank you for the invitation to come and talk about current monetary policy here
at the Swedish Property Federation.
In December, we increased the repo rate for the first time in over seven years. I
can imagine many people asking themselves why we have started to increase the
rate now and how we foresee monetary policy further ahead. And households,
who are more indebted than ever before - can they cope with higher interest
rates?
These are questions that I will try to respond to today, based on our latest
forecasts and assessments. As I see it, there is good reason to take cautious steps
towards higher interest rates, in part because historically speaking, we find
ourselves in a special environment.
As you know, forecasts are always uncertain, and therefore I intend to conclude
by discussing some of the factors that could lead to us deviating from our
monetary policy plan. But let me start by outlining why we have decided to start raising
the interest rate.
Why is it appropriate to start raising the interest rate?
To understand why we have now started to increase the interest rate, it may
useful to go back in time a little. In 2014 and 2015, we could see that inflation in
Sweden had developed so weakly that confidence in the inflation target risked being
undermined. Powerful monetary policy stimulus was required to reverse the
trend. In addition to lowering the interest rate below zero, we have also
purchased large volumes of government bonds.
We now see that inflation has been close to target for a longer period, while
confidence in inflation remaining around the target has been strengthened,
illustrated by the fact that inflation expectations have been around 2 per cent in
recent years (see Figure 1).
Figure 1. Inflation close to 2 per cent and confidence in the target has
strengthened
... and confidence in the inflation target has
Inflation around 2 per cent ...
strengthened
Note. Left-hand graph. Annual percentage change in the CPIF. Right-hand graph. Inflation expectations among all
participants, per cent, mean values.
Sources: Statistics Sweden and TNS Kantar Prospera
Economic activity abroad remains healthy, despite growth having recently
slowed somewhat. However, there is some difference between developments in
the United States, where growth has remained strong and unemployment is at its
lowest level in almost 50 years, and the euro area, where developments have
been more subdued. Wages are now rising increasingly rapidly in countries like
Germany and the United States and are helping to push up inflation. But despite
these basically good prospects, we also see a substantial number of risks
regarding developments abroad, which I will come back to at the end of my speech.
For some time now, we have been in an economic boom in Sweden. This in turn
is partly due to the expansionary monetary policy. Despite a partial slowdown in
growth, output is still above its trend level (see Figure 2). It was striking that GDP
fell between the second and third quarters of last year, but we believe most of
this has to do with temporary factors, including the fact that household
consumption of cars was brought forward to quarter 2 due to amended tax rules, which
pushed down car sales in quarter 3.
Figure 2. Economic activity still strong in Sweden
High output level High pressure on the labour market
6 6
GDP gap
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
-8 -8
01 04 07 10 13 16 19
Note. Left-hand graph. GDP gap refers to the percentage deviation of GDP from the Riksbank's assessed trends.
Right-hand graph. Net figures.
Sources: National Institute of Economic Research, Statistics Sweden and the Riksbank
For future inflationary pressures, the situation on the labour market plays a
particularly significant role. The tighter the labour market, the higher the pressure on
wage development. In our assessment, the situation on the labour market is tight.
An indication of this is that labour shortages - as reported by companies in
National Institute of Economic Research surveys - are at record-high levels (see
Figure 2). The effect of the labour market situation on wage and price development
tends to occur with a certain time-lag. There is hence good reason to believe that
wages and prices will increase more rapidly in the period ahead.
Our previously established criteria for starting to increase the
interest rate have been met
Inflation and inflation expectations close to 2 per cent and the healthy economic
activity are in themselves arguments in favour of slightly reducing the support
from monetary policy. But what prompted us to take this step just now? In
conjunction with the two previous monetary policy decisions in September and
October, we said that we would initiate slow increases in the repo rate in December or
February if economic developments continued to "support the prospects for
inflation". It is, in other words, a forward-looking perspective on inflation that guides
monetary policy. And in this context, not so much has actually changed since the
beginning of autumn. Even though inflation outcomes have been slightly lower
than expected, we still expect CPIF inflation a year or so ahead to be around 2 per
cent. Cost pressures in the economy are rising, while the major variation in energy
prices, which we believe to be of a temporary nature, means that inflation will
vary somewhat in the near term (see Figure 3).
Figure 3. Criteria met for slow rate increases - inflation prospects still favourable
3 3
Contribution of energy prices to CPIF
CPIF
2 2
1 1
0 0
-1 -1
11 13 15 17 19 21
Note. The CPIF in terms of annual percentage change and the contribution from energy prices in percentage
points. The contribution of energy prices in the forecast is calculated as the annual percentage change in energy
prices multiplied by their current weight in the CPIF.
Sources: Statistics Sweden and the Riksbank
After the increase in December - what will happen
with the interest rate going forward?
Moving on from the interest rate decision in December. As I mentioned by way of
introduction, we have now starting a slow journey towards higher interest rates. I
would now like to say a little about what this journey might look like.
The repo rate is expected to be increased very slowly - we are
"taking our foot of the gas" rather than "applying the brakes"
According to our forecast in December, the next interest rate increase is expected
during the second half of this year. Thereafter, the forecast indicates that the
interest rate will be increased by about 0.5 percentage points per year. From a
historical perspective, this is a very slow rate-hike cycle. We can see this in the
lefthand figure in Figure 4, which compares with previous periods when the repo rate
has been raised.1 Note that this figure shows the change in the repo rate
compared with the initial position, and the horizontal axis indicates the number of
days that have passed. The repo rate is expected to have risen by about 1.5
percentage points during the whole forecast period. In the right-hand figure, we see
that, in the end of the forecast period, the fourth quarter of 2021, the repo rate is
expected only to have reached a level of 1 per cent.
Figure 4. The interest rate going forward - more "taking our foot off the gas"
than "applying the brakes"
Slow increases compared with previous Low level of repo rate even at the end of
episodes the forecast period
3.5 3.5
July 2010 to July 2011
January 2006 to September 2008
3.0 3.0
November 1999 to July 2001
Forecast for the repo rate
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
0 200 400 600 800 1 000
Note. Left-hand graph. The vertical axis shows the change in the repo rate in percentage points. The horizontal
axis specifies the number of weekdays after the first rise of the repo rate. The repo rate forecast refers to
quarterly averages. Right-hand graph. Per cent.
Source: The Riksbank
There are several reasons why the journey towards higher interest rates is
expected to be so slow this time. I have already touched on the first reason. As such
substantial monetary policy measures have been required to establish inflation
and inflation expectations close to the target, it is important to phase out
monetary policy support at a slow rate, so that inflation continues to remain around 2
per cent going forward. There is still uncertainty regarding the strength of future
inflationary pressures. The second reason is that we are operating in a new
2
environment compared with previous rate-rising episodes. An important
circumstance is that global real interest rates (i.e. interest rates adjusted for inflation)
have been exceptionally low for a long time, and in all likelihood will continue to
be so for some considerable time. Monetary policy cannot influence global real
interest rates but must relate to the developments we see. The lower global
interest rates are, the lower the policy rate must be to have the same expansionary
effect on the economy. Another circumstance that has changed the monetary policy
landscape - and which I will address later - is that households are more affected
by interest rate adjustments than previously.
What happens to the bond holdings?
As you may know, in addition to lowering the interest rate to negative levels, we
have also purchased significant volumes of Swedish government bonds to a
nominal value of approximately SEK 350 billion - to make monetary policy even more
expansionary.
There is much talk about interest rates rising in the future, but many may not be
so aware of how adjustments to the repo rate going forward relate to our bond
holdings. The figure shown in Figure 5 has been taken from the article we
3
published in December 2017. The shaded parts of the figure show roughly what has
happened since then.
Figure 5. The Riksbank's overall normalisation plan for monetary policy
New purchases of bonds were discontinued in December 2017, which also
signified the end of phase 1 in Figure 5. Phase 2 in Figure 5 describes developments
last year up until December. We are now in the early stages of phase 3: The repo
rate is starting to be raised, while reinvestments are continuing so that the bond
holdings are more or less held constant. We have communicated that we will
reinvest principal payments and coupons "until further notice", but we have brought
forward reinvestments of large principal payments that are due during the first
half of this year to obtain a more even reinvestment profile over time. An issue
we need to address during the spring is how to manage reinvestments of the
principal payments due next year. Phase 4 in Figure 5 implies that the repo rate has
been raised slightly more. Not until then do the bond holdings start to decrease.
The fifth phase in Figure 5 actually concerns developments in the long term. Our
strategy is that the repo rate and the repo rate path will in the long term revert to
being the main monetary policy tools. Purchases of government bonds or other
securities then act as a complement when the policy rate is close to its lower
bound.
Figure 6 shows the Riksbank's purchases and holdings of government bonds: The
left-hand graph shows the development of our purchases, and the right-hand
graph is a technical illustration of how our holdings might develop if bonds that
mature after June 2019 are not reinvested. In the left-hand graph in Figure 6, the
conclusion of new purchases is marked by the disappearance of the blue bars, and
the right-hand graph reflects how the bond holdings can be expected to be
gradually scaled back.
Figure 6. The bond portfolio can be expected to decrease in the longer term
We have concluded new purchases and are Expected gradual reduction in the portfolio if
reinvesting until further notice reinvestments were to cease
80 80
Reinvestments of coupons
70 70
Reinvestment of principal payments
New purchases
60 60
50 50
40 40
30 30
20 20
10 10
0 0
H1 H2 H1 H2 H1 H2 H1 H2 H1
2015 2015 2016 2016 2017 2017 2018 2018 2019
Note. Left-hand graph. Nominal amounts, SEK billion. The development of reinvestments from mid-2018
onwards is a forecast and refers to nominal amounts. The final amounts will depend on current market prices.
Right-hand graph. Nominal amounts, SEK billion. Forecast up until June 2019, after that a technical projection
with the assumption that no further reinvestments are made. The vertical line marks the shift between forecast
and technical projection.
Source: The Riksbank
The purpose of the bond purchases has been to support general economic
development and to safeguard the inflation target. But obviously, it is also important
for us to continuously assess how the Riksbank's earnings will be affected during
the course of the journey. This is something we have discussed in different
contexts.4 Our latest estimate indicates that the effect on earnings from the bond
holdings could be quite close to zero seen over the entire holding period. But how
earnings will be ultimately affected depends on how the interest rate develops in
the future.
Can households cope with higher interest rates?
Swedish households current have record-high debts in combination with a large
proportion of variable-rate mortgages (see Figure 7). As you are no doubt aware,
the Riksbank has been concerned for many years about the high level of
household indebtedness and the potential negative effects on the Swedish economy of
rising interest rates or falling house prices.5 From our horizon, it is therefore
important to carefully analyse the interest-rate sensitivity of households. We have
also returned to this issue on a number of occasions, most recently in the
Monetary Policy Report in December.6
Figure 7. Households have increasingly high debt and shorter interest-rate
fixation periods
Shorter interest-rate fixation periods for
Household indebtedness has increased
household mortgages
100 100
80 80
60 60
40 40
20 20
0 0
98 01 04 07 10 13 16
Variable Fixed
Note. Left-hand graph. Percentage of disposable income. Total household debt as a share of their disposable
income, totalled over the past four quarters. Right-hand graph. Percentage of mortgages. Refers to loans from
mortgage institutions. Percentage of mortgages in each category is calculated based on the value of the loans.
Variable rate refers to interest-rate fixation periods up to and including three months. Fixed rate refers to
interest-rate fixation periods over three months.
Sources: The Riksbank and Statistics Sweden
Most households can continue to pay their mortgages even at
significantly higher interest rates ...
The question is whether households' interest-rate sensitivity - in combination
with rising interest rates - might result in them quite simply not being able to
meet their interest payments. This could lead to banks incurring direct credit
losses on their mortgages, which in turn might affect financial stability.
But I am not overly worried about this risk. Banks do what is known as a
"left-tolive-on" or "discretionary income" calculation, as part of their credit assessment.
As a rule, they don't grant mortgages if there is a deficit in the calculation. The
estimated interest rate they use in the calculation is on average around 7 per cent,
which is some way above a long-term normal level, which can be assumed to be
7
between 4.5 and 6 per cent. Calculations done by the Swedish financial
supervisory authority, Finansinspektionen (FI), on a sample of new mortgage holders
show that only just over 5 per cent of households have a deficit in their
discretionary income calculations if the mortgage rate rises to 7 per cent.8
There is hence nothing to indicate that the household sector as a whole would
encounter significant problems in paying their interest expenses even if interest
rates were to rise substantially in relation to their current levels. And, as I said
earlier, our forecast indicates extremely limited rate increases in the years to come.
But when the rate rises, many households might have to adapt their consumption
to cope with the increased interest payments. From a macroeconomic and
monetary policy perspective, it is therefore important to understand how household
consumption is affected when interest rates change.
... but their cashflows are affected more by interest rate
adjustments than before
Increasingly higher household indebtedness - in combination with a large share of
mortgages taken at variable interest rates - has resulted in their cashflows being
more affected by rate changes than previously. Traditionally, we tend to talk
about the so-called interest rate channel when discussing the effects of monetary
policy on household consumption. Simplified somewhat, the interest rate channel
implies that it will be more attractive to save than to borrow when the interest
rate is raised - and vice versa when the rate is lowered - which affects
consumption. Another effect is that when the interest rate is raised, disposable income for
savers increases and decreased for borrowers - and vice versa when the rate is
lowered - which also affects consumption. This is usually referred to as the
cashflow effect of monetary policy.9
We can understand this effect by looking at how disposable income is defined:
Disposable income ≈ wages + transfer payments + interest income + other capital
income - interest expenditure - taxes
According to the Financial Accounts from Statistics Sweden, households' debts are
approximately twice the size of their interest-bearing assets. Which is why a rate
increase has a negative net effect on total disposable household income. This
effect has increased as household indebtedness has grown.
What then does an increased effect mean in actual monetary terms? We have
studied this as well.10 Table 1 shows a few practical, down-to-earth calculations: a
typical housing purchase in Sweden and Stockholm in 2004 and 2017
respectively.11 We see that prices have increased significantly during the period, as has
the size of the mortgages, while interest payments have not. This is due to the low
mortgage rates. The figures can hence be deceptive. As we see, a 1-percentage
point higher mortgage rate would have increased borrowing costs by significantly
more in 2017 than in 2004. For a typical household in Sweden, a 1-percentage
point higher interest rate in 2004 would have led to an increase in interest
expenditure per month of less than SEK 500. This can be compared to 2017, when
the same typical household would have seen its interest payments increase by
over SEK 1,100. For the equivalent typical household in Greater Stockholm, a
1percentage point higher interest rate in 2004 would have increased their interest
expenditure by just over SEK 900 per month, while a similar rate hike in 2017
would have pushed up interest expenses by more than SEK 2,300 per month.
From a monetary policy perspective, one thing we need to do is to assess what
the increased interest-rate sensitivity of households means for the effects of the
repo rate on their consumption.
Table 1. Households more affected more by interest rate adjustments than
previously
Interest payments for a typical housing purchase, SEK per month
Sweden Greater Stockholm
2004 2017 2004 2017
Housing price (SEK million) 1.3 3.0 2.6 6.0
Debt (SEK million) 0.8 2.0 1.6 4.0
Interest rate (%) 3.7 1.6 3.7 1.6
Interest payments 1793 1814 3452 3643
Increase in interest payments (+1%) 485 1161 934 2351
Note. The amounts have been adjusted for tax relief on interest payments. The table does not include
amortisations.
Sources: Finansinspektionen, Statistics Sweden and the Riksbank
Rate increases in line with the Riksbank's forecast are expected
to have minor cashflow effects on households as a whole ...
In the Monetary Policy Report in December, our assessment was that total
disposable household income would slow by about 1.3 per cent in a three-year
perspective as a result of rising interest rates.12 This must be considered a minor effect,
especially bearing in mind that rising wages, among other factors, will contribute
about 4 percentage points a year to the growth in disposable household income
in the coming years. Total disposable income, according to our forecast, will
continue to grow at a healthy rate in the years to come, despite rising interest rates.
Surveys from the National Institute of Economic Research indicate that
households expect rising interest rates in line with the Riksbank's repo rate forecast.
This is probably one reason why saving among households is at a historically high
level. That said, however, there are a number of uncertainty factors to consider.
... but major differences among different groups
The aggregated figures conceal vary large differences among different
households, a fact substantiated by the Riksbank's analysis of data on individual
households' debt.13 We can categorise households based on their indebtedness. Figure
8 shows how much an interest rate hike of 1 percentage point will subdue
disposable income expressed as a percentage for all borrower households and for the
14
most indebted. For borrower households as a whole, disposable income will
slow by just under 2 per cent. For the 10 per cent most indebted households,
disposable income will slow by more than 6 per cent.
Figure 8. Major variation between different groups
Cashflow effect on disposable household income of a rate increase of 1 percentage point
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
All borrower households (DTI ≈ 2.6) 10 per cent most highly indebted (DTI ≈ 8.7)
Note. Per cent. Refers to the average for each group. Within each group, the figure in paranthesis refers to the
average debt-to-income (DTI) ratio.
Source: The Riksbank
This variation among households can also have a bearing on the total effects on
consumption. If the most highly indebted households adapt their consumption
mostly in the event of a given change in income, the total effect will also be
greater. As the interest rate affects housing prices, it can also affect the scope of
households to consume by borrowing against their home as collateral. Currently,
many households not only have high debts in relation to their disposable income
but also in relation to the value of their home. But in order to ascertain how
differences among households can affect total consumption, we would need better
data on household assets.15
From this perspective, there is therefore reason to proceed cautiously with rate
rises, in light of the uncertainty surrounding how the most highly indebted
households will act. But ultimately, it is the repo rate's effect on overall economic
development and the prospects for inflation that are the decisive factor for monetary
policy.
I would also like to point out that household indebtedness in a broader
perspective constitutes a vulnerability for the Swedish economy, as households with large
debts are not just sensitive to higher rates but also to other types of changed
economic circumstances, such as falling housing prices and weaker economic activity
with higher unemployment.
Several factors can affect our forecasts - no
"auto-pilot" towards higher interest rates
So far, I have talked about the Riksbank's monetary policy in terms of our best
assessment or main scenario. But, as the world-famous physicist and Nobel Laureate
Niels Bohr is reported to have said: "Prediction is very difficult, especially if it's
about the future". We have most certainly not switched on an "auto-pilot"
towards higher interest rates. As always, we are prepared to reassess monetary
policy if developments were to justify it.
So, what factors could affect our forecasts and future monetary policy? We can
divide them into four different categories: economic developments abroad, the
domestic economy, the development of inflation and structural changes.
As regards economic developments abroad there are three obvious uncertainty
factors that we have considered in conjunction with the most recent monetary
policy decisions. The first concerns the effects of the United Kingdom's
withdrawal from the EU - Brexit. As you know, people in the UK voted to leave the EU
in a referendum back in June 2016, so this risk has indeed been with us for some
time now. And the recent course of events has increased the uncertainty still
further. The second risk these past twelve months concerns the trade conflict
between the United States and China. Developments seem to have subdued export
orders abroad. And recently, growth looks to have slowed in China, which has
otherwise provided traction for global growth over a long period. The third risk
concerns Italian fiscal policy. The discussion between the EU and the Italian
Government about the Italian budget has periodically created unease on the financial
markets, even though the most recent course of events is providing some
breathing space.
As regards the domestic economy, the Riksbank has long since warned about
developments on the Swedish housing market, which is the most important
domestic factor that could trigger poorer economic development than in our forecast.
After having risen sharply over a long period of time, housing prices started to fall
quite rapidly last autumn. During the course of 2018, prices have recovered
slightly, and our forecast is for them to continue to rise at a modest rate in the
coming years. But I think that the situation on the Swedish housing market is still
very uncertain. Weaker developments than in our forecast pose a significant risk
to the Swedish economy. Those components of domestic demand that would be
negatively affected first of all would be housing investment and household
consumption.
But as I am here at the Swedish Property Federation today, I would also like to
mention that the weaker developments on the housing market since last autumn
have not escaped housing developers. You can read more about this in an article
in our Financial Stability Report, published in November.16 An important
conclusion we can draw from developments in recent years is that housing developers
have burdened households with substantial risks during the building process. In
the prevailing market situation, these risks have come to the fore, causing
households' interest to wane, especially when move-in dates to new homes are far-off
in the future. This will require modified business models in order to rekindle the
interest of prospective house-buyers in newly built homes. My assessment is also
that newly built homes are currently far too expensive for many groups. Cheaper
new builds and better turnover in the housing stock could help untangle this knot.
There are of course many uncertainty factors not only surrounding future
economic developments, but also surrounding inflation. An obvious reason for why
inflation can be higher or lower is the kind of risk for different economic
developments that I have just talked about. But one factor that has puzzled us is the
surprisingly low wage growth in Sweden bearing in mind how the economy has
strengthened in recent years.17 Even though we have seen that wages are now
rising more rapidly both abroad and in Sweden, uncertainty remains over the
strength of inflationary pressures. This is also a reason why we are expected to
proceed very cautiously with repo rate rises in the coming years.
The Swedish krona may grow weaker or stronger than our forecast, but as we
have tried hard to get inflation to rise towards the target, we are more concerned
about the potential effects of a rapid and sharp appreciation of the krona.
The fourth and final category of uncertainty factors concerns ongoing major
structural changes, the effects of which are very difficult to assess "in real time". I have
mentioned two factors today: the trend of low global real interest rates and the
increasing interest-rate sensitivity of households. But there are also other factors
that I have not discussed today, but that are nevertheless very important to
consider. The mega trend towards greater digitalisation is changing many parts of
society, and at the Riksbank we are affected not only as regards monetary policy but
also as regards our other operations, such as our responsibility for a safe and
efficient payment system.18 Another important trend from Sweden's point of view
concerns changes in demography and labour supply, not least in light of major
migration flows into Sweden in recent years.19 My assessment is that the changes
we still face are substantial and comprehensive. It will probably be even more
difficult to learn from historical data and correlations when making assessments in
the future.
As always, we stand ready to reassess both our forecasts and monetary policy if
developments were to justify it.
Thank you for this opportunity to speak to you!