Separate minute of the Executive Board meeting on 11 February
Present:
Urban Bäckström, Chairman
Lars Heikensten
Eva Srejber
Villy Bergström
Kerstin Hessius
Lars Nyberg
Sven Hulterström, Chairman of the Governing Council
Johan Gernandt, Vice Chairman of the Governing Council
Kerstin Alm
Claes Berg
Hans Dillén (§1, 1.1–1.2)
Richard Gröttheim
Björn Hasselgren
Per Jansson (§1, 1.1–1.6)
Hans Lindberg
Hans Lindblad (§1, 1.1–1.6)
Christina Lindenius
Pernilla Meyersson (§1, 1.1–1.2)
Robert Sparve
Åsa Sydén
Joachim Wadefjord (§1, 1.1–1.2)
Michael Wallin
Per Walter (§1, 1.1–1.2)
Staffan Viotti
Göran Zettergren (§1, 1.2)
§ 1. Monetary policy discussion and decision
It was noted that Christina Lindenius and Hans Lindberg would prepare draft minutes of the meeting.
The meeting began with a discussion of the factors in economic development in Sweden and the rest of the world that are of importance for inflation prospects and the formation of monetary policy (sections 1.1–1.6 below). The discussion of each factor was preceded by presentations by Bank staff from the Economics Department and the Monetary & Exchange Rate Policy Department. The presentations were based on the technical assumption that the Riksbank's repo rate would be unchanged at 3.40 per cent up to the end of 2000.
The Executive Board's assessment of inflation prospects (section 2) and the monetary policy situation (section 3) started from an account of the conclusions that had been reached in a corresponding discussion in the Bank's monetary policy group.
1. Economic developments in Sweden and elsewhere
1.1 International activity and inflation
In the December 1998 Inflation Report it was judged that GDP growth in the OECD area would be around 1.5 per cent in 1999 and approximately 2 per cent in 2000. The annual rate of inflation in the coming two years was expected to average approximately 1.5 per cent.
The Board discussed the international picture in detail and made the overall assessment that growth and inflation in the OECD area would probably be somewhat lower than the Riksbank had counted on in the Inflation Report. It was also noted that in parts of Asia there were signs of a stabilisation. For the Chinese economy, however, growth prospects had become somewhat worse.
The US economy shows signs of continued strength; growth in 1998 was higher than expected and inflation remained low. Private consumption in particular is still increasing robustly. The Board considered that some slowing of activity in the US economy is probable in the coming two years: household saving is already very low, which limits the scope for a continued increase in private consumption, and expectations of decreased corporate profits may tend to retard investment. But in view of the recent strong growth, the slowdown is likely to occur further ahead than was envisaged at the time of the December Report.
In the euro area, economic activity has slackened markedly in the late autumn and winter, accompanied by a further reduction of inflation. Exports have been weaker than expected. Manufacturing confidence has also deteriorated, with a poorer inflow of orders, lower output growth and declining capacity utilisation. Consumer confidence, on the other hand, has gone on rising. The Board's overall impression was that for the euro area in 1999 and 2000, growth will be somewhat weaker and inflation somewhat lower than expected earlier. Two members of the Board did, however, underscore the strong consumer confidence's importance for the future cyclical trend and stated that their assessment of growth in 2000 was unchanged.
The Japanese economy is still in a recession and the future path remains highly uncertain. No clear signs of a recovery are discernible. Producer and consumer prices are continuing to fall and there are some fears of a deflationary spiral. The Board considered that growth prospects for Japan in 1999 and 2000 are now weaker than they were some months ago.
The Board also considered the risks in the international economic picture. In particular it noted that contagious real and financial effects to date from the crisis in Brazil were fairly limited, in contrast to the situation last autumn after the Russian debt moratorium and devaluation of the rouble and the near failure of the US hedge fund LTCM. Still, the Board perceived a risk of the problems in Brazil spreading to other countries in Latin America, which could ultimately give rise to real and financial effects in the OECD area. Compared with developments last autumn, however, the potential contagious effects were judged to be more limited.
US stock markets were identified as another source of risk. In the opinion of the Board, these stock markets are at a high level and a sudden correction might lead to an abrupt slowdown in the US economy, with effects on the rest of the OECD area, and also generate contagious financial effects.
Against these two downside risks there was the possibility of the US economy continuing to achieve the combination of high growth and low inflation, accompanied by a trend in Europe that is better than expected, due to persistently strong consumer confidence and a pull from US demand.
1.2 Interest rates, exchange rate, money supply and credit
The Board discussed the development of interest rates and the exchange rate. It was noted that while the krona had strengthened somewhat more quickly than envisaged in the December Report, the path was broadly in line with that Report's assumption of a successive appreciation. The Board therefore saw no reason to revise its view of the krona's future development. In this context it was also noted that market expectations of the future path of the effective exchange rate largely tally with the Riksbank's assessment.
The rapid appreciation of the krona was seen as the result of a combination of factors. The decreased international financial unrest was considered to have led to a natural reversal of last autumn's depreciation, which was judged to be unfounded in relation to economic fundamentals in Sweden. The similar path that the currencies of Canada and Australia, for example, have followed in the past six months supports this impression. A conceivable explanation is that, like the Swedish krona, those currencies were highly exposed to the global financial unrest on account of comparatively large external debt. Moreover, increased expectations of Sweden adopting the euro and the related expectations of adherence to ERM were considered to have contributed to the krona's appreciation. In the run-up to Stage Three of EMU there was also some concern about how the krona would be affected; after the transition, this concern subsided and the krona strengthened.
Since the publication of the December Inflation Report the repo rate has been reduced 0.20 percentage points to 3.40 per cent. The Board noted that after that the short-term interest rates went on falling, partly because market players expected a further downward adjustment of the repo rate. It was also noted that the long bond rates had decreased markedly and broadly in line with European bond rates. While the fall in the long nominal interest rates has been accompanied by lower inflation expectations, the real level of interest rates does seem to be somewhat lower than before. How long this will last is an open question, particularly as the long nominal rates have recently tended to turn upwards.
Against this background, the combined impact of the exchange rate and interest rates on demand in 1999 and 2000 was then discussed. The Board noted that, if the exchange rate's future path is the same as assumed earlier and the future real level of interest rates is adjusted downwards in the light of the recent tendency, then the combined impact on demand seems to be somewhat more expansionary than was envisaged in the December Report.
The Board then proceeded to discuss the recent development of the money supply and lending. The Board noted that M3 growth had slackened in December 1998 but the relatively rapid increase in narrow money (M0) had continued, accompanied by comparatively strong growth of lending to the household sector. The Board considered that this supported the picture of a strong trend in retail trade and private consumption, together with low but slightly rising inflationary pressure, roughly in line with the assessment in the December Report.
1.3 Demand and supply
In the main scenario in the December Inflation Report, GDP growth in Sweden had been judged to be between 2 and 2.5 per cent in 1999 and around 2.5 per cent in 2000. The Board found that growth prospects for Sweden's economy in 1999 and 2000 still appear to be relatively good, though the international slowdown is judged to have some dampening effect. Business expectations and manufacturing orders show a negative shift. Most things therefore suggest that net exports and investment will be somewhat weaker than expected earlier.
The development of stockbuilding is, as always, difficult to assess, yet investment in stocks is a significant item in growth prospects. Stock movements from 1998 Q2 to Q3 had a negative impact on GDP growth. In the December Report it seemed reasonable to count on stockbuilding's contribution to GDP growth being negative in 1999 and 2000. The Board adhered to this assessment.
Private consumption is developing strongly and approximately in line with the Riksbank's earlier assessment. Other statistics show continued increases in new car registrations and house prices. Retail turnover is also rising and households are still optimistic about their own economic prospects. During 1999 private consumption is expected to be stimulated by rising real wages, lower interest expenditure and tax relief. The international slowdown may, however, make households somewhat less confident about the future, leading to more saving and less consumption.
Employment rose more than expected in 1998, despite a late increase in the number given notice. The Board noted that the poorer growth prospects probably mean that employment will rise more slowly than expected earlier.
The future wage trend was also discussed. The main scenario in the December Report assumed that no wage agreements will be terminated. The Board considered that, notwithstanding the somewhat poorer growth prospects, this assumption is still reasonable. The wage outturn for 1998 was judged to be well in line with the Report's main scenario. The Board noted, however, that with the prospect of more subdued growth in 1999 and 2000, the wage trend, particularly in the private sector, is likely to be somewhat weaker than the Riksbank envisaged earlier.
In the December Inflation Report it was judged that at the end of 2000 the Swedish economy would still have some unutilised capacity. The Board noted that as a consequence of some fall-off in GDP growth, capacity utilisation probably decreased towards the end of 1998. Together with the somewhat poorer prospects for future economic growth, this led the Board to conclude that the unutilised capacity towards the end of 2000 would be somewhat larger than envisaged earlier.
1.4 Prices
The Board noted that current inflationary pressure in Sweden is still low and that inflation's underlying trend has been somewhat weaker than expected in the latest Inflation Report. The 12-month rate of CPI inflation in December 1998 was 0.3 percentage points lower than had been expected in the Report. Around 0.1 percentage point of this discrepancy can be attributed to lower mortgage interest expenditure and approximately 0.1 percentage point to lower world market prices for oil.
The discussion then focused on producer prices and the Board noted that, as expected, price pressure from manufacturing was still subdued, particularly as regards intermediate and energy-related products. On the other hand, import prices to producers, above all for consumer goods, are developing strongly, presumably in part as a consequence of the weaker exchange rate last autumn. However, the producer price rise for consumer goods has not passed through to consumer prices and the stronger exchange rate may reduce a future pass-through.
In the December Inflation Report it was judged that international commodity prices would rise towards the end of 1998 and early in 1999. The Board noted that instead, world market commodity prices have continued to fall to date.
1.5 Transitory factors
In the December Report it was judged that changes in indirect taxes and subsidies, together with lower interest expenditure, would have downward effects on consumer prices of –0.5 percentage points in 1999 and –0.3 percentage points in 2000.
The Board first noted that no new decisions concerning indirect taxes and subsidies had been made that could conceivably influence the Riksbank's assessment of the consumer price trend. Moreover, interest rate movements in recent months, with a downward tendency for short as well as long-term rates, were resulting in decreased house mortgage interest expenditure; the CPI effect in December 1998 was –0.1 percentage point. The Board concluded that the downward CPI effect from mortgage interest expenditure would probably be greater than assumed in the December Report, in 1999 as well as in 2000.
The Board judged that changes in indirect taxes and subsidies, together with lower interest expenditure, would have total downward effects on consumer prices between –0.5 and –1.0 percentage point in both 1999 and 2000. There was reason, finally, to endeavour to develop the analysis to determine whether and, if so, to what extent the weak international price trend, for example for commodities, represented a supply shock with only transitory effects on inflation.
1.6 Inflation expectations
The Board noted that inflation expectations, as measured in surveys, had been revised downwards since the time of the December Report. In January 1999, Statistics Sweden's survey of household purchasing plans showed that households expected the rate of inflation in the coming twelve months would be 0.8 per cent. In the October 1998 survey, which provided the most recent observations for the December Report, the expected rate had been 1.4 per cent. The National Institute's business tendency data for manufacturing and service industries show a similar picture. The Board took notice of the fact that, according to Prospera's survey in February 1999, the long-term inflation expectations are now also below the Riksbank's 2 per cent target, which had not previously been the case.
2. The Executive Board's assessment of inflation prospects
The Board noted that in the main scenario in the December Report, the 12-month change in the CPI was judged to be 1.2 per cent in December 1999 and 1.4 per cent in December 2000. The corresponding rates for underlying inflation, measured as UND1X, were 1.7 and 1.8 per cent, respectively.
On the basis of the presentations to and the discussions during the meeting, the Board made the following assessments.
2.1 Main scenario for inflation
- CPI inflation twelve to twenty-four months ahead, given that the repo rate is unchanged at 3.40 per cent, is judged to be below the Riksbank's 2 per cent target. This is partly explained by transitory factors that are not considered to have a lasting effect on inflation and therefore do not influence the formation of monetary policy.
- Changes in indirect taxes and subsidies, together with lower interest expenditure, are judged to have a downward effect on consumer prices of between –0.5 and –1.0 percentage point in 1999 as well as 2000.
– Even excluding transitory factors, inflation in twelve to twenty-four months time will be below the 2 per cent target.
2.2 Risk assessment
- The Board's discussion also underscored the importance of the risk spectrum for the formation of monetary policy. The Board noted that in the December inflation assessment the downside risks had been greater than the upside risks and that this had to do with the risk of the international economic slowdown being more marked and prolonged. The downside risks are still judged to be somewhat greater on account of the contagious real and financial effects from the crisis in Brazil as well as the risk of a US stock market fall with repercussions on the real economy and other financial markets. Two members of the Board emphasised that the trend in Europe may be stronger than expected, above all in view of the positive expectations among consumers.
3. The Executive Board's assessment of the monetary policy situation
- The discussion in the Bank's monetary policy group, which had started from the assessment that inflationary pressure would be somewhat weaker than envisaged in the December Inflation Report, had led to the conclusion that the repo rate ought to be lowered 0.25 percentage points and that this adjustment should apply from the repo that was scheduled to run from 17 February 1999. The group had also noted that, with the deposit rate at 3.25 per cent, a repo rate cut of 0.25 percentage points would not be accommodated in the interest rate corridor. The reduction of the repo rate would therefore call for a downward adjustment of the corridor. In view of the proposed repo rate reduction and the more comprehensive assessment of inflation prospects that was due in March, the group had recommended a reduction of the deposit and lending rates, in both cases by 50 basis points, to 2.75 and 4.25 per cent, respectively, as of 17 February.
- In the Board's discussion, all six members were in favour of adjusting the instrumental rates. It was pointed out that changes to the interest rate corridor may be perceived as signals of the future monetary stance and this must be taken into consideration. It was also noted that previously the corridor had often been changed in steps of 0.5 percentage points. Furthermore, the assessment of inflation prospects that would be made in connection with the March Inflation Report provides a natural starting point for the continued formation of monetary policy. Against this background the Board considered that a reduction of the interest rate corridor by 0.5 percentage points was appropriate.
- The Board then proceeded to discuss whether and, if so, by how much the repo rate should be reduced. Two main alternatives were identified: reductions by 0.20 and 0.25 percentage points, respectively. One Board member stated, however, that the repo rate ought not to be reduced in steps that are unduly small. In that member's opinion, the Riksbank could wait until inflation prospects had become clearer and a reduction of the interest rate corridor would perhaps suffice for the time being. In that case the repo rate could be reduced by a larger amount later on.
4. The Executive Board's decision
- The Chairman summarised the discussion and noted that a majority of the Board's members considered that the repo rate should be reduced by 0.25 percentage points and the interest rate corridor by 0.50 percentage points.
- The Chairman therefore proposed that the Executive Board decides
– to reduce the repo rate by 0.25 percentage points and announce a fixed rate repo with a duration from the 17th to the 24th of February 1999 at a rate of 3.15 per cent and a fixed rate repo with a duration from the 24th of February to the 3rd of March 1999 at a rate of 3.15 per cent, and
– to reduce the lending rate by 0.5 percentage points from 4.75 to 4.25 per cent and the deposit rate by 0.5 percentage points from 3.25 to 2.75 per cent as of 17th February 1999.
The Executive Board decided in accordance with the proposal.
