Separate minute of the Executive Board meeting on 22 April 1999
Present:
Urban Bäckström, Chairman
Lars Heikensten, Eva Srejber
Villy Bergström
Kerstin Hessius
Lars Nyberg
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Sven Hulterström, Chairman of the Governing Council (§§1–2)
Johan Gernandt, Vice Chairman of the Governing Council (§§1–2)
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Kerstin Alm
Claes Berg (§§1–2)
Hans Dillén (§1)
Richard Gröttheim (§§1–2)
Kurt Gustavsson (§1), Björn Hasselgren
Per Jansson (§1)
Hans Lindberg (§§1–2)
Hans Lindblad (§1)
Christina Lindenius (§§1–2)
Pernilla Meyersson (§1)
Robert Sparve
Göran Zettergren (§1)
Helena Öström (§1)
§ 1. Monetary policy discussion
It was noted that Christina Lindenius and Hans Lindberg would prepare draft minutes of items §§1 and 2 on the agenda for 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 aspect 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 2.90 per cent up to the end of 2001 Q1.
The point of departure of the Executive Board's assessment of inflation prospects (section 2) and the monetary policy situation (section 3) was 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 Inflation Report that was published on 25 March it had been judged that GDP growth in the OECD area would be just above 1.5 per cent in 1999 and almost 2 per cent in 2000. The annual rate of inflation in these years in the OECD area was expected to be just below and somewhat above 1.5 per cent, respectively.
The Board considered that economic prospects in the OECD area were broadly the same as at the time of the March Inflation Report. Still, it looked as though economic activity in the United States would be somewhat stronger during 1999 and the ECB’s interest rate cut at the beginning of April could be expected to act as an economic stimulus in the euro area. The risk of a longer and deeper international economic slowdown was judged to be smaller than when the Report was published, partly in view of the recovery that is becoming discernible in some Asian countries.
The US economy continues to be characterised by strong consumption growth and declining unemployment. Households are optimistic about the economic future and the stock market trend remains strong. Manufacturing, however, has slackened by degrees, with a fall-off in manufacturing production growth and lower capacity utilisation. The Board considered that US economic growth in 1999 would be somewhat higher than had been expected in the Inflation Report, while in 2000 it would be as foreseen in the Report.
In the euro area, the slowdown in manufacturing seems to have continued. A drop has been noted, moreover, in consumer confidence, albeit from very high levels. The Board was of the opinion that the effects of the ECB’s interest rate cut probably act as a counterweight to these developments. The weakening of the euro since the beginning of the year is working in a similar direction.
In Japan there are still few signs of an economic recovery. Unemployment continues to rise and prices are falling in all areas of the economy. The Board concluded that the prospects do not differ from the assessment made at the time of the Inflation Report. In the rest of Asia the Board noted that a cautious recovery seems to have begun in South Korea, Malaysia and Thailand.
Effects of the Kosovo crisis on international economic developments were discussed but the Board was of the opinion that no definite conclusions could be reached at present. The overall impact of the crisis will depend in part on how consumer confidence in the OECD area is affected and how the military intervention is financed.
The Board observed that international price pressure remains subdued. While oil prices have recently risen markedly, somewhat longer forward prices have been less affected and deviate only marginally from the assessment in the Inflation Report. The Board concluded that the future development is uncertain, but that under the present circumstances it seemed reasonable to count on a higher oil price than in the Report, above all during 1999.
The Board members expressed somewhat different opinions about how stronger international economic activity may affect external inflationary pressure. One member judged that as a result of structural changes in a number of economies, it was not certain that inflation will follow the same pattern as in earlier upswings; consequently, a somewhat stronger economic trend need not lead to an international price pressure that is higher than assumed in the Inflation Report. In this context the member noted that in the Report the Riksbank had counted on the price pass-through being more marked than envisaged in, for example, the IMF’s latest economic report. Another Board member considered that when growth picks up, prices might be affected more quickly than expected. A third member agreed with this and also observed that prices for oil and other commodities may rise rapidly if international demand becomes stronger, for instance in connection with the recovery in Asia. A fourth member pointed out that while indications of stronger international activity might warrant an upward revision of the Board’s assessment of international price pressure, it could be sufficient to adjust the distribution of the risks in the inflation assessment. This member also noted the risk of a future sharp stock market fall in the United States and considered that such a scenario should likewise be incorporated in the overall assessment of risk.
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 since the Riksbank’s repo rate cut of 0.25 percentage points at the end of March the krona had become somewhat stronger, in effective terms as well as against the euro. Along with the euro, however, the krona has weakened against a generally stronger dollar. All in all, the krona’s effective path has been somewhat weaker than foreseen in the Inflation Report.
The co-variation of the krona and the euro against the dollar has increased recently, in keeping with the earlier tendency in periods when the international financial markets are calm. The krona’s exchange rate volatility is still low and close to the average level in recent years. The Board noted that, according to survey data, market players continue to believe in an appreciation of the krona in the longer run, in effective terms as well as against the euro. This is in line with the Riksbank’s assessment in the Inflation Report.
In connection with the publication of the Inflation Report in March, the repo rate was reduced 0.25 percentage points to 2.90 per cent. As a result, the 3-month market rate has moved down correspondingly. Long-term interest rates in Sweden have largely followed the European tendency and decreased some tenths of a percentage point. Partly in light of the Riksbank’s repo rate cut, the Board noted that the combined effect of the exchange rate and interest rates now appeared to be somewhat more expansionary than had been assumed in the Inflation Report.
The Board observed that for a time after the repo rate cut in March, market prices had indicated expectations of a further cut. This had been particularly evident just after the ECB’s interest rate reduction. In the past few days, however, these expectations seem to have disappeared. In this context, the Board noted that repo rate expectations derived from implied forward interest rate curves may mirror both the inflation expectations of the financial players, together with the monetary stance these expectations suggest, and the market’s perception of the Riksbank’s intentions.
Consequently, forward interest rate curves cannot be used to tell whether prices reflect a change in the financial players’ inflation assessments, together with the associated interest rate tendency, rather than just their perception of the Riksbank’s intentions. There have not been any Riksbank statements recently that could be interpreted in terms of the repo rate’s future path, which might have conveyed the impression that the rate will be kept unchanged. The Board noted that in this respect the situation in connection with the monetary policy decision on 24 March had been different in that a number of Board members had indicated, in speeches and interviews, that inflation prospects appeared to be subdued.
The Board went on to discuss the recent development of money supply and credit. M0 growth was continuing at a relatively high level, which supports the assessment of a strong trend for retail trade and private consumption. The supply of credit was also expanding comparatively rapidly. Recently, it was corporate borrowing from banks that had been rising in particular, while the increase in bank lending to households was somewhat weaker.
1.3 Demand and supply
In the main scenario in the Inflation Report, GDP growth in Sweden had been judged to be 2.1 per cent in 1999 and around 2.5 per cent in 2000. The Board considered that since the publication of the Report, the picture of GDP had become marginally more positive. The March repo rate cut to 2.90 per cent was judged to contribute to somewhat higher growth, above all during 2000 and chiefly via positive effects on investment activity. Signals from the manufacturing sector also pointed to unexpectedly strong activity.
The Board noted that, with the Government’s Spring Bill, fiscal policy during 1999 now appeared somewhat less expansionary than at the time of the Inflation Report. However, the picture for 1999 and 2000 combined, with some easing of the fiscal stance, is broadly the same as in the Report.
The Board observed that since the March Inflation Report, the strong development of private consumption has continued, as has the positive development of the retail sector. The March repo rate cut can be expected to act as some additional stimulus to private consumption.
The strong increase in employment towards the end of 1998 has continued this year. The Board noted the possibility of this giving a weaker turn to the path of average labour productivity. At the same time, however, the somewhat stronger outlook for GDP implies a positive effect on productivity, above all during 2000.
As regards total resource utilisation, in the Inflation Report it had been considered that in two years time the economy would probably still have unutilised capacity. In the opinion of the Board, more recent information provided no grounds for an essential revision of that assessment. Still, even though the somewhat improved growth prospects had to do with increased investment, they could be expected to result in somewhat higher resource utilisation.
1.4 Prices
The Board noted that the recent development of consumer prices did not occasion any considerable reassessment of the path of inflation in the Inflation Report’s main scenario.
The CPI increase of 0.4 per cent from February to March 1999 gave an unchanged level from March 1998. The development of CPI has been in line with the Report’s main scenario, however with a somewhat weaker tendency than expected for interest expenditure and somewhat stronger underlying inflation. The rate of underlying inflation in March 1999, measured as UND1X, was 1.4 per cent, which was 0.1 percentage point higher than had been forecast. The discrepancy had to do with slight underestimates of imported as well as domestic price components.
The Board noted that the producer price tendency has been weaker than assumed in the Inflation Report. Data from Statistics Sweden show a subdued producer price tendency for consumer goods in February 1999. It also looks as though increased competition in the electricity market is beginning to result in lower prices. Moreover, the telephone market is now on the verge of structural changes, but the impact on prices is difficult to foresee. The increase in commodity prices, on the other hand, has been stronger than expected, mainly due to the price rise for oil.
Price effects of the EU agreement in the field of agriculture in connection with Agenda 2000 were also discussed and the Board noted that they are very difficult to assess. Estimates suggest, however, that Swedish consumer prices may be lowered by a total of 0.3–0.4 percentage points over a ten-year period, of which the major part is foreseen during 2000 and 2001. To some extent, however, these effects had already been taken into account in the Inflation Report’s main scenario.
1.5 Transitory factors
In the March Inflation Report, it was judged that changes in indirect taxes and subsidies, together with lower interest expenditure, would have total downward effects on consumer prices of 0.5 percentage points in one year and 0.2 percentage points after two years.
The Board first noted that the Government had proposed a number of new changes to indirect taxes and subsidies, for instance in the Spring Bill. Proposals affecting 1999 include the postponement of the tax on waste to 2000 and a higher ceiling on the maximum annual personal charge for prescribed medicines. Other proposals are a prolongation of the temporarily reduced rate of property tax to include the year 2000 and the introduction of a maximum day-nursery charge from 2001. All in all, these proposals are judged to have some downward effect on consumer prices in one to two years time. The Board also concluded that in view of the recent fall in interest rates, the trend for house mortgage interest expenditure would probably be somewhat weaker than was assumed in the Inflation Report.
The Board considered that changes in indirect taxes and subsidies, together with lower interest expenditure, would have a total downward effect on CPI inflation in the region of 0.5 percentage points in both one and two years time.
1.6 Inflation expectations
The Board noted that inflation expectations, as measured in surveys, are still low and broadly unchanged since the time of the Inflation Report. A survey by Prospera, however, does indicate that expectations in the money market have been adjusted marginally upwards.
The expectations of inflation one to two years ahead are below the Riksbank’s inflation target. Statistics Sweden's survey in March 1999 shows that households, for example, expected the rate of inflation in the coming twelve months to be about 0.8 per cent. The long-term inflation expectations are more in line with the Riksbank's target.
2. The Board's assessment of inflation prospects
The Board noted that in the main scenario in the Inflation Report, the 12-month change in the CPI was judged to be 1.1 per cent in March 2000 and 1.4 per cent in March 2001. The corresponding rates for underlying inflation, measured as UND1X, were 1.7 and 1.8 per cent, respectively. The Report’s inflation assessment had also been judged to carry some overall downside risk from tendencies for international economic activity and inflation to be weaker than envisaged in the main scenario. This downside risk meant that the mean assessment of inflation was 0.1–0.2 percentage points below the forecast in the main scenario.
2.1 The monetary policy group’s appraisal of inflation prospects
The point of departure for the Board’s discussion of inflation prospects was an account, presented at the meeting, of a corresponding discussion in the Riksbank’s monetary policy group.
The policy group had noted that in two years time the economy would probably still have unutilised resources and that even with the March repo rate cut, the rate of inflation excluding transitory effects may be marginally lower than envisaged in the Inflation Report’s main scenario. The background to this assessment was the view that the effects of somewhat stronger economic activity would be more than offset by price effects associated with rule changes proposed in the Spring Bill, Agenda 2000, increased competition in the electricity market and a revised path for oil prices, with a steeper increase during 1999 followed by a slower rise in 2000 and 2001.
In a discussion of the risks to the inflation assessment, the policy group considered that the degree of uncertainty in the assessment was of the same order as at the time of the Inflation Report. The spectrum, however, was judged to have shifted so that it was now more evenly balanced around the main scenario. The arguments for this were an increased probability of domestic activity being somewhat stronger, accompanied by international prospects that looked more stable.
2.2 The Board’s discussion
One Board member judged that excluding transitory effects, inflation one to two years ahead would probably be somewhat below the Riksbank’s target. In terms of the rule of thumb for the Riksbank’s monetary policy, the March repo rate cut had not been large enough to bring inflation prospects—as perceived at that time and presented in the Inflation Report—into line with the target. The member considered that global competition, increased Internet trading, deregulation and, for Europe, the economic and monetary union, suggested that international inflation would be subdued notwithstanding stronger economic activity. Additional factors in favour of low inflationary pressure in Sweden were the low inflation expectations and the probability of unutilised resources still existing in two years time. The member also considered that political decisions of the kind that has led to downward pressure on CPI inflation in recent years probably do not act as isolated events but rather as an element in a long-term process of change. It is conceivable, for example, that a gradual reduction of tax pressure in Sweden can help in time to subdue the price trend. In light of the above, the member did not find it improbable that in a coming economic upswing inflation will be weaker than suggested by historical patterns. In other words, growth could be somewhat stronger than indicated by current forecasts without causing inflation to rise above the Riksbank’s target in one to two years time.
A second member considered, on the other hand, that with the present repo rate, it was conceivable that one to two years ahead underlying inflation might actually be above 2 per cent. The member noted that the rate of underlying domestic inflation was above 2 per cent at present and that credit and monetary aggregates are expanding rapidly. The member underscored the markedly expansionary monetary stance and the possibility of its impact towards the end of the forecast period being stronger than estimated as the economy moves towards full capacity utilisation and growth is still judged to be comparatively high. To date, moreover, the krona has been weaker than had been envisaged in the Inflation Report. Another uncertain factor in this context was fiscal policy.
In the opinion of a third member, the new information did not essentially alter the picture of inflation but real economic development now looked somewhat stronger than had been foreseen in the Inflation Report. This member cited a number of uncertain factors with a bearing on the inflation assessment: the risk of a rather dramatic share price fall in the United States; the difficulty in assessing the Swedish economy’s long-term productivity trend; and the extent to which there will still be unutilised capacity in two years time.
A fourth member pointed out that transitory demand and supply factors had probably played a considerable part in the weak international price trend in recent years. Consequently, when activity now strengthens, the price rise could very well be stronger than the policy group envisaged. Prices may also be affected by many other uncertain factors, for example the development of oil and electricity prices and the timing of political decisions.
A fifth member considered that in the present situation there were not sufficient indications that the picture of inflation had changed appreciably since the Inflation Report. The member also emphasised that a low-inflation regime has been established in Sweden and that this will affect how inflationary pressure develops in an upward cyclical phase.
The sixth Board member considered that the most recent information had not essentially altered the picture of inflation. However, in this member’s opinion, the downside risk in the inflation assessment as presented in the Report had now decreased and the risk spectrum was more evenly balanced around the main scenario.2.3 Main inflation scenario and risk assessment
In the opinion of the Board, there had been some positive shift in economic activity, internationally as well as in Sweden. At the same time, in this situation the Board members were not in complete agreement about the inflation prospects in the main scenario, though the differences between the individual member’s assessments of inflationary pressure were relatively limited. The Board also noted that the assessments do not deviate markedly from the picture presented in the Inflation Report. A number of members pointed out that inflation prospects would be assessed more comprehensively for the next Inflation Report, to be published at the beginning of June.
The Board observed that the risk of a more marked and longer international economic slowdown had decreased. The risk spectrum for the domestic economy had also shifted as a result of signals of unexpectedly strong manufacturing activity in Sweden. All in all, this had reduced the downside risk in the inflation assessment, so that the risk spectrum now appeared to be more evenly balanced around the main scenario than had been the case at the time of the Inflation Report.
3. The Board's assessment of the monetary policy situation
3.1 The monetary policy group’s appraisal of the situation for monetary policy
The discussion in the Bank's monetary policy group had started with the observation that the Riksbank’s monetary policy framework implies that the repo rate ought to be adjusted continuously so that inflation prospects for the coming one to two years are in line with the target. This means that, in the absence of any dramatic developments, the inflation assessments will almost invariably be close to the 2 per cent target. The monetary policy decisions will therefore amount to fine tuning the inflation prospects in relation to the target. From this it follows that the arguments for and against a repo rate adjustment will normally be finely balanced.
Even so, the policy group had regarded the monetary policy decision in March as relatively clear because, excluding transitory effects, inflation in the main scenario had been judged to be below the target and the risk in the inflation assessment had been on the downside. On the present occasion, on the other hand, opinions in the group differed about what ought to be done with the repo rate. Still, the group ended up by proposing a repo rate reduction of 0.25 percentage points. That would also call for a reduction of the lending and deposit rates; the policy group considered this should be restricted to 0.25 percentage points so as to avoid financial market expectations of further repo rate reductions.
3.2 The Executive Board’s discussion
In the opinion of one Board member the repo rate should be reduced because, in this member’s view, inflation will probably be somewhat below the target in one to two years time. The main argument for this is that the economy will still have unutilised resources in two years time; other factors were the downward effects on international prices and low inflation expectations in Sweden. The member saw an advantage in reducing the interest rate at an early stage if inflation prospects warranted this.
Swedish as well as international experience has shown that further into an upward cyclical phase it may be more difficult in practice to lower the interest rate and still maintain the credibility of monetary policy’s commitment to price stability. If the decision is postponed, there is accordingly a risk of an interest rate which is somewhat higher than necessary being established for a longer period. The member considered that this had been a feature of developments in 1993–94 and also, though to a considerably smaller extent, in 1996–97. If the inflation assessment points to inflation being below the target during the entire forecast period or most of this—and the interest rate is still not reduced even though the situation is not unusually uncertain—this can result in a path of inflation that is unduly low. There would then be a risk of the Riksbank acting asymmetrically in practice because such a wait-and-see approach would probably not prevail when inflation is judged to be correspondingly above the target.
The other members considered that the repo rate should be left unchanged. In the opinion of four of them, even if international and domestic economic activity have been strengthened somewhat more than had been expected in the Inflation Report, inflationary pressure seemed to be developing largely as assessed in the Report and recent information had not essentially altered the picture of inflation. The members underscored that it was too early to decide whether there was room for another interest rate reduction and accordingly emphasised the importance of waiting for the comprehensive assessment that will be made for this year’s second Inflation Report. The fifth member considered that the repo rate should be left unchanged because the monetary stance is already markedly expansionary and the possibility cannot be ruled out of this, combined with increasingly strong activity, generating a rate of price increases that is higher than envisaged in the March Report’s main scenario.
§ 2. The monetary policy decision
The Chairman summarised the discussion under §1 and noted that a majority of the Board's members considered that the repo rate should be left unchanged.
The Chairman then proposed that the Executive Board decides
- – to announce a fixed rate repo with a duration from the 28th of April to the 5th of May 1999 at an unchanged rate of 2.90 per cent and a fixed rate repo with a duration from the 5th to the 12th of May 1999 at an unchanged rate of 2.90 per cent, and
- – to announce the decision to keep the repo rate unchanged with the motivation and wording contained in the draft before the meeting of Press Release no. 31 1999, Annex A to the minutes.
The Executive Board decided in accordance with the proposal.
Deputy Governor Lars Heikensten entered a reservation against the decision and stated that the repo rate should be reduced by 0.25 percentage points and both the deposit and the lending rate by 0.25 percentage points. In his opinion, the decisive argument for this was that, excluding transitory effects and with the repo rate unchanged, inflation one to two years ahead would be somewhat below the target. To refrain from lowering the interest rate in the present situation could mean the establishment of a higher than necessary interest rate for a longer period of time.
