Heikensten:The krona has shifted the risk spectrum

At today's meeting of the Trevises Economic Club in Malmö, First Deputy Governor Lars Heikensten spoke about the economic situation.

 

"The Riksbank presented an Inflation Report on 31 May. The chief message was that in the period 1-2 years ahead that is monetary policy's main focus, inflation would be in line with the 2 per cent target. For a number of reasons, however, the picture was more uncertain than usual. The Executive Board unanimously chose to leave the repo rate unchanged," Mr. Heikensten said.

"Against the background of the subsequent discussion, there may be reason to elaborate and comment on the message in the Report:

• In the Report's main scenario we counted on a gradual economic recovery in Sweden in the years ahead. The slowdown in the United States has recently led to a slackening of growth in Sweden. When an upturn occurs in time in the United States, we foresee that in the same way it will have a favourable effect on the Swedish economy. Our domestic demand is fundamentally strong, with considerable increases in household income that in turn provide room for a good development of consumption. At the same time, construction, for example, is expanding. Growth this year will therefore presumably be approximately what we believe the economy is capable of without risking an increase in inflation. But it is worth noting that in the following years we count on growth being somewhat higher.
• The rapid price rise this spring was, in our opinion, mainly due to price increases for petroleum products and food. Moreover, the effects of earlier deregulations in the electricity and telecom markets came to an end and rents have risen from unusually low levels. This was accompanied by a more cautious increase in other prices that was essentially expected. It presumably has mainly to do with the high resource utilisation in the Swedish economy. Of course one cannot rule out that as a consequence of the high resource utilisation, inflation will accelerate more quickly in the future than we counted on. But it is not effects of that type that we have seen in the statistics during the spring.
• The picture of economic activity and inflation in Sweden is not unique. On the contrary, in many ways it matches what we see abroad. Just as in Sweden, inflation in the United States and the euro area has risen recently and for mainly the same reasons. The level, however, is lower in Sweden. We also share the ongoing slowdown with the rest of the world. Early this year it was commonly considered that economic activity would be affected more in Sweden than in the euro area. That no longer appears so certain. It follows that Swedish monetary policy faces decision-making problems that in many ways resemble those in the rest of the world. Higher inflation occasioned by supply shocks, accompanied by an economic slowdown, is a situation that is more complex than what we have had to handle in recent years. It is an advantage, however, that inflation expectations are very stable and that wage agreements have been concluded for the coming three years at levels which are decent for inflation," Mr. Heikensten said.

"The new information about economic activity and inflation in Sweden and the rest of the world does not motivate any appreciable change in the appraisal of inflation prospects one to two years from now. The inflation figures that were presented yesterday are well in line with the Riksbank's assessment in May. Underlying inflationary pressure seems to have risen approximately as we foresaw," Mr. Heikensten continued.

 

"There is, however, one clear deviation from what we counted on. The Swedish krona has continued to weaken, which is the opposite of the assumptions on which the Inflation Report's main scenario is based. As I see it, that amounts to a shift in the spectrum of inflation risks we presented at the end of May. The unduly low exchange rate during a large part of the past decade has not affected inflation as much as had been expected. But a currency that has a permanently low value clearly does have effects on inflation. That is particularly the case in that resource utilisation is high. If the exchange rate were to remain weak and nothing untoward happens in other respects, it would have consequences for monetary policy," Mr. Heikensten said.

 

"The principal instrument for a central bank that targets inflation is the interest rate. But in a situation where the exchange rate deviates from a reasonable value and simultaneously constitutes a risk for inflation, currency-market interventions may be motivated," Mr. Heikensten concluded.