Heikensten: Inflation high but a reassessment premature

First Deputy Governor Lars Heikensten spoke about "The Swedish Economy" at a seminar in Oskarshamn arranged by the municipality, the local branch of the Federation of Private Enterprises and the business centre. His theme included economic developments since the time of the Riksbank's latest Inflation Report, published in December.

"The economic picture the Riksbank presented in the December Inflation Report envisages a gradual recovery in the rest of the world as well as in Sweden. An important factor behind the recovery is the major realignment of economic policy that has occurred in the United States and many other industrialised countries. The interest rate cuts and fiscal stimuli will have a successive impact. Meanwhile, the adjustments of stocks and investment that are a normal feature of a cyclical low is continuing. If developments follow the pattern from earlier downward phases, it is reasonable to count on a recovery during the second half of this year," Mr Heikensten said.

"The recent months' statistics broadly confirm this picture. In the United States, consumer and business confidence, for example, are beginning to pick up, stock adjustments seem to have come a good way and it looks as though productivity growth is still good. But it is still too early to sound the all clear. Unemployment's upward tendency can subdue Americans' consumption propensity and the stimuli from falling energy prices may turn out to be only temporary. Moreover, there is still concern about conceivable consequences of the underlying imbalances in the U.S. economy, manifested, for example, in low household saving and large trade deficits. The signals about economic activity in Europe are mixed. The clouds over Germany, for example, have not dispersed completely," he said.

"Developments in the Swedish economy also seem to have been more or less in line with what the Riksbank foresaw in December. It is conceivable, partly in view of revised GDP statistics, that demand last year was somewhat weaker than assumed in the Inflation Report. This is contradicted, however, by the relatively strong employment figures and the favourable development of household income. The retail statistics suggest that consumption is stabilising. The picture of incoming orders is also somewhat brighter. Households and firms have become less pessimistic about the future," Mr. Heikensten continued.

"So on the whole there do not seem to be any grounds at present for an appreciable revision of the Report's assessment of economic developments in Sweden and the rest of the world. A recovery should get going during 2002. But there is a risk of a weaker development and there is still considerable uncertainty," he added.

"The exchange rate was a major source of concern last year. It has strengthened, as expected, since the time of the Inflation Report and the appreciation by just over 2.5 per cent is somewhat more than foreseen in December. Now that economic activity and share prices seem to have become more stable, there are good reasons to expect a continued appreciation. This is also indicated by substantial current-account surpluses, stable government finances and a strong competitive position for exports. Further support should come from expectations of Sweden's full future participation in EMU," Mr. Heikensten said.

"The picture of inflation is still problematical. During the past six months inflation has admittedly matched the pattern drawn by the Riksbank, with a subdued tendency for the groups of goods and services for which prices rose most dramatically last spring. But the rate of price increases has continued to be somewhat higher than calculated earlier. From November to December the CPI rose 2.9 per cent and the rate of underlying inflation (UND1X) was 3.4 per cent, which exceeded expectations by some tenths of a percentage point. However, various measurements indicate that inflation expectations have returned to the Riksbank's targeted rate and a majority of observers predict a marked drop in inflation during the spring," Mr. Heikensten added.

"That inflation is still too high cannot be ignored," he emphasised. "The risk that the inflation propensity in the Swedish economy may be higher than calculated was highlighted by the Riksbank in a number of Inflation Reports last year. Our studies to date do not confirm that this is the case but the risk unquestionably remains. In December we counted on a slackening rate of inflation during the spring. This was an expected result of weaker economic activity, a stronger exchange rate and lower commodity prices. Clear effects were also expected from the prospect that last year's temporary price increases for food and electricity, for example, would drop out of the statistics. There is no reason to alter this general picture today. But the uncertainty exists and there are distinct risks. This naturally affects the room to manoeuvre in monetary policy," he continued.

"In December, when allowance had been made for the risks of economic activity being weaker and domestic inflation somewhat higher, the Riksbank concluded that in the period one to two years ahead the rate of price increases would be more or less in line with the 2 per cent target. There are no grounds for changing that assessment appreciably," Mr Heikensten concluded.