Heikensten: Inflation rise expected to be temporary

Riksbank Governor Lars Heikensten today spoke at a meeting organised by Hammarby bandy club on the subject of "Some monetary policy issues".

"The Inflation Report published by the Riksbank in December anticipated a gradual and tentative recovery in economic activity during 2003. The course of events is influenced by two factors that partly counteract one another. A negative effect comes from the consequences of the stock market bubble bursting and the fact that investment in certain sectors - particularly IT and telecom - was exaggerated. A positive effect comes from the normal business cycle pattern that indicates an upturn in both fixed investment and stocks. Economic activity in the US in particular, but also in other areas, is supported by expansionary fiscal policy and low interest rates," began Mr Heikensten.

"Sweden was in some aspects harder hit by the downturn during 2001 and 2002 than most other countries. Share ownership was more important here than in many other European countries. The IT and telecom sectors also played a stronger role here. Nevertheless, economic growth and employment developed relatively well. The main reason for this was that fiscal policy was highly expansionary; households experienced record-high increases in income last year. The low value of the krona also had a favourable effect on the course of events."

"One difficulty when looking ahead is to determine whether households are prepared to continue increasing their consumption or whether they will instead want to compensate for the negative effects on their wealth from the stock market fall and therefore increase their saving. This question will be brought to a head in Sweden as rises in income over the coming years are expected to be much lower than before. Central government finances will not contain any scope for protecting households from an economic slowdown as was the case in 2001 and 2002. The question with regard to investments is how large the over-investment really was? The answer to this will provide an idea of when investment activity may recover. Both consumption and investment are now being held back by the concern over the Iraq crisis," continued Mr Heikensten.

"There is no reason at present to revise the basic view we had of economic activity and inflation prospects in the December report. However, there are some signs of a weaker development, particularly in Europe. This will to some extent have an effect on Sweden, where industrial production is currently marking time. Households have also become more pessimistic over the past six months in their views of the future. All in all, this indicates that economic activity will be slightly weaker in the near future," said Mr Heikensten.

"The most tangible change since December concerns inflation, which has shown a marked rise recently. The situation is reminiscent of spring 2001, when inflation gathered momentum mainly due to temporary factors. Mad cow disease and foot and mouth disease pushed up meat prices and poor harvests led to soaring prices for fruit and vegetables. Then, as now, we also had a water shortage in the hydro power reservoirs that pushed up electricity prices. This time the price rise is possibly even more concentrated to a couple of product groups; electricity and oil. The Riksbank's assessment is that the rise in inflation is temporary and that we can expect significantly lower inflation as early as late spring and the summer."

"In a couple of weeks' time the Riksbank will be publishing a broad survey of economic activity and inflation perspectives. In this context it is important to balance the risks of a weaker development, and what these may entail for inflation, against the risk of inflation setting in," concluded Mr Heikensten.