Heikensten: Minor changes to the inflation outlook

Date 30/11/2004

Governor Lars Heikensten today spoke at a meeting organised by Handelsbanken in Gothenburg about the current economic situation and monetary policy.

”The Riksbank published its most recent assessment of the economy and inflation in the middle of October. Since then there have been a number of developments that call for a slight revision in the Bank’s outlook. The most important of these is the rapid decline in the dollar recently and indications of weaker developments in the euro area,” began Mr Heikensten.

”In recent years the dollar has weakened gradually against both the euro and the Swedish krona. This decline has accelerated of late. Today the dollar is weaker against the krona than any time since 1996 and against the euro since the introduction of the single currency in 1999. It appears that an increased focus on the large US current account deficit has been the main driver of this development. In general, there is good reason not to be quick to revise long-term forecasts solely as a result of fast movements in the market. However, most forecasters today seem to expect the dollar’s depreciation to continue. A slight revision of the forecast for the krona’s development in trade-weighted terms over the coming months appears reasonable, though,” continued Mr Heikensten.

”As regards real developments in the euro area, there has been a number of less positive signals since mid-October; among other things, growth in the third quarter slackened more than expected. This slowdown has most likely been due to the high oil price and the strong euro. As the oil price can be expected to be somewhat higher and the euro stronger in the period ahead, compared with the assumptions in the previous Inflation Report, GDP growth in the euro area can be expected to be weaker next year as well,” said Mr Heikensten.

”In light of this, what is my overall view regarding the economic outlook? In October the Riksbank expected global economic activity to continue to strengthen this year as well as in 2005 and 2006. In the OECD area, growth this year was forecast to be around 3,5 per cent. For the coming two years we predicted somewhat lower growth, 2,8 per cent on average. So here there is reason for a slight downward revision. My view remains, however, that global economic activity will continue to strengthen in the period ahead. This is partly because real interest rates are still very low, despite monetary tightening in a number of countries,” said Mr Heikensten.

”Over the past year the Riksbank has held a positive view of the Swedish economy. Despite that, we have gradually had to revise up our growth forecasts, in October as well. In recent quarters the Swedish economy has grown faster than what is usually considered to be sustainable in the long term. Nevertheless, inflation has not yet picked up, largely due to robust productivity growth and low import prices. In October, GDP growth in Sweden was forecast to be around 3.5 per cent this year and a little over 3 per cent in 2005 and 2006. By and large I stand by this assessment, even though somewhat weaker growth abroad and a stronger krona is likely to mean that the growth forecast may need to be revised down slightly in the period ahead," said Mr Heikensten.

”Swedish unemployment and employment have essentially developed in line with the assessment in the previous Inflation Report. This means that the labour market is still relatively weak, despite a clear rise in the number of hours worked. In the previous Report, it was judged that the continued firm growth would contribute to an increase in employment and a drop in unemployment over the course of next year. There is currently no reason to change that assessment,” said Mr Heikensten.

”So what does this mean for inflation? In the previous Inflation Report we forecast that increasing domestic and international capacity utilisation and mounting cost pressures would cause inflation to rise, approaching the target of 2 per cent in the course of 2006. The risks of higher inflation, e.g. due to a higher oil price or lower productivity growth, were deemed to be balanced by the risks of lower inflation. My opinion now is that this assessment is essentially still unchanged. We have progressed a bit further into the cyclical upswing. That in itself tends to result in higher inflation at the end of the forecast horizon. But at the same time the somewhat weaker growth, and the resultant lower resource utilisation, should have a slight dampening effect on inflation. There is perhaps also reason to assess the risks somewhat differently. For example, a more dramatic fall in the dollar could cause a sharper slowdown in growth. Nevertheless, my assessment is that given the information available at present it is reasonable to believe that inflation a couple of years ahead will be in line with the target,” said Mr Heikensten.

”By way of conclusion allow me to say that the most likely scenario – despite the small slackening tendencies seen of late and the concerns that are currently affecting the foreign exchange market in particular – is that we eventually must expect a higher repo rate. This is because growth in the next few years is forecast to continue at a pace that is higher than what the economy can sustain in the long term. That means that the Riksbank sooner or later must intervene to ensure an inflation rate in line with the target and a stable economic performance in Sweden in the long term. When this will be appropriate remains to be judged, however, “ concluded Mr Heikensten.