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Why is Sweden one of the first countries to lower interest rates?

Sweden, along with Switzerland, is among the first countries to lower interest rates in Europe. Why is this?

Published: 10 May 2024 14:56 CEST
Why is Sweden one of the first countries to lower interest rates?
Nordea's head economist Torbjörn Isaksson. Photo: Tomas Oneborg/SvD/TT

Sweden joined Switzerland, Czechia and Hungary in the small group of countries to lower their so-called policy rates earlier this week when the country’s central bank lowered the interest rate from 4 percent to 3.75.

There are natural explanations for this, according to financial experts.

“Sweden’s economy is more affected by interest rate hikes,” head economist at Nordea, Torbjörn Isaksson, told TT newswire.

Sweden’s GDP has shrunk four quarters in a row, putting Sweden at the bottom of the table when it comes to growth over the past year. Unemployment and bankruptcies have also gone up more than elsewhere.

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Isaksson believes that that’s the main reason Sweden is lowering its policy rate before other central banks, although he predicts the European central bank is only weeks away from lowering its key interest rate.

Although inflation in Sweden has dropped, the country still has higher inflation than both Denmark and Finland – the main reason for cutting the rate in Sweden is the fact that households here are so much more sensitive to high interest rates.

“A high level of household debt and short term loans has meant that high interest rates have hit harder here than elsewhere,” Isaksson said.

“That’s why there’s a greater need to take our foot off the brakes slightly.”

Having said that, Sweden’s economy still has a strong foundation.. Swedish business remains competitive, salaries are set “responsibly”, and the country has strong state finances, Isaksson said.

“Lowering interest rates while remaining hawkish is the best way to go,” SEB head economist Robert Bergqvist said.

“The central bank is showing that they’re taking this first step, they’re ready to take further steps, but they want to keep expectations low.”

Bergqvist described the Swedish economy as being out in the open sea, exposed to strong waves.

“We have strong state finances which work as an airbag, but I think the central bank is happy it can show that it’s reacting to what’s happening in the Swedish economy,” he said.

“It would almost be professional misconduct to not lower the interest rate based on what’s happening with inflation, so it’s hard for the central bank to avoid doing so.”

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MONEY

Swedish central bank chief: Economy entering ‘new phase’

Erik Thedéen, governor of Sweden's central bank, the Riksbank, believes that the country's "surprisingly resilient" economy is entering a new phase after a few years of inflation and rising interest rates.

Published: 20 May 2024 14:56 CEST
Swedish central bank chief: Economy entering 'new phase'

“Concerns remain, but from an inflation perspective, prospects look much brighter,” Thedéen said at an event at the Swedish Economic Association. “We are entering a new phase for monetary policy and for the Swedish economy, as inflation is now back close to the [two percent] target, which among other things enables real wage increases.”

Earlier in May, the central bank lowered the policy rate by 0.25 percentage points to 3.75 percent – the first time the rate has dropped in eight years, after a period of eight hikes between 2022 and 2023, where the rate rose from 0 to 4 percent.

These hikes were made in order to lower inflation, which at its highest point in December 2022 stood at 10.2 percent.

“The upturn [in inflation] was partly due to a series of global supply shocks that led to sharp cost increases for companies, and partly due to a large pent-up consumption need among households after the pandemic, and thus high demand,” he said.

“Together, these factors in turn contributed to a change in the nature of companies’ pricing behaviour. This manifested itself in more frequent price increases and a greater pass-through from cost increases to price increases.”

The most recent inflation figures from March and April this year put inflation at 2.2 and 2.3 percent, much closer to the central bank’s 2 percent target.

“We now know that inflation is by no means ‘dead’, as it was sometimes labelled when inflation was below the central banks’ inflation targets for a long period,” Thedéen said, before warning that prices may be more prone to increasing now than they were in the past.

“The threshold for raising prices may be lower now than it was before. For monetary policy, it will be important to monitor price-setting indicators,” he added.

He warned that we may not yet have seen the full impact of the hikes to the country’s policy rate, while describing the Swedish economy as “surprisingly resilient so far”.

“Interest rate-sensitive parts of the Swedish economy have of course been affected by the rate hikes. Household consumption has declined and residential investment has fallen sharply. But at an aggregate level, this has been offset by the relatively better performance of other parts of the economy.”

One factor behind this resilience, he said, was the high demand for labour.

“This may reflect the fact that companies have not anticipated a deep or prolonged downturn in economic activity and that real wages have been weak.”

Things are definitely looking brighter, but we may not be out of the woods just yet, he warned.

“There are some questions about what has happened to the structural economic relationships after the years of high inflation and, as always, there are risks of worse developments ahead. But so far, a ‘soft landing’ seems to be within reach.”

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