Riksbank Under Pressure for a Half-Point Rate Cut to Aid Economy

(Bloomberg) -- Sweden’s central bank faces growing calls for sizeable interest-rate cuts to boost a faltering economy.

The Riksbank has outlined two or three quarter-point rate cuts before the end of this year, yet a half-point cut next week is no longer an impossible scenario as pressure from investors, economists and labor unions to do more is becoming more vocal. They cite expectations of inflation remaining below the central bank’s 2%-target and growing unemployment as key reasons.

“The Riksbank should rapidly move toward an interest rate of about 2.5%,” Cevian Capital co-founder Christer Gardell said in emailed comments. “The Swedish economy is weak and inflation will probably approach zero, or deflation, if nothing is done to stimulate the economy.”

The debate mirrors the US discussion on how the Federal Reserve should respond to weaker economic data. It also puts the onus on the Swedish central bank to shift from a policy of gradual easing that has been designed partly to avoid unwanted currency weakening that would fuel imported price growth.

While the Riksbank is widely expected to take its benchmark rate to 3.5% from 3.75% at its meeting on Aug. 19, critics argue that just as the bank moved in larger steps when it tightened policy, it should now do more to boost domestic supply.

While the outlook for Sweden’s economy has improved this year, recent readings of growth and economic activity suggest that the expected recovery is yet to materialize.

Torbjorn Hallo, chief economist at LO — Sweden’s largest umbrella organization for labor unions — said it would be reasonable for the Riksbank to cut the rate by half a point.

“We are in a situation where the labor market is weak, and growth is tepid,” he said in an interview. “I think that the policy rate should be normalized as soon as possible.”

The risk of adverse currency effects may however limit the central bank’s appetite to go bigger than a quarter-point cut, as a weak krona has been a constant concern for officials led by Governor Erik Thedeen in the past few years. Deviating too much from the European Central Bank’s easing trajectory could weigh on the currency, which has lost 1% of its value against the euro since the Riksbank’s policy meeting in June.

For Hallo, the currency risk isn’t enough to prevent a bigger move. He said the Riksbank has “made its own bed” by not arguing forcefully enough that Sweden’s economy has features allowing for lower rates than those of the ECB. The factors that set Sweden apart include a large portion of variable-rate mortgages, as well as a model for setting wages through collective-bargaining agreements that limits the risk of wage-price spirals.

“There is a risk that the currency could weaken” if the Riksbank makes a bigger than expected move next week, Hallo said. “However, the issue now is not whether inflation will exceed the target but whether it will undershoot.”

--With assistance from Rafaela Lindeberg.