Sweden's Central Bank Cuts Key Rate as Europe Moves Ahead of the Fed -- Update

By Dominic Chopping

STOCKHOLM--Sweden's central bank lowered its key interest rate for the first time in more than eight years on Wednesday, underlining the readiness of European policy makers to move ahead of the Federal Reserve as inflation cools.

The Riksbank cut its key rate to 3.75% from 4.0%, in line with a majority of economists polled by The Wall Street Journal, becoming only the second central bank from a rich, advanced economy to begin its easing cycle following the post-pandemic surge in inflation. Switzerland's central bank was the first to move in March.

This century, Europe has typically followed the U.S. in lowering borrowing costs. Cutting before the Fed risks weakening the national currency, pushing prices of imported goods and services higher and boosting inflation.

But a weaker economic outlook means European policy makers have more reason to be convinced that inflation has been tamed, and more to lose in terms of lost output and jobs if they wait.

After peaking at over 10% at the end of 2022, the pace of inflation in Sweden has slowed much more than expected recently, with the bank's target measure dropping to 2.2% in March, its lowest level in more than two-and-a-half years. At the same time, economic growth in the country has contracted for four straight quarters and unemployment is on the rise.

But policymakers are still wary of lowering borrowing costs too quickly, since the krona has already weakened sharply this year against both the euro and dollar.

"As inflation now falls from very high levels, there is uncertainty on both the upside and downside. The risks that may cause inflation in Sweden to rise again are primarily linked to the strong U.S. economy, the geopolitical tension and the krona exchange rate," the central bank said in a statement Wednesday.

The risks of a further depreciation against the euro appear limited, since the European Central Bank has signaled it will start to cut its key rate next month. However, the Fed has become more hesitant, with rate cut expectations being pushed to the end of this year.

"Today's decision confirms that European central bankers have no problem starting to cut rates before the Fed," wrote Andrew Kenningham, chief Europe economist at Capital Economics, in a note to clients.

But by moving ahead of the Fed, the Riksbank has decided that domestic conditions are its main priority. In a speech last month, Riksbank Governor Erik Thedeen acknowledged that higher rates abroad could influence the krona and inflation, but said the Riksbank shouldn't link Swedish monetary policy directly to the actions of other central banks.

"It is inflationary pressures and the prospects for inflation here in Sweden that determine our monetary policy," he said at the Stockholm Chamber of Commerce in April.

While Europe's economies have grown more slowly than the U.S. over the last 18 months, Sweden has been particularly anemic. That is partly because the economy is more sensitive to changes in interest rates, since most Swedish mortgages carry short-term floating rates. In the U.S. and many other parts of Europe, fixed-rate mortgages are more common.

One consequence of that sensitivity is that Swedish house prices have fallen more rapidly than elsewhere. U.S. house prices at the end of 2023 were 11.5% higher than at the end of 2021. And in the European Union as a whole, prices were 3.8% higher. But in Sweden, prices were 6.5% lower.

The Riksbank said Wednesday that monetary policy will be adjusted cautiously going forward with gradual cuts in the policy rate.

If the outlook for inflation holds, the central bank said it expects to cut the policy rate two more times during the second half of the year, in line with its forecast in March.

Write to Dominic Chopping at [e-mail]

(END) Dow Jones Newswires

05-08-24 0425ET