By Intermoney
Monetary policy made several major headlines on Thursday. However much the Middle East conflict might have affected the future direction of the major central banks, until Thursday we had not seen any of them make a move (except for the Reserve Bank of Australia, but it had already started before the conflict). But that changed when the Norgesbank raised its key rate by 25 basis points to 4.25%, a move that caught a good number of forecasters off guard, though not all of them. The reason a hike could be expected was that, at the last meeting, policymakers had already sent a clear, hawkish message which we believed could pave the way for yesterday’s rise.
With CPI at 3.6%, and, above all, core inflation at 3.0%, it was logical to think that the Norwegians might tighten their policy to address the risks of higher energy prices being passed on to other areas. Whilst second-round effects are less pronounced in other parts of the continent, stiffer wage costs in Norway and a tight labour market (2.1% unemployment) mean that these effects are more visible in the Nordic economy. In fact, Governor Wolden clarified that the rise was not solely due to the impact of the war per se, but rather to underlying factors in the Norwegian labour market and wage growth.
There were fewer surprises from their Swedish neighbours, as the Riksbank kept its key interest rate unchanged at 1.75%, in line with all forecasts. Like the eurozone and the UK, the Swedish economy faces conflicting risks for its monetary policy arising from the conflict in the Middle East. At the previous meeting, the bank presented various inflation scenarios related to the Middle East conflict; in one of these, a prolonged energy crisis would justify monetary tightening despite the downside risks to growth. Having to balance downside risks to activity against upside risks to prices is no easy task, particularly given the economy’s heightened sensitivity to interest rates, which could mean that further rate hikes in response to the surge in energy prices would weigh even more heavily on economic activity.
For this reason, we doubt that the Swedish central bank will take further action in the future, beyond issuing a statement with a more restrictive tone. In this regard, on Thursday it already emphasised its readiness to act if necessary, which in itself is a more hawkish stance. But it is one thing to warn and another to act, and as we say, for the moment it seems highly unlikely that they will use any tools other than words. That would help keep inflation expectations anchored, which is where the bank is focusing most of its attention.
And on this point, we must emphasise that the risks of second-round effects are lower than in 2022, thanks also to a stronger krona. If we add to this the impact of VAT cuts on food (which carry significant weight in expectations), we should expect price risks to remain relatively contained without any change to interest rate policy.