Swedish central bank talks rate hikes amid recession fears

Sweden's Riksbank has stuck with its plan to start withdrawing stimulus later this year or at the beginning of next year, surprising analysts who were expecting the central bank to strike a dovish tone.

The central bank, however, said it will be raising its key interest rate at a slower pace than it had previously expected.

"As before, the interest rate is expected to be raised towards the end of the year or at the beginning of next year," the Riksbank said in a statement. "However, low interest rates abroad and worsened sentiment mean that the interest rate is expected to be increased at a slower pace thereafter than in the previous forecast."

The Swedish central bank's rather hawkish stance comes as other major central banks, including the US Federal Reserve and the European Central Bank, are contemplating further monetary easing to deal with slowing economic growth amid US-China trade tensions and Brexit uncertainty.

'Serious risks to credibility'

The Swedish economy unexpectedly contracted in the second quarter. The gross domestic product fell 0.1%, well below analysts' expectation of a growth of 0.3%. The biggest Nordic economy also witnessed a sharp pickup in unemployment in July.

"The raft of very weak economic data suggests that the economy is probably crying out for additional stimulus rather than a withdrawal of stimulus which the Riksbank seems hellbent on delivering," David Oxley, senior Europe economist at Capital Economics, told DW. "So, there is a big gulf that has opened up between what the Riksbank says it's going to do and what the markets expects it to do. This poses serious risks to its credibility."

Deutsche Bank strategist Robin Winkler said if the central bank were to hike rate in the next few months, it would be a "policy failure."

"The fundamentals in Sweden are deteriorating at least as fast as in the eurozone, and decoupling policy from the ECB seems to be an unnecessarily aggressive step," he told DW.

A 'stubborn' Riksbank

In December, Stockholm-based Riksbank, which is the world's oldest central bank, raised its interest rate for the first time in seven years and committed itself on a path of monetary tightening despite uncertainties posed by global trade disputes.

The global economic outlook has turned much grimmer since then. The US-China trade war has escalated with both sides raising tariffs on each other's goods, European economic powerhouse Germany is on the brink of a recession and the outcome of the Brexit crisis remains unclear.

"Maybe the central bank knows more than we do — or perhaps it is just being stubborn," Frederik Engholm, chief strategist at Nykredit in Copenhagen, told DW. "Things are deteriorating fast, so basing your policy view too much on existing conditions of the economy might be a little dangerous."

Read more: Does Germany need a stimulus package to cope with recession?

The inflation argument

The Riksbank, which was the first central bank to launch negative interest rates following the global financial crisis, kept its main interest on hold at -0.25%. It said inflation was holding up close to its target of 2% despite a faster-than-expected slowdown in economic activity, arguing that there was no need to change its hawkish stance.

"I think they're being quite cute in using that as an argument for maintaining a positive view of the world," Oxley said. "I think over the second half of the year we will see core inflation pressures start to ease as the economy disappoints."

Most analysts don't see the Riksbank following through on its rate hike plan, at least in the time frame it's proposing.

They say a raft of weak domestic data suggests that the Swedish economy is just too fragile to withstand a tighter policy. Sweden has been flirting with a technical recession over the past few quarters. A technical recession is marked by two consecutive quarters of contraction.

"Our call is that Riksbank will have to cut rates in February or perhaps in April," Michael Grahn, Danske Bank chief economist, told DW. "It would be very strange if the Riksbank actually raises rates by the end of this year, unless there is a sudden turnaround in the economy."