2.

Sweden's Technical Recession Here, Annual Recession Underway

SWEDEN REACT: Technical Recession

Here, Annual Contraction Ahead
By Selva Bahar Baziki (Economist)

(Bloomberg Economics) -- OUR TAKE: Sweden’s technical recession, confirmed by the

negative print for the third quarter, is only the start of bad news. The economy is set to contract
by 0.7% overall this year and remain close to stagnation in 2024. We don’t see a full recovery in
the growth rate until 2025.

 3Q23 GDP came in at -0.3% over the quarter on a seasonally adjusted basis, following 2Q23’s -
0.8%. The print was above our forecast for a 0.5% contraction but below the 0.0% median
consensus.
 Household expenditures shrunk for a fifth straight quarter, which we see related to high price
gains and borrowing costs eating into purchasing power. Real disposable incomes were down by
0.6% in 3Q23 over the year, according to Statistics Sweden.
 Investment contracted for the fourth consecutive quarter in revised data, as the hit to the
construction sector dragged the overall figure down. The positive growth seen in exports, by
1.4% over the quarter, was among the few bright spots in the release. But this is unlikely to last
given growth concerns in Sweden’s main trading partners.

Muted Growth Ahead for Sweden

Source: Statistics Sweden, Bloomberg Economics

Macro Outlook

 As the 3Q23 print was slightly better than we expected, we are revising up our annual forecast
for 2023 to -0.7% from -0.8%. 2024 will likely manage a meager performance, posting an annual
gain of 0.2%.
 The bleak outlook on activity confirms our expectation that unemployment will rise in 2024 to a
peak of 8.6%. The hit to demand will help the Riksbank’s battle against price gains. We see
headline CPIF inflation near the central bank’s target rate of 2% by mid-2024.
 By then, with headline inflation contained and core price gains likely on a receding trend, we see
the Riksbank delivering its first set of rate cuts in 2H24. That will support a pick-up in activity in
2025.

4. Sweden’s Dec. Inflation Dips Toward Target, Choppy Ride Ahead

SWEDEN REACT: Inflation Dip Confirms

Next Riksbank Move Is a Cut
By Selva Bahar Baziki (Economist)

(Bloomberg Economics) -- OUR TAKE: Sweden’s December CPIF print confirms the
discussion is no longer whether the Riksbank’s next move will be a rate cut, but when will easing
begin. Inflation is set to follow a choppy but downward trajectory ahead, reaching the central
bank’s 2% target rate by mid-year. Rate cuts will likely arrive early in the second half, but
sustained favorable surprises may move the date closer.

 December’s year-on-year CPIF inflation eased to 2.3% from 3.6% in November. That’s slightly
higher than both our expectation and the median estimate from a Bloomberg survey for 2.2%. In
November, the Riksbank forecast a year-end rate of 2.1%.
 The down-step was mainly driven by favorable base effects related to last year’s energy price
surge. Excluding energy, core inflation took a more muted step down to 5.3% from 5.4%. Still,
this is good news for the Riksbank, which expected a print of 5.6%. Our call and the median
consensus expectation was for a slide to 5.2%.
Sweden Inflation Takes a Deep Dive

Source: Riksbank, Statistics Sweden, Bloomberg Economics

 We expect headline inflation to temporarily climb back to around 3% in 1Q24, as base effects
wane, but reverse again to the Riksbank’s 2% target rate by mid-year. At the same time, we
forecast core inflation to be contained near 3%.
 Given this inflation outlook, our base scenario sees the Riksbank on hold in 1H24 before starting
a series of rate cuts in August.
 That stands in contrast to the Riksbank’s own projections, made in November, which assign a
less-than-50% probability for another rate hike early this year. The central bank does not see a
rate cut coming until 2025.
 Ongoing price pressures from firms’ pricing plans, the uptick in global shipping costs, and a
potential surge in oil prices mean upside risks are alive. While these factors may slow the
downward slide in price gains, we don’t see them as a trend-reversing threat.
 On the other hand, if inflation in early 2024 eases faster than expected, we may see a rate cut as
early as June, especially if other major central banks also move their easing cycles forward.
5. Riksbank to Hold Rates, Deliver Faster QT and Hawkish Guidance

SWEDEN PREVIEW: Riksbank to Deliver

Faster QT, Hawkish Guidance
By Selva Bahar Baziki (Economist)

(Bloomberg Economics) -- The Riksbank will likely keep rates unchanged at 4% at its first
policy meeting of 2024, but announce a pickup in the pace of its balance sheet runoff, as well as
provide guidance for further hikes if inflation data disappoint. Our baseline is for rates to stay on
hold before an easing cycle begins in August, with risks tilted to a sooner cut in June.

 In its Jan. 31 meeting, the central bank will probably decide to quicken its monthly government
bond sales to a minimum of 7 billion kronor from 5 billion kronor currently. It will likely keep
rates steady but state that the Executive Board is ready to lift borrowing costs if upside risks to
the inflation outlook materialize.
 Faster quantitative tightening and tough talk will serve to keep financial conditions restrictive.
As we showed in an earlier analysis, announcements on changes in the balance sheet and
forward guidance have a sizable impact on longer term yields.
 But we expect shoring up the krona will be the real motive behind these steps – especially as the
central bank’s foreign currency sales will likely be over soon (we estimate in early February). The
substitution of one krona support with others will help alleviate the Board’s concerns of
passthrough from a weak currency to price gains.

Riksbank’s Next Rate Move a Cut

Source: Riksbank, Bloomberg Economics

 CPIF inflation will decelerate toward the Riksbank’s 2% target rate by mid-year, with core
inflation well contained around 3% by then, in our estimates. Given this outlook, we expect the
Riksbank to remain on hold through the first half of the year, delivering its first rate cut in
August.
 Sustained favorable surprises to the inflation outlook, similar to those seen in 2H23,
and earlier rate cuts in other major economies than currently forecast are risks that could put
the Riksbank on an easing cycle as early as in June.
 The central bank’s latest policy rate projections, published in November do not feature a rate
cut until 2025. It had previously announced that it will not be publishing new forecasts alongside
its January meeting decision.

9. Riksbank Balanced in Nov. Minutes, Will Act if Inflation Acts Up

SWEDEN REACT: Balanced Riksbank Will

Act if Inflation Misbehaves
By Selva Bahar Baziki (Economist)

(Bloomberg Economics) -- OUR TAKE: The Riksbank’s November meeting minutes indicate
policymakers are focused on communicating a readiness to act on the likelihood of a worsening
inflation prospects. We expect inflation to approach the central bank’s 2% target rate by mid-
2024 and see this hawkish forward guidance as a tool to avert a premature easing of financial
conditions.
  The Executive Board recognized inflation is high but on a falling trajectory, while easing activity
and a likely hit to employment from rising borrowing costs have dialed down price pressures
ahead. At the same time, the Board remained cautious about favorable prospects reversing and
necessitating a further rate hike.
 The Board offered a balanced message on the need to remain contractionary to ensure easing
price gains. Policymakers also indicated an openness to further hikes should the inflation
outlook worsen. That consideration matches the policy path in the November Monetary Policy
Report, which suggested a further hike in early 2024 is possible.
 We agree that a worsening in the inflation outlook would warrant further tightening. However,
we think the minutes, as well as the policy rate path provided in the report, indicate that the
central bank is aiming to keep financial conditions tight over the the near-term, rather than
reflecting concrete plans for future hikes. Our earlier analysis found that forward guidance has a
large impact on the Swedish yield curve.

Riksbank Board Shifts Toward a More Neutral Position

Inflation Outlook

Board members were upbeat in recognizing that inflation expectations remain well anchored.
They also noted wage dynamics, firms’ price setting tendencies and the recent krona appreciation
all support the ongoing disinflation process. We see this keeping CPIF inflation on a falling
trajectory, reaching the central bank’s 2% target rate by mid-2024.

Board members list supply shocks, global tensions, and the krona among upside risks to the
inflation outlook. On the latter, the krona has gained some lost ground following the Riksbank’s
foreign currency sales that began in late September. The operations were announced on the same
day as the Sept. 21 policy rate decision and began shortly after. That contributed to the
currency’s near 6% gain against the euro since Sept. 20 — the best performance among G10
peers.

Despite the gains, Board members still see the currency as weak and a reversal of the recent
performance could be a potential reason to hike early next year. But the Riksbank is likely to
pick-up government bond sales in January, which will add support to the currency’s recent
appreciation trend.

Rates and Macro Outlook

The Riksbank’s tight stance will take a toll on growth this year and next. Sweden is likely to
grapple with the worst recession among major European peers in 2023 — we see the economy
contracting by 0.7%. That estimate matches the latest forecast from the Riksbank, which was
issued in late November. The ensuing rise in the jobless rate — we see this peaking at 8.6% in
2024 — will also help ease inflationary pressures.

We expect the economy to post a stagnant growth rate of 0.2% for 2024. The Riksbank, on the
other hand, forecasts a second year of recession, with output contracting by 0.2%. We explain
the divergence in our growth outlooks as being related to the difference in our policy-rate paths.

 Our long-held view is that the Riksbank’s policy rate peaked at 4% in September, with the next
move being a rate cut in the second half of next year. That coincides with when we see CPIF
inflation being well contained at the 2% target rate. Given the economy’s high interest rate
sensitivity, we see such a move as resulting in a pick-up inactivity, culminating in a low but
positive growth rate for the year in 2024.
 The Riksbank’s November report, however, sees rates peaking at 4.1% — implying a less than
50% chance of another 25 basis point hike to arrive in early 2024 — and for the policy rate to
then remain on hold until a possible rate cut in 2025. The message of a restrictive stance,
including possible rate hikes next year, was corroborated in the meeting minutes and would be
in line with a lower growth rate than our forecast.

11. Riksbank Minutes Suggest Weak Krona Risks More Hikes

SWEDEN REACT: Riksbank Minutes Show
Weak Krona Risks More Hikes
By Selva Bahar Baziki (Economist)

(Bloomberg Economics) -- OUR TAKE: The Riksbank’s June meeting minutes show
policymakers were united in their decision to deploy multiple tools — all in line with our
earlier call — in the fight against inflation. We maintain our forecast for a 25-basis point hike in
September, but recognize the risk of additional tightening further out, especially if the currency
continues to slide.

 In June, the Riksbank Executive Board voted for a higher policy rate (to 3.75% from 3.5%) and a
tighter policy path going forward. Policymakers also agreed to a pick-up in the pace of
government bond sales. We see the unanimous decision as the central bank communicating a
firm stance against high inflation. At its previous meeting, in April, the Board was divided on
both the policy rate and its path — the first time in three years.
 The Board remains justifiably unimpressed by the recent fall in headline inflation — singling out
a drop in energy prices against high base effects as a key driver. We view the rates outlook as
marked by concerns over core price gains (particularly in services) and further currency
depreciation.
 Following the minutes, we maintain our call for the Riksbank to lift its policy rate by 25-bps to
4% in September. Beyond that, risks are tilted to the upside, especially relating to further
currency weakness.

Riksbank Board Is Hawkish

Source: Riksbank, Bloomberg Economics

Inflation and Rates Outlook

 CPIF inflation is down from a multi-decade high of 10.2% in December (6.7% in May) and is set
to follow a falling trajectory for the remainder of the year. The central bank sees CPIF inflation at
2.2% by December, up from their earlier call of 1.9%. Our call is for a year-end rate around 2.5%.
Both forecasts are close to but above the central bank’s target rate of 2%.
 Underlying dynamics paint a less rosy — if not gray — picture. Core inflation is sticky (8.2% in
May) and price rises remain broad-based with more than 75% of the CPI basket seeing gains
greater than 4%. Board members highlighted concerns over price increases in services – which
account for nearly half of the basket.
  The krona has fallen further since the policy meeting, making an all-time low against the euro —
justifying the Board’s concerns over inflationary pressures due to a weakening currency.
 In this setting, and even as we see economic activity contracting going forward, we expect the
Riksbank to hike its policy rate to 4% in September. That would mean the central bank delivering
on its forecast of rates rising “at least one more time” this year, and, in our view, bring the
tightening cycle to a close.

Risks to the Outlook

 The minutes show Governor Erik Thedeen seeing “no reason” for the central bank to respond to
temporary exchange rate movements. Deputy Governor Martin Floden referred to the krona
decline in the last year as “unjustified,” while Thedeen said he expects a stronger currency going
forward.
 However, the minutes also highlight concerns among Board members that inflationary pressures
from a weaker currency may increase in a setting with high inflation. That, in our view, would
result in additional Riksbank action if the current krona trend persists. In this scenario, we would
expect the Riksbank to lift the policy rate by a further 25 bps in November, bringing Deputy
Governor Per Jansson’s comment on shifting “the plan further in a tighter direction” to life.

12. Straight Talk, Shock Hike, QT = Riksbank Toolkit

SWEDEN INSIGHT: Straight Talk, Shock

Hike, QT = Riksbank Toolkit
By Selva Bahar Baziki (Economist)
(Bloomberg Economics) -- The Riksbank has two problems: sticky core inflation and a weak
currency. The central bank has three potential tools it can deploy to tackle both: a larger-than-
expected policy rate hike, speedier quantitative tightening and firmer forward guidance. Our
analysis of how each factor impacts the yield curve suggests the Riksbank will likely lean on the
latter two on June 29, but there is a significant risk that it deploys the first as well.

 The Riksbank is facing a difficult stream of data as it approaches the next meeting. Headline CPIF
inflation is falling at a fast pace and is set to follow a downward trajectory for the rest of the
year. Yet, broad-based core price gains are stuck at high levels and the krona hit an all-time
low against the euro, igniting fears that import prices may fuel inflationary pressures.
 Our long-standing call is for the Riksbank to lift its policy rate by 25 basis points to 3.75% in June.
Could it do more as the inflation outlook worsens? Our simple yield curve analysis gives
statistical backing for a likely pick up in the central bank’s unwinding of the balance sheet, as
well as a firmer guidance on possible future hikes.

Five-Year Bond Yield Variances by Policy Shock

Source: Laseen (2020), Bloomberg Economics

Three Policy Options, Two Likely Contenders

We base our analysis on a 2018 study on the US economy and look at the relative impact of the
Riksbank’s three policy tools on Swedish bond yields. We focus on shocks to monetary policy,
balance sheet movements (in the form of quantitative easing) and forward guidance.

 In our analysis we find that a lift in the policy rate by a larger step than anticipated has a limited
impact on long term yields, probably muting support to the currency. Like the Bank of England,
 the Riksbank may yet resort to an outsized hike in June, but with core inflation stable (not
accelerating like in the UK) we see less need for drastic measures.
 Announcements on changes in the balance sheet have a sizable impact on longer term yields
and that could attract foreign investment to help with the struggling currency. We see the
Riksbank pulling this lever on June 29.
 One caveat is that our analysis is based on quantitative easing episodes. The impact on yields
may be smaller in the reverse direction.
 The policy tool that has the biggest impact on yields in our sample period is forward guidance. It
accounts for nearly half to two-thirds of the variation in five-year bond yields in the decade and
a half before the pandemic. We think the Riksbank will also lean on that tool.

We stick to our view of a 25-bp hike on June 29. Markets saw upside risks to that view at the
close of last week, pricing in around a 30% probability of a 50-bp hike. We see the central bank
announcing a pick up in the pace of its asset sales, and shift in the tone of its guidance from April
when it introduced ambiguity on the timing of its next move.

Methodology

We broadly follow Rogers, Scotti and Wright (2018) in extracting the surprise components of
forward guidance and balance sheet operations in two steps. The approach builds on the
assumption that a central bank’s policy rate moves have an impact in short, forward guidance in
medium (two-year), and quantitative easing (or tightening) operations in longer (10-year)
maturities.

In step one, we regress daily changes in two-year government bond yields around policy
announcement dates on surprise changes in the interest rate — which are obtained from Laseen
(2020). The residual of this regression is defined as the surprise change in forward guidance.

In step two, we regress daily changes in 10-year government bond yields on surprise changes in
policy rates and forward guidance obtained in step one. We refer to the residual of this regression
as ‘unexpected changes’ in the central bank’s balance sheet.

As a final step, we regress daily changes in five-year government bond yields on all three
surprise changes to compute their relative importance in explaining movements in the yield in
pre-QE (2003-2014) and QE (2015-2018) samples.