Higher-for-longer was the narrative for quite some time, until it suddenly wasn´t. In the final two months of 2023, rate cut expectations increased sharply and, as one example, in Sweden, the market pricing on the expected policy rate by December 2024 moved from 3.75% to 2.40%. The re-pricing was clearly more driven by speculation and forecasting than evidence. As it has not been validated by incoming data thus far in 2024, or softness from Fed and ECB, the market has rightly bounced back.
In following charts, we have tried to put a perspective on things. We have studied key reaction function data, and the situation in those, in past Riksbank cutting cycles (1998, 2002, 2008, 2011) and the huge QE response in 2020, following the Covid outbreak. The red colored lines marks those episodes.
Firstly, it is clear that inflation has effectively always been markedly below target at the point where policy easing was initiated, with difficulties to produce a forecast for the years to come of well-anchored inflation. From here, inflation is very likely to continue to abate, but we are not there yet and most bank forecasts are not expecting inflation to reach or breach 2% until autumn/winter.
Secondly, the Riksbank´s own measure of resource utilization is typically clearly in negative territory when rates have been cut in the past. Currently, this measure is largely in neutral territory.
Thirdly, as a small open economy, the Riksbank has effectively never initiated a rate cutting cycle unless it has already been initiated by Fed and ECB. That is not the same thing as it could not happen, but to push the Riksbank into this direction, inflation likely need to surprise notably on the downside.
Lastly, growth and growth indicators have been weak for quite some time, and clearly support a looser policy on its own merits. However, a central bank is unlikely to use this as a stand-alone argument if not inflation and or the labor market is validating it. If anything, recent months have witnessed some “fish-hooks” in indicator data, suggesting that the worst is behind us.
Conclusion: the economy is clearly not strong, and inflation has and will likely continue to abate. However, it normally requires a little more and broader evidence in data for the Riksbank to tip the policy into actual easing mode. The pricing of rate cuts that took place the final stages of 2023 was clearly premature and the correction in 2024 makes it look a bit healthier. Inflation data and signals from ECB and Fed will largely dictate the development from here.