Aurores boréales : la fin des taux d’intérêts négatifs en Suède

Key points:

  • Northern lights: what the Riksbank can tell us about negative rate policy
  • Stranded buccaneers: the Brexiters’ complex fiscal/political equation
  • German cycle: stabilisation at low level provides little comfort

Northern lights: towards the end of negative rates in Sweden

While observers last week were understandably focusing on Mario Draghi’s last press conference (see our Macrocast #18 for our own assessment of the European Central Bank under his tenure) in terms of hard news the interesting bit came from Sweden.

Indeed, although the Riksbank fully acknowledged a deterioration in the economic outlook in its new monetary policy report, it chose to stick to forecasting a hike of its policy rate from -0.25% to zero this December. The message is quite subtle actually, since it has also revised down its likely path for rates beyond that date relative to its September batch, so that the monetary stance would stay unchanged for long after the December move. But it is still bold in the current environment to telegraph an end to the negative rate policy.

There might be a Scandinavian micro-climate when it comes to monetary policy. After all the Norges Bank effectively hiked rates in September. But contrary to Norway, Sweden is not a commodity exporter and relies heavily on its manufacturing base. We think it is highly significant that a small open economy with a floating currency is still considering exiting from negative rates against a background of weaker foreign demand and monetary easing by the bigger central banks. We have been noting in Macrocast the change in the intellectual mood around negative rates since the summer, but the Riksbank is a step ahead and preparing to act.

Interestingly, in the 42 pages long monetary policy report no particular concern is expressed about the adverse consequences of negative rates. The conclusion of the dedicated box on “side-effects of monetary policy” is quite benign (“the banks’ results and lending capacity have not been tangibly affected by the low and negative interest rates”). But the Riksbank wants to be pre-emptive, with Governor Ingves stating that “there are concerns over long term effects if people think negative rates are permanent” and quite candidly that “we are aware that many think negative rates are rather strange …and [by raising rate to zero] then that’s not something we have to worry about”.

So in essence, it seems the Swedish central bank is keen to “rip off the band aid” and get rid quickly of a controversial aspect of its arsenal to focus attention on what remains a still accommodative stance of the central bank, stressing that by keeping the policy rate at zero afterwards it would still be “unusually low”. In the new monetary report the policy rate would remain unchanged throughout 2020-2021, to reach only 0.1% in 2022. In the September report, the repo rate was forecasted to stand at 0.2% in 2021.

At least in the case of the ECB the negative rate policy was primarily seen as an effective tool to avoid currency appreciation. And we agree that there is a good reason to believe negative rates have a “non-linear” effect on exchange rates: managers of official reserves may not be profit-seeking, but incurring actual losses on parking currency reserves where cash is “taxed” by a negative policy rate may be too much to stomach. Central banks would thus have to be very cautious when exiting from such territory. We are now having an interesting natural experiment with the move in Sweden. Obviously it’s very early days, but we note that the Swedish krona’s knee-jerk appreciation immediately after the Riksbank announcement evaporated in a matter of  hours (Exhibit 1). Investors may have chosen to focus on the dovish side of the central bank’s message, which would suggest exiting from negative rates is possible without triggering too much disruption, provided it is encapsulated in a suitably dovish package. 

Exhibit 1 – manageable market reaction


 

Exhibit 2 – but SEK had weakened before

True though, the Riksbank is taking a very controlled risk with this move, since Sweden has been benefitting from a significant depreciation in its currency since the beginning of the year (Exhibit 2). This was mentioned several times in the monetary policy report. It seems that Governor Ingves could have lived with some rebound in the currency.

Exhibit 3 – Key difference with the euro area: inflation expectations are close to the Riksbank’s target

Source: Riksbank

But beyond the FX issue, we would focus on a key difference between Sweden and the Euro area: in the former, long term inflation expectations are not significantly below the central bank’s target (Exhibit 3). Even if the “money market players” measure has declined over the last 12 months, at 1.8% it is only 20 basis points below the Riksbank’s goal. In the Euro area, the ECB’s favourite market-based measure of long term inflation expectations is currently wallowing at 80 bps below target. It is thus much easier for the Swedish central bank to prepare for some measure of “normalisation” – within a still overall accommodative stance – than for the ECB. 

Still, we think that at least psychologically the message from Stockholm is another piece of incriminating evidence in the case against negative rates. Most of the dissenters against the September 12th ECB package did so because of their reservations on resuming quantitative easing. But we are now hearing notes of caution from “non-dissenters” against negative rates.  

The Governor of Banca d’Italia Ignazio Visco stated “I wouldn’t encourage going too much in the direction of even lower rates” on October 18th, adding to the sense that this time we have probably finally found a bottom for the deposit rate, even with the mitigation brought about by “tiering”. But our attention was drawn to the very thoughtful and comprehensive interview given by Pierre Wunsch, the Governor of the Belgian central bank, to Bloomberg, as evidence of the growing “negative rate fatigue” in Europe. We would highlight in particular this point: “We already have a highly accommodative monetary policy and at some point going lower on rates could lead to decreasing returns…if side effects would become prominent, we may have to consider a sort of escape clause for our forward guidance”. Pierre Wunsch was very careful to remain agnostic as to how close we are of these “decreasing returns” and that actually there might still be some leeway, but arguments are piling up. 

Finally, we would mention Peter Praet’s long interview in l’Echo this weekend. The former chief economist of the ECB had a quite simple message: he continues to think that negative rates were necessary, but this can’t be “a permanent state”. This would not be “manageable socially and politically". We think this is key. We can spend hours discussing whether or not we have reached the “reversal rate” at which the policy becomes counterproductive from a technical point of view, but the key issue lies outside monetary policy proper. Generating negative income for savers and twisting capital allocation can end up triggering a backlash against the central bank. 

This is not to say exiting negative rates would be a walk in the park. For instance, it would be quite easy for the Riksbank to accompany such exit with resuming quantitative easing at a powerful pace, if need be, while the hurdles against this abound in the ECB’s case as we have been discussing at length in Macrocast. We always come back to the same problem: monetary policy should stop taking the lead at the current juncture and we need a fiscal push – a point Peter Praet made in his interview. As long as this fiscal push remains elusive, the ECB will be very reluctant to remove any component of its current accommodative stance. In a nutshell, the Riksbank shows us that it can be done, and how it could be done. But we don’t think the ECB is on the brink of emulating their Northern counterpart. Still, we can now fairly safely say the deposit rate won’t go further down. 

Stranded buccaneers

Brexit is in limbo once again. The deal negotiated with the European Union was endorsed in principle by the Commons but the government’s move to expedite the parliamentary process so that the UK could formally leave the EU on October 31st was thwarted by a majority of Members of Parliament. They wanted to retain the possibility to amend, for instance to force the British government to ask for the whole of the UK to stay in a customs union with the EU, or to make the deal’s final approval dependent on a confirmatory referendum. Boris Johnson reacted by stalling the parliamentary process and move instead for early elections on December 12th. However, since he needs two thirds of the MPs to support this option, and the labour party’s position on this is “fluid”, we may be completely stuck. The Liberal Democrats and the Scottish Nationalists may have come up on Sunday morning with a solution to the gridlock: amend the “fixed term parliament act” so that with only a simple majority of the House early elections could be decided. In their plan, the elections would take place on December 9. 

The EU has yet to make a decision on granting the extension grudgingly requested by the British government, or more precisely whether to grant only a few weeks, to try to force the deal back on the British parliamentary docket, or three months to allow time for elections and a fresh government. The likely compromise is probably a “double trigger” extension (a pledge to prolong an initial short extension with a longer one should elections be formally announced). But this in itself would simply make a multiplicity of outcomes possible. It would not clarify the situation. 

Brexit is the product of a democratic decision (the referendum). It may not be resolved without another democratic decision. General elections are needed, even beyond Brexit, since in any case the government can no longer count on a majority in this current parliament. The economic platforms issued in these elections could tell us a lot on what a post-Brexit UK could look like.

Chancellor of the Exchequer Sajid Javid has this week already shelved his flagship proposal of cutting tax for the top of the income distribution. The idea was to push the threshold for the higher income tax rate (40% instead of 20%) from GBP 50,000 to GBP 80,000. This single measure would have cost the budget GBP 8bn per year , i.e. 0.4% of GDP, raising after tax income of someone making GBP 80,000 by 10%. This could have made the tory party quite vulnerable in an election. The median income in the UK is below GBP 30,000 per year, and to win they need to snatch seats from Labour in the less wealthy Midlands and the North (they will probably lose constituencies to the Lib-dems in the South and to the SNP in Scotland).  Instead, the party’s election manifesto is likely to focus on public spending.

Here we find again the usual tension between Boris Johnson economic vision for post-Brexit UK and the electoral coalition he needs to put together to win a majority. The “protectionist” leavers want more public spending and a re-regulation of the economy. The “liberal” leavers want less tax and a further de-regulation of the economy. Something has to give, and the adjustment valve may well be the fiscal deficit. After all, the “supply-side revolutions” of the early 1980s in the US and the UK were accompanied – and probably made politically acceptable – by a transitory increase in government deficits. 

With the current economic slowdown it is already unlikely the British government will be able to comply with its current pledge to keep the deficit below 2% of GDP in the next two years. We would expect more drift ahead. In the short term it is probably manageable. At 86.8% of GDP British public debt is close to the European average. But in the configuration of a Brexit which is any case going to impair long term growth prospects, even with a deal, the UK’s economic equation in the medium term will hinge a lot on the Bank of England’s capacity to make it sustainable. Interest rates never fell in negative territory in the UK, and interest payments absorb a significantly bigger share of government income than in Germany and France (6.4% in 2018, against 2.0% and 3.2% respectively). There is no question an accommodative fiscal policy stance is what the UK, just like the rest of Europe, needs at the moment. But just like in the Euro area, this cannot work without an accommodative central bank. This in our view should be kept in mind by investors when betting of a “re-normalisation” of British monetary policy once and if a “deal” is secured. This should also put a cap on a sterling’s rebound. 

Germany cycle: stabilisation at low levels provides little comfort

Those who like to see their glass half full probably took comfort in the fact that in Germany the manufacturing Purchasing Managers Index rebounded by 0.2 pp in October relative to September, but this was again short of expectations and the absolute level remains very concerning. At 41.9, this is deep into “manufacturing recession territory”. We would need to see a much more significant rebound to be sure the ongoing German downturn can be nipped in the bud. Given its specific product mix the German industry is very dependent on the global investment cycle. From that point of view, we are concerned by the further deterioration in US capital goods orders. The key “non defence/non aircraft” component fell by 0.7% mom in September, well short of market expectations, and August was revised down. We may see some improvement once the “trade truce” starts percolating to US economic sentiment, but it may be too late for Germany to avoid a full-blown contagion to its own domestic economy. The drop in the services PMI there, to 51.2, is another worrying signal. The services sector may not be in contraction, but the PMI is now 0.5 standard deviation below its long term average (Exhibit 4).

Exhibit 4 – Contagion to services continues in Germany


 

Exhibit 4 – German fiscal stance: from intentions to implementation

Chatter about some fiscal flexibility in Germany continues to get momentum, but no hard decision has yet been made. We have already opined in Macrocast that while we think Berlin will give up the “Schwarz null” next year and let automatic stabilisers play, a clear conversion to a proper discretionary stimulus is not yet on the cards. Moreover, we note that on these matters implementation has not always been on par with intentions. The structural balance was supposed to be loosened by 1% of GDP in 2019 in the original programme agreed by the German government. According to the European Commission, the stimulus for this year will end up being closer to 0.5% of GDP.

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