In the late winter of 2015, Sweden under its then-new Prime Minister Stefan Loven – ex-welder, ex-unionist and minority Government holder – became the first country to enter negative interest rates territory as it sought to stave off what it saw as looming Japanese-style deflation.
It seems the Riksbank, Sweden’s central bank and the oldest one in Europe, is now set to lift rates to zero, despite the fact the economy shows signs of flagging and the central bank hasn’t yet achieved its stated 2 per cent inflation target. If the central bank moves this coming Thursday, as the market expects, it will bring to an end a five-year experiment with negative rates.
It’s hard to know what to think about this move. Is Sweden signalling that the economy is back on track? Or are they admitting defeat – admitting, in effect, that the damage done to the elderly and to savers by low interest rates is worse than the attempt to stimulate the economy?
Most traders state that there is no economic reason for a hike in rates; that growth remains weak, as does inflation; and that the move is philosophical rather than economic.
What levers are there left to pull?
If this is true then it has left both economists and politicians scratching their heads, signalling as it does a failure of Keynesian theory and the Chicago school, and leaving us all asking: If Sweden starts to enter recession anyway, then what levers does the government have left to pull to drive growth?
If you want an example of where this is already a real problem you don’t have to look any further north than Japan. Despite four waves of macro-economic stimulus (the much touted “four arrows” of Abenomics), intense government borrowing, wage compression and export focus, Japan will record an annualised GDP growth of -6.3 per cent – the worst since 2014 – and may tip into recession.
The reality is that the negative-rate party started by the Swedes has had something of a contagion effect on all of western Europe. Banks in the Eurozone claim negative rates have seen them pay more than $US137.5 billion ($198 billion) to the European Central Bank (ECB) since it took rates below zero in mid 2014, eroding already-thin bank profit margins.
This means that the new Swedish experiment of setting rates at zero is being closely monitored by everyone from the Germans to the Americans to see what impact it has on inflation, economic growth and consumer behaviour.
If the answer is that it has no effect then banks all over the world may simply abandon negative rates, bringing to an end an $13 trillion-plus negative-bond party. If the answer is that Sweden fails to achieve any reform and tips over an already-fragile economy, then we are in new economic territory and the long upward trend since 1949 may finally be over.