Why the Riksbank Will Have To Raise More

The Swedish Riksbank today raised as expected short term interest rates from 3.75% to 4%, which means that it now reaches interest parity with the euro area countries. And if as expected, the Fed cuts by another 25 basis points today, then that will mean that the spread between U.S. and Swedish nominal interest rates (As inflation and inflationary expectations are much higher in U.S., real interest rates is in fact already much higher in Sweden) will be reduced to 50 basis points, down from 175 basis points as recently as in August.

They will most likely have to raise interest rates again in the next few months. Money supply- and credit growth remains very high. And while some news papers have in recent days published anecdotal signs of falling house prices, that is likely misleading and more reliable reports indicate rising prices. And to the extent it is true that price increases have slowed down, that is likely a temporary factor related to how many Swedes wants to sell their homes before new year's eve to avoid the planned increase in the capital gains tax. With credit growth remaining high, with the housing tax reform and with construction levels remaining relatively low, prices should rise significantly next year, especially in the greater Stockholm area which is most affected by the housing tax reform.

Meanwhile, other factors including soaring food- and energy prices and higher increases in unit labor costs (i.e. wage increases uadjusted for productivity increases) is likely to help push consumer price inflation higher.

All of this means that the Riksbank will likely be forced to raise again.