The markets were surprised yesterday by the decision of the Swedish central bank, which cut its repo rate to -0.10 percent and introduced QE. In that way, the Riksbank joined the club of central banks introducing negative interest rates (others are the Danish central bank, the SNB and the ECB). What does it mean and what are the implications for the gold market?
Figure 1: Sweden Benchmark Interest Rate from April 2014 to February 2015.
Source: tradingeconomics.com
Concerns about low inflation, or deflation phobia, turned one of the oldest central banks in the world (or actually the oldest one) to lower its repo rate from 0.00 percent to -0.10 percent. According to the official statement:
The Executive Board of the Riksbank assesses that a more expansionary monetary policy is needed to support the upturn in underlying inflation so that CPIF inflation approaches 2 per cent and to ensure that long-term inflation expectations are compatible with the inflation target. The Board is therefore cutting the repo rate to -0.10 per cent.
What does it mean? The cut of repo rate, i.e. the rate at which central bank conducts money market operations, to negative 0.1.means that banks can borrow from the Riksbank at a negative rate. Simply put, commercial banks can give back less than they borrow, or they are paid to borrow from the Riksbank. Theoretically, the rationale is the excess liquidity in the banking system. Introducing negative rates, the Swedish central bank wanted to induce banks to expand credit, which would help stimulate the economy and boost inflation. In the EU, banks grant few loans to the private sector, due to low interest rates, high uncertainty or lack of creditworthy entrepreneurs.
However, in practice the imposition of negative interest rate may not necessarily be the revolution. Abstracting from the fact that the level of the repo rate is only 0.1 percent below zero, the repo rate is not the sole instrument of the Riksbank. The repo rate, which fell into negative territory, is the interest rate at which banks can borrow or deposit funds at the Riksbank for a period of seven days. However, the Swedish central bank has a separate overnight deposit facility. The lending overnight rate is 0.65%. The Riksbank implements also fine-tuning operations every day to stabilize the overnight rate. This is achieved by the bank system as a whole being able to borrow or deposit at the Riksbank, normally at the repo rate plus/minus 0.1 of a percentage point. Therefore, this lending rate is at zero now, not negative.
Additionally, the Swedish central bank would buy government bonds worth SEK 10 billion, or about $1.2 billion, which is a rather tiny sum compared to quantitative easing programs conducted by other central banks. Therefore, the QE announcement should be interpreted rather as a signal for investors in order to affect market expectations than real monetary stimulus.
Summing up, the Riksbank joined other central banks which have recently eased their monetary policies due to concerns about low inflation, slowdown in the global economy and in order to boost exports by depreciating currency (yesterday the Swedish krona lost ground to the U.S. dollar and the euro). Taking into account the divergence between central banks, including the Riskbank, and the Fed, we may expect the strengthening of the U.S. dollar, which could be negative for the gold.
On the other hand, the Fed’s hike is not certain and gold behaves very well during global slowdowns, and especially during slowdowns and in a low interest rates environment. Investors should also very carefully analyze news about negative interest rates. For example, last year there was a lot of fuss about the EBC’s negative deposit facility interest rate. However, its impact was not significant, because the marginal lending facility (at a positive rate) was a much more important tool of monetary policy. Therefore, it is too early to assess precisely the impact of the Swedish central bank on the financial market.
Arkadiusz Sieron
Sunshine Profits‘ Market Overview Editor
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