Slow Growth in Sweden Equals Risk of Deflation

The Swedish economy grew at a slower-than-expected rate in the second quarter. The central bank slashed its main policy rate to help ward off the specter of mild deflation

GDP Growth in Q2 Was Weaker than Expected

Recently released data show that real GDP in Sweden rose at an annualized rate of only 1.0 percent in Q2-2014 (top chart), which was significantly weaker than the consensus forecast. A breakdown of the real GDP data into its underlying demand components shows, however, that the underlying pace of growth in Sweden is not quite as sluggish as the headline rate would suggest. Specifically, real personal consumption expenditures shot up at an annualized rate of 3.9 percent, and government spending grew 1.2 percent. The overall rate of economic growth was held back by the 3.0 percent drop in investment spending in the second quarter. In addition, net exports sliced 1.2 percentage points off of the top-line GDP growth rate as exports were essentially flat during the quarter, while imports grew 3.4 percent. 

The few data releases for the current quarter that have been released thus far have been mixed, but they generally show that growth remains positive at present. The manufacturing PMI remains well above the demarcation line separating expansion from contraction, and the service sector PMI surged to a three-year high in July. However, consumer confidence slumped in July relative to the previous month, which may reflect the recent rise in the unemployment rate, which remains elevated around 8 percent. The consensus forecast sees the rate of GDP growth strengthening from 1.6 percent in 2013 to 2.5 percent this year to 2.7 percent in 2015. 

Is Sweden in Danger of Deflation?

Nevertheless, the weaker-than-expected GDP data for the second quarter seem to vindicate the decision by the Swedish Riksbank (the country’s central bank) on July 3 to slash its main policy rate to only 0.25 percent from 0.75 percent. Although the Riksbank shares the consensus view that Swedish economic growth will strengthen going forward, it remains concerned by the low rate of CPI inflation in the country. As shown in the middle chart, the overall rate of CPI inflation in Sweden has meandered around zero percent for more than a year, and it currently stands at only 0.2 percent. Indeed, the overall rate of CPI inflation has been below the Riksbank’s target of 2 percent for more than two years. 

The 50-bp rate cut last month should help stimulate real GDP growth, thereby eventually leading to higher inflation. First, interest-rate-sensitive spending should get a boost from lower rates. In addition, the depreciation of the Swedish krona that the rate cut has helped bring about should contribute to stronger export growth in coming quarters. The krona has weakened to a two-year low versus the U.S. dollar (bottom chart), and our currency strategy team looks for further krona depreciation against the greenback in coming quarters as the Federal Reserve moves to a less accommodative monetary policy stance.