Sweden has confounded investor expectations and left its central bank repo rate unchanged. Economic activity is strong and inflation is approaching 2%, the Riksbank notes in its explanation of this morning's decision.

The Riksbank’s monetary policy has contributed to this. But it has taken time to stir up inflation. A continued expansionary monetary policy is required for it to stabilise around 2 per cent, the central bank adds.

The formal announcement states that the Executive Board of the Riksbank has decided to hold the repo rate unchanged at −0.50 per cent. It adds that the first rate increase is not expected to be made until the middle of 2018, which is the same assessment as in April.

Bond purchases to continue unchanged

Purchases of government bonds will continue during the second half of 2017, as decided in April. At the end of the year total purchases of government bonds will amount to SEK 290bn, excluding reinvestments.

Maturities and coupon payments will be reinvested until further notice. International economic activity is increasing in line with the Riksbank's forecasts. The risk of setbacks has declined, but there is still economic and political uncertainty in many parts of the world.

Global inflationary pressures are still subdued and monetary policy abroad is expansionary, says the Riksbank. It adds that its low policy rate and extensive purchases of government bonds, has contributed to strong economic activity with a rapid rise in employment.

Important that inflation stabilise

Inflation has been below-target for a long time. This means there is a risk of inflation expectations being more sensitive than usual to downside surprises, it continues. Given this, it is now especially important that inflation stabilises more lastingly close to the target.

A prerequisite for this is that economic activity continues to be strong and gradually has a greater impact on price development. In addition to continuing robust economic activity, it is important that the krona does not appreciate too rapidly.

The Riksbank points out that this could happen if, for example, its monetary policy deviates clearly from that of other countries.

Tightening buzz

The international financial media have been buzzing in recent days with predictions that monetary policy in Europe is about to enter a tightening phase. The fact that several senior European Central Bank figures are to make speeches this week has grabbed the attention.

The Financial Times featured a story saying that more than two-thirds of investors surveyed by Swedish bank SEB said they expected the Riksbank to remove its bias towards easing this week.

The same story featured a comment suggesting that central banks have quietly executed a policy about-turn and could be looking for excuses not to tighten after all. This is not confined to Europe.

Australia sets an example

The Reserve Bank of Australia also today decided to leave its cash rate unchanged, at 1.5%. It acknowledges a broad-based pick-up in the global economy is growing, labour markets have tightened and forecasts for global growth have been revised up since last year.

Analysts expect the RBA to keep rates on hold throughout 2018, says the BBC. RBA Governor Philip Lowe notes that consumption growth remains subdued. This reflects slow growth in real wages and high levels of household debt, he comments.

Bearing out Bosomworth

All this activity, or non-activity, could bear out the suggestion made by Andrew Bosomworth, head of PIMCO portfolio management in Germany, at the start of this week. He asked if markets had overreacted to a speech made by ECB governor Mario Draghi.

“We interpret Draghi's speech as consistent with the European Central Bank’s evolving changes to forward guidance,” he said. “We do not interpret Draghi’s speech as a hawkish change in policy.”

He noted that many market observers focused on the one sentence in Draghi’s Sintra speech on 27 June 2017 that unsurprisingly suggested the ECB will taper government bond purchases.

Stance to remain accommodative

Yet they appeared to attach little value to his comments that the “monetary policy stance needs to be persistent”, ie, the stance will remain accommodative, because “inflation dynamics are not yet durable and self-sustaining”.

Or that the ECB will need to act with “prudence” in gradually adjusting its policy parameters, ie, the normalisation process will occur in baby steps.

Here is what we expect from the ECB

• Indicate in September and provide details in October that it will taper QE effective January 2018
• Wind down QE during the second half of 2018, earliest by end June, latest by end December
• Raise the deposit facility rate in the first half of 2019
• Discontinue reinvesting the proceeds of bonds purchased under QE in 2020

New normal likely to prevail

While we think markets are enthusiastic in their expectations for policy normalisation, we should not forget recent market movements, he said. The long period of easy global monetary policy compressed term (and credit) risk premia.

QE contributed to decoupling Bund yields from their anchor of nominal economic growth. Backed by firm improvements in eurozone economic data, recent market moves could go further.

Lest we forget, however, real economic output in the eurozone is barely above the level recorded a decade ago, and the risk that China’s credit bubble destabilises world growth is not insignificant. New normal bond yields are therefore likely to prevail.