Sweden cuts interest rates as Europe changes course from Fed

Sweden's central bank lowered interest rates for the first time in eight years, aligning with European monetary policymakers in diverging from the US to bolster their economies, potentially at the cost of stronger currency rates.

On Wednesday, the Riksbank lowered its main interest rate by 0.25% to 3.75%, marking the first instance of policy loosening ahead of the US Federal Reserve this century.

Erik Thedeen, the Riksbank Governor, contends that most risks lean towards the upside, including the potential for further depreciation of the Swedish Krone resulting in elevated imported inflation, geopolitical uncertainties, and the persistent robustness of the US economy.

The Swedish rate cut, mirroring recent actions by the Swiss, Czech, and Hungarian central banks, underscores Europe's increasing inclination to diverge from the US on monetary policy.

An anticipated rate cut by the European Central Bank at its upcoming meeting would solidify this divergence. Given the size of the US economy and the significant impact of its financial markets and the Dollar, the Federal Reserve typically takes the lead in rate adjustments.

Following the Riksbank's decision, the Krona depreciated by 0.4% against the US Dollar and 0.3% against the Euro.

Sweden's currency ranks as the third poorest performer among the G10 group of most traded currencies this year, having depreciated by 7.5% against the USD and 5% against the Euro.

With US inflation persisting higher than anticipated and its economy maintaining robust growth, the Fed indicated last week that it was inclined to maintain higher interest rates for an extended period.

Nonetheless, inflation and growth in Europe have lagged behind the US in recent months, creating an opportunity for the region's central banks to commence lowering borrowing costs ahead of the Fed.

The ECB has indicated its inclination to commence rate cuts at its upcoming policy meeting on June 6th if price pressures continue to fade as anticipated. The Riksbank has previously acted ahead of the ECB, as in 2019 when it abandoned negative interest rates more than two years before they were phased out in the eurozone.

Sweden's economy is highly sensitive to fluctuations in the Euro and ECB monetary policy decisions, given that more than two-thirds of its imports and half of its exports are traded with the EU.

However, concerns arise that if rates decline more rapidly in Europe compared to the US, it could lead to European currencies depreciating against the Dollar. This, in turn, would elevate import prices and potentially stimulate higher inflation.

Thedeen recognized that the Krona, and possibly monetary policy, could be impacted by the strength of the US economy, potentially prompting the Fed to postpone rate cuts beyond initial expectations.

The Swedish rate cut diverges with the sentiment in neighboring Norway, where the currency is also weak. Norges Bank indicated last week its intention to keep rates steady, with some economists now predicting no rate cut until December or even next year. This would likely make it one of the last major central banks to implement loosening measures.

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