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On 4 May 2022, the Riksbank announced that the key interest rate would be raised because future expected inflation is expected to be above the inflation target of 2 per cent. It started with a 0.25 percentage point increase to 0.25 per cent. This meant that for the first time since 2014, the policy rate had moved above 0 percent. However, there is very little evidence that the policy rate will stay at 0.25. The Riksbank's interest rate forecast shows that the interest rate will be raised gradually until it reaches a level of 2% in 2024. If each rate increase is implemented by the same number of percentage points each time, we should be able to expect 7 rate increases before a policy rate of 2% is reached.
The policy rate, formerly known as the repo rate, is the interest rate at which banks can borrow money from the Riksbank. In other words, the policy rate determines the cost of borrowing for banks. It therefore follows naturally that a higher policy rate makes it more expensive for companies and individuals to take out loans, as the banks themselves pay more for the money they can lend.
In Sweden, we use monetary policy to steer the economy. The cornerstone of the monetary policy model is, as the name suggests, to control the amount of money in society in order to control inflation and steer the Swedish economy in the right direction. One of the Riksbank's main tasks is therefore to maintain a fixed monetary value, which it does by maintaining a low and stable inflation rate. In explicit terms, the objective is to keep the inflation rate, measured as the change in the consumer price index, CPIF, at around 2% per year. One of the most effective tools the Riksbank has at its disposal to control inflation is by adjusting the policy interest rate.
To put it simply, the Riksbank uses the policy rate as an accelerator or brake pedal to influence inflation and movements in the Swedish economy. Based primarily on future expectations of inflation developments, it continuously evaluates the Swedish and international economic situation and makes decisions on the policy rate.
If the Riksbank judges that future inflation will exceed the inflation target and that the economy will become overheated, where the value of money today is lower than it will be tomorrow, it will press down the brake pedal and raise the key interest rate. This will have a dampening or cooling effect on the economy, as higher policy rates make it more expensive for banks to borrow money, which in turn makes it more expensive for businesses and individuals to take out loans. This means that the willingness to invest in society will decrease. More people will prioritise saving over spending, leaving a lower proportion of money in circulation, which in turn will cause inflation to slow down and turn downwards.
Should the situation be the opposite, that the Riksbank considers future inflation to be too low, it would instead lower the key interest rate to increase the willingness to invest and thereby also drive up inflation. In other words, it works counter-cyclically, in the opposite direction to the current economic situation, in order to try to keep inflation in check. This is why interest rates are raised when there is inflation.
It is precisely for the reasons we have just mentioned, that inflation is considered to be too high if the policy rate is not adjusted. But pinpointing the precise reasons why inflation is too high is not straightforward, as the rate of inflation is affected by and part of rather complex macroeconomic movements and shifts. However, one can point to three broad reasons why inflation has been rising.
First and foremost, it is a reaction to the monetary policy measures put in place after the 2008/2009 financial crisis. The Riksbank cut the key interest rate sharply, and since then we have had very low interest rates to stimulate the Swedish economy, which has led to natural inflation. The corona pandemic has also contributed to today's high inflation. Many companies had to reduce their production volumes and were thus unable to meet market demand, which led to rising prices and higher inflation. Even in the wake of the pandemic, the same trend has continued, as the rapid opening of the economy and subsequent high demand has meant that production companies have not been able to produce at the pace demanded by the market. And, once supply began to catch up with demand, Russia shocked the world by invading Ukraine. Once again, production and supply chains were severely affected, while electricity prices soared, leading to even more price rises, which in turn pushed up inflation.
As a private individual, you are mainly affected by rising interest rates in the sense that your loans will become more expensive to pay. The biggest loans we have as individuals are often our mortgages, which will see higher interest rates regardless of the term when the policy rate rises. In other words, housing costs will increase for you as a private individual, and you may need to review your finances and spending habits to cope with the higher interest rates.
However, you don't have to pay full lip service just yet. Adjusting inflation with higher policy rates is rarely something that happens overnight. The time horizon for monetary policy actions is usually quite long, and it is therefore not impossible that for some time, before the interest rate hikes take hold and have a real impact, we will see high inflation with relatively low interest rates. In times of high inflation, the best way to "protect" one's money from being eaten up by inflation is usually to own real capital and fixed assets such as housing, as these are not as inflation-sensitive.
The direct impact of rising interest rates will be relatively limited for most companies. This will, of course, depend on the size of the company's borrowings and interest costs. But in general, especially SMEs, have very little and low interest costs. The exception is companies in the real estate industry, which may see greater negative effects on earnings from increased interest costs.
On the other hand, companies are indirectly affected by rising interest rates, as higher interest rates mean that households' purchasing power decreases, which has a negative impact on sales. It is therefore a good idea to take this into account now when planning for the future.
Are you worried about how the new interest rates will affect your business in the future? Or do you just want someone to bounce ideas off about how to think about interest rates and their impact on your business? As well as being experts in accounting, we at Saldo have extensive experience in business development and profitability. We are happy to provide advice, support and new ideas on how best to tackle the new interest rate environment. Drop us a line, or drop us an email, and we'll take it from there.
