Here is a chart showing interest rates set by Sweden’s central bank plotted against property price increases, from HSBC global economist James Pomeroy:
You can’t find a clearer warning that ultra-low, zero, or negative interest rates fuel bubbles in the property market. Rates go down, house prices go up. Low interest rates let consumers borrow mortgage money at ultra-low rates. That increases the amount of debt those consumers hold, but because the money is in the form of mortgage loans it drives demand for houses and pushes property prices upward.
The fear is that if Sweden ever reverses course and increases interest rates — or if a recession hits — then all of that goes into reverse, with disastrous consequences for the Swedes. Imagine an entire country trying to pay down its debt and sell its houses in order to raise cash, all at the same time.
The problem stems from the Riksbank’s inflation target of 2%, which it has missed for at least three straight years:
- Target inflation: 2%
- Actual inflation: 0.1%
- Central bank policy rate: -0.35%
- Q3 2015 year-on-year GDP growth: 3.9%
- Credit growth year-on-year: 7%
- House price growth: 25%
If you believe — as economists do — that low interest rates fuel inflation, then one of those numbers is the odd man out: When the central bank is printing money at -0.35% rates, then actual inflation should be spiralling through the roof. Especially when you have got healthy GDP growth of nearly 4%. At Business Insider, our pet theory is that inflation is already through the roof in Sweden: in the form of house prices, growing at 25% a year. Pomeroy wrote in a recent note to investors:
Credit growth is running at around 7% yoy in one of the most highly indebted economies in the world. Simply, Sweden’s economy does not warrant negative interest rates.
He added in an accompanying video:
All in all, we have no success in achieving monetary objectives, we’ve got a potential house price bubble, and the economy does not warrant interest rates this low. This presents a warning, not just to the Bank of Japan or to the ECB but to any other central bank around the world who may be considering such a policy.
Note: The chart actually understates house price rises in Sweden because it describes percentage growth, not actual growth.