The central banks of Switzerland, Denmark and Sweden were among the first to push policy rates into negative territory. Moody’s Investors Service reports that one year into “this novel experience” of the three countries Sweden runs the greatest risk of an – ultimately unsustainable – asset bubble.
In the credit rating agency’s (CRA) report, entitled ‘Governments of Switzerland, Denmark & Sweden: Negative interest rates have unintended consequences, with Sweden most at risk of asset bubble,’ Moody’s notes the three countries’ central banks have progressively lowered their key policy interest rates to the current -0.75% in Switzerland, -0.65% in Denmark and -0.5% in Sweden, although for different reasons.
The Swiss and Danish central banks were aiming to reverse the intense appreciation pressure on their currencies as a result of the European Central Bank’s (ECB) introduction of its quantitative easing (QE) programme. In Sweden, the central bank is focused on lifting persistently low inflation, in the context of the ongoing strong economic expansion.
“The Danish and Swiss central banks have achieved their main objective given that the appreciation pressure on their currencies has eased or, in the case of Denmark, even disappeared completely,” said Kathrin Muehlbronner, a senior vice president at Moody’s.
“But this is not the case for Sweden, where the Riksbank has not been successful in engineering higher inflation, while Sweden’s gross domestic product (GDP) growth continues to be among the strongest in the advanced economies.
“At the same time, the unintended consequences of the ultra-loose monetary policy are becoming increasingly apparent – in the form of rapidly rising house prices and persistently strong growth in mortgage credit.”
The CRA believes these trends will likely continue as interest rates will remain low, raising the risk of a house price bubble, with potentially adverse effects on financial stability as and when house prices reverse trends. In all three countries, households are highly leveraged, and while they also have high levels of financial assets, returns on these assets will be under increasing pressure if the negative interest and yield environment persists.
Moody’s says that is less concerned about Switzerland and Denmark as it considers these trends as “unavoidable” side effects of an otherwise successful policy. Mortgage lending also shows first signs of slowing in both countries, and Switzerland in particular has deployed several macro-prudential tools to reduce risks to financial stability.
However, the CRA thinks the situation is different in Sweden and believes that the Riksbank will find it difficult to achieve its objective of significantly pushing up consumer price inflation in a deflationary global environment, while the sustained and strong growth in mortgage lending and house prices risks leading to an – ultimately unsustainable –
The Swedish authorities have imposed counter-cyclical capital buffers on their banks, and the country’s banking regulator has announced additional measures with effect from mid-2016 onwards. However, Moody’s conclusion is that it remains to be seen how effective these measures will be in achieving a material slowdown in credit growth and house prices, while interest will likely remain at negative – or very low – levels.
“In general, Moody’s believes that macro-prudential tools are most effective if they complement rather than oppose the direction of monetary policy,” the CRA comments.
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