Why Sweden’s central bank’s unchanged rates affect Swedish stocks

The Riksbank left its repo rate at 1% on Thursday

As expected, the Riksbank (Sweden’s central bank) made no change to its repo rate at its meeting this week. The central bank uses the repo rate to determine the level of money supply in the economy. By leaving the rate at 1% and stating that it intends to keep it low through 2014, the Riksbank is telling investors to continue to expect accommodative monetary policy for the foreseeable future.

Inflation is increasing in Sweden, which is positive for the economy

Central banks try to smooth out business cycles by influencing both the supply and demand for money. Influencing the supply of money is straightforward: central banks can print up as much money as they want. Influencing the demand of money is a bit more nuanced: this is done by setting expectations for future policy.

2013 10 28 sweden riksbankEnlarge Graph

With inflation at 1.3%, the Riksbank is still below its 2% target. Even so, the bank appears to be concerned with housing prices in Sweden. This is a risk to equities because the tools available to central bankers are blunt, and an attempt to control asset prices through monetary policy could damage the Swedish economy.

Swedish stocks are performing well this year

The iShares MSCI Sweden ETF (EWD) is up over 20% in the last 12 months, as the country’s export sector benefits from a recovery in Europe. Sweden is positioned well to continue to take advantage of a recovery on the continent over the next year, as long as the Riksbank doesn’t prematurely tighten policy by raising interest rates.