Anna Breman: Inflation is falling, but risks remain

“The policy rate hikes are contributing to the fall in inflation. Demand is weak and forward-looking indicators suggest that inflation will continue to fall. But it is important to point out that this will not happen by itself. To ensure that inflation continues falling and then remains at a low and stable level close to the target, monetary policy needs to remain contractionary.”

Weaker demand is contributing to companies no longer planning to raise prices as much as before. “Quite simply, it is more difficult to raise prices when demand in the economy is no longer as high. We know that companies’ pricing is influenced by several factors, such as the balance between supply and demand, the cost of changing prices and competition. And how often companies change their prices varies, of course, between companies, but also over time. In general, prices are rather sticky, but with microdata, we can see that companies’ pricing behaviour has changed in recent years.”

We need to be open to the idea that firms’ price-setting behaviour may have changed

One of the Riksbank's research projects analyses nearly five million price observations from 2001 to the end of September 2022. This shows that individual prices are normally sticky, they rarely change. However, in recent years, when companies have had unusually large cost increases and been affected by supply shocks at the same time as demand has been strong, they have tended to raise their prices much more often. There seems to be a strong correlation between the frequency of price changes and the rate of inflation. It is the frequency of price changes that is the main driver of changes in inflation over time, not the magnitude of the price changes. This is a pattern in Swedish data that is consistent with research from other countries.”

The correlations between producer prices and consumer prices, between energy prices and consumer prices, and between exchange rates and inflation have not followed historical patterns in recent years. “To understand the dynamics of inflation going forward, we need to be open to the idea that the price-setting behaviour may have changed, and that companies may adjust prices more frequently in the future, partly because new technology makes it easier and cheaper to adjust prices more often. If we could have even better access to microdata, it could give us early indications of when inflation is about to rise or fall,” Ms Breman continued. The Riksbank is actively working to gain access to more updated microdata to be able to deepen our analysis.

The banks' price-setting behaviour also seems to have deviated from the normal pattern. The banks were quick to raise mortgage rates, but not as quick to raise interest rates on savings. Higher savings rates are part of the monetary policy transmission, i.e., how changes in policy rates affect households and companies via changes in market rates. Higher policy rates should result in higher interest on savings accounts and this usually contributes to households saving more and consuming less, which dampens demand and leads to lower inflation. “Households and companies are now affected by higher interest rates on loans, but it took longer before households also received higher interest on their savings accounts, which had a negative effect on the transmission of monetary policy. One explanation for this could be poor competition in the banking sector, which means that banks do not have to compete with pricing on savings accounts,” said Ms Breman.  

“Ahead of our next monetary policy meeting, we will receive new data on how economic activity, the labour market and inflation are developing. We are seeing a clear slowdown in the Swedish economy. At the same time, the signals from companies are mixed when it comes to price developments. In the National Institute of Economic Research's Economic Tendency Survey, price plans are still at elevated levels, while the Riksbank's Business Survey suggests significantly lower price pressures going forward. All in all, we see good conditions for inflation to continue falling, but we should not underestimate the risk of setbacks,” concluded Ms Breman.