Sweden lambasts Krugman over Japan-style deflation warning

STOCKHOLM/HALMSTAD, Sweden Wed Apr 23, 2014 12:34pm EDT

STOCKHOLM/HALMSTAD, Sweden (Reuters) - Swedish policymakers hit out on Wednesday at suggestions by Nobel laureate Paul Krugman that the Nordics' biggest economy was in a Japanese-style deflationary trap.

Finance Minister Anders Borg and two central bankers said Krugman's analysis - set out in a commentary in Monday's New York Times in which he called the Riksbank "sadomonetarist" - had misrepresented the country's situation.

In his op-ed titled "Sweden Turns Japanese", Krugman said the Riksbank, the central bank, had killed off a promising post-crisis recovery in around 2010 and dragged the country into deflation.

"I don't think that the comparison with a stagnating Japan is all that accurate," Borg, one of Europe's most respected and long-serving finance ministers, told reporters on Wednesday.

Sweden's triple-A rated economy has been the envy of much of Europe, with public debt at around 40 percent of GDP - about half of Germany's - and with one of the best growth rates in the European Union.

Home to iconic brands like IKEA and Volvo (VOLVb.ST), Sweden's Nordic model has managed to combine global competitiveness with high taxes, economic growth and a cradle-to-grave welfare state.

But underlying inflation - which strips out changes in mortgage costs - has been below the bank's 2 percent target for three years. Consumer prices unexpectedly slipped 0.6 percent year-on-year in March. Underlying inflation was zero.

The fear is a repeat of what happened to Japan's economy with its virtual stagnation since the early 1990s, when it slipped into a deflationary phase that it has struggled to emerge from ever since.

HOUSING BOOM, OR BUST?

Sweden's central bank is now edging closer to cutting interest rates in July because of persistently low inflation.

However, it is also worried that looser monetary policy will further fuel a housing boom and raise already high levels of household debt - currently at around 170 percent of GDP - that have raised fears of a credit bubble.

Those factors have driven a policy debate that has divided the bank's six-member rate-setting council, with policymakers Karolina Ekholm and Martin Floden consistently voting for earlier rates cuts than their four colleagues.

Central bank Deputy Governor Cecilia Skingsley, who has previously voted with the more hawkish majority of the Riksbank on rates, said she saw there could be a need for further policy stimulus following the March inflation data.

"All things being equal, at least for me, it opens up for an additional need for stimulus," Skingsley told reporters at a conference in the southern town of Halmstad. "But we have more data to take into account before I can take my decision."

Markets were pricing in a roughly 60 percent chance of a cut when the Riksbank announces its next rate decision on July 3.

The majority of the Riksbank's board have worried that high household debts make Sweden vulnerable to the kind of economic shock that hit neighbor Denmark after the 2008 credit crunch.

Danish house prices fell by more than 20 percent and the economy has still to recover to pre-crisis levels.

Policymakers and some analysts rejected criticism that Sweden faced Japan-style falling prices over the longer term.

Borg said productivity growth, a strengthening currency and moderate wage increases were factors behind low inflation, but that the economy was growing faster than other nations.

"Sweden's economy has fared best in Europe throughout the crisis," Borg said.

A sluggish global recovery has affected demand abroad, making it hard for Swedish exporters to raise prices, while a mild winter has kept electricity prices relatively low, factors the Riksbank can do little about. A strong crown has also lowered import prices.

Some analysts say the picture given by headline inflation is misleading. The CPI includes mortgage costs which have fallen as interest rates have declined. Underlying inflation - which strips out changes in interest rates - was flat in March.

Christina Nyman, Deputy Head of the Riksbank's Monetary Policy Department, said deflation would be a worry if companies and households started to believe prices were going to start falling ahead and held back on spending, hurting growth.

"However, we see no sign of this," she said. "Inflation expectations are also well-anchored around 2 percent in the longer term."

Economic output in Sweden grew 3.1 percent on an annual basis in the October-December period and the government recently raised its forecast for growth this year to 2.7 percent.

"I believe that inflation has bottomed and I think it will slowly move upwards," Torbjorn Isaksson, chief analyst at Nordea, said. "The risk that we end up in deflation is very, very small."

(Reporting by Johan Sennero, Simon Johnson and Johan Ahlander; Editing by Alistair Scrutton and Susan Fenton)

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