Swedish Inflation Dip Looks Tempting—Is a Hidden Surge Looming?

• You may be underestimating the impact of Sweden's temporary VAT cut on food.
• Underlying electricity price trends could reignite inflation later this year.
• Bond yields and the krona are poised for volatility as the Riksbank refines its March forecast.
• Historical patterns suggest a possible rebound—missing it could cost investors.

Most investors dismissed the VAT cut as a one‑off boost; that’s a mistake.

Swedish Central Bank’s Inflation Outlook for 2024

First Deputy Governor Aino Bunge told markets that Sweden’s inflation rate should fall noticeably this year, largely thanks to a temporary reduction in the value‑added tax (VAT) on food. The official flash estimate released by Statistics Sweden shows the consumer price index with a fixed interest rate (CPIF) up 2.0% year‑on‑year in January. While 2.0% is comfortably within the Riksbank’s 2% target band, Bunge cautioned that the headline figure masks underlying dynamics that could shift the trajectory.

Key to her message is a call for a granular look at the January data—specifically, the interplay between electricity price movements and an “additional inflation outcome,” a phrase that likely references the core CPIF excluding volatile components such as energy and food. The deputy governor’s emphasis on these sub‑indexes signals that the Riksbank is preparing for a more nuanced March inflation forecast.

Why the VAT Cut May Mask Underlying Price Pressures

The temporary VAT reduction on food, announced in late 2023, lowered the statutory tax from 12% to 6% for a six‑month window. By design, this policy aims to curb headline inflation without altering the broader monetary stance. However, the reduction is a short‑term fiscal lever that does not address structural price drivers:

• Energy Costs: Sweden’s electricity market remains volatile, with wholesale prices reacting to fluctuating hydro‑reservoir levels and European gas price swings.
• Supply‑Chain Frictions: Global freight rates and component shortages continue to pressure manufacturing costs, especially in the automotive and tech sectors.
• Wage Dynamics: Collective bargaining agreements in the public sector are set to tighten later in the year, potentially feeding into wage‑price spirals.

When the VAT cut expires, the food price index could rebound sharply, adding upward pressure to the headline CPIF. Investors who ignore this timing risk mispricing the inflation trajectory.

Sector Ripple Effects: Retail, Energy, and the Krona

Even a modest shift in inflation expectations reverberates across multiple asset classes:

• Retail Stocks: Companies like ICA Gruppen and Axfood benefit from lower food taxes in the short term, but a re‑imposition could compress margins if they cannot pass costs to consumers.
• Energy Utilities: Vattenfall and Fortum are sensitive to electricity price swings. A sustained rise in wholesale rates would improve earnings, but also feed into broader CPI figures.
• Currency Market: The Swedish krona (SEK) has appreciated modestly against the euro as inflation expectations dip. A reversal could trigger a sell‑off, especially if the Riksbank signals a tighter stance.
• Bond Market: Swedish 10‑year government yields have slipped below 0.5% following the VAT announcement. A surprise uptick in core inflation would pressure yields upward, eroding bond prices.

Historical Parallel: Sweden’s 1990s Inflation Cycle

Sweden navigated a similar inflection point in the early 1990s. After a steep devaluation and a series of fiscal stimulus measures, inflation surged from 1.5% to over 10% within two years. The Riksbank’s response—a series of aggressive rate hikes—led to a prolonged recession but ultimately anchored long‑term price stability.

The lesson? Temporary policy levers can delay but not eliminate inflationary pressure. When underlying forces—particularly energy and wage dynamics—remain unchecked, the economy can experience a “second‑wind” inflation spike.

Technical Corner: CPIF vs CPI Explained

Sweden reports several inflation measures:

• CPIF (Consumer Price Index with Fixed Interest Rate): Adjusts for changes in interest rates, providing a measure that reflects the cost of living without the distortion of monetary policy shifts.
• CPI (Consumer Price Index): The more commonly known headline metric, which includes all consumer goods and services.

Investors should focus on CPIF because it aligns more closely with the Riksbank’s inflation target and its policy decisions. Core CPIF, which excludes energy and food, is the “inflation underlying” metric that the central bank monitors for longer‑term trends.

Investor Playbook: Bull and Bear Cases

Bull Case: If the Riksbank’s March forecast confirms a sustained decline in core CPIF, the SEK could continue its modest appreciation, Swedish bonds may see yields dip further, and equity sectors tied to consumer spending (retail, groceries) could enjoy higher profit margins. Positioning: Long SEK, short-duration government bonds, and overweight retail equities.

Bear Case: If electricity prices stay elevated and the VAT cut expires, core inflation could rebound above 2%, prompting the Riksbank to tighten policy earlier than expected. This would push bond yields up, weaken the SEK, and pressure high‑growth sectors reliant on cheap financing. Positioning: Short SEK, long-duration bonds with inflation protection, and defensive sectors such as utilities and consumer staples.

In either scenario, keep an eye on the Riksbank’s upcoming March inflation bulletin and any statements regarding the future of the temporary VAT cut. The data released in early March will be the decisive catalyst for market direction.