FX Watch – Scandi FX Strategy

by: Georgette Boele

150114-Scandi-FX-Strategy.pdf ()
  • Scandinavian currencies have been under pressure …
  • …because of dovish central banks, lower oil prices (Norway) and lower inflation (Sweden)
  • We expect to see further weakness in SEK and NOK going forward

Scandinavian currencies under pressure

The Norwegian krone and the Swedish krona underperformed the euro in 2014 by 8% and 6%, respectively.  This reflects that the Norges bank and the Riksbank have erred of the dovish side, lower oil prices (Norway), low inflation (Sweden) and their relatively small market size.

20150115 - Scandi1

20150115 - Scandi2

Deflation priority for the Riksbank

Inflation has been too low in Sweden. At the October meeting, the Riksbank cut interest rates by 0.25% to 0 and made a significant downward revision to the repo-rate path. On 16 December it left monetary policy unchanged, but it continued to sound dovish. In the statement it said that the repo rate needs to maintain at zero percent for a slightly longer period than was forecast earlier. It is not until the second half of 2016, when CPIF inflation will be close to 2%, that it will be appropriate to begin raising the repo rate. It is open to further postpone the rate hikes when necessary. In addition, it is preparing further measures that can be used to make monetary policy more expansionary, if necessary.

20150115 - Scandi3

It is unlikely that the Riksbank will start normalising the repo rate as long as inflation remains low, even if growth recovers further. Therefore, we have pushed out all the rate hikes to 2017. Indeed, further monetary easing is likely in the near term to increase inflation. This is despite the upward surprise of the December inflation data. The ECB is expected to announce quantitative easing including buying sovereign bonds at the 22 January meeting. This will keep the euro on the defensive. To avoid the Swedish krona from strengthening and to create some inflationary pressures, the Riksbank will likely opt for unconventional monetary policy easing as well. Since the end of November, the 3 months interest rate for the end of 2015 has turned negative. Since the start of 2015, this rate has turned even more negative. This reflects market expectations that the Riksbank may introduce negative repo-rate at the 12 February meeting.

20150115 - Scandi4

It is likely that the Riksbank will take more measures than financial markets have currently priced in. This could for example be in the form of negative interest rates or quantitative easing. While on the other hand, financial markets have almost fully prices in sovereign quantitative easing by the ECB. Therefore, downside risks to Swedish krona versus the euro remain. Our new forecasts reflect this. The recovery of the krona is only likely once the Riksbank has announced what is necessary to revive inflation. This may well take at least 6 months.

Growth priority for the Norges Bank

In the case of the Norges Bank, low inflation was not the primary reason for the recent reduction in rates to 1.25%. The Executive Board of the Norges Bank acted to counter the risk of a pronounced downturn of the Norwegian economy, because of the sharp drop in oil prices. In its monetary policy report it was very transparent in its motivation about the rate decision. The domestic growth outlook was by far the most important reason for lower interest rates.

Interest rates abroad were also taken into account but only at the margin. These drivers more than outweighed the inflationary effects of a lower Norwegian krone, which could push inflation beyond its 2.5% target. As long as growth remains weak, it seems minded to tolerate higher inflationary pressures. Currently, the Norges Bank expects to keep its key policy interest rate on hold between 2015 and 2016 and only to start to hike slowly in 2017.

If the Norwegian economy deteriorates further because of the impact of low oil prices, the Norges Bank could reduce interest rates again at the 19 March meeting. This risk is quite significant. Recently our energy analyst has revised down his oil forecasts to 50 USD per barrel at the end of Q1 and 65 for the end of this year. This should take away some of the downward pressure on the Norwegian krone as it closely tracks oil prices. Even though these oil prices are above the reported fiscal break-even oil price of USD 40 (Fitch Ratings), investments could be more depressed dragging down economic growth. Therefore, we expect the Norges Bank to remain dovish and the Norwegian krone to move lower in the coming months.

20150115 - Scandi5

20150115 - Scandi6